The paradox of ULIPs

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: A couple of days ago there were some announcements from the Life Insurance Council, a lobbying body formed by life insurance companies. Broadly, these announcements appeared to say two things. One, that the terminology of Unit-Linked Insurance Plans (ULIPs) would be made uniform. And two, insurance companies would refuse to underwrite insurance-linked schemes issued by mutual fund companies.

Behind both these issues is a struggle that is going on between life insurance companies and mutual funds. Here’s what this fight is all about. Mutual funds and life insurance are two distinct products, one being intended as a savings vehicle and the other a safety net. However, over the last few years, this distinction has become blurred. Today, if one looks at the actual money that is flowing in, then the life insurance companies are also in the business of running mutual funds. These mutual funds are called Unit-linked Insurance Plans (ULIPs). ULIPs have a mixture of the characteristics of both insurance and mutual funds. Crucially, the mutual fund aspect of ULIPs is regulated by the government under a very different set of rules compared to real mutual funds. From the investors’ point of view (which is obviously the most important point of view), the biggest difference lies in how much of his money is actually used for his insurance and his savings and how much is taken away to pay the commissions to agents and the expenses of the insurance company. The second big, related difference is the quality of the information he is given about his investments.

Mutual funds deduct no more than 2.5% of the agent’s commission. And this deduction is 0% (by law) if investors don’t use an agent and go directly to a fund company. In ULIPs, the agents’ commission varies but in the first year, it could be anywhere between 25% and in some cases, 75%. There are a lot of things in finance that are difficult to understand but the difference between paying 0% commission and 75% commission is not one of those. Even the difference between 2.5% and 25% is pretty easy to understand.