Investor’s Query: A lot of my colleagues are investing in ULIPs towards their Retirement and other long term financial goals of their family. Let me know your suggestion about investing in ULIPs Vs Mutual Fund Schemes is better towards retirement or other long term financial goals of my family?
Mr. Gerard Colaco: I have seen the PowerPoint presentation of ABC Life Insurance Company which compares ULIPs on the one hand, with a combination of mutual funds and term insurance, on the other. It has several defects, besides containing outright lies.
First, there may be many individuals who do not need life insurance. On this ground alone, the ULIP becomes a bad investment, because there is an embedded mortality charge in a ULIP. If someone who does not need life insurance pays this charge in a ULIP, she is paying for something she does not need. This is a sheer waste of money.
Second, it is false that mutual funds suffer from a lack of transparency. In fact, ULIPs were extremely vague products and were compelled to be more transparent in recent years only because of widespread criticism about their opacity, and competition from mutual funds.
Third, the statement of this insurance company that operational expenses of mutual funds are not pre-fixed, is laughable. No one can estimate expenses in advance. In the case of ULIPs, there is a charge called the policy administration charge. This charge is made known to the insured at the beginning, including the quantum of the charge. But the fine print of many policies mentions that the policy administration charge can be changed from time to time by the insurance company. This is a classic case of uncertainty in future expenses of a ULIP.
In mutual funds, the total expense ratio (TET) is within a maximum ceiling fixed by SEBI and this ceiling is known in advance. The actual future TER is not known in advance. But each month, the TER is published in the fact sheet of the mutual fund which is available in the mutual fund website.
Fourth, liquidity is a cardinal principle of investment. Here, mutual funds beat ULIPs hands down. Liquidity is important even for the long term investor. What if an investor aged 35 is willing to invest for 25 years, but develops a life-threatening disease in 25 months and then desperately needs the liquidity to pay for treatment/end of life care?
Fifth, comparing mortality charges of a ULIP with the mortality charges of term insurance is foolishness of the highest order. Substantially higher amounts have to be invested in a ULIP for only a limited life cover. But in a pure term plan, huge life covers can be purchased. Also, while mortality charges by themselves may be reasonable, what about the high, front-ended expenses and commissions which are most profitable for insurance agents and companies?
Sixth, in a term plan–mutual fund combination, there is a diversification between investment and insurance. But in a ULIP, if the insurance company goes bankrupt, the insured can lose both the life cover as well as the investment. This was brilliantly pointed out by Eric Tyson in Personal Finance for Dummies. It was proved when one of the largest insurers in the world, AIG, went bankrupt in the wake of the Global Financial Crisis of 2008, and had to be bailed out by the US government.
In the case of a mutual fund, independent trustees hold the money and securities of fund investors. Therefore, mutual fund insolvency is irrelevant to the safety of investor assets. The values of mutual fund investor assets can of course fluctuate because of changes in market prices, but cannot be endangered because of asset management company bankruptcy.
Seventh, the statement that mutual funds have no tax benefits at maturity is false. Income on all equity funds is exempt from long term capital gains (LTCG) tax. Income on non-equity funds is not tax-free. But it is taxed at a relatively lower rate, after applying cost inflation indexing, if the investment is liquidated after a holding period of 3 years. Sometimes, this can result in some LTCG tax. At other times, it may result in notional long term capital loss (LTCL), when inflation indexing is calculated. This LTCL can be carried forward and set off against LTCG over the next 8 financial years. Whichever way you look at it, there are tax benefits on mutual fund investing in the medium to long term.
Eighth, the statement that ULIPs enforce more discipline over the long term is false, though amusing. There are a high number of lapsed ULIPs, where people do not pay further premiums once they come to know of the disadvantages of ULIPs. Very often, they lose the first, or the first few premiums paid. entirely. ULIPs enforce losses to investors and facilitate rampant mis-selling, rather than discipline. There are millions of low-key, long-term, publicity-shy investors who have never ‘invested’ in insurance, including ULIPs.
Ninth, the point about flexibility in ULIPs is false. There is a lot of flexibility in mutual funds. In fact, there are excellent asset allocation plans which rebalance between debt and equity automatically, within the plan itself. In such mutual fund asset allocation plans, there is no question of redemption and re-entry.
Tenth, the point about ideal tenure is a joke. Ideal tenure or the time horizon of an investment, has nothing to do with either insurance or mutual funds. It has to do with the objective of the investment and the type of asset class and investment avenue chosen to meet that objective. The investment objectives mentioned by ICICI Prudential for ULIPs and mutual funds are absurd.
Mutual funds can meet all normal investment objectives just by using short-term debt funds and diversified equity funds in the right proportions. In fact, mutual funds have a much wider mandate. For example, they can include real estate, which is also an important asset class. A single mutual fund can have elements of gold, real estate, debt, commodities and equity, with regular rebalancing between these asset classes at regular intervals, giving it a much wider multiple portfolio strategy option than an investment-linked insurance plan.
Eleventh, the biggest falsehood in the entire presentation is about costs. What if a mutual fund investor decides to invest in a short-term debt fund and two equity index funds, one tracking the Nifty index and the other tracking the Nifty Junior index? Immediately, the investor gains exposure to the short-term bond market as well as India’s top 100 stocks.
The total expense ratio of Indian short-term debt funds averages 0.75%. The total expense ratio of Indian index funds averages 1%. If these options, which are very much available in mutual funds today, are selected, the entire ULIP argument about cost advantages falls apart.
Twelfth, ABC Life Insurance Company pontificating about mutual fund entry and exit loads is more bad humour. There have been no entry loads in India since 2009. So why mention about entry loads of mutual funds in the presentation?
Where exit loads are concerned, almost all leading short-term debt funds have no exit loads. Most equity mutual funds do not have exit loads after a year. But let us assume that an equity fund does have an exit load of 2%. If the investor exits from the equity fund, she will get back 98% of the value of the fund as on the date of exit. Would ABC Life Insurance Company care to tell us what percentage of the first year’s premium a ULIP holder will get if she exits in a year?