Last Updated on
The charges associated with a Unit linked Insurance Plan (ULIP) can significantly impact the returns from the policy. A two-part discussion on ULIPS: first how charges reduce returns and then a category-wise study of ULIP returns and how to compare them with mutual funds.
This post is entirely due to an interesting thread started by Guru Rudagi at Facebook group Asan Ideas for Wealth with key comments from Ramesh Mangal (one of my personal finance influencers) and Butan Mohapatra who took the trouble of sending me his ULIP statement with a detailed explanation.
A ULIP which is active has four key charges:
- Premium allocation charge
- Policy administration charge
- Fund Management Charge
- Mortality Charge
Premium allocation charge will be deducted from the premium before investing.
Policy administration charge will be levied by deducting units accumulated at the start of each month.
The fund management charge will be removed from the NAV like good old mutual funds.
The mortality charge will be removed from units accumulated once a month. Thanks to Ramesh for pointing this out. This charge will change depending on the age and insurance cover opted for.
This charge will change depending on the age and insurance cover opted for.
All these charges will vary from insurer to insurer, and are subject to service tax and applicable cess!
Here is an example from HDFC Life
Premium allocation charge:
Year 1: 2.5%
Year 2: 2%
Year 3+: 0%
Butuan showed me charges of a Canara HSBC ‘smart future plan’ which was much higher and zero only after 10 years!
Policy administration charge:
Year 1 to 5: 0.42%
Year 6 to 10: 0.83%
Year 11 to 15: Nil
Year 16 onwards: 0.83%
These will be deducted monthly and is subject to a maximum charge of Rs 500 per month.
Fund management charge (expense ratio) 1.35% a year.
Mortality charge is the cost of the life cover.
HDFC Life uses the following formula
Annual mortality charge =
(Mortality rate x Sum insured) /1000
The mortality rate changes with age as shown below
Notice how the insurer perceives higher risk (of paying out the sum insured) for children and naturally to senior citizens.
How ULIP Charges Reduce Returns!
For the sake of argument, we will assume Rs. 1000 as the one-time premium of a ULIP.
Step 1 If the return from change in NAV is 10%, the impact of the mortality charges alone is shown below
The NAV return is assumed to be always 10% for simplicity. This data is for a person who started to invest in the ULIP at age 24.
For a person who started to invest at age 34, the impact due to mortality charges alone would be greater.
The NAV return of 10% is after taking into account the fund management charge.
Step 2 Now if we take into account Policy administration charges for the ULIP started at age 24, the return drops further.
For ULIP return calculation, premium allocation charges should not be factored in as they are deducted before investment. However if we wish to compare returns to a mutual fund, then it becomes like an entry load.
Step 3 For the policy started at age 24, after taking into account the premium allocation charges (only for the first year, since it is a one-time premium).
Step 4 Factor in service tax for steps 1,2 and 3!! Too tired to do this. Just we reduce another 0.5%?
The purpose of this post is two-fold
1 To illustrate how ULIP charges reduce returns (done)
2 To determine a reasonable number by which we should reduce the ULIP NAV returns reported if we have to compare them with mutual funds.
If the mutual fund return (after taking into account the much higher expense ratio ~ 2.5%) is 10%, the corresponding ULIP return (after expenses)
for a 10 year policy started at age 24 would be _____ (only an estimate)
for a 10 year policy started at age 34 would be _____ (only an estimate)
Can you please fill in the blanks by looking at the tables above? Thank you.
About the Author
M. Pattabiraman(PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. since Aug 2006. Connect with him via Twitter or Linkedin
Pattabiraman has co-authored two print-books, You can be rich too with goal-based investing (CNBC TV18) and Gamechanger and seven other free e-books on various topics of money management. He is a patron and co-founder of “Fee-only India” an organisation to promote unbiased, commission-free investment advice.He conducts free money management sessions for corporates and associations on the basis of money management. Previous engagements include World Bank, RBI, BHEL, Asian Paints, Cognizant, Madras Atomic Power Station, Honeywell, Tamil Nadu Investors Association. For speaking engagements write to pattu [at] freefincal [dot] com
About freefincal & its content policy
Freefincal is a News Media Organization dedicated to providing original analysis, reports, reviews and insights on developments in mutual funds, stocks, investing, retirement and personal finance. We do so without conflict of interest and bias. We operate in a non-profit manner. All revenue is used only for expenses and for the future growth of the site. Follow us on Google NewsFreefincal serves more than one million readers a year (2.5 million page views) with articles based only on factual information and detailed analysis by its authors. All statements made will be verified from credible and knowledgeable sources before publication.Freefincal does not publish any kind of paid articles, promotions or PR, satire or opinions without data. All opinions presented will only be inferences backed by verifiable, reproducible evidence/data. Contact information: letters {at} freefincal {dot} com (sponsored posts or paid collaborations will not be entertained)
Connect with us on social media
- Twitter @freefincal
- Subscribe to our Youtube Videos
- Posts feed via: Feedburner
Our Publications
You Can Be Rich Too with Goal-Based Investing
This book is meant to help you ask the right questions, seek the right answers and since it comes with nine online calculators, you can also create custom solutions for your lifestyle! Get it now. It is also available in Kindle format.Gamechanger: Forget Startups, Join Corporate & Still Live the Rich Life You Want
This book is meant for young earners to get their basics right from day one! It will also help you travel to exotic places at low cost! Get it or gift it to a young earnerYour Ultimate Guide to Travel
Free Apps for your Android Phone
- All calculators from our book, “You can be Rich Too” are now available on Google Play!
- Install Financial Freedom App! (Google Play Store)
- Install Freefincal Retirement Planner App! (Google Play Store)
- Find out if you have enough to say "FU" to your employer (Google Play Store)
Good eyeopener on ULIPs. Without knowledge i took an ULIP ,( Reliance pay five plan )from one of my friends relative in my early career days and just saw all the charges associated with it. My god , going to surrender it ASAP !!! Its prremium allocation charge for 1st year is 9.25% and from 2nd to 5th year premium allocation charges is 6.5% !!!!
Rajkumar
Yes the old ones had huge expenses.
A good post with simple illustrations!
Thank you.
While I personally don’t believe in buying a ULIP and have not bought (and that is for a different reason altogether).
However, there’s a fallacy here in the logic here. IMO. It’s not appropriate to cull out the mortality charge and compare it with a MF. After all if you want to buy a term cover for that value – you will have to pay the mortality charge (If they are charging more than what a term cover would, then it’s fair to add the delta).
Fair enough. If you were to compare ULIP of 1Cr SI and a MF +Term plan for the same cover, which do you think is better?
I wish a feedback on single premium ulips that are floating in the market..
GREAT WRITE UP!
No nonesence, straight to the point.