A friend entered HDFC Life office to surrender an existing ULIP. He came out with a new one. Essentially, he surrendered his existing one and was convinced to purchase a new one.
As I understand, the said friend was not satisfied with returns on this existing ULIP. They sold him a ULIP which had a fund with very good returns.
Full marks to HDFC Life on salesmanship.
ULIPs have become quite attractive to a number of investors since the introduction of tax on LTCG in equity funds. There is no such tax on proceeds from ULIPs. Even though I have highlighted various other issues in ULIPs, I cannot deny the huge tax advantage ULIPs offer over equity funds.
One of the issues that I have with ULIPs is that of charges. In this post, let’s look at how various charges in ULIPs can destroy wealth for you.
How can Charges in ULIP destroy wealth?
Let’s look at the charges in the plan that my friend purchased: HDFC Life ProGrowth Plus
Premium allocation is deducted upfront from the premium paid. Therefore, if your annual premium is Rs 60,000, Rs 1,500 would be deducted from the premium upfront. Of course, there will be GST over and above it.
Policy administration charge is recovered by cancellation of units. As you can see, the charges mentioned are expressed as a percentage of the annual premium (to be deducted every month). 0.42% per month of annual premium translates to 5.04% per annum. If the annual premium is Rs 60,000, the net impact will be 5.04%* 60,000 = Rs 3,024 per annum. GST extra.
Let’s how these charges add to the costs.
You can see, 6 to 10% of the annual premium is going towards meeting these charges. This is bound to affect your returns from the plan.
The bizarre part about Policy Admin Charges
For the first 5 years, it is 0.42% of annual premium per month. From the years 6 till 10th, it goes up to 0.83% per month. Why?
Ideally, you would expect the charges to go down.
From the year 11th till 15th year, it is zero. Then again, from 16th year till 20th year, it goes up to 0.83% per month.
I have no idea. Perhaps, HDFC Life can explain.
Fund Management Charges and Mortality charges
Policy admin and premium allocation charges are not the only charges.
Any ULIP will have Fund management charges (FMC) and mortality charges. However, these charges are quite justified.
FMC is for managing your funds. Mortality charges go towards providing life cover.
The impact of FMC is built into the fund NAV. Mortality charges are recovered through cancellation of fund units.
Now, this is an important aspect
Typically, we compare performance simply by looking at NAV.
However, in case of ULIPs, some of the charges (mortality and policy admin in this case) are recovered through cancellation of units. Therefore, the impact of these charges will not reflect in the NAV. These charges reduce the number of fund units you own (effectively your fund value).
Premium allocation charges is levied on the premium upfront (before the money gets invested). So, even this charge will not reflect in the NAV.
Therefore, your ULIP fund NAV is not the true indicator of the returns you will get.
Most sales presentations will focus on the NAV. However, unlike mutual funds, growth in NAV is not your return in ULIP.
What is the impact of these charges on returns?
To calculate returns, we will have to make a few assumptions.
Here, I will ignore the impact of mortality charges.
Essentially, we are looking at the impact of Policy Admin and premium allocation charges.
To further simplify calculations, I will deduct Policy Admin charges at the end of the year (and not on monthly basis). Btw, this step will only have a positive influence on returns.
Assuming the ULIP fund gives a constant return of 12% p.a., these twin charges will reduce the return to the investor to 11.23% p.a. over 15 years. In my opinion, this is a huge hit over the long term.
Do note this is before the impact of mortality charges. Mortality charges will reduce the returns further. The impact of FMC is already adjusted within the NAV. Therefore, there will no additional impact due to FMC.
Moreover, since the policy admin charges and premium allocation charges are constant while returns (in reality) won’t be, the sequence of returns can also a role of play in determining your returns.
Let’s contrast HDFC Life ProGrowth Plus with HDFC Click 2 Invest
HDFC Click 2 Invest is a very popular ULIP from HDFC Life.
Let’s compare the charges between the two ULIPs.
#1 Fund Management Charges are the same under both ULIPs.
In fact, Fund Management Charges are capped as per IRDA guidelines at 1.35% p.a. As I see, both these ULIPs give you the same choice of funds.
Therefore, fund performance (NAV wise) will be exactly the same.
#2 HDFC Click 2 Invest has NIL Premium allocation and policy administration charges. On the other hand, these charges in HDFC Life ProGrowth Plus range from 6 to 12% of the annual premium in the first 10 years.
It is not difficult to see that HDFC Click 2 Invest will deliver better returns than HDFC Life ProGrowth Plus.
Comparing mortality charges of HDFC Life ProGrowth Plus and HDFC Click 2 Invest
Since mortality charges can also affect returns, let’s compare the mortality charges too.
I have captured the tables from the policy wordings of the two ULIPs.
Mortality table for HDFC Life ProGrowth Plus
You need to refer to Age and Column “1” for corresponding values.
You can see mortality charges increase with age.
Mortality charges are expressed as per 1,000 of Sum at Risk. If the value for a corresponding age is 1.5, the insurance company will charges Rs 1.5 for every Rs 1,000 of Sum at Risk for the year.
Since both these plans are Type-I ULIPs, the Sum-at-risk will go down with the rise in Fund Value.
Sum at Risk = Death Benefit – Fund Value
Therefore, the impact of mortality charges will go down gradually as the fund value grows.
If the Sum at risk is Rs 3 lacs and mortality charge is Rs 1.5 per thousand, the mortality charges for the year will be Rs 1.5* 3 lacs/1000 = 450. These charges are adjusted on a monthly basis.
After a couple of years, even though the rate may be Rs 2 per 1,000 of Sum at risk, the total impact may be lower because the Sum at risk may have gone down to say Rs 2 lacs. 2*2 lacs/1,000 = Rs 400 for the year
Now, let’s look at mortality table from HDFC Click 2 Invest.
You can see HDFC Click 2 Invest has lower mortality charges (than HDFC Pro Growth Plus).
For instance, for age 30, the value under HDFC ProGrowth Plus plan is 1.77. The value under HDFC Click 2 Invest is 1.0555.
I have never really been able to understand why this should happen.
Well, the insurance company can always say that they have laxer underwriting norms in HDFC Life ProGrowth Plus and hence higher mortality charges. However, from an investor’s point of view, it is an unnecessary cost with no real benefit.
Therefore, HDFC ProGrowth Plus is a worse plan (as compared to HDFC Click 2 Invest) in each and every aspect.
It has higher premium allocation, policy admin and mortality charges. The choice of funds and the FMC is the same.
Why would any investor go for HDFC ProGrowth Plus (instead of HDFC Click 2 Invest)?
By the way, the mortality charges in even HDFC Click 2 Invest are way higher as compared to a plain vanilla term plan. Under a term plan, you pay only mortality charges (and nothing else). So, fairly easy to do this comparison.
The question we all need to ask HDFC Life
Why do they have a ULIP with such high charges? Perhaps, an unfair question. It is their prerogative.
I do understand HDFC Life Click 2 Invest is a purely online plan and thus can afford to have lower charges. However, the charges in HDFC ProGrowth Plus are still quite high. This plan was sold by HDFC Life branch officials themselves. Hence, there is no need to incentivize intermediary.
If a ULIP had to be sold, they could have asked him to purchase HDFC Life Click 2 Invest there and then.
The investor could have invested in the same (well performing) fund through other ULIPs too. Why did they not recommend a cheaper ULIP?
Did they tell him about HDFC Click 2 Invest? No.
Did they tell him that the said fund was a midcap fund and hence the results in the past 5 years were so good? No.
By the way, my friend didn’t know that. I suspect that the salesperson didn’t know that either.
In no way, do I intend to absolve my friend. He must take a fair share of the blame. He should have done some research before purchasing the plan.
Even though I wouldn’t this case an example of blatant mis-selling, HDFC Life could have done a better job.
What is the lesson for us?
- No two ULIPS even from the same insurance company are the same.
- The returns will vary due to the nature and quantum of various charges.
- Even if you have decided to invest in ULIPs, do look at the quantum of these ancillary charges (Premium allocation, policy administration charges etc).
- The only two charges that you will always find in ULIPs (and rightly so) are Fund Management Charges (FMC) and mortality charges. Any other charge is an unnecessary burden.
- Therefore, if you find a ULIP with any charge apart from FMC or mortality charges, give it a pass.
- There are quite a few ULIPs that have FMC and mortality charges as the only charges. HDFC Click 2 Invest is an example.
- There may be contingent charges such as discontinuance charge, switch charge etc. No issues with such charges.
- Purchasing an online ULIP will help you reduce the impact of charges and effectively increase your returns.
Is this post a recommendation to purchase HDFC Click 2 Invest?
But yes, if someone were to put a gun to my head and ask me to choose between HDFC Life ProGrowth Plus and HDFC Life Click 2 Invest, I will go with HDFC Life Click 2 Invest.
Since this is hardly ever the case, you need to decide first if a ULIP is the right product for you. I have covered various pros and cons of ULIPs in this post. This should help you make the right choice for you.
However, if you must invest in a ULIP, you can pick up one with the lowest charges and good fund performance. Always remember, returns can vary. Costs are guaranteed.
I picked up the case of HDFC Click 2 Invest to highlight:
- A subtler aspect of mis-selling (HDFC Life could have sold a cheaper plan)
- That not all ULIPs (even from the same company) are alike
- That you need to look at all the charges while making a decision. There are quite a few ULIPs where there is no premium allocation or policy admin charge. If you must invest in a ULIP, pick up one of those ULIPs.
- That you must look at the quantum of mortality charges too while making a choice.
Are you planning to invest in a ULIP? If yes, have you looked at all the charges?