Index funds by life insurers vs mutual funds: What's a better deal

A clutch of life insurance companies recently launched small-cap index funds, marking a new trend. Life insurers rarely launch such funds: Mutual fund (MF) companies do that.

There is a catch: To invest in a small-cap index fund of a life insurance company, a customer 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 offerings, but a customer can invest in such a fund if she buys a ULIP.

A ULIP doubles as an insurance and investment product. Mutual funds are pure investment products. In a ULIP, a portion of your accumulated wealth goes towards providing life cover and rest is invested for growth. A life insurance company will offer you a choice of ULIP funds, which are just like mutual funds, for investment. 

All ULIP funds offered will be managed by the same life insurer. You can split your money in any pattern you want among a set of ULIP funds. You can’t split your money across ULIP funds of 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 of a life insurance company 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.

ULIP costs 

ULIP is a life insurance product and there is a cost attached to it (known as mortality charges). Mortality charges increase with age. There can be other types of charges such as premium allocation, policy administration etc. 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. 

The Insurance Regulatory and Development Authority of India, the industry’s regulator, caps the fund management charge (FMC) for a ULIP fund at 1.35 per cent per annum. Life insurers may charge less, but they tend to keep FMC closer to the permissible cap of 1-1.35 per cent per annum. Mutual funds typically have lower expense ratios.

A ULIP investment faces lower competitive pressures because you can’t exit an underperforming product anytime. What you can do is to move your money from one ULIP fund to another (within the same life insurance company). 

You may take out your money completely once you complete five 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. There may be some 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.

Various charges in ULIPs are adjusted in three ways: Directly from the premium installment (premium allocation charge); through cancellation of units (policy administration charge and mortality charges), or by adjusting within the NAV (Fund management charge).

Now, the performance of any ULIP fund (shown on the insurer’s or other websites) will hide the impact of the first two options on investor returns. Not exactly unfair but the investor loses a bit of returns to all these charges.

ULIP vs mutual fund

With mutual funds, what you see is what you get.

Note, high-premium ULIPs are taxable. Choosing an index fund of a mutual fund company makes better sense because of greater flexibility, fewer restrictions, and likely lower costs.

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.

Investing in an index fund from an insurer

To invest in an index fund offered by life insurance companies, you will have to invest in a Unit-Linked Insurance Plan (ULIP)

In a ULIP, you can only invest in the funds offered by that insurer (not funds belonging to other insurers)

One has to pay costs like mortality charge (the charge levied for insurance coverage), which increases with age

While the fund management charge is capped by the insurance regulator, many insurers levy a charge closer to the maximum limit

Many ULIPs have costs like policy administration charge and premium allocation charge. Once invested, you can’t exit a Ulip before five years

The writer is a Sebi-registered investment advisor.