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: 30^th 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.