How ULIP Charges Reduce Returns!

Published on / By M. Pattabiraman Twitter: @pattufreefincal / 8 Comments

Published: June 16, 2016 at 7:29 am

Last Updated on September 2, 2021

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:

  1. Premium allocation charge
  2. Policy administration charge
  3. Fund Management Charge
  4. Mortality Charge

Premium allocation charge will be deducted from the premium before investing.

Build a complete financial plan with our Robo Advisory Tool. More than 1000 investors and financial advisors use it!
Get free money management solutions delivered to your mailbox! Subscribe to get posts via email! (Subscribers get exclusive discounts!)

New Tool! => Track your mutual funds and stocks investments with this Google Sheet!

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

ULIP-mortality-charge
Source: HDFC click-2-invest ulip

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

ULIP-mortality-charge-2
Policy start age 24: impact of mortality charges alone

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.

ULIP-mortality-charge-3
Policy start age 34: impact of mortality charges alone

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.

ULIP-mortality-charge-4
Policy start age 24: impact of mortality charges and policy administration charges alone

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).

ULIP-mortality-charge-6
Policy start age 24: impact of mortality charges, policy administration charges and premium allocation charges

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.

Do share this article with your friends using the buttons below.
Use our Robo-advisory Excel Tool for a start-to-finish financial plan! ⇐ More than 1000 investors and advisors use this!
  • Follow us on Google News.
  • Do you have a comment about the above article? Reach out to us on Twitter: @freefincal or @pattufreefincal
  • Join our YouTube Community and explore more than 1000 videos!
  • Have a question? Subscribe to our newsletter with this form.
  • Hit 'reply' to any email from us! We do not offer personalized investment advice. We can write a detailed article without mentioning your name if you have a generic question.
Get free money management solutions delivered to your mailbox! Subscribe to get posts via email! (Subscribers get exclusive discounts!)
 
Explore the site! Search among our 2000+ articles for information and insight!

About The Author

Pattabiraman editor freefincalDr 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. He has over nine years of experience publishing news analysis, research and financial product development. Connect with him via Twitter or Linkedin or YouTube. Pattabiraman has co-authored three print books: (1) You can be rich too with goal-based investing (CNBC TV18) for DIY investors. (2) Gamechanger for young earners. (3) Chinchu Gets a Superpower! for kids. He has also written seven other free e-books on various money management topics. He is a patron and co-founder of “Fee-only India,” an organisation for promoting unbiased, commission-free investment advice.
  Our flagship course! Learn to manage your portfolio like a pro to achieve your goals regardless of market conditions! ⇐ More than 3000 investors and advisors are part of our exclusive community! Get clarity on how to plan for your goals and achieve the necessary corpus no matter what the market condition is!! Watch the first lecture for free!  One-time payment! No recurring fees! Life-long access to videos! Reduce fear, uncertainty and doubt while investing! Learn how to plan for your goals before and after retirement with confidence.
Our new course!  Increase your income by getting people to pay for your skills! ⇐ More than 700 salaried employees, entrepreneurs and financial advisors are part of our exclusive community! Learn how to get people to pay for your skills! Whether you are a professional or small business owner who wants more clients via online visibility or a salaried person wanting a side income or passive income, we will show you how to achieve this by showcasing your skills and building a community that trusts you and pays you! (watch 1st lecture for free). One-time payment! No recurring fees! Life-long access to videos!   
Our new book for kids: “Chinchu gets a superpower!” is now available!
Both boy and girl version covers of Chinchu gets a superpower
Both boy and girl version covers of Chinchu gets a superpower.
Most investor problems can be traced to a lack of informed decision-making. We have all made bad decisions and money mistakes when we started earning and spent years undoing these mistakes. Why should our children go through the same pain? What is this book about? As parents, what would it be if we had to groom one ability in our children that is key not only to money management and investing but to any aspect of life? My answer: Sound Decision Making. So in this book, we meet Chinchu, who is about to turn 10. What he wants for his birthday and how his parents plan for it and teach him several key ideas of decision making and money management is the narrative. What readers say!
Feedback from a young reader after reading Chinchu gets a Superpower (small version)
Feedback from a young reader after reading Chinchu gets a Superpower!
Must-read book even for adults! This is something that every parent should teach their kids right from their young age. The importance of money management and decision making based on their wants and needs. Very nicely written in simple terms. - Arun.
Buy the book: Chinchu gets a superpower for your child!
How to profit from content writing: Our new ebook for those interested in getting side income via content writing. It is available at a 50% discount for Rs. 500 only!
Want to check if the market is overvalued or undervalued? Use our market valuation tool (it will work with any index!), or you buy the new Tactical Buy/Sell timing tool!
We publish monthly mutual fund screeners and momentum, low volatility stock screeners.
About freefincal & its content policy Freefincal is a News Media Organization dedicated to providing original analysis, reports, reviews and insights on mutual funds, stocks, investing, retirement and personal finance developments. We do so without conflict of interest and bias. Follow us on Google News. Freefincal serves more than three million readers a year (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 paid articles, promotions, 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
Our publications

You Can Be Rich Too with Goal-Based Investing

You can be rich too with goal based investingPublished by CNBC TV18, this book is meant to help you ask the right questions and seek the correct answers, and since it comes with nine online calculators, you can also create custom solutions for your lifestyle! Get it now.
Gamechanger: Forget Startups, Join Corporate & Still Live the Rich Life You Want Gamechanger: Forget Start-ups, Join Corporate and Still Live the Rich Life you wantThis book is meant for young earners to get their basics right from day one! It will also help you travel to exotic places at a low cost! Get it or gift it to a young earner.

Your Ultimate Guide to Travel

Travel-Training-Kit-Cover-new This is an in-depth dive analysis into vacation planning, finding cheap flights, budget accommodation, what to do when travelling, and how travelling slowly is better financially and psychologically with links to the web pages and hand-holding at every step. Get the pdf for Rs 199 (instant download)