Investment oriented insurance products are not bad as it completely depends on the investor and need of the investor, said Rahul Parikh, CEO, Bajaj Capital.
Q: Do you subscribe to this view that there is wide perception that investment oriented insurance products are a bad play? What would your opening remarks be?
Parikh: I don’t agree with the view that investment oriented insurance products are bad. I think it depends upon the investor and the need of the investor. They are fantastic vehicles to invest for long term and when I said long term, anything upwards of 10 years is what I would qualify as a right investment horizon for investing into a ULIP kind of product from insurance companies. I believe that they can fulfil both the things the protection part as well as investment part for longer periods of time and generally I think we would encourage young investors to look at ULIP favourably after the chart structure has been modified by the regulator.
Q: The timeline that Rahul Parik also mentioned is important because he is saying if you can be in it for at least 10 years. What is your opening view?
Nath: As what he was telling in the beginning that perception has kind of gained ground that ULIPs are not good or traditional plans are not good and you need to basically separate term and investment and there is some merit in that argument there is no doubt about it. But over the last five to six years after the regulatory changes have been brought about after the cost structure have been rationalised some of these plans have become quite efficient and so investors has to be discernible to figure out which plan to choose, unless he is looking at something which is actually hybrid in kind of investment which is mix of insurance as well as investment. But if he is looking at pure investments then there are certain products with each insurance companies which are as efficient today as a mutual fund.
Q: Just quickly run us through some of the fixed income oriented traditional policies? Of course we are not spending too much time over there because we will be spending more time looking at products which are linked to the equity market but which are the fixed income market linked insurance policies and the sort of returns that one can expect?
Nath: When it comes to fixed income, the traditional plans of insurance companies actually merit a good look. So, whether you look at endowment plans, or money back policies and all the insurance companies have those products which have two features one is assured return. So, an investor is guaranteed a minimum return of 5-6 percent over the lifetime of the policy as well as some guaranteed those additions and bonuses as they call and they call it differently by different insurance companies. So, those plans basically compare well when you compare with vis-à-vis a fixed income investment for an investor who is in a high tax bracket.
If you are going for a fixed deposit at 8 percent post tax you are going to get something like 5-5.50 percent and so if you are let us say looking at a traditional insurance policy which is like an endowment plan it is actually going to give you something similar 5-6 percent kind of return maybe a little more. So, they compare quite well with – but when you look at a ULIP which is a probably a fixed income, there because of the chart structures you may not be at a very efficient stage.
Q: Your take on first of all the traditional policies? Right now we are talking about instruments which are linked to the fixed income market. So the argument that maybe a 5-6 percent return is not too bad, do you subscribe to it because it also takes away the flexibility? All said and done in a fixed deposit at least I have instant liquidity?
Parikh: I would agree with what Raghvendra Nath mentioned that there are good traditional plans which offer you anywhere between 5-6 percent post tax returns and for a person in a high income tax bracket I think it makes immense sense because let us not forget India has a large savings market and the savings market typically ends up investing into products like either deposits or maybe long term products like PPF etc. and there I think such products compare favourably.
Also I think it covers one more need which is the insurance need which helps you to kind of build asset on day one of your investing, so in that sense I would say that large portion of savings market can be targeted through traditional products because they compare favourably on a post-tax bases for people in the high tax bracket.
Q: Can you outline a couple of product examples on the traditional policy side which you think merit some kind of a look at from investors or a policy buyer's point of view?
Nath: It is a very wide segment. In fact, in each insurance company that segment is the widest segment because of the kind of structures that they have, the chart structures. However, generally I found that Life Insurance Corporation (LIC) plans which are traditional, they are quite efficient. There have been some policies which have given as high as 7-8 percent returns also to investors. However, I would not have something very specific that this plan is efficient and this is not, but most of them are in that range of 5-6 percent. As Rahul was saying, it basically depends on what kind of investor you are.
Q: Your thoughts as well, it is a wide sort of a canvas, but if you are looking at traditional plans whether it is an endowment policy, money back policy, maybe some product names as well where the cost structure is low and the returns are fairly efficient?
Parikh: I think Raghvendra rightly pointed out, LIC policies are good option. However, if you were to look at in private sector, we would prefer Birla Secure Plus, Exide Star Saver, and Tata Smart Income Plus; these are the traditional policies that we would recommend.
Q: I know you have done some calculations for us because it is very important to understand the cost structure. We are taking a 10 year period because as both of you highlighted that to do a favourable analysis, let us look at a 10-year period, an investment amount of about Rs 10 lakh which is going to be split in terms of premium that I am paying for the insurance policy and Rs 10 lakh as an investment in a mutual fund and then look at a market return. Now you tell me which is the more efficient product and where do I get better returns?
Nath: If you look at an insurance policy, the charges are split in three or four buckets versus let us say a mutual fund which has one like the total expenses 2.5 percent or 2.6 percent which is regulated by Sebi. So insurance policy will have a mortality charge, it will have a premium allocation charge, it will have a fund management charge. So some three or four charges are levied on the policy. Some of them are a percentage and some of them are absolute amount. So premium allocation charge I observed is an absolute number every time. So the insurance company may charge Rs 6,000-7,000 or Rs 60 per month or Rs 70 per month as premium allocation charges depending on the nature of investment that you are doing.
Q: That remains constant through the life of the policy?
Nath: Let us say in a single premium plan, that charge will be charged one time. In case of annual pay, it will be charged every year till the time you are paying. Then there is a policy administration charge which is charged annually. So typically in a single pay that policy administration charge is very less whereas in a multiple pay and annual pay or a quarterly pay, that charge is higher and that is the reason why initial years a policy is not very efficient because of the multiple charges. However, as the period elapses, then the only charge that you are paying is of fund management charge.
Q: From what I understand, the mortality charges are much higher when you initially buy the policy and then gradually do they reduce?
Nath: It is very interesting in case of a ULIP because in case of a term plan, when you are paying certain sum of premium, your risk cover is constant. So let us say you get Rs 1 crore or Rs 50 lakh or whatever is the sum; here an insurance policy is giving the higher of the two. Your fund value or the sum assured as the risk cover.
Q: Upon death?
Nath: Upon death and therefore as your fund value keeps increasing, the sum assured basically or for which the premium has to be charged, keeps on reducing. So initially it will be higher and then it starts falling down.
Q: Your thoughts on some of these charges and how do they stack up when we are looking at a very neat and tidy figure of 2.5-2.6 percent which would be the total expense ratio for a mutual fund?
Parikh: There are four buckets like Raghvendra mentioned, policy administration charges, premium allocation charges, fund management charges, mortality charge. Now each of these four components, we need to put it in perspective. So, the allocation charges typically for the regular premium kind of policies are higher upfront generally. They range between 0 to 6 percent and then eventually they kind of keep on decreasing.
Also, they can be offset by guarantee loyalty additions. So I think that can take care of some of these allocation charges. Then there is this administration charge which increases with every passing year by 5 percent or so. Then there is mortality charges and mortality charges typically shoot up when one goes 50 years and above. So generally ULIP may not be a right product for anybody above 45 years because the mortality charges are very high and they take a significant sum out of your investment.
All of this when you put together, that is when the initial years you would find that ULIP will underperform compared to mutual funds up to almost 10 years. We did a bit of maths on this, but after 10 years because the only thing which is left out is fund management charge which is significantly better than mutual funds, I think they tend to kind of outperform mutual funds on a similar return basis.
Another thing that I would want to highlight is about the fund performance. We compared a basket of almost 74 ULIPs with around 160 odd mutual funds and we figured out that at least in historic terms a lot of mutual funds have outperformed ULIPs by a significant margin on a CAGR basis which ranges from 100 basis points to as high as 400 basis points over various time periods and I am talking about three years, five years, seven years kind of time period. So I think there is no right or wrong answer in terms of choosing this, but I would advise that it should be a combination of the charges that you are paying as well as the kind of fund performance that the ULIP showcases when you are comparing vis-à-vis an equity mutual fund because that is where the real picture will pan out. Generally speaking, mortality charges being high after 45, one should avoid ULIP and only stick to mutual fund for investment purposes.
Q: Just to put the numbers in perspective, I know you have done this model, so, what we are assuming is that the investment is Rs 10 lakh, I think the age is 40 because that is still a good enough age to consider a ULIP and you are assuming market returns of about 12 percent.
Nath: So let us say you invested Rs 10 lakh in ULIP versus a mutual fund and you invested that money for 10 years and let us say both of them generated the same returns of 12 percent.
Q: Let me ask you one more question – in ULIPs can I be certain that almost the entire amount that I am putting in, the Rs 10 lakh is going to go towards investment because the entire does not, right? So how do I account for that?
Nath: Yes. So that premium allocation charge, which is that 3-4 percent in case of a single pay is what gets deducted. Everything else is going in investment. So to that extent, you are starting with 3 percent less, in case of mutual fund you are starting with 3 percent more. So let us say over a 10 year horizon, ULIP basically and we looked at two ULIPs, we looked at an ICICI Prudential Elite Wealth and we looked at Birla Sun Life Aspire and in both the cases the charges were around similar.
So, the overall charge worked out to something like 1.8-1.9 percent versus a mutual fund – let us say you are going for a regular plan with the help of a distributor and not the direct plan, so there the charge was around 2.5-2.6 percent depending on the size of the fund. That 0.7 percent differential basically amounted to a difference of something almost like Rs 3 lakh on a 10 year period. So Rs 10 lakh would have become Rs 26 lakh in ULIP and Rs 10 lakh became Rs 24.5-24.8 lakh in mutual fund. However, now that difference was not much; that was only Rs 1.5 lakh difference, but because of the tax element now 10 percent, that has got enhanced.
Q: You have raised some very important point, so let’s now boil this down to simple questions – what are the key things as a policy buyer I must ask my broker or distributor before buying a unit linked insurance policies (ULIP)?
Parikh: Two things that you should definitely ask for is what has been the fund performance of the ULIP in the past and what are the charges that are being levied if your sole purpose why you are investing that is for the long-term investment purposes. One additional point I want to make over here in addition to what Raghavendra mentioned is it also depends upon the kind of investor you are. So if you are a retail investor, typically for lower ticket sizes in the ULIPs the premium allocation charges are higher which means that the return comparison that Raghavendra just spoke about of over ten years may significantly vary also we need to remember that in equity mutual fund there is a long-term capital gains and the capital gain is charged at 10 percent plus cess only above 1 lakh. So one also needs to differentiate between the retail and high technology market investor because the calculations will change over year but the two questions which I paramount is what has been the past track record and fund performance and what the charges in the ULIP are.
Q: If you could recommend some of the products, some of the names that you think are fairly decent and is there a lot of variants in these premium allocation charges because that’s a red flag and we as policy buyers need to be aware and constantly ask about the nature of these charges. Is it not very uniform?
Parikh: Raghavendra did mentioned about some of the well performing ULIP. I would add to that Bajaj Future Gain; above 2 lakh there is zero allocation charges but below 2 lakh of premium amount there are allocation charges and its slab wise. So as I said the lower the ticket size the higher will be the allocation charges.
Q: Your advice and some of the products that you have seen are decent to look at?
Nath: The biggest advantage that a mutual fund today offers is flexibility of withdrawal – that liquidity and flexibility of choice. If a fund manager is not doing well he can switchover to somebody else and these are the two things which you are compromising. So the first one which is liquidity is not so important because in every person’s portfolio there will be some investment which he can definitely sacrifice liquidity for long-term which typically is retirement money and in future because the new categorization of mutual funds have come about, the outperformance that the mutual funds have had in the past may come down a bit. So now the ULIPs will have a little more level playing field when it comes to fund performance versus mutual fund.
Q: Any examples you would like to give?
Nath: ICICI and Birla are the two I look at. So Birla Aspire and ICICI Elite Wealth turned out to be quite efficient products and as Rahul mentioned Bajaj also has one of them. So every insurance company will have one product actually.