NO – LTCG on equity does not make ULIPs better

Unit Linked Insurance Plans (ULIPs) have always been aggressively positioned in India.  The recent (re)introduction of Long Term Capital Gains (LTCG) Tax on equity has added another dimension to the promotion of ULIPs. In this illustrative post, we look at how Equity mutual funds still provide better post-tax returns due to their flexibility and choice.  To help the comparison, all the assumptions will be biased in favour of ULIPs.

Promotion
Promotion

What are ULIPs

We assume that the reader is familiar with ULIPs. In short these products combine investment with insurance. Your investment (net of charges) goes into a fund that works just like a mutual fund. The funds are managed by the insurer and you have to choose only from the handful of options. Fund management charges, as well as the insurance charges, are deducted from the value of the fund.
For more information, you can read this link from HDFC Life. (For illustration, this articles uses information on products from the HDFC group.)

Comparison Scenario

Since insurance itself is a must-have for any investor, the appropriate comparison would be  this: a) ULIP  vs b) Mutual Funds + Term Insurance.  We would use this comparison.

Insurance Charges/Mortality rates

In a term insurance plan, the premium amount is paid as per the schedule. In an ULIP, the mortality charges are deducted from the fund value by cancelling units. Mortality charges themselves are well researched and regulated. For simplicity, we will assume that the effect on the investible amount is the same in both cases. i.e. The buyer pays 16,000  for the ULIP (of which Rs 1,000 is used for mortality charges); for the second scenario, the buyer pays Rs 1,000 for the term insurance premium and invests Rs 15,000 in the chosen mutual fund. 

Fund Management Charge/Expense Ratio

In mutual funds, the published NAV is net of expenses.  The ULIP funds deduct a fund management charge. It is not clear if the indicated returns are inclusive of the charges are net of the charges. Some insurers suggest that the daily unit price is net of charges. An example is the statement from HDFC Life: 

“The daily unit price is calculated allowing for the deduction of the fund management charge, which is charged daily.”

For simplicity, we would assume that the returns are net of the charges for ULIPs. This then makes them similar to mutual funds.  (Note: Most direct plans in equity have TER comparable to or less than typical fund management charges.  For debt, the fund management charges are higher than the TER of debt funds.)

Other charges

There are plans, particularly online, which have low or zero other charges – premium allocation charges, administrative fees, etc.  For simplicity, and to err on the side of ULIPs, we would ignore all these charges.

The three comparisons put together make the comparison straightforward – we directly compare the published returns and expected returns.

ULIP choice

Every life insurance provider in India has a number of ULIP products.  A lot of these companies also have associates in the mutual fund business – SBI Life and SBI AMC; HDFC Life and HDFC AMC; ICICI Pru Life and ICICI Pru AMC, etc. The insurance comparison websites provide a view of the various features of the ULIPs.   One such comparison is below. (Assumption: Payment of Rs 20,000 every month for 12 years)

Information courtesy CoverFox

The difference in estimated returns is due to the variety of charges. The historical performance of the funds, as well as the choice of funds, vary across the insurers.  Balancing all the factors, we would choose HDFC Life Click2Invest   The performance snapshot of the 8 funds is below.

Data courtesy CoverFox

Among the funds, we would choose the Blue Chip Fund. Based on this, we would also select the category of large cap in mutual funds. Large cap funds provide a better balance of risk and returns.  If one wants to use the data for Opportunities Fund, the appropriate mutual fund category would be multi-cap funds.  To have a favourable comparison, we can check that among the ULIP large cap funds, HDFC Life’s fund indeed has the best 5 year performance.

 

Mutual Fund choice

Since we have picked a large cap fund from the ULIP space, we would look at the large cap category.  A quick selection in VRO gives us the following list.  Please note that  many of the well performing mutual funds easily outperform the ULIP funds. 

Open-ended – Equity: Large Cap – Return Five Year – Top 10

Fund Rating Category Launch Expense
Ratio (%)
5-Year
Return (%)
5-Year
Rank
Net Assets (Cr)
Reliance ETF Junior BeES  |  Invest Online Feb-2003 0.23 20.35 1/62 542
JM Core 11 Fund Mar-2008 20.24 2/62 36
Reliance Large Cap Fund  |  Invest Online Aug-2007 2.30 20.09 3/62 11,601
ICICI Prudential Nifty Next 50 Index Fund  |  Invest Now Jun-2010 0.85 19.83 4/62 300
IDBI Nifty Junior Index Fund Sep-2010 1.74 18.83 5/62 53
SBI Bluechip Fund  |  Invest Online Feb-2006 2.35 18.10 6/62 20,702
HDFC Top 100 Fund  |  Invest Online Sep-1996 2.02 17.49 7/62 15,874
Aditya Birla Sun Life Focused Equity Fund  |  Invest Online Oct-2005 2.36 17.42 8/62 4,263
ICICI Prudential Bluechip Fund  |  Invest Now May-2008 2.08 17.17 9/62 19,836
Motilal Oswal Focused 25 Fund – Regular Plan  |  Invest Online May-2013 2.38 17.10 10/62 1,171
Sourece: Value Research Online
By default, VRO lists the regular plans.  The 5 year return of  the direct plan of HDFC fund is 18.3%

Comparison of Net Returns

With the information that we have collected so far, we look at the returns from the two scenarios.   Since mutual funds have more flexibility and better overall returns, we have assumed a difference of 1.5% in the returns compared to ULIPs.

Comparison ULIP Mutual Fund
Provider HDFC Life HDFC AMC
Plan Name HDFC Life BlueChip Fund HDFC Top100 Direct
Investment amount

(15,000 per month)

1.8 lac per year 1.8 lac per year
Investment period 20 years 20 years
Assumed XIRR 12% 13.5%
Total invested amount 36 lacs 36 lacs
Corpus after 20 years 75.15 lac 85.99 lac
Taxes 0 4.99 lac
Net corpus after tax 75.15 80.99
It is clear that the mutual fund gives a larger corpus, even after taxes. In fact the difference is positive even if the difference in the two CAGRs is only 0.75.  Continuing to err on the side of ULIPs, we have also ignored the fact that LTCG applies only to gains more than 1 lac in any year. Most investors would chose to book these capital gains every year.  With that assumption, the corpus for equity fund would be higher by about 1.8 lacs.

Wait, what about 80(c) savings

It is true that the entire amount of Rs 16000 is tax exempt in the case of ULIPs. For the second scenario, only the term insurance premium of Rs 1,000 is tax exempt. However, most investors have enough ways to fill up the 80(c) limit without having to buy a high cost product like ULIP. (Please see this article for a partial list.) 

For other supposed advantages of ULIPs over mutual funds, you can read this article: Do not buy ULIPs because equity mutual fund LTCG will be taxed!  

Conclusion

In this comparison, we loaded the odds in favour of ULIPs.  The only advantage provided to mutual funds was the assumption of higher returns. In spite of the unfavourable odds, we see that mutual funds can be expected to give a higher corpus even after accounting for taxes.  So continue to say a big NO to ULIPs.

 

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