When we talk about Unit Linked Insurance Plans (ULIPs), the detractors point to higher charges that lead to lower returns. On the other hand, the proponents point to the favourable low-cost structure that came into existence after IRDA revised Unit Linked Regulations, 2010.
Both seem to have a valid point. Higher charges do eat into the returns. On the other hand, the new-age ULIPs are nowhere close to their evil avatars in the first decade of this century.
Who is right?
In my opinion, both are to an extent. However, it is still a better choice to segregate your investment and insurance needs.
Let’s first look at the charges in a Unit Linked Insurance Plans.
What are the various charges in ULIP?
Nomenclature and quantum may vary but charges will normally follow a similar structure.
- Premium Allocation Charges (charged as a percentage of annual premium)
- Policy Administration charges (flat charges or percentage of premium)
- Fund Management Charges (% of your fund value, capped at 1.35% p.a. by IRDA)
- Mortality charges (this portion goes towards providing life cover)
Various insurance companies can do innovation and play around with various levels of charges. Fair enough.
The intent, in this post, is not to get into the nature and level of charges in a ULIP and how it affects your returns. I have discussed this aspect in detail in an earlier post.
In this post, I want to focus on how much you pay to get life cover in a ULIP. It will also be useful to compare the price for the same life cover that you will pay for a pure term insurance plan.
How is mortality charge in a ULIP calculated?
The premium of a term life insurance plan can be construed as pure mortality charge since there is no element of investment involved.
In case of a ULIP, the calculation is a bit more nuanced.
Mortality charge depends on the Sum at Risk.
Sum at Risk is the amount that the insurance company has to pay from its pocket in the event of the death of the policyholder.
In a type-I ULIP, the nominee gets the HIGHER of (Sum Assured, Fund Value). Therefore, as the fund value grows, Sum at risk goes down.
In a type-II ULIP, the nominee gets the SUM of (Sum Assured, Fund Value). Therefore, Sum at Risk remains constant at Sum Assured.
For more on Type-I and Type-II ULIPs, go through this post.
Moreover, while the premium for a term life insurance plan remains constant during the policy term, the mortality charges increase every year in a ULIP.
In case of a ULIP, there is a mortality table. In the table, mortality charges are expressed at per thousand of Sum at Risk per annum.
An example of mortality table is provided below.
Therefore, as per mortality table, if the entry is 3 for your age and the Sum at Risk is Rs 10 lacs, you will pay mortality charge of Rs 3 X (Rs 10 lacs/Rs. 1,000) = Rs 3,000 for that year.
And mortality charges increase with age. Therefore, assuming Sum at Risk remains constant (which it would in case of a Type-II ULIP), your mortality charge will increase as you age. Mortality charges are typically recovered from you on a monthly/quarterly basis through cancellation of fund units.
Continuing with the above example, units worth Rs 250 (Rs 3,000/12) will be cancelled (redeemed) from your account every month. Please note I have not yet considered the impact of GST. GST shall be charged on the mortality charge.
ULIP vs Term Life Insurance: Comparison: Mortality Charges
Let’s try to see how much you pay to get life cover for the same amount under a term plan and a ULIP.
For the comparison. I have picked up a pure term insurance plan and a ULIP from the same insurance company. I have picked up ICICI Prudential iProtect Smart plan (a term plan) and ICICI Prudential Wealth Builder II (a type II ULIP).
We consider a 30-year old male who wants to purchase a life cover of Rs 1 crore for 30 years.
The premium for the term plan will be Rs 10,978 per annum. Do note the premium stays constant for the next 30 years.
Now, let’s compare this to mortality charges in a ULIP. I will use the mortality table ICICI Prudential Wealth Builder II plan.
You can see, for the same feature (same level of life cover), you are paying a much higher amount in case of the said ULIP.
Points to Note
With ULIPs, the Sum Assured (death benefit) is typically a multiple of Annual premium paid.
Therefore, if your annual premium is Rs 50,000, you will get a life cover of Rs. 5 lacs (10 times the Annual Premium). In general, Sum Assured is not less than 10 times Annual Premium since, in that case, your tax benefits for premium payment may get affected. Moreover, the maturity proceeds won’t be tax-free.
If Sum Assured is a higher multiple (greater than 10), then a lot of your money will go towards mortality charges, which will impact returns. Therefore, most companies settle at 10 times annual premium for young people.
Therefore, to purchase a life cover of Rs 1 crore under a ULIP, you will have to pay an annual premium of Rs 10 lacs. Seems out of bounds for most people.
If you are too adamant about avoiding term plans and can’t afford such a high premium, you may end up being under-insured.
Additionally, you can see the mortality charge in a ULIP even depends on the Sum Assured. The mortality charges are much higher for a low Sum Assured. I don’t understand the reason behind this sharp difference.
I have considered a Type-II ULIP for my analysis. Therefore, the Sum-at-risk for the insurance company remains constant.
If I had considered a type-I ULIP, the Sum-at-risk would have consistently gone down due to rise in fund value. In fact, once the fund value breaches the Sum Assured, there is no Sum-at-risk for the insurance company and hence the mortality charge will not be applicable. Now, you know how Type-I ULIPs will give you better returns than Type-II ULIPs. However, do note the coverage is lower in Type-I ULIP.
Clearly, there is a sharp difference between the price you pay for getting the same level of life cover under a ULIP and a term life insurance plan.
As I understand, the underwriting norms for a unit-linked insurance plan (ULIPs) are relatively relaxed as compared to a term insurance plan. A part of the reason is that the level of risk that an insurance company takes may not be as high. After all, the Sum Assured is a multiple of annual premium (as discussed above).
In case of term life plan, you get a cover of Rs 1 crore by paying a premium of mere Rs 10,000-15,000.
Because of these relaxed underwriting norms, it may be easier to purchase a ULIP as compared to a term life insurance plan. Many who may be declined coverage under a term plan may be offered life cover under a ULIP from the same life insurance company.
However, if you can qualify for a term life plan, does it make sense for you to pay higher mortality charges under a ULIP?