From April 1, a seller of unit-linked insurance plans (Ulips) will be able to make a stronger pitch to the potential customer – no long-term capital gains (LTCG) tax on investing. The Union Budget 2018 has imposed an LTCG tax of 10 per cent on investors in stock markets who sell their shares after one year. However, it has kept insurance products out of the ambit of this tax. And this could lead to more mis-selling in Ulips. At present, Ulips have three things going for them. One, a robust stock market. Two, there are more insurance than mutual fund agents who can push Ulips, and now, the tax arbitrage. And given that insurance agents are paid significantly higher commissions, there could be a rush to push these products.
“Once you bring the comparison down to Ulips versus mutual funds (MF), the reality is that a purchaser will look at both, and there are a large number of people at our companies who are selling it may also be highlighting only the savings (investment) element rather than the core protection element. I think it is the wrong way to look at it,” said Arijit Basu, MD and CEO, SBI Life Insurance, at the recent Business Standard Insurance Round Table. According to him, Ulips are an alternative avenue to channelise savings. So a person chooses Ulips from the perspective that he will get a very good return, but there is also an insurance element to it. It’s easy for an investor to get swayed in favour of Ulips with these advantages.
But investment managers believe that mutual funds are still the best vehicles for long-term wealth creation. “We are still not confident of recommending Ulips to our clients due to the five-year lock-in and opacity in costs. Also, if a Ulip fund is not doing well, an investor has no option but to stay with the company,” says Prateek Pant, head of products and solutions at Sanctum Wealth.
Tax arbitrage: The introduction of capital gains tax on long-term equity investment directly takes 10 per cent from the gains an investor has made. Of late, insurers have also started launching low-cost Ulips that are sold online. If you only consider charges, these are comparable to direct plans of mutual funds. “In the new Ulips, insurers are also adding back a certain portion of charges into investors' funds,” says Santosh Agarwal, head of life insurance, Policybazaar.com.
If a 30-year old invests Rs 100,000 a year for 10 years in, say, Edelweiss Tokio’s Wealth Plus (an online Ulip), he will get Rs 1.44 million at the end of the policy term if the returns are at 8 per cent, according to data from Policybazaar.com. If a mutual fund gives the same returns, the investor stands to get Rs 1.37 million on redemption after 10 years after paying capital gains tax. However, only 10 per cent of policyholders use the online route.
“While this may look attractive, the return from a Ulip will start dropping as the age of the investor increases due to higher mortality charges,” says Dhaval Kapadia, director – portfolio specialist, Morningstar Investment Adviser (India). The return will be even lower if the individual is a smoker or suffers from a chronic disease. In mutual funds, none of these will matter.
There is another important difference. When a person buys a Ulip offline, several costs like premium allocation charge and others kick in. The numbers, then, look dramatically different.
Regulatory arbitrage: For many years, there has been a significant regulatory arbitrage between the Securities and Exchange Board of India (Sebi) and the Insurance Regulatory and Development Authority of India (Irdai) when it comes to their respective products. The former has been aggressively pushing for cutting commissions to mutual fund distributors. Last week, it barred closed-end funds from charging 20 basis points extra in lieu of exit load. It has also changed the definition from B15 to B30 for charging an extra 30 basis points. Both these changes will mean lower expense ratios for investors.
In its March 2016 guidelines, Sebi clearly said that MFs have to declare the amount of actual commission paid by asset management companies (AMCs) to distributors (in absolute terms) in its half-yearly report against the investor’s total investment in each MF scheme. “The term ‘commission’ here refers to all direct monetary payments and other payments made in the form of gifts/rewards, trips, event sponsorships, etc, by AMCs/MFs to distributors,” said the Sebi note.
On the other hand, Irdai increased the commissions for agents from April 1, 2017. Called Payment of Commission or Remuneration or Reward to Insurance Agents and Insurance Intermediaries Regulations, 2016, the new rules have raised overall payments in the insurance sector to agents and intermediaries. In addition, the regulations allowed rewards for agents and intermediaries. Rewards will include sales promotion, gift and other such items.
Higher commissions lead to more push: There is a good reason for bank relationship managers to promote Ulips vis-a-vis mutual funds. The first-year commission for agents and intermediaries is as high as 35-40 per cent of premium. Even the renewal commission is a good 7.5 per cent a year. Compare this with a MF, and there is a huge arbitrage. MF distributors get around 1.5-2.5 per cent commission for the first year in equity schemes. For an exchange-traded fund, it would be lower at 0.5-1 per cent. For debt funds, it can be as low as 0.2 to 0.8 per cent. And the trail commission is around 0.5-1.5 per cent for equity funds.
Mutual funds still score over Ulips: Investment managers say that while Ulips have been improving drastically, they still prefer mutual funds for long-term savings. “A fund house’s core competency is investment. The primary function of an insurance company is managing risk.
An investor is, therefore, better off with MFs for investments,” says Amar Pandit, founder of HappynessFactory.in. He also adds that if an investor only chases returns or is obsessed with costs, he will end up making expensive mistakes.
When an investor is doing his portfolio review, he can redeem his investments from a scheme and shift it to another from a different fund house. In Ulips, you have to stick to the same company for at least five years. The only option is to switch from one fund to another of the same insurer. Wealth managers also say that Ulips are not as transparent as mutual funds. “We are still not confident about the cost structure of Ulips. In some products, there’s still opacity in charges,” says Pant. He adds that the five-year lock-in is another aspect of Ulips that makes them less attractive. An investor can exit mutual funds anytime with a small exit load.
While Ulips do enjoy a tax advantage now, there’s no certainty they will continue to do so. “There could be a similar tax on this product category, too, in the future. Then, the investor will find himself in a soup because he can’t get out of it. Investors should continue to separate their investments and insurance,” says Arnav Pandya, a certified financial planner.