Why Ulips don’t deliver as advertised
Service tax, mortality charges, commissions are often left out of the benefit illustrations in brochures to inflate returns
With mutual fund costs set to increase, you’ll find more than a few reports declaring unit-linked insurance plans (Ulips) cheaper over the long term. Mutual funds will soon have a maximum cost of around 2.9% per annum, whereas the difference between gross and net yield of a 15-year Ulip can be no more than 2.25%. That’s a wide margin, but doesn’t reflect reality because it doesn’t factor in all costs of the Ulip.
Cost more than mentioned
A Ulip has two types of costs – mortality and rider charge on the insurance component and a handful of charges on the investment component. There’s also a service tax that needs to be paid on the fund management charge and the mortality charge. To calculate the difference between gross and net yield, the Insurance Regulatory Development Authority (IRDA) has permitted companies to exclude ‘extra premium due to underwriting emanating from extraordinary health conditions, cost of all rider benefits, service tax on charges (as applicable) and any explicit cost of investment guarantee.’
These charges significantly drive up the cost of a Ulip. With SBI Life’s Smart Performer plan, for example, the guarantee charge is 0.5% per annum. Then there’s the mortality charge, which costs little if you’re young, but a lot more if you’re in over 40. Service tax, which is half the reason for the increase in the cost of mutual funds, isn’t even included in the calculation. For example, with HDFC’s Pro Growth Flexi plan, the difference between gross and net yield is 2.15%. But, after deduction of mortality charges and service tax (there is no guarantee charge), its cost increases to 2.5%.
If mutual funds do increase as expected by 0.4%, HDFC’s Top 200, one of the cheapest equity funds, will cost 2.17% from 1.77%. That would be marginally costlier than the net yield of Pro Growth Flexi plan, at 2.15%. But after factoring in all other charges, the HDFC Ulip becomes 0.33% costlier than the mutual fund.
Charges excluded in illustrations
That IRDA allows insurers to exclude certain charges while calculating net yield is only half the problem. The other half is that insurers, in their brochures and on their websites, show you illustrations of the returns their scheme can generate while leaving these charges out. A few insurers may also not adequately factor in the fund management charge or commission. Here’s how to vet the charges of a Ulip:
Read the disclaimer: Disclaimers of benefit illustrations can be shocking, especially if you read them after buying the policy. SBI Life’s, for example, revealed that ‘the interest rates of 6% and 10% are gross rates (taken before the deduction of fund management charge)’. Aegon Religare’s e-Ulip iMaximize disclaimer says that ‘the net yield has been calculated by assuming mortality charge, service tax on charges and cost of guarantee as zero’. This means that, in reality, the net return it calculates will be much lower than the 8.70% it predicts.
Double-check: Don’t assume the disclaimer is true. Insurers sometimes claim that they have only excluded a single charge, but may have excluded a couple of more charges. For example, in Aviva’s Freedom Life Advantage brochure’s benefit illustration, only the service tax is said to be excluded. However, the same illustration online claims to exclude the mortality and guarantee charge.
Ask questions: Illustrations sometimes don’t mention commissions at all. Aviva and SBI Life include commissions, but their disclaimers are ambiguous about whether they have been factored into the calculation. Before making your decision, find out whether the commission you’ll be paying has been factored into the illustration. In fact, ask for all the charges that have been included.
|Aviva Life||Service tax, mortality charge, guarantee charge, riders, commissions|
|Aegon Religare||Service tax, mortality charge, guarantee charge, riders|
|Bajaj Allianz||Service tax, mortality charge, guarantee charge, riders|
|ICICI Prudential||Service tax, mortality charge, riders|
|HDFC Life||Service tax, mortality charge, guarantee charge, riders|
|SBI Life||Service tax, mortality charge, guarantee charge, riders, fund management charge|
|Reliance Life||Service tax, mortality charge, guarantee charge, riders, commissions|
Ulips, therefore, might appear to give better returns than mutual funds, but this may only be because a particular benefit illustration doesn’t factor in all the charges. You can save yourself a great deal of money by simply finding out what the net yield of a Ulip will be, after factoring in service tax and mortality charges.