MUTUAL FUND VS.

INSURANCE

As competition hots up between insurance companies and mutual funds, both are finding
innovative ways of getting business. First it was insurance companies who launched ULIP plans
to snatch away business from mutual funds by promising returns and risk cover end assured
customer that his/her long term goals would be achieved even if he/she was not there to
contribute. He/she would be convinced that his loved ones will not be put to hardships after
he/she was no more. Although the unsuspecting client is never made aware of the high cost of
ULIPs.

Mutual funds could not keep quiet for long and see their business snatched under their nose by
insurance companies.

MFs came up with the novel idea of offering capital growth along with free insurance cover
(there is maximum cover cap) with no medicals and disclosures to be made as demanded by
insurance companies. The insurance premium to be completely born by the asset management
company (AMC).

Mutual funds offer cover for unpaid installments of a systematic investment plan
(SIP). If the term of SIP is 10 years and if investor dies after 3 yrs then 7 yrs unpaid SIP is risk
cover. Risk cover ends as soon as the SIP stops or any withdrawal is made from investment. A
fund house has come out with new plan which offers cover (100 times the monthly SIP amount)
through out the tenure of the SIP provided at least 3 years of installments have been paid. The
cover reduces from the original value to the fund value of SIP installments paid.

One would wonder how come MF have become so generous and offering free risk cover when
there is no free lunch. Through these plans, MFs are committing investors to pay for long
periods. The tenure of such plans is age 55 minus current age. If an investor is 30 yrs old he has
to pay for 25 years to avail of risk benefit. In this manner, MFs have ensured that in case they
have to pay death benefit, the customer will pay regularly pay for 25 years, thus ensuring regular
cash flows, Part of this additional business generated can be parked in safe instruments to pay for
insurance payouts.

One needs to be very sure of his/her paying capacity for such long periods because no partial
withdrawals or switchovers are allowed. If either of these is done, the risk cover ends. It means
one can not use his money in case of emergency. In my opinion term plans along with MF
investments (where there is no long term commitment) are still the better choice.
Insurance vs Mutual Funds
How can one compare unit-linked plans of insurance companies, which are aggressively
promoted as investment products with investments made directly in mutual fund schemes?
Darshit Sabharwal

Both these instruments are designed to serve different purposes and are not comparable. A unit-
linked plan from an insurance company is an insurance policy designed to pay a lump sum on
maturity or on death if earlier. Premium paid under these plans is eligible for tax deduction under
Section 88 of the Income Tax Act. On the other hand, mutual funds are investment avenues to
participate in the growth of financial markets and do not provide any tax deduction (except ELSS
and pension funds).

For a unit-linked insurance plan, providing life cover is the most important function; returns are
just an added benefit, which gets magnified, given the tax rebates. Though unit-linked plans offer
transparency in returns in terms of net asset value and flexibility in investment options in debt,
equity or a mix of both, these advantages remain secondary. Whereas for a mutual fund, the main
objective is to provide returns.

Moreover, unit-linked plans are not as liquid as mutual funds. There is a lock-in of three years.
Even if one redeems after three years, you would be at a loss because of higher initial
administrative charges. For example, the upfront charges for the first two premium amounts are
as high as 20-27 per cent. Then there is an annual management fee of 0.8-1.25 per cent and a flat
fee of Rs 15-20 per month. Finally, there is a deduction for risk cover. This goes towards
contribution to the sum assured or the life insurance cover, which is based on mortality rates as
calculated by actuaries. Though mutual funds too have entry and exit loads (maximum 2 per
cent) and expenses (maximum 2.5 per cent), these costs are lower than unit-linked plans.

MFs Vs Unit-linked Plans: A Comparison

Equity Mutual funds Equity-linked Insurance Plans
Initial load/ administrative 20-27% of premium for the initial
0-2%
charges few years
Annual expenses/ adm. 1.0-2.5% (including mgmt.
A flat charge of Rs 180-240 per year
Charges fee)
Management fee 0.8-1.5% 0.80-1.25%
Life cover Nil Yes
Lock-in Nil 3 years

From your perspective, consider unit-linked plans only if you want insurance cover and not as an
investment avenue to participate in the equity or debt market. If you want an exposure to the
stock or bond market, mutual funds are better investment avenues. Don't go by the performance
of these unit-linked products. Both unit-linked plans and mutual funds invest in the same
financial markets. If the equity market is doing well, both equity-linked insurance plans and
equity mutual funds will do well. But as an investment tool, you would be better off investing in
mutual funds rather than unit-linked plans due to high fees charged by insurance companies.
However, one has to forego that for the life cover that they offer. Thus, by design, unit-linked
plans and mutual funds are not comparable and are meant to suit different objectives.