POSTED BY January 7, 2011 12:29 pm COMMENTS (10)ON
I have attempted a proper comparison between a ULIP and a MF-term combo for investment cum insurance requirements in present circumstances.
Raw data used:
Two ICICI Pru Life time premier illustrations sent by Shashank (thanks to him).
1. Converted the LTP illustrations into the proper spreadsheet system, and calculated the actual percentages used by the company.
2. Then, reversed the percentages with appropriate yearly conversion factors. Eg. the FMC of 1.35% worked out to be 1.28-1.29% (about 5% lower).
3. I found the yearly S&P500 and Nikkei 225 returns since 70 years ago. Then tried to put those returns instead of the “senseless & impractical” 6 and 10% scenarios.
4. Did the two calculations inside the workbook, and in the corresponding final sheets, you can change the returns,MF FMC and see the result between the two!
5. Kept the MF FMC at 2% (actual calculations are with 1.95, same reduction of 5% as ULIP MF).
6. Used the term insurance of Kotak preferred plan (the cheapest and quite reasonable offline plan).
7. No increase in FMC or other charges of ULIP have been considered, which actually will decrease the returns.
The final sheet is provided at
My final thoughts:
1. I still believe that the term+MF has a slight edge over the ULIPs. That is very reasonable because that amount of discipline should fetch some “extra” return.
2. The MF still provide better flexibility and choice. (though not in the usual manner, of chopping and chasing the highest return of the “best” funds).
3. ULIPs perform about 3% lower, but offer more automation at present rates.
4. With the newer DTC, MF+term will continue to get the same treatment, while the ULIPs will suffer. I will wait for that to be clarified.
More thoughts are welcome.
Hope this helps.
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10 replies on this article “Comparison between ULIP and MF-term using Excel sheet with Real life data.”
Good dicussion. Keep it coming.
This comment is much different than the one I had typed Ramesh and which I failed to post at last moment power failure. The following story I had just mentioned.
Some 5 years back I was discussing PPF investment with a client cum friend at his residence when I went there to make my call. This person was a GM level employee in a listed multinational engg company with work experience of @ 20 yrs. As we were talking about PPF investments he said to me that he already invests substantially in PPF and he has also worked out some calculations regarding the corpus he would be accumulating in next 15 years, till his retirement. He pulled out his laptop ( I don’t carry one on a call. My tools are a sheaf of plain papers and pen. I even teach my associates and clients as well how to attemt complex cash flow calculations with a very good degree of accuracy without calculators or Excel sheet!).
He showed me how he has gone about assuming interest rates on PPF a/c for future years. He said he has done it with a cautious or conservative attitude. For the coming next five years he had considered the intt rate to be 8% only. Then for the next 5 years he had taken it to be 6% and for the last five years taken it to be 4.5% only. And so much money would be accumulated at the age of his retirement in the PPF a/c! He was quite satisfied with the way he had made all these calculations with a conservative manner. And can you really find a fault with this logic of being conservative? No,rather we will say what a sensible and prudent guy such a person is, isn’t it? This is how everyone should attempt it rather than being unnecessarily optimistic about returns on our investments in future and relying on such optimistic figures to base our decisions of future goals, isn’t it?
Upon looking at all these calculations I asked him if he thinks about inflation then does he think that it will go down or move up? He replied it would definitely move up and that is how a conservative person should think or consider it to be. So I asked him then why he has considered that inflation is going to go down all these years in future and probably reaching a figure @3-3.5% in the years near to his retirement? He was confused for a moment. I said don’t you think the PPF scheme, a government run one, would try to link the returns to the general inflation level. Hasn’t it been the case in these last years when the rate was brought down from a high of 12% to the present level of 8%?
Suddenly he realised the folly of his assumptions; the arbitrary and sensible sounding, he had considered for future calculations and projections. Till then he was following a narrow and unilateral perspective about investment and returns! This mistake is done by a majority of not only lay persons but many of the financial planners also. The mistake of narrow perspective and unlinked thinking!( When I will show you this link which should be factored in even between the ‘financial capital’ and the ‘human capital’ for proper financial planning, you will think how could you neglect these fundamental principals and why no one told me these simple and important aspects of financial planning. But more on this ‘human capital’ sometime later!)
Ramesh I don’t know whether you had read this comment on one of the querries on the forum. But I think it is apt here to show again that mere ‘unlinked’ conservatism is simply wrong.
The level term plan rates factor in an interest rate regime. That is how the insurance companies are charging a level premium for the same SA but increasing mortality in a insurance contract. In a zero interest rate regime the level term premium rates would be much higher for the same sum assured and same mortality table. So you cannot randomly select a particular geography’s level term rates and try to connect it with another geography’s equity returns.
As a savvy investor would chose increasing premium term plans, if he can earn a higher return by putting the money in a higher yielding investment than the insurer; who would put it only in G-Secs/Bonds, the similar theme is made available through a ULIP.
Kotak and LIC are using the same tables. No new tables have yet been made available by Institute of Actuaries yet, which they are supposed to do so shortly(also new morbidity data is also being compiled, first time in India). Whatever changes are made are based on experience of the individual insurers. (The insurance companies have to justify if they move away from the basic mortality table approved by the IRDA )
What we see is large sum assured discounts not reduction in mortality rates significantly.
term prem. + MF = ULIP in this equation or comparison the interest rates are factored in the level premiums and which are applicable to a particular economy. Hence that economy’s equity returns have to be considered otherwise it is wrong comparision. Our data might be short compared to western economies but only it is to be used to give us the right perspective, by extrapolations or whatever correct statistical technique.
I don’t think the insurance products can be canabalised. They are created with different combinations of security and saving elements. And the product designers have worked on this to create a zero sum game . A term plan created by them to be used to demolish/canabalise their whole other spectrum of products whether in traditional or ULIP space? I don’t think we can win this battle with the actuary using his own creations against him.
Yes, I had seen that comment previously too. And I agree with your analysis there. And still waiting from the “human capital” thing!!
Unlinked conservatism can be wrong. But not always. Over long terms, the average equity returns are “same” for same type of economies! To give you an example, equity returns from 1972-2005 (34 years) in NASDAQ (US) was 12.5, FTSE (UK) was 11.7, MSCI EAFE (developed countries outside US-Canada and include Europe, Australasia, Far East) was 12.8 and S&P500 (US) was 12.7. Though the average returns are almost the same (no significant statistical difference) but the yearly returns were very different. S the destination is the same, but the routes are entirely different. Why did I use those data only? Because I expect Indian markets to behave in this manner in future (at near-developed country rates from the past). Not a wrong notion, I think. I put the Japanese data, as it is an anomalous market in the sense that it has a very long underperformance. Besides, I have put the Sensex data also in the more-modified sheet!
The result remains the same for any data, any period. for Term+MF & Ulip II, Ulips are better only after 18-19 years, not before that. for MF & Ulip I, ulips are better AGAIN only after 18-19 years!! (Disclaimer: On excel sheet).
Whatever tables are made by the Actuary does not matter directly to the consumer. Why? Because all insurance companies use different models + commission structures, etc. If on the basis of the same table, one company is giving me discount on a larger sum assured, I would be happy to get that discount. Why not?
Your point that term plans have two components. One for the actual mortality charge and the other for investing in GSec so that the future mortality charges can be taken care of. This leads to the following conclusions on paper:
1. By using the term plans and not other traditional plans, you are actually investing the least amount in GSecs while getting the maximum out of the total premium for the life insurance.
2. If one uses traditional plans, one is paying for the mortality charges plus the rest of the premium is invested in GSecs (usually).
3. A Ulip uses the same tables and therefore, it should deduct mortality charges according to the age of the person. And it should increase with age.
4. Ideal solution will be a plan which pays an increasing amount of premium which is actually linked to the mortality charges (without any component of GSec anywhere).
But practically, you can yourself see that the Ulip LTP72 charges 7,250 for 50 lakh for 26 year (1.45 per 1000), Ulip LTP50k charges 5,075 for 35 lakh for 26 year (again 1.45 per 1000), Kotak preferred term plan charges 4,263 for 30 year term for 35 lakhs (=1.22 per 1000). So the Kotak plan appears to give a 18% discount plus includes the Gsec investment component, since the premium remains the same throughout the whole period. The actual value according to the 1994-96 modified table from http://www.actuariesindia.org gives a value of 1.14 per 1000 for 26 years age. (One more thing, the Kotak ACE investment Ulip type I plan also charges 1.42 per 1000 for that age).
So, it appears that the current term insurance plans give significant discounts on basis of sex and smoker/non-smoker status and on top of it, the online plans are even better in the sense that the agent commission is decreased. No such benefit in the Ulips or even in LIC plans. If the Ulips start giving that, then maybe. Newer tables should be beneficial for the customers!
Regarding “zero sum game” by product designers. It may be a zero sum game if and only if the two options are mortality charges for insurance and GSecs for investment. But there again, there is a significant component of agent commissions in the traditional plans which will lead to a decreased overall return in a traditional plan as compared to a term + PPF (Though PPF has an upper limit).
By using products which have no relation to the actuary, we can beat him!
The premium rates of life insurance in traditional plans carry a savings/investment element. Even level term plans premiums would also be designed depending on the assumptions by the actuaries what would be the G-Sec rates; where most of the investments would be parked, in the mid and long term. So naturally a particular economy, its growth rates, inflation and the interest rates on secure debt assets would be factored in. There will be a some correlation between the risk free rates and the investor expectations from the stock market returns. There would be a connection between what banks are charging and what an enterpreneur would expect by leveraging these loans. So if the interest rate structures are going to reflect in the product creation, expected returns from the equity asset class by enterpreneurs and general investors, how can we implant the data of some other economys in this comparision? Because this exercise is not only of how a particular asset class which can yield high returns like equities can or has behaved over a long period. In the comparison one one side there is a factor incorporating this intt rates projections. So I think if at all we are going to feed the model fluctuating returns data, then it has to be local not foreign.
Agreed that feeding the model a constant and continuous same growth rate or returns is not the practicle thing in the sense that it does not so happen in practise. But will it matter if we do so. Will he wo approaches show us substantially different scenarios on various time scales? What do you think?
It never hurts to be more conservative in future projections. So using data from any developed nation is not wrong. Their long term interest rates are 3-5% while equity returns are 8-15%. Ours are at present around 7-8%, but I would bet they are going to come down in 10-15-20 years. Globalization will have its effect very fast.
And by the way, which side has the interest rate structures in it in our example. In my view, the excel sheet does not have that anywhere in a significant amount. The term insurance is of kotak which uses more recent and modified insurance tables. (LIC uses the archaic life tables). correct me if I am wrong.
Indian data is too short. My only problem. You can also put that data. One thing is sure, you would not get these rates in future (it can be less, it can be more!!).
Regarding constant and continuous same growth rate will not give you a correct picture.
Moreover, the excel sheet is completely modifiable. you can put your data (any country, any timeframe, contant/variable). Try it.
This attempt is just to give a fairer comparison.
Second thoughts: Just going through the various permutations, in some projections, the amount of money has remained almost same for at the end of 15 years! Well, somebody needs to try and put some behavioral aspect also. Cannot see, how to do that!!
Added the necessary changes in the modified sheet at the same location.
Now, there are two sections regarding the FMC in both ULIP and MF with revised effective FMC, which fluctuate with the annual returns.
The annual charge being FMC we need not treat it like intt rates. In case of intt rates nominal and effective annual rates we need to consider. So I think we should take it 1.35 and 2.0 only as the FMC would be charged at any period of time at the these stated rates only.
Ramesh, why have you given link to Deepak Shenoy’s article. You are good enough intellectual adverssary, if I want to fight any intellectual battles with. And he is not so much sophisticated in his thinking, approach and knowledge also. You are much(way ahead actually in my opinion) better than Deepak Shenoys of world and your link has not impressed me even a bit. On the other hand I feel sorry for this guy who is so poorly developed on all the three fronts
1) Knowledge of ULIPs and the features
2) Lacks total understanding of working of a mutual fund ‘portfolio'( I’m not talking of single scheme) and trying to prove his point with a single fund absolute comparision and all in hindsight!
3) He doesn’t understand basics of financial planning( he thinks he knows!)
These guys are victims of ‘product side comparisions’ whereas they should look at the things from the ‘need side comparisions’. Typically all these excel experts who are coming from finance backgroung do this error. But lets leave this.(I will write on this need side comparision, just a hint- what will be insurance need of a person who is investing 50k? and if I take that income and think of insurance cover required , then my comparison will be different- more on it later)
(Sorry again I have to run, will catch up with you on that nikkei and s&p500 rates of returns.should we use them or our own sensex data for any 25/30 yrs block)
The FMC- actually I did some rough calculations also. The idea started with the FMC that your illustrations provided. They have used a 1.35% FMC, but the effective FMC comes to 1.28-1.29%. Reason being there is a 6% increase and since FMC gets deducted daily, so if differentials and integrals are used then it can be proven that the effective annual FMC will come out to be the nominal rate -/+ the annual increase/decrease. So, with 6% increase, the FMC will decrease by 6% and for 20% decrease the FMC will increase by 20% (1.35% will become 1.62%). I compensated that by doing the same for both (effectively, it nullifies the rates between the two). A better excel can thus be prepared! I hope this satisfies your query regarding the change which I incorporated.
Looks like you are really miffed by Mr Shenoy. Well, lot of people follow his blog. I will get information from any source, following it or not is my decision, like it is yours!! Yep, lets leave this.
And regarding the nikkei and s&p500 rates that I chose. I used that because it has a long history (bse has 31-32 years only), has a reasonable solid foundation (in the initial years, ours was problematic because of less depth and less volumes), have a reasonable long term growth (a range of 8-15% 20-25 years growth rate in the equity markets). I would go with these rates only in future calculations and not the sensex returns of ours.
Also the 70 years data gives use about 40 scenarios of 30 year periods. So we can put them in our imaginary excel sheet and have a reasonable idea about the outcomes. I used japan’s too which by nikkei has not given good point-to-point returns for last 20 years. Can happen with us also!
Why not any other country’s? We can use any country’s data in our sheet. But it should be variable enough. Hope it clarifies the points that you have raised.
Reducing the ULIP’s FMC charges by 5% is done to take in the ffect of loyalty bonuse being paid, is that right? If that is so then I don’t think we should reduce the FMC charges on the MF also by 5% and bring it to 1.9% . Because those loyalty additions are a defined feature of the ULIP from the inception which is not the case in MFs.
The illustrations which I sent are type II ULIPs, this will help us the analyse the situation better. But I have chosen the maximum multiplier available with the plans at a particular age. In this case it is 70x below age 30. I wnt to elaborate a bit on why this multiplier was chose.
Few years back there were very few preffered(non smoker,non alcoholic) plans available in the market, may be just one or two insurers were offering. Even large sum assured premium product offering through offline mode was started in last 2-3 yrs. The online phenomenon ihas spread in the last 1 year and in the last 3-4 months mostly.
The level term plans available before 4-5 yrs back were having very large premiums when compared to today’s product offering. In those times the mortality charges inside a ULIP were hardly 50% of the level term premiums prevailing(Even today his you would notice incase of LIC very clearly) . The mortality charges at age 30 for 10 lakhs cover were in the range 1300-1500 wheras the level premium charges were in the the range 3200-3500 for a 30 yr cover. The mortality inside the ULIP was growing by @6% for 12 yrs, then by @8% for next 10 yrs and then by @10-11% for next 6-7 yrs. So growing the difference of these two was creating a big advantage if one goes for higher premium multipliers. More the multiplier chosen bigger was the benefit in short, mid and long term. This was the advantage created by the structure of the ULIP product which works on the basis /principle of increasing premiums as opposed to level premium product structure. The expenses which were higher could be compensated by advantage derived from differential amount growth by equity growth rates.
With introduction of low premium plans, the overall premium on high covers is reduced drastically but similar large sum assured lower mortality has not been introduced in the structure of the ULIPS, (which may happen in future along with preffered mortality rates for non smoker-non alcoholic persons–but lets leave this apart as they are not offered today)
S now the increasing premium rates advantage seems to reduce drastically. The level premium rates of the term are hardly noticeably more than ULIP mortality. In the current comparision you would notice that the ULIP mortality is mathching the level rates in just 7-8 yrs and after that it seems to zoom ahead of the level premiums. This was not the case previously.( And mind you people who have been crying against the ULIPs from so many yrs never even noticed how these benefits are to be used).
Now even if the FMCs of ULIPs have been drastically reduced compared to a normal MF; this advantage will vanish if HIGHER multipliers are chosen. Ramesh my hunch is that at a ;lower multiplier of say @ 40x we will find that ULIP is working better than MFs.
So can you do these two things:
1)Reducing the multiplier to @40-50
2) Keeping the FMC of MF at 2% and not at 1.9%
If required I will send the EBI’s again.
My basic premise is simple-we can’t beat the ‘actuary’ who really controls who can win on the comparision of ULIP vs Term+MF, because he is present on both the side deciding the crucial factors’ play. The equity market is present on both the sides in same way, so we can discount the market. The FMC is lower on the ULIP side though other expenses are higher.
My hunch- we can’t defeat the actuary.
Nope. 5% reduction is done because the annual charge of 1.35% is actually cut every day/month. So, on increasing fund value, we would not be able to apply a full 1.35% charge. In Jan, it will be lesser because of lower fund value and in Dec, more because of higher fund value. So to average it out, the total FMC will be slightly lower in increasing fund values and vice versa. So, I have levelled the playing field by incorporating the nominal and the actual FMC in both the ULIP and MF by the same percentage amount.
A proper multiplier is a must. We all agree that “usually” a multiplier of 120x of monthly (=10x of annual income) is required. So, multiplier should be high and should have a proper term period also according to the earning potential of the person.
I have used an offline (and not online) insurance product only. An online product will be even more beneficial for the term+MF.
What prevents the companies to use the improved/better/less expensive for customers life tables in ULIPs. Many of them are using them for online term insurances, then why not for ULIPs. I fail to understand that. On the contrary, most of the companies have changed the tables and now use more expensive tables for the newer ULIPs (from Sept 1, 2010).
Also, once you are locked into a ULIP, you cannot get out without hurting yourself. Getting into a newer “better” ULIP does not work because the actual benefits of a ULIP only start about 10 years after the start.
Moreover, if there is no significant benefit in using a ULIP, then why should we use it. yes, it has benefits for the non-initiated and non-disciplined. But…!
Also have a look at this post.