ULIP Vs ‘Life Insurance + Mutual Fund’ -- Comparison 1
The Policy that I have taken for comparison is,
· HDFC Unit Linked Endowment Winner Policy
The reason for taking this policy for study is because my bro has taken this policy. I have nothing against this company and this study is done purely for academic reasons. Even though I am taking only this policy for comparisons, the results can be generalised for all the companies which are in the ULIP business.
ASSUMPTION:
1. I am assuming that the policy holder pays the premium amount at the exact date and continues the payment till policy term. This way the late charges or the surrender charges can be excluded from the study, which will make the study easier to understand.
2. Just to make calculation regarding the Term Assurance Policy easier, I am assuming that the policy holder dies after paying the last premium. This will give a more understandable cash flow situation. This is because the nominee of the policy holder will get the sum assured and also the units available at the end. Since this amount is quantifiable, the study can be understood easily.
HDFC UNIT LINKED ENDOWMENT WINNER POLICY:
Details:
Date of Commencement of policy: 30th June 2009
Age on Commencement of Policy: 34
Instalment Premium: 120,000 Rs
Frequency of Payment: Annual
Sum Assured: 600,000 Rs
Term of Policy: 15 yrs
The sum assured refers to a Term Assurance Policy for which risk premium is paid every year and which is deducted from the premium paid by the policy holder. Also the policy administration charge is assumed to increase by 5% each year to factor in inflation. The various cash flows that happen for this policy for 15yrs are given in Table 1.
TABLE 1
| Year | Premium Allocation Charge | Policy Administration Charge | Risk Charges (for death benefit) | Fund management Charges | Death Benefit |
| 1 | 48000 | 750 | 1225 | 1.25% of NAV | _ |
| 2 | 36000 | 788 | 1225 | 1.25% of NAV | _ |
| 3 | 2400 | 827 | 1300 | 1.25% of NAV | _ |
| 4 | 2400 | 868 | 1340 | 1.25% of NAV | _ |
| 5 | 2400 | 912 | 1400 | 1.25% of NAV | _ |
| 6 | 2400 | 957 | 1450 | 1.25% of NAV | _ |
| 7 | 2400 | 1005 | 1530 | 1.25% of NAV | _ |
| 8 | 2400 | 1055 | 1610 | 1.25% of NAV | _ |
| 9 | 2400 | 1108 | 1680 | 1.25% of NAV | _ |
| 10 | 2400 | 1163 | 1770 | 1.25% of NAV | _ |
| 11 | 2400 | 1222 | 1890 | 1.25% of NAV | _ |
| 12 | 2400 | 1283 | 2040 | 1.25% of NAV | _ |
| 13 | 2400 | 1347 | 2200 | 1.25% of NAV | _ |
| 14 | 2400 | 1414 | 2310 | 1.25% of NAV | _ |
| 15 | 2400 | 1485 | 2560 | 1.25% of NAV | 600000 (inflow) |
This information is taken from the schedule given by the company. The policy holder pays Rs120, 000 in the beginning of every year. These charges mentioned above are levied from it and then the remaining amount is invested in funds and converted to units. The fund management charges are levied by selling the units appropriately. Other charges like service charges are also levied, but they are not included here for ease of calculation.
This ULIP is similar to taking a Term Assurance Policy along with investments in Mutual Funds. The Term Assurance Policy I have chosen for comparison is ‘HDFC Term Assurance Policy’. If the same policy holder wants a Term Assurance Plan for 15yrs for an assured sum of Rs 600,000 the premium per year is Rs. 1802 with Policy Management Fee of Rs 150 per year.
The amount of money invested in Mutual fund is considered to be same as that invested by ULIP managers. So the entry and exit load, if any will be the same. Also service charges for this combination of investment also will be less than a ULIP. But it is ignored for ease of calculation. The cash flow for this combination of investment is shown in Table 2.
TABLE 2
| YEAR | Premium for Term Assurance | Policy Fee | Fund Management Charge | Death Benefit |
| 1 | 1800 | 150 | 2% of NAV | _ |
| 2 | 1800 | 158 | 2% of NAV | _ |
| 3 | 1800 | 165 | 2% of NAV | _ |
| 4 | 1800 | 174 | 2% of NAV | _ |
| 5 | 1800 | 182 | 2% of NAV | _ |
| 6 | 1800 | 191 | 2% of NAV | _ |
| 7 | 1800 | 201 | 2% of NAV | _ |
| 8 | 1800 | 211 | 2% of NAV | _ |
| 9 | 1800 | 222 | 2% of NAV | _ |
| 10 | 1800 | 233 | 2% of NAV | _ |
| 11 | 1800 | 244 | 2% of NAV | _ |
| 12 | 1800 | 257 | 2% of NAV | _ |
| 13 | 1800 | 269 | 2% of NAV | _ |
| 14 | 1800 | 283 | 2% of NAV | _ |
| 15 | 1800 | 297 | 2% of NAV | 600000 (inflow) |
The policy fee is increased by 5% per year to factor in inflation.
Now if we compare Table 1 and Table 2, we can clearly see that ULIP investing in funds and customer investing in Mutual funds are almost the same. So the charges relating to investment can be avoided. But the ‘Fund Management Charge’ has a difference of almost .75%, which can have an impact in the long term. But since this depends on market movement which is beyond the scope of this paper, we deduct a considerable amount from the final result.
Table 3 gives the differential cash flows for ULIP and ‘Term Assurance + Mutual Funds’. The Present Value of these differential cash outflow is found, to quantify the amount lost by the policy holder. To find the present value, the discount rate used is 8.5%, which is the return for a provident fund.
TABLE 3
| Year | Cash outflow for ULIP | Cash outflow for 'TERM + MF' | Differential outflow | PV of Differential outflow |
| 1 | 49975 | 1950 | 48025 | 44263 |
| 2 | 38013 | 1958 | 36055 | 30627 |
| 3 | 4527 | 1965 | 2562 | 2005 |
| 4 | 4608 | 1974 | 2635 | 1901 |
| 5 | 4712 | 1982 | 2729 | 1815 |
| 6 | 4807 | 1991 | 2816 | 1726 |
| 7 | 4935 | 2001 | 2934 | 1658 |
| 8 | 5065 | 2011 | 3054 | 1590 |
| 9 | 5188 | 2022 | 3166 | 1520 |
| 10 | 5333 | 2033 | 3301 | 1460 |
| 11 | 5512 | 2044 | 3467 | 1413 |
| 12 | 5723 | 2057 | 3666 | 1377 |
| 13 | 5947 | 2069 | 3878 | 1343 |
| 14 | 6124 | 2083 | 4041 | 1290 |
| 15 | 6445 | 2097 | 4348 | 1279 |
| Total Present Value | 95267 | |||
As we can clearly see from Table 3, the outflows are more for ULIP. That is every year the customer pays more for the ULIP when compared to taking a combination scheme of ‘Term Assurance + MF’. This comparison can be made only because; the combination of ‘Term Assurance + MF’ gives a similar investment vehicle like ULIP.
Present Value of the differential outflow is Rs.95267, which gives the extra amount that the customer is paying for ULIP. Now the difference of 0.75% for the Fund Management Fee has to be included in this PV. An approximate sum of Rs25000 is taken as the PV of differential cash flow got from the difference of 0.75%. So as a whole the customer looses Rs70267, if he opts for ULIP over the combination of ‘Term Assurance + MF’.
CONCLUSION:
From the above study we can clearly see that it is favourable for a customer to go for a combination of ‘Term Assurance + MF’ when compared to ULIP.
PS:
Many assumptions have been considered for this study. If these assumptions are not taken it will make the paper more complicated, which will be beyond the scope of this paper.
These are my inferences and care should be taken before following this conclusion.
To be Contd...
I will be happy to discuss about any difference in opinions regarding the above view . Looking forward to many interesting discussions.
