Thursday, December 17, 2009

Heads who wins? Tails who wins?

"Heads you win. Tails you win" - said the brochure of SBI's Smart ULIP, handed over by a marketing executive.

I knew that the current status of ULIPs in India is not that good and that one should always apply caution when opting for one. I never came across a decent online illustration of  ULIPs until today. This illustration in SBI's website details the plan for the customary 6% and 10% returns. It saved me the trouble in decoding various charges deducted at different points in time, in different denominations and at different rates.

As given in the illustration, the premium (for a 40 year old) is 50,000, paying term is 5 years and maturity is at the end of 10 years. Death benefit is 2,50,000 till year 5, and from then onwards it will be the fund value at that point in time. Till the end of 5 years, if the policy is surrendered, there will be a penalty. The maturity value at the end of the term is approximately 4,10,000, if we assume a growth rate of 10% per annum.

As with any unit linked insurance plan, SBI Smart ULIP combines investment with insurance. For analysis, let us consider these two separately.

  • For insurance, let us consider a term plan by Max New York Life. For a 40 year old: for a term of 5 years and sum assured of 2,50,000, the annual premium is Rs.1,320.
  • For investment, let us consider a simple FD. The investment amount is 48,680 (50,000 - 1,320) and let us assume a bare minimum interest rate of 7% per annum. The amount of 48,860 plus the maturity amount from previous year is reinvested in FD till year 5.
Till year 5 in this case, the death benefit will be 2,50,000 plus whatever is available in FD at that point in time. There is no such thing as surrender penalty and the returns are more or less guaranteed (it will go up or down every year, but our assumption is that it averages to 7% per annum). The maturity value at the end of the 10 years term is approximately 4,20,000.

The calculations are shown in this excel sheet.

You can notice that the death value, surrender value and fund value is always higher in the case of Term policy plus FD plan. It can be argued that ULIP will give tax benefits, but this can be offset to an extent by opting for a tax saving FD. Please bear in mind that for Tax Saving FDs, there is a lock-in period of 5 years (against 3 years for ULIPs) and the returns are taxable (against tax free returns in ULIPs).

But, the most important thing is that we have considered our 7% guaranteed returns FD example against 10% non-guaranteed returns ULIP plan. If we too take the risky equity route through a mutual fund, and assume 10% annualized return over the 10 year term, the maturity value would become a whopping 5,25,000 (approximately) - 25 - 30% more than that provided by SBI Smart ULIP.

You can change the interest rate cell in the excel sheet to see how much the returns will vary.

One of the unique features of this plan highlighted by the insurer is the guaranteed NAV. Is this something really attractive? It is stated that the guaranteed NAV of SBI Smart ULIP on maturity will be the highest of the NAV during the first seven years. Now, the probability of NAV at maturity (end of 10th year) going below the NAV at 7th year is very low. And smart fund managers can always switch to safer debt options to minimize any such risk during the last 3-4 years. So the guaranteed NAV does not mean anything that particularly attractive for an investor.

So now tell me.. Heads who wins? Tails who wins?

Disclaimer: The views posted in this blog are my own and are based purely on my own way of assessments. Readers are  requested to consult with their financial/ insurance advisers before making any investment/ insurance decision, do their own due diligence and validate factual information.


Manish Chauhan said...

Nice points . you have given a very simple and effective comparision of ULIP comparision :)

One thing we should look at is IRR of that ULIP . so even if the illustration is at 10% , the IRR comes out to be around 7.5% for abn average ulip . So that itself makes the situation worse . Note that point is not what what we will get at the end , IRR says that this is the interenal rate of return of the product till date .

Another qustion I had was your Term Inrance premium , Does Max New york provide 2.5 lacs term insurance for 5 yrs at 1,320 ? :) . I thought all the companies give for minumum 10 lacs . no ?

The toher imporant point we should remember that FD + Term gives us more flexibility in controlling each of them seperately , which is into that easy in ULIP :)


Ganesh said...

@ Manish,
Thanks for your comment.
Yes, IRR is the right measure to evaluate a ULIP, but typically well hidden by insurance companies. :-)

Have a look at this link ->
Max NewYork do provide a quote for 2.5 lakhs and the premium is Rs.1,320. I keep referring back to their site as they seem to be the only one providing lower sum assured for term plans. Their only logic seem to be keeping the premium greater then 1000 Rs.

I also agree with the flexibility of FD (or any other equity/ debt option) vis-a-vis a ULIP. Just that one need to spend and think a little bit about their own personal finances!

Srikanth said...

My, my , really awesome analysis. I was stumped.
You are doing a great job Ganesh. How about ICICI Health Saver Plan., what do you feel about it??

Ganesh said...

@ Srikanth,
Thank you for your kind comments.
For a coverage of 5 lakhs, the annual premium for ICICI's Health Plan is Rs.12,000 (Rs.1,000 per month - Refer
To critically analyze this plan, let use the same logic as with the case of Smart ULIP - by considering insurance and investment separately (which i will refer to as the alternate plan).
(1) For health insurance, consider Reliance's Individual Mediclaim policy. For 5 lakhs coverage, the yearly premium is Rs. 5359.(Refer
(2) For investment, assume that Rs.6,641 (12,000 - 5,359) is invested yearly in a mutual fund giving annualized returns of 6% or 10% (as the case may be that it needs to compared against).
If we assume an optimistic 10% returns for the alternate plan and compare it against the illustrated 10% returns of ICICI Health Plan:
- At the end of 10th year, the alternate plan beats the returns of ICICI Health Plan by 9%
- At the end of 20th year, the alternate plan beats the returns of ICICI Health Plan by 21%
- At the end of 30th year, the alternate plan beats the returns of ICICI Health Plan by 42%
Note that the returns from both the plans are market linked and hence equally risky.

Hope this clarifies your query.


vijaya rajgopal said...

My son is 23 yrs old. He is a software engineer and working for a MNC. As a dutiful parent i have advised him to save to avoid income tax. Now, his bank through a agent is trying to sell Birla Sunlife Calssic Endowment ULIP. I want to know are the present ULIPs working like 3 years ago(making money for the instituion) or are they any better? according to me Insurance and investment should be kept apart. please advise as to what advise can I ginve my son.

Ganesh said...

First of all thank you for stopping by, and reading the blog.
I am not a financial advisor by profession, but here is my suggestion:
(1) You are right in keeping insurance and investment separate. Your son, assuming he is not married, can go for a term insurance. Since he is only 23, the premiums will be cheaper now, than if he takes it when he is 30. He can go for lower cover now and add on at a later stage.
(2) I would say, invest AND save tax, rather than invest TO save tax. Investing and tax saving too need to be seen separately. Being young, small investments made now can reap big returns as time go by. He should direct his investments to equity (risky, but he is young) through mutual funds. It may not get him tax benefits, but can be good bet for superior returns. He can utilize PF/ PPF for balacing his investments in debt and for tax savings. He can also invest in ELSS funds for tax saving.

In my opinion, Birla Sunlife Classic Endowment is a decent plan (refer - But buy ULIPs only if you understand the product. It is not easy as the agents describe, nor as difficult as it appears to be.