ULIP vs MF – Perhaps, Most Relevant of Articles You Have Read!

There are already plenty of articles written on ULIP vs MF. 

This an FAQ. This became further more VFAQ since Long Term Capital Gain (LTCG) Tax was (re)imposed on Equity Mutual Funds. This question started when Life Insurance policies became Investment vehicles more than Risk management instruments. But now Mutual Funds have started offering Life Insurance! This kind of ‘cross-border invasion’ has created all the more confusion. Then what is the purpose of this one more article about the same matter? What more or different I have to say about this Frequently Asked and Widely Answered Question?

I wish to talk about the practical (relevant) and less discussed points. End of the day they are the most important. Well, however, for the relevance of the topic it may be inevitable to repeat some things you already know or what other hundreds of articles have already spoken about a lot.

PERFORMANCE:

Let’s begin with first things first. The Returns…Performance. This is at the top of your mind and first important thing you want to know about? “Kitna Dega” (How much it gives)? or “Kaun Jyada dega” (Who gives more)?

Many articles have churned out tables of projections and illustrations. They have assumed some figures for charges, returns and taxes. Many of them have concluded (rather proved) MF’s are better and some others claimed ULIP’s are winners.

Charges:

It’s common sense that what these instruments / investments charge will have an impact on the returns. But considering charges in isolation is a mistake. End of the day, what returns you make post-charges is what matters to you. However, it’s very important to be aware of the details about cost / fee structure of the products / schemes you invest in. As known to you ULIP’s have more number of charges – Premium Allocation Charges, Mortality Charges, Policy Admin Charges and Fund Management Charges (FMC) against Mutual Funds that have only One Charge – Fund Management Charges [Actually it is Total Expense Ratio (TER) and it has components within, but for making it comparable to ULIP’s it is fair to consider it parallel to FMC]. Though Mutual Funds charge only one thing – FMC (i.e., TER), its rate is far higher than the corresponding FMC of ULIP. Both MF’s and ULIP’s charges have come down drastically than what they used to be few years ago. But our interest is to know between MF and ULIP which charges lesser. Many articles which are subtly or clearly biased towards ULIP’s, by showing some illustration charts, claim that ULIP’s turn to be cheaper over long period of time (say ~10+ years). Those illustrations mostly don’t consider Mortality Charges and Taxes, which are significant portions of an ULIP’s total premium. Even regulatory requirements about showing Reduction In Yield (RIY) don’t require those things to be considered in the calculation. May be the rationale is, for mortality charges the investor / policy holder is getting value as life cover and taxes are external to the scheme. But the MF’s TER is inclusive of all charges and taxes. To put things in perspective for easier understanding we may say ULIP’s charge 2%-8% upfront (entry load) in the name of Premium Allocation Charges, Policy Admin Charges, Mortality Charges and Taxes plus Fund Management Charges @ ~1.3%. This is similar to old cost / fee structure of old days of MF in Entry Load era. Then also MF’s used to charge 2% as entry load, in addition to Fund Management Charges. Now, there is no entry load. All that MF’s charge is about 1% to 3% (Depending on type of scheme, plan and fund size) TER. Most schemes have TER @ ~2.5% or lesser. As said above, if Mortality Charges are considered to be of some value as they give life cover and should not be part of the cost comparison, my argument in counter will be that these days few Mutual Funds offer Free Life Insurance Cover for Systematic Investment Plans (SIP) – up to ~100-120 times of monthly SIP amount. This is equal to the life cover (default 10 times of annual premium) offered by ULIP’s. And MF’s don’t charge even a paisa for giving this cover!

So, on the basis of charges, ULIP’s are still far more expensive than MF’s

Returns:

Some other articles have compared the actual past performance than assumed figures. Depending on what period of comparison is chosen, one may show MF has given better returns than ULIP or other way round. But ULIP’s if considered as investment option, given their illiquid nature and cost averaging / moderation over long period, must be considered for long term and should compared with MF’s accordingly to give it a level playing ground. OK, granted. So, long term (ideally 10+ years) performance vis-à-vis MF’s is what matters / to be compared. Now here are couple of practical problems.

Firstly, there are no very reliable and / or very updated and comprehensive resources or tools (portals / websites, apps, magazines, third party & neutral research / rating agencies) to measure the relative performance of ULIP schemes. Most of the comparison most of the articles written have done is by compiling the performance numbers in the fact-sheets disclosed by each Life Insurance companies on a given date. That’s a static report. If I have to compare the performance today or anytime, I find it too difficult. However, there are some portals which do compare the ULIP performance.

Here is an example: https://www.morningstar.in/tools/top-performing-insurance-fund.aspx

I don’t find it as comprehensive and versatile as their own MF comparison tools. However, I quickly checked the performance of Equity and Equity Oriented Hybrid Funds’ performance for 10 Years. Mostly, ULIP’s have generated far lesser returns than their MF peers in each category (Large Cap, Mid-Small Cap, Multi Cap, Equity Hybrid, Asset Allocation etc). To simply summarize, performance of the first / top quartile (top 25%) ULIP schemes in each Equity & Hybrid category is comparable to last / bottom quartile (bottom 25%) of the MF schemes.

Secondly, we should remember that these performance numbers reported / published of ULIP in the above portal or even on the Life Insurance Company’s website are based on the Net Asset Values (NAV, means price of each unit of ULIP or MF; it is comparable to price of a each equity share (stock / scrip) of a company). Well, that’s same for MF’s also. But the growth in this ULIP NAV’s are not Investor Returns. In ULIP’s for recovering the Policy Administration and Mortality Charges, units will be cancelled / deducted / reduced. So, Investor returns will be lesser than the returns depicted by NAV growth. In case of MF’s, NAV growth correctly represents the investor return, if the investor stayed invested for that period.

With passing time, Life Insurance Fund Management Team and Process is becoming better equipped, more resourceful and competent to become at-par with Asset Management Industry. The relative performance comparison and tracking (and making all ULIP Funds performance available at once place) is catching up. This close following / tracking, information dissemination further prompts higher scrutiny and better performance delivery. But currently Asset Management (MF) Industry is far more evolved, obviously because of their sharp focus and super specialization in invest management.

So, on the basis of gross returns (post expenses / charges), MF’s so far, have been winners over long term, by huge margin. Remember these returns are, after all the charges discussed above but before the taxes discussed below.

Taxes and Tax Savings:

All Life Insurance policies give tax benefit on the amount paid as premium (invested). MF’s have ELSS which offer tax benefits on the amount invested. Actually these days, rather than tax exemption on the amount invested (under section 80 C), it is the tax exemption on the withdrawable / maturity corpus is more important. There are many more ways to get the tax exemption under 80 C. There are two types of tax impacts, at present, that MF’s have but ULIP’s don’t have.

First, is Tax Impact arising while doing asset allocation (portfolio re-balancing). As we are more concerned about long term investment here, during this long term, asset allocation (simply put, Shifting / moving / reallocating money between Debt and Equity) becomes very important and inevitable. Starting from this year, long term (more than 1 Year, as per tax rules) gains from the Equity Mutual Funds, in excess of Rs.1 Lakh, attract 10% tax and Short Term (less than 1 year) Capital Gains (STCG) attract 15% tax. Similarly, Short Term Capital Gains of Debt Mutual Fund investments attract tax as per your tax slab. I ignore Long Term Capital Gains (LTCG) for Debt MF, as they are insignificant post- indexation benefit. Whenever you do a withdrawal / redemption, for reinvesting in other scheme or switch out to some other scheme within the fund house, then gains realized will be impacted by the taxes. On the other hand in ULIP’s when you move (switch) money from Equity to Debt or Debt to Equity, there is no tax implication. This is the greatest feature / advantage the ULIP has. If proper, disciplined and intelligent asset allocation is followed, ULIP’s may give at par or even better returns than MF’s, though ULIP’s equity schemes underperform their MF peers. But remember, doing asset allocation tactically isn’t that easy.

Second, the final corpus withdrawal (simply any withdrawal) from MF schemes is also taxable in the same way described above. On the other hand ULIP’s maturity proceeds are tax free.

Many articles written on this subject have done calculated projections and illustrated that post-tax corpus from both MF and ULIP will be same or even MF’s corpus will be higher, thanks to higher returns (based on rates that they assumed for their calculations) of MF’s will more than compensate for taxes. What these calculations missed to consider (well, not really possible to accurately consider), the asset allocation switches and tax losses on those switches, with respect to MF investments.

So, though not possible to quantitatively say what amount extra gains, if any, one would be able to make from ULIP against MF’s, ULIP’s certainly have tax arbitrage advantage over MF’s. In a way it is a loop hole in the system. It can be beneficial only if you could use it intelligently. It will be of no use to buy ULIP based on this point but then you never or hardly do asset allocation. In fact, if you are not good at asset allocation, then you are better off being invested full time in a diversified Equity MF.

However, don’t rely too much on tax advantages. There is no guarantee that the tax rules will remain same over long period, which is of our interest here. In fact it is prudent to assume that the rules will definitely change over the long period. Enjoy them as long they are. We don’t know what the new rules will be. As I said the above tax arbitrage is a loop hole, Govt will be mostly plugging it in the future, like it has done about many other in the insurance, that were there earlier. Same goes with MF’s. Recall very recent imposition of LTCG tax on equity.

INSURANCE

The main reason for, component and benefit in ULIP (or any Insurance) should have beenInsurance. But unfortunately the real main purpose is reduced to a formality (to make and sell it under life insurance umbrella) and investment portion / component has become practical main purpose. No person who can afford to pay any given premium under ULIP (or any other ‘Insurance cum Investment’ policy) can adequately be covered for the Insurance he / she needs / deserves. Pure and simple Term Insurance is a must and does all the job of real Insurance cover. It should be ideally a first and last life insurance policy one would buy. From old days, there are couple of ULIP plans offered by MF companies and anyways today, MF’s are offering FREE life Insurance cover with SIP’s. For the sake of argument, as I said above, the case / argument of ULIP’s offering Insurance cover also apart from being great investment (that is, ideal proposition is reversed!) hardly makes sense compared to almost same amount insurance offered with SIP’s, freely. Well, let me clarify, neither ULIP nor MF SIP provided insurance is adequate, for any person capable of paying premium out of his income of any size (small to big). It should be just treated as a nice box covering in which you get the jewelleries you purchase or very attractive wrapper around the chocolate you buy.

REGULATION, TRANSPARENCY AND DISCLOSURES

IRDAI is the regulator for Insurance Industry and SEBI for MF Industry. Regulatory compliance requirements for MF’s are far more higher than that for Insurance (ULIP’s).

Mutual Funds are required to provide so many disclosures, few of which, the end consumer (investor) finds too much to refer or hardly find it relevant to refer. The fee / cost structure, commissions, investment portfolio etc (just very few to list) are disclosed with granular detail. There are very detailed compliance requirements with regards to investment management, branding, marketing and selling the Mutual Fund products. Many of these regulations and compliance requirements are to the height that are seen in very few or no other country in the world. SEBI is a proactive and activist regulator protecting the investor interest.

This kind of regulatory framework of highest standard ensures, you investments are indeed managed well and your interests are protected first and best.

ULIP, in fact is the most transparent product type among all life insurance policies. IRDAI has done commendable job in increasing the transparency, reducing costs, increasing accountability, policy holder education and interest protection in the Insurance Industry. A policy holder is far more very educated, empowered and protected than few years back. However, relative to SEBI regulated MF’s, IRDA regulated ULIP’s still enjoy a big Regulatory Arbitrage.

EASE OF INVESTING & TRANSACTING AND LIQUIDITY & FLEXIBILITY

ULIP is an Insurance Contract end of the day, irrespective how much focus is put on it as an investment. As an Insurance contract it must follow the underwriting process and obviously takes time to get started with an ULIP. Moreover it’s a long term contract with rigid lock-in period with no option for liquidity for 3-5 years. However, in this article, our interest is long term only and liquidity limitations or lock-in periods do not matter. Only small thing is that MF’s (non ELSS) offer liquidity in case you have an emergency situation. Once the ULIP is bought / started, it is pretty easy and quick to make switches from one fund to another or making an additional ‘Top-up’ premium payment or renewal premium payment. Same is the case in MF’s – Fresh purchase, Additional Purchase, SIP, Switch and Redemptions can be initiated quickly and easily. On Redemption (withdrawal) after lock-in period or maturity, the proceeds (amount) from ULIP usually take slightly more time to get credited to your bank account compared to that in case of MF’s. You are free to Increase, decrease, stop, restart you regular investments (SIP) in Mutual Funds. Whereas, it is mandatory for you to pay premiums for minimum period (3 years most cases) to get something back as surrender / maturity value after lock-in period. ULIP’s do provide of options like Premium Holiday, etc, but flexibility is no where comparable to MF’s, especially in the early years (first 3 years) of the ULIP.

Well, those are all the points I wanted to cover. Hope now you have more clearer picture now and feel like having real complete picture of the differences. So, It’s MF’s win more rounds than ULIP in the fight!