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Opinion

Counterpoint: Term plans + MF are better than ULIPs

A. Sanjeev writes at rediff that Term plans are not as good as ULIPs and goes on to demonstrate using calculations and formulas. Unfortunately, Sanjeev hasn’t perhaps taken all facts into consideration, and there are a number of flaws in his article, which I shall highlight. My point is: Sanjeev is incorrect; term plans are FAR better than ULIPs.


Term of paying Premiums

Sanjeev says that ULIPs require only 3 years of premiums, while a term plan needs premiums paid throughout the term. This is incorrect. If you don’t pay premium for a ULIP, the mortality charges get reduced from your fund value. Don’t believe me? Read the new ULIP guidelines:

Premium Holiday: If the policyholder stops paying premium instalments after paying premiums for three years, the risk premiums and the applicable charges can be adjusted from the balance in the account value, till such time as the balance in the account reduces to one year’s premium. This would help policyholders who are unable to pay premiums owing to a temporary disruption in income because of change in employment, or any other sudden drop in income. The premium holiday option ensures continued insurance protection by transferring the risk premium and charges due from the account value, which is built up over a period. But the policy would lapse and this benefit would not be available if premium payments are stopped within three years.

That means, regardless of your attempting to not pay premiums, your charges will get reduced from your fund value, meaning you are paying them. Just not handing over a cheque, that’s all.

Even the Prudential ICICI LifeTime policy which Sanjeev has reffered to has a clause stipulating that if the fund value reaches less than 1.1 times the annual premium (meaning if it reached 33,000 or less). It’s 75,000 now, and he has to pay annual charges of 11,000, which increases every year as mortality charges increase (plus service tax). Technically he will lose it all in four years.

Another thing you can do is to make the policy “paid up” but that means your cover will be completely lost (only your fund value remains). That is of no use because Sanjeev’s friend Amit will lose the cover he so very much needed to insure against his housing loan.

Ease of paying premiums
Sanjeev says he likes ULIPs because you can stop paying premiums after three years, which is good for his client, because “being a software engineer, his work required him to travel most of the times. Plus he also felt that keeping track of premium payment for 25 years would be too tedious”.

This is fundamentally flawed. Most insurers, including LIC, allow premium payment online. And this software engineer has to pay other bills also, does he not? If he can pay his monthly phone bills online and his credit card bills online, why can’t he pay a premium online once a year? I don’t think this is a deterrent to anyone.

Secondly, as I mentioned earlier, you can’t just stop paying premiums. Your insurance cover will lapse if your fund value can’t cover your premium.

No service tax?
Since 2006, Mr. Amit would need to pay 12.24% effective service tax on the “risk” portion of his premium, taking total amount of premium to Rs. 31,096. This is extra money for no extra value i.e. his sum invested and cover remains exactly the same. In a term plan too he will have an extra amount too.

Service tax is one thing that effectively kills your returns. It is not going to you, or to the insurance company – it is going to the government. Which has already taxed you before you invested!

Note: I had earlier presumed that service tax would apply on the entire premium – but I was mistaken, as pointed out in some of the comments below (thanks Ganesan and Jackson!). So I’ve redone the calculations.

“Sum assured not sustainable”
I went to ICICI Prudential’s premium quote calculators and chose “Life Time Super”. Then I put in parameters – 32 years old, 45 lakh sum assured, 30,000 annual premium. Also chose the 3 year “cover continuance” option – meaning you don’t have to pay the premiums after three years (charges still get reduced though). Then I click the “Generate EBI” button. It tells me “Sum assured not sustainable”.

Now I try with lower sum assured – I find out that the highest sum assured they will show me is Rs. 24 lakhs. That is about half the value Sanjeev has written! For 45 lakhs, you need to put in 58,000 per year. And if you use that, the return ratio will be skewed completely towards Term Plans + MF (because more money will then be put into the MF). To give you an indication, at the same growth rate the ULIP will return 1.82 lakhs, but the term plan+MF will return 2.34 lakhs.

Comparing wrong terms
Sanjeev compares a 3 year premium paying ULIP, to a 25 year premium paying Term plan. In the latter, the coverage is available for 25 years, and for the former, probably only for five, under the new ULIP rules. Perhaps 10 at the very maximum. If you take a 5 year policy for 45 lakhs from LIC (the costliest insurer) you get a premium of Rs. 10,620. Which will alter the complete ratios! (I will demonstrate the true ratios later)

Comparing mortality charges over three years
Term plan mortality charges remain the same over the entire term – meaning even 20 years later, Amit pays the same mortality charges. In a ULIP, mortality charges increase every year. Now if I assume that Amit wants to REALLY cover his home loan for 25 years, then he will want to continue to pay at least mortality charges for the rest of the term. In 18 years, when he is 50, the mortality charges paid will be Rs. 23,000 for 45 lakhs, according to the lifetime brochure. The term plan stays fixed at Rs. 16,000 or so.

Comparing wrong types of returns
If Amit dies in 10 years, what does his family get? In a ULIP, it will only be 45 lakhs (higher of fund value or sum assured). In a term plan + mutual fund he will get 45 lakhs plus the fund value. Different fundas.

Commission under ULIPs
Now Sanjeev says that ULIP advisors make lesser money (Rs. 5,700)than term plan advisors (Rs. 26,243). But he takes the 25 year period of the term plan, but only three years for the ULIP! Secondly, he uses pretty high figures for term plan premiums but low values for ULIPs – this will probably need to get clarified. If you consider his values, for 25 years, the ULIP agent still gets around 18,000 (still less than the term plan advisor).

One-of-a-kind scheme
Note that this is because this is a special policy that does not have upper limits on the sum assured. Most other policies limit the sum assured to a maximum of 5 times annual premium, at which rate the temr plan premiums are significantly lower, and advisor commissions also become appropriately lower. The equation goes COMPLETELY in favour of term plans (even with advisor commissions) if you take any ulip that limits your sum assured.

Let us consider all factors
Let us consider service tax (assume applicable for insurance premiums from April 2006 onwards) and also entry loads in MFs (most of which started charging 2.25% in 2005, prior to that SIPs had no load). Also I will use HDFC Taxsaver as it is an 80C tax saving instrument on the lines of insurance.

So the Term + MF strategy yields about Rs. 2,500 more than the ULIP. But if we are comparing short terms – just 5 years, why don’t we take LIC’s 10,620 as the premium instead?

Now the term plan is better off by (nearly) Rs. 30,000!

The premiums are higher by the amount of service tax (for insurance risk premium) and I assume that we will compare the same amount invested in either strategy. Even with the one-of-a-kind ULIP that provides a HUGE sum assured for a low premium, you can see how a Term plan + Mutual Fund has performed much better.

Also if you consider ONLY the investment part, the mutual fund part has grown at an annualised rate of 105%. The investment part of the ULIP has only grown at 48%. That means the investment on the mutual fund has been double of the return on a ULIP. Even though the term plan premiums are higher in the first few years compared to the mortality charges of a ULIP, the extra returns are worth it.

The author says that even earlier private mutual funds were shunned. But that was because they performed badly, or charged people too much! Now the rules are more strict and funds have limits on all charges. Even insurance is getting there but there is still a lack of transparency – portfolio disclosures are not mandatory, units are deducted on a regular basis for various charges etc.

Plus, these are the nascent years and premiums don’t really reflect true insurance coverage – simply because most people who have bought these are young (<50 years). In about 10 years, we will start to see a larger number of claims - let us then see how all these insurers perform. ULIPs for them are better because by that time your fund value will cover most of the sum assured - so their risk is lower. But true insurance is term insurance. Low premiums, high insurance.

  • Aditya Yogi Kalra says:

    >wats the persons age..u have taken too much mortality charges!

  • Aditya Yogi Kalra says:

    >also mortlity charges are deducted on monthly basis!! not at one go..so initially the fund has more money..which may apprexiate more in a bull phase.. for a 60 year old mortality charges are app 1420 per lac..in ULIP

  • Deepak Shenoy says:

    >Aditya: The original article assumed 32 years, which is what I’ve taken as data. Also most of the data is sourced from the same article. I’ve changed figures to reflect reality.

    Also about mortality charges- yes they are deducted monthly but that hasn’t t really made a difference. The net value today of the investment is Rs. 75K for a ULIP and for the same kind of deal would have been Rs. 105K for a Term+MF plan.

  • Anonymous says:

    >Thanks Deepak for this article which is insightful as always. I was really astounded when I read Sanjeev’s piece in Rediff yesterday and I knew that what he wrote could not be true. Thanks for your great rebuttal 😉 and the time and effort you put in to this blog.

    Thanks,
    Srini

  • Ganesan Rajagopal says:

    >Good rebuttal though somewhat long for my taste. One clarification, the service tax for life insurance is only applicable on the risk cover (i.e. mortality charges) – not the invested amount.

  • Anonymous says:

    >Deepak…Thanks for writing that wonderful article! I have been a regular reader of your blog for months now.

    Thanks to you, I am really impressed with the need for purchasing an insurance cover. Is there any online site where I can get a comparision of all the term insurance plans? Or does one have to manually read through all the different policies?

  • Deepak Shenoy says:

    >Ganesan: Almost all quotes I’ve seen include service tax on the entire amount (not just mortality charges) – are you sure about this?

    Anon: I have no term plan sources – though Outlook Money prints a table every month (it’s a printed magazine).

  • karthik says:

    >Hi Deepak,
    Good Article…Post this in the comments area of that rediff article..
    There is a plan called Special Term Plan in Reliance Life insurance. This plan gives back the premiums paid if we survive the maturity…Can you please suggest on this?

  • Deepak Shenoy says:

    >Karthik: Yes, most insurers have “return of premium” plans with term plans. Unfortunately the premium for that is about three times your premium without this option!

    That means for a 30 year old, a term plan for 30 years, 30 lakhs, without return of premium will cost Rs. 10,000 annually. With return of premium it would cost Rs. 30,000 annually.

    They take the extra and invest it so they can give back your charges. If you work it out it actually means less than 8% for you – and service tax will reduce that even more.

  • Jackson David says:

    >Kudos, Deepak. On the service tax angle, i agree with Ganesan. The service tax is only on the risk premium and not the full amount. Even then, the edge for term plan + MF is pretty clear.

  • Deepak Shenoy says:

    >Thanks Jackson. I have redone the calculations assuming service tax only on teh mortality charges (and on the FULL term charges)

    The edited post is now above.

  • Anonymous says:

    >Deepak, your entire article is written without understanding the product.

    Let me explain you why.

    1. Term of paying premiums needs to be extended only if the corupus is not sufficient to pay the next year’s premium. And the corpus value is based on the returns earned in the past. The plan I was referring to has earned an annualised rate of return of 36% since inception. I will discount this by 50% and consider 18% as the average rate of return. At this rate the fund will sustain itself for the rest of the term.

    2. Ease of paying the premium: I dont know if you are a financial service provider. But believe me when I say this, people prefer shorter premium paying option as compared to 20-30 years. This is the main reason why ULIPs are so successful.

    3. Service tax: You have acknowledged your error, nothing more to add on this.

    4.Comparing wrong terms: There is nothing wrong with this. In the example I quoted, premium paying term of three years for ULIP is sufficient to keep it alive for 25 years. However in term plan you have to take a policy of 25 years if you want a life cover for 25 years.

    5.Mortality charges: See my next article in Rediff, you will understand.

    6. Comparing wrong type of returns:

    From the fouth to the tenth year investments in mutual funds will take place in this option also. So in case Amit dies, what his family will get is 45 lakhs+ fund value. There are no different fundas here.

    7.Commission under ULIPs:

    ULIPs have a three year premium paying period, therefore commission for three years is considered. Term plan premiums have to be paid for 25 years, therefore commission for 25 years is considered. Do you find it strange? Also, in ULIPs from the third year only 2% commission is paid where as in term plan it is 5% till the end of the plan period.

    7.One of a kind scheme:

    When there is a ULIP available which gives a higher life cover, I dont understand your logic of assuming investment in those ULIPs where the life cover is lower.

    8. Can you show me which mutual fund has given an annualised return of 105% over a longer investment horizon? For Five year return period the best fund is Reliance Growth which has given 60.81%. For three years, it is Magnum Global with 66% return.

    On the one hand you say advisors paint a wrong picture by taking unrealistic returns while selling ULIPs. And here you are, asking people to invest based on one year’s return of 105% (fund?)

    Sanjeev

  • Deepak Shenoy says:

    >Sanjeev, thanks for your comments. I believe you’re the one with the lack of understanding of the product. Let me explain.

    1. You can’t assume an 18% return always. The historical return of hte nifty is about 12% and in the last few years, ULIPs have underperformed by about 40%. You have to assume that, and then your risk cover (which keeps increasing every year) will not be covered. In fact, just two bad years and your policy will lapse.

    2. Ease: This is just not true. Most people I know will be happy to pay lower premiums, year on year. No body wants to pay 1 lakh a year or even those 50K a year ULIPs. 15K a year is quite affordable for one who needs a 45 lakh cover. Secondly, ULIPs are successful because of misselling, not anything else.

    4. You’ve compared wrong terms. If you want a 25 year cover, you can use a dividend plan on your MF investment and get enough return to cover your temr plan also in the same way. You don’t seem to compare that.

    5. I will wait for the next article.

    6. Very different fundas. If you wnated to really compare that you should compare a Term Plan plus dividend paying MF, as against what you have compared (which is a combination of ULIP for first three years, plus term plan for the rest)

    7. If one ULIP is good, then it doesn’t mean the entire ULIP universe is good. this si a one-off policy – all other ulips simply loot investors by paying high commissions. And guess what, advisors make lots of money that way.

    8. I don’t see the logic of your saing “ULIPs are better” when there is only one ULIP that matches the criteria. Choose to highlight ONLY that ULIP. In general they loot people, don’t they?

    9. Please don’t twist the logic. My funda was that MFs have given DOUBLE return for the same time frame as compared to ULIPs. You can’t give me a ULIP that has even existed 10 years ago, no?

    in annual investments it is not the mutual fund growth that matters. It’s the internal rate of return for the cash flows. If you use that formula, you will see how, for the same cash flow in MF versus the investmetn part of the ULIP, the ULIP is far inferior.

    And this is not one year returns of 105%. it is ANNUALIZED three years of returns from HDFC taxsaver, considering the three different investment chunks that were put in.

    If you are a financial person, consider this the yearly averaged return. I can demonstrate on an excel sheet how this is calculated. Put the investments for each year in one column, assume an interest rate, and calculate return for each year, compounded every year. For the HDFC Taxsaver investment the yield is 105% annually, and the ULIP yields 45%.

    And I am sure that going forward the ULIP will underperform any good MF severely.

    – Deepak

  • hari says:

    >Hi Deepak,

    Another astounding article from your side. ULIPS are not the way to go.I find a lot of misselling.Also I have found this fact when I was speaking to my colleague at my office. These ULIP promoting “greedy” so called financial experts say that its enough if you pay the premium for 3 years. Also Deepak the other reason why people do not understand the greatness of term plans is that they are not able to digest the fact that if nothing happens to them they will not get the money back.This is the main reason why term plans are not so popular.
    Thanks for the article. We are all indebted to you for the charity you are doing to us in the form of such wonderful articles.

    Regards
    Hari

  • Raghuraman says:

    >Hi Deepak,

    I was waiting for an article on this topic to come. Thanks to you for this. Nice one too… May be we cud have some more nice articles on insurance as this seems to be “THE TOPIC” of the day and everyone is out to get the best policy these days…and insurance companies keep cashing in..Keep them coming Deepak…

    Cheers,
    Raghuraman

  • Anonymous says:

    >Hi Deepak,
    I had put 25000 half yearly in HDFC Endowment Suvidha Plus for a 20 year term with 5 Lakhs sum assured. First year 60% allocation charge and from 2nd year onwards 1% allocation charge.Can you advice me when can i surrender the policy? I need what i have invested.I think this is going to hurt me badly..

    Ramesh

  • Deepak Shenoy says:

    >Ramesh: I couldn’t find a HDFC Endowment Suvidha Plus on the HDFC assurance web site. But I assumed Unit Linked Endowment plus and checked.

    The surrender charge, according to the brochure, is “60% of the difference between the regular premiums expected and received in the first year of the contract”. but you will get that only after three years of the policy. Perhaps Means no surrender charges if you paid hte first year premium in full, but you’ll get the money only after three years of the contract.

  • Anonymous says:

    >Hi Deepak,
    Thank you for your views. Its Endowment Suvidha Plus only. I checked my policy. But they dont have the details in their website. Thanks once again.

    Ramesh

  • Jackson David says:

    >The whole crux of Sanjeev’s argument lies on someone getting such a high level of cover on the ULIP premium (because ULIPs actually subsidize the mortality charges with other charges on premium). This is not easy and practically no insurer is willing to give such a high cover. The max they normally go is 40 times annual premium.

    Also, the specific example you have chosen is among the lesser of evils. Here in my place in Kerala, what is being sold mostly by the whole lot of corporate agents are ULIPs with up to 70% premium allocation charges in first year. Simple robbery !!!

  • Anonymous says:

    >Hi Deepak,
    Need your opinion on the following option

    I have decided to go with Term Plan + MF …

    Now for term plan , would you suggest LIC Jeevan Anmol or Reliance Term Plan ( both no money back on maturity) . I am looking for a cover of about 25 years

    For Mutual fund , Please suggest some good plans I could look at.Should I look at established funds with a track of 6 odd years or newer ones …

    Details : – Female , 32 , widow , one child ( 4 years)

  • Deepak Shenoy says:

    >Anon: I’d say go for either – but LIC has a longer experience in claims processing, so if the difference in cost is not much you might want to go with LIC.

    Mutual fund: for tax saving, SBI Magnum Taxgain has been excellent. There are good funds that have crossed 5 years in existence – Reliance Growth/Vision, SBI Magnum Taxgain etc. Some of the newer ones have performed well recently too (DSPML TIGER for instance)

  • Sreeni says:

    >Take any number, any number of permutations and combinations.. Simple rule of thumb.. “Dont consider the Insurnace as an Investment” like “Dont ask the God when are you going to die”

    I totally agree with Deepak, I only buy Term Insurance without return.. just keep paying that minumum premium and feel good that you care about your folks..
    Thanks Deepak, keep your good work

  • sahil says:

    >hi deepak..well i guess all the tables u have taken are from the same rediff article,which itslef is not worth it as i think he has taken huge mortality charge..so that is wrong,one.that is y mutual funds returns seemed higher.2nd the rediff artilce says the fund mgt fee in ulips is on avg 2.25%,which again is wrong,as the highest fee in ulip is only 1.6% and most of thm charge 1.5% and hdfc charge 0.8%.
    now c this..if this person invest 1.5 lacs,one time for term plan he can easily get 30 lacs cover.remaining 2.5 lacs if he invests in sbilife unitplus single plan,which stands cheaper thn mutual funds also,this also one time,he acn take a cover of 6.25 times on his investment(6.25 * 2.5 lac ) , he will be adequately covered for more thn 15 lacs and will be covered for 25 years without..moreover he will get nearly 17lacs on maturity,assumin his investment grows at 10%,even if it does not grow at 10%,he will always be covered and definitly he will get some return.and in this case u will not found what u saw when u searched at ipru site..again the maturity proceeds for himn will be tax free in this case.m not a regular visitor,so u can write me at ichishti@gmail.com

  • Mandar says:

    >Hi Deepak,

    I had stumbled upon your blog while i was deciding to buy a ULIP to cover my home loan. And your analysis on ULIP’s was an absolute eye opener. I have actuall turned into a crusader discouraging people around to resist from buying a ULIP.

    I am a M/27 married with a 4 monh old baby. I am looking for a Term plan, and sure you will agree that no cos intend to sell them readily.

    Request your advise on a term plan for a 25-30 year term and cover of 25-30 lakhs. In one of your discussions i have read about double/ triple accident cover. Also are riders like Total permanent disability helpful.

    Thanks & Best regards,

    Mandar Karnik
    mandarkarnik7@yahoo.com
    karnik.m@gmail.com

  • Anonymous says:

    >Hi,
    I want review about invest asure flexy plus from tata aig which gives 60 times insurance for 80 years of age isn't it benificial to me?
    My ageis 41.With term plan of reknown co. like lic, icici or reliance it cost me 15000(approx) annualy for 20lacs ins & give coverage for age 65 only !If i take same coverage up to age 80 with flexy plus i have to pay 34000(approx)anualy.Now if i take TP+MF(15000+19000)What will be difference in gaining after 20 years?& With TP after 65(my age)i will not get money &coverage if i m alive! if u suggest me for cheap TP like Iterm can i trust? (regarding claim settelment)
    Dr pallav-9426276825