ULIPS VS Mutual Funds: High costs and few benefits

Insurance | admin | September 14, 2011 at 8:04 am

Gone are the days when an insurance company focused solely on insuring your life, health and assets. Nowadays, insurance companies are more eager to manage your investments through unit-linked insurance plans (ULIPs). Indeed, almost 60% of new insurance sales are in ULIPs (the figure is even higher for some new private insurance companies), suggesting that things are topsy-turvy in the insurance world. So much so that a couple of insurance companies offer only ULIP plans, and no traditional insurance products.

Time was when insurance companies insured your life, health and assets, while mutual funds managed your investments. But today , insurance companies' profitability depends largely on attracting investments in the garb of life cover. It's a common complaint that insurance applications for health or vehicle protection are often rejected on flimsy grounds. If your application were accepted, chances are the premium would send you in a tizzy. It appears as if most insurance companies are strangely uninterested in the business of providing insurance these days.

Many retail investors believe insurance is a part of one's investment portfolio. Insurers capitalise on this common misconception and push investment products like ULIPs over traditional insurance products like a term policy or whole life policy. Insurance is primarily a product for protection, whereas mutual funds are ideal conduits for managing investments. So insurance should be used to insure and protect, and mutual funds should be used to create wealth over the long term. Mixing the two, as ULIPs do, can be injurious to your long-term wealth.

ULIPs bundle insurance cover with an investment benefit, in a single contract. They are similar to mutual funds in terms of structure and functioning. The insurer allots units to ULIP investors in the same way as a mutual fund, and the net asset value (NAV) is declared on a daily basis. So, of the total premium you pay on a ULIP, part goes into an investment portfolio, and the rest is used to offer life cover.

ULIPs are quite expensive, as most of the charges are recovered at the start of the tenure—usually in the first three years when your money is locked in. So very little is actually invested during those years. Most investors discontinue early, or sign up for five- to 10-year terms, thus suffering high costs and poor returns. ULIPs make sense only if investments are made for a long tenure—say , 15 or 20 years—thus defraying initial costs.

A better alternative to a ULIP is a combination of low-cost term insurance and a good equity mutual fund. Term insurance provides coverage for a specified period, and is amongst the cheapest insurance products. Its no-frills design only covers your life for a fixed period. Combining it with an equity, balanced or debt mutual fund gives you the benefits of a ULIP at a much lower cost. In the end, your long-term returns are higher. Let's analyse a few aspects of investing in ULIPs versus mutual funds.