Recently, I read about a couple of life insurance companies highlighting the launch of small cap index funds. Link 1 Link 2
This is a new phenomenon. You don’t often see a life insurance company launching index funds. Usually, mutual fund companies do that.
Hence, this came as a surprise to me. However, there is a catch. To invest in that small cap index fund by a life insurance company, you will need to invest in a ULIP (Unit-Linked Insurance Plan). A life insurance company can add an index fund to its suite of ULIP funds. But you can invest in these funds only if you invest in a ULIP.
You can’t just invest in an index fund by a life insurance company, just like you invest in mutual funds.
Sounds complicated, no? Let’s break down the product structure a bit.
Note: This post is not about whether you should or how much you should invest in small cap funds. Yes, these are good times to launch small cap funds. Small cap stocks have done well over the past few years. And nothing sells like good past performance. Makes good business sense for the product seller. This post is about life insurance companies launching an index fund. The life insurers could have very well launched a Nifty 50 index fund and we would still be having the exact same discussion.
What are ULIP funds and how does all this work?
You invest in a ULIP product, say from ABC life insurance company.
A ULIP product doubles as an insurance and investment product. Contrast this with mutual funds that are pure investment products. In a ULIP, a portion of your accumulated wealth goes towards providing life cover and rest remains (gets) invested for growth.
The ABC life insurance company will offer you a choice of ULIP funds to invest your money in. ULIP funds are just like mutual funds offered by AMCs (mutual fund houses).
All the ULIP funds offered will be managed by the same life insurer (ABC life insurance company). You can split your money in any pattern you want among that set of ULIP funds.
You won’t get an option to split your money across ULIP funds from multiple life insurers.
Another point to note:
A life insurer may offer multiple ULIP products (say Product 1, 2, and 3).
And multiple ULIP funds (say Fund, A, B, C, D, E, F, and G)
Whether you invest in ULIP Product 1, 2, or 3, you have the choice of investing in any of these ULIP funds.
Now, when you are talking about a new ULIP index fund (say Fund I), it is about adding to the choice of ULIP funds.
Even the existing investors in ULIPs from ABC life insurance will get an option to invest in the new fund (fund I).
However, to invest in Fund I, you must invest in any one of the ULIP products 1,2, or 3 offered by ABC life insurer.
But a ULIP has its own set of costs
Firstly, a ULIP is a life insurance product. And there can no life insurance product without any life insurance component. And life insurance does not come free. There is a cost attached to it (known as mortality charges). And the mortality charges go up with age.
Over and above, there can be other types of charges such as premium allocation, policy administration etc.
Now, if you are not interested in life insurance cover, this is an unnecessary cost.
Secondly, the expense ratio of ULIP funds tends to be higher than mutual funds. Note it does not have to be that way.
IRDA caps the fund management charge (FMC) for a ULIP fund at 1.35% p.a. The life insurers have an option to charge less, but they tend to keep FMC closer to the permissible cap. 1-1.35% p.a. Direct mutual funds tend to have lower expense ratios.
A ULIP investment, once made, faces lower competitive pressures. Why?
Because you can’t exit an underperforming ULIP product whenever you want. The maximum you can do is to move your money from 1 ULIP fund to another (within the same life insurance company). Hence, the same life insurance company still owns your money.
Yes, you do have an option to take out your money completely once you complete 5 years. And move to a ULIP product from a different insurer. However, that’s a lot of work and you can face the same issues with the next insurer too.
Contrast this with a mutual fund. There is no restriction on exiting. Yes, there may be some friction due to tax costs but no rule that prevents you from exiting. You can sell from a scheme from mutual fund house X and reinvest proceeds in any scheme from the same or a different fund house.
How are various charges in ULIPs adjusted?
In 3 ways.
- Directly from the premium installment (Premium allocation charge)
- Through cancellation of units (Policy administration charge and mortality charges)
- Adjusted within the NAV (Fund management charge)
Now, the performance of any ULIP fund (shown on insurer website or other websites) will hide the impact of (1) and (2) on investor returns. Not exactly unfair. But the investor loses a bit of returns to all these charges.
With MFs, what you see is what you get.
Between ULIPs and mutual funds
My opinion is biased, yet logical.
I have written a detailed post on this topic. Note this post was written before the high premium ULIPs became taxable. Suggest you go through the above post.
If I were to choose between index funds (on the same index) from an insurance company and a mutual fund company (AMC), I would likely choose an index fund from a mutual fund company.
Why?
Greater flexibility. Lesser restrictions. Likely lower costs. Agnostic to investor age.
Having said that, the launch of an index fund by a life insurance company is a healthy development. I would hope that this trend continues, and many more insurers add index options to their suite of ULIP funds. And that the insurers don’t limit the choice of index to only small cap indices. Low-cost index options on bellwether indices such as Nifty 50 and Sensex would add a lot of value to ULIP investors.
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This post is for education purpose alone and is NOT investment advice. This is not a recommendation to invest or NOT invest in any product. The securities, instruments, or indices quoted are for illustration only and are not recommendatory. My views may be biased, and I may choose not to focus on aspects that you consider important. Your financial goals may be different. You may have a different risk profile. You may be in a different life stage than I am in. Hence, you must NOT base your investment decisions based on my writings. There is no one-size-fits-all solution in investments. What may be a good investment for certain investors may NOT be good for others. And vice versa. Therefore, read and understand the product terms and conditions and consider your risk profile, requirements, and suitability before investing in any investment product or following an investment approach.
