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Foundations

ULIP Underperformance: Stunted By Guarantees

Unit Linked Insurance Policies tend to be very complex and highly loaded with costs. But some policies have looked good in theory, but they turn out to be dud performers anyhow.

In an email conversation I was referred to an excellent analysis of ULIP costs by RRK which talked about how ULIP costs could actually be low. He used the analysis of an IDBI Federal Dreambuilder Plan, which offers just a first year allocation cost of 3%, and fund management charges of just 1.35%.

Over a 15 year period, the return on the policy beats the return on the mutual fund+Term plan method, according to RRK; the return on the ULIP comes to 30 lakhs while the MF+Term approach gives you just 28.5 lakhs.

(35 yr old, 10 lakh sum assured, 1 lakh per year premium, 15 year policy, 10% returns assumed).

In theory, awesome policy. With low allocation charges which apply only in year 1, the difference is that mutual funds charge an average of 2% as charges every year, and the ULIP In question had only a 1.35% charge. Over the long term, the difference works out to be a gerat

Sadly, the devil is in the details. The fund outperforms because of two “guaranteed” loyalty additions of 3.15% – one at the end of the first 10 years, and the other after 15 years. Without these guaranteed additions, the ULIP would underperform, giving just 28 lakhs after 10 years.

How does the guarantee work? Does IDBI Federal give money out of the goodness of their hearts?

This guarantee is available across most of their ULIPs. Which means that they must bake in the cost somewhere. The answer is: Fund Performance.

Let’s look at the IDBI Federal Equity Fund performance since inception, compared to HDFC Taxsaver and HDFC Top 200, two funds that aren’t the best today but are something that I have used as benchmarks over the last five years. (The IDBI Fund Starts 17-Mar-2008)

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In the last four years:

HDFC Top 200: 53% (Annualized: 10.60%)

HDFC TaxSaver: 45% (Annualized: 9.25%)

IDBI ULIP’s Equity Growth Fund: 26% (Annualized: 5.7%)

The IDBI fund has underperformed by over 3% per year.

We assume that a ULIP fund and a mutual fund will perform at the same level – both after all invest in the same assets. But mutual funds have no such “guarantee”; does the guarantee hurt the performance of the fund?

The cost of this guarantee seems to be hidden inside the fund management strategy. If you assume that the ULIP will do about 2% lesser every year, then the net return, after 15 years is:

Term Plan Plus MF: Rs. 28.5 lakhs.

ULIP: Rs. 23.5 lakhs. About 5 lakhs lesser.

What’s the Point?

That ULIPs are terrible investment vehicles. But you know that.

That there are two kinds of costs: a) stated and b) hidden. Hidden costs are not just shrouded in complexity, they are invisible unless you do the kind of analysis I did above. And who has the time for that?

Needless Complexity

If you’re still here, I consider myself lucky. It’s very boring, complex and unnecessary. Why bother with “guaranteed” loyalty additions? How does an investor know that this gives you a small guarantee but takes away hugely from your return? Why should anyone bother investing in such a policy unless they are excel wizards with too much time on their hands?

If you don’t have the time, invest where the proposition is simple.

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