Unit linked insurance plans (ULIPs) have managed to attract many individuals into investing in them. Simply put, ULIPs function like a mutual fund with a life cover thrown in.
However, in spite of the huge money being pumped into ULIPs by individuals, few can claim to have deciphered the impact of expenses on the returns of a ULIP.
We have quantified the impact that a difference in the expenses can have on the returns. For this purpose we have considered two leading private sector life insurance companies and have discussed the expenses and returns on their ULIPs threadbare.
Let us first look at the information we have taken into consideration:
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An individual aged 38 years, wants to 'invest' in ULIPs for a sum assured of Rs 400,000.
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His investment tenure is 30 years and the annual premium he will have to shell out in case he opts for a ULIP from either insurance company is Rs 20,000.
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He is also assumed to have a high-risk appetite and therefore, would like to remain invested in 100% equities throughout the 30-year tenure.
Expense structure of 100% equity ULIP from Company A
In case the individual opts for a ULIP from Company A, 27% of the annual premium amount is deducted from each of the first two years' premiums on account of initial expenses. The deductions from annual premium falls to 1% thereafter.
In addition, an administration charge of Rs 180 per annum (p.a.) is levied (this charge has been subjected to an annual inflation of 5%). Mortality expenses have been charged as applicable. Fund management charges (FMC) are assumed to be 1%.
Expense structure of 100% equity ULIP from Company B
In case the individual opts for a ULIP from Company B, 19% of premium paid in the first year is deducted on account of initial expenses. From years 2-5, this charge falls to 4%. It falls further to 2% for years 6-10 and finally settles at 1% thereafter.
In addition, an administration charge of Rs 720 p.a. is also levied (this charge has been subjected to an annual inflation of 5%). Mortality expenses have been charged as applicable. FMC are assumed to be 1.50%.
Given the differences in the expense structure, let us look at how an investment in the respective ULIPs will pan out. We have assumed a growth rate of 10% p.a. for both the ULIPs. This will help investors understand the difference expenses can make across ULIPs of a similar nature with a similar growth rate.
Expense structure of Company A
| Tenure (Yrs) | |||
| 10 | 20 | 30 | |
| Yearly premium (Rs) | 20,000 | 20,000 | 20,000 |
| Expenses (%) | |||
| Initial 2 yrs (pa) | 27.00 | 27.00 | 27.00 |
| Remaining tenure (pa) | 1.00 | 1.00 | 1.00 |
| Annual administration expenses (Rs) | 180 | 180 | 180 |
| Annual fund management charges (%) | 1.00 | 1.00 | 1.00 |
| Fund value (Rs) | 286,219 | 989,840 | 2,638,373 |
| Effective rate of return (%) | 6.43 | 8.01 | 8.39 |
As can be seen from the table, if the individual buys a ULIP from Company A, his corpus will grow to Rs 286,219 after 10 years. That's a compounded growth rate (CAGR) of approximately 6.43% p.a. The corpus will grow to Rs 989,840 (8.01% CAGR) and Rs 2,638,373 (8.39% CAGR) at the end of 20 years and 30 years, respectively.
Expense structure of Company B
| Tenure (Yrs) | |||
| 10 | 20 | 30 | |
| Yearly premium (Rs) | 20,000 | 20,000 | 20,000 |
| First year expenses (%) | 19.00 | 19.00 | 19.00 |
| Expenses from 2nd-5th year (%) | 4.00 | 4.00 | 4.00 |
| Expenses from years 6-10 (%) | 2.00 | 2.00 | 2.00 |
| Expenses 11th year onwards (%) | 1.00 | 1.00 | 1.00 |
| Annual administration expenses (Rs) | 720 | 720 | 720 |
| Annual fund management charges (%) | 1.50% | 1.50% | 1.50% |
| Fund value (Rs) | 275,985 | 906,687 | 2,300,702 |
| Effective rate of return (%) | 5.78 | 7.28 | 7.68 |
As opposed to this, had the individual invested in a ULIP from Company B, its effective growth rate would have been lower than that of Company A. At the end of the 30-year tenure, the individual's fund value is Rs 2,300,702 (effective rate -- 7.68% CAGR). That's a difference of Rs 337,671. This is about 14.7% lower than the fund value on the ULIP from Company A!
How the expenses makes a difference has been explained in the points given below:
1. Difference in fund management charges
This makes a significant difference. FMC is levied on the fund value at a particular point in time. This is unlike how other charges are levied (i.e. as a percentage of the annual premium). Therefore, higher the FMC, lower is the value of your investments. Over a longer tenure (i.e. 30 years in our example), the power of compounding magnifies the difference in the FMCs of the two ULIPs by way of a significant disparity in the maturity value/corpus.
2. Differences in regular expenses
Regular expenses include initial charges and sales and administration expenses. These charges are levied as a percentage of the annual premium. A higher charge means a lesser amount of premium available for investments. This has an impact on the value of your investments in the initial years (as can be seen from the low CAGR across both ULIPs after 10 years).
However, since the annual premium amount remains the same throughout the tenure, these charges even out over the tenure alongwith a growth in the fund value.
Of course, the illustration given above is indicative. The figures will vary with a change in the annual premium, FMC, sales and administration charges among other variables.
Expenses make a significant difference to the maturity value of your investments. The impact gets magnified over the years; so what seems like a 'small expense' to you, will actually burn a hole in your investments over a longer tenure of say 30 years.
Of course, that is not to say that investors ignore other important factors like fund management style or the equity and debt allocation available in a ULIP and focus only on ULIP expenses. But expenses certainly deserve more credit than they get.
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