As financial planners, we get queries from our clients on how to go about managing their finances. We were recently faced with a rather interesting query related to ULIPs. In this article we discuss the query and our solution for the same.

Let us look at the information available,

• The client's age is 38 years and he wants a life insurance cover for Rs 5,000,000. He has an above-average risk appetite.
• He has been recommended a ULIP (unit linked insurance plan) by his insurance agent with a sum assured of Rs 5,000,000 till he reaches the age of 84 years. This works out to the client being insured for a tenure of 46 years (i.e. 84 - 38).
• The premium paying term however, is only ten years and the actual premium he will have to pay per annum is approximately Rs 894,000.

 

The client has also been advised by his agent to consider investing his premiums in the 'Aggressive' (as has been defined by the insurance company in question) option, which allows upto 35% exposure to equities.

 

We have always maintained that one's interests would be best served if he keeps his life insurance and investment needs distinct.

Given below is our solution based on the client's needs.

 

The insurance component

To begin with, we knew from our interaction with the client and based on the Human Life Value Calculations that he is underinsured. An immediate action point for him would be to buy a term plan. And considering his annual income, he would need to buy a term plan for more than the sum assured recommended on the ULIP (i.e. Rs 5,000,000). Even if we were to consider his sum assured to be Rs 5,000,000 (as per the ULIP) for a term plan, the annual premium he would have to shell out would be approximately Rs 30,000 per annum for a 30-Yr period.

 

The investment component

Having taken care of the client's insurance needs, now let's shift our focus to his investments. We took into consideration the client's current financial portfolio. He had a sizable portion of his portfolio invested in fixed income instruments like bonds and fixed deposits. Bearing this in mind, our view was he did not need to have another debt-heavy (ULIP with a 65% debt component) product in his portfolio. Instead what his portfolio needed was a higher equity component; this would not only balance's his portfolio but also ensure that the portfolio reflects his true risk profile.

 

It was also relevant that the client invest in equities since he was considering his investments from a long-term (over 30 years) horizon. This could be achieved by investing in equity-oriented mutual funds. Mutual funds can offer several benefits:

 

• Several studies have shown that over the long term, equities give a higher return vis-à-vis fixed income instruments like bonds and gsecs. And given that the client's investment horizon is of over 30 years, this is an ideal time frame to reap the rewards of investing in equities. Also, over a 30-Yr period, a 100% equity mutual fund is better geared to outperform a ULIP portfolio with a 65% debt component.

• ULIP tend to be expensive propositions (vis-a-vis mutual funds) during the intial years. However, over longer time horizons, the expenses balance out and ULIPs work out to be cheaper as compared to mutual funds. However, even if the lower expenses of a ULIP vis-à-vis that of a mutual fund scheme were to be considered, the latter would still surface as the better option.

• Several mutual funds also have a track record to boast of. PersonalFN recommended equity-oriented funds have a proven track record extending over several years and across market cycles. ULIPs do not have much of a track record to show for; in fact most ULIPs are yet to experience a bear phase.

• Investing in a mutual fund portfolio will offer the benefit of diversification to the client. The investor will reap the reward of diversifying across several fund management styles. On the other hand, by investing all his money in just one ULIP, the client would be committing his entire corpus to just one style of investment. This can prove to be quite risky over the long term.

• You can make adjustments to your mutual fund portfolio. If you believe you have made a wrong investment decision, you can redeem your investment in a particular mutual fund and invest in another one. Such adjustments are not entirely feasible in a ULIP.

The tax aspect
We also had to contend with Section 80C tax benefits. However, given the client's annual income, the Section 80C tax benefits were being taken care of by way of Employees Provident Fund (EPF) as well the recommended term plan. The client therefore can invest in regular diversified mutual funds and not necessarily in tax saving funds (ELSS).

 

As can be seen, term plans combined with mutual funds have the potential to add considerable value to an investor's portfolio. In our view individuals should first ensure that they are adequately covered by opting for a term plan. Then they can either opt for ULIPs for the investment component or as we have shown, they can consider mutual funds.

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