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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.


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