ULIP charge deduction

A mutual fund's costs are already inside its NAV. What the investor sees is what the investor got.

A ULIP does not work that way.

Most of its costs are taken out of the fund itself. The insurer cancels units to pay for the mortality cover and the policy administration.

So the NAV can look perfectly healthy while the investor's own holding quietly shrinks.

The workbook draws the conclusion for us. Because charges come off the fund value, the post-expense return is difficult to calculate.

IRDAI caps the maximum charges. But a cap on charges is not the same thing as a clear statement of return.

There is a second reason comparison is hard. Some insurers create bonus units for loyal investors. The workbook says this means newer contributors to the fund are subsidising the older ones.

So two ULIPs can report the same fund performance and hand two investors very different outcomes.

The comparison that states it, section 19.2.3. Against a mutual fund, whose maximum charges are regulated by SEBI, a ULIP's maximum charges are regulated by IRDAI — and insurance (mortality) and other charges are deducted from fund value, making post expense return calculation difficult.

The mechanism, from the Chapter 2 case study. Row 6 of the Mr Jeevan comparison sets the two regimes side by side:

The workbook states the deduction point two ways, and they are not the same. Section 2.3, introducing unit-linked insurance, says: the risk cover charges are deducted from the regular premium paid by the insured during the period of insurance, and the balance is invested as per the agreed asset allocation. That is a deduction at the front, off the premium. Section 2.3's own case study and section 19.2.3 instead say charges are debited by cancelling units from the fund value. The workbook does not reconcile the two descriptions. Read which section a question is set in: the premium-deduction wording comes from the introduction to ULIPs, the unit-cancellation wording from the mutual-fund comparison in Chapter 2 and the product comparison in Chapter 19.

The disclosure and cap rules, section 1.8.2. This is where the figures are.

• Insurers must provide the prospect or policyholder all relevant information about the various charges for each policy year.
• Insurers must provide benefit illustrations giving two scenarios of interest — at 4% and at 8%.
• The prospect is required to sign the illustration as well as the proposal form.
• A cap on charges has been imposed from the 5th year onwards, to smoothen the charge structure for the policyholder.
• Discontinuance charges are capped as a percentage of fund value, as a percentage of premium, and also as an absolute value. Section 2.1 gives that absolute figure: a maximum of Rs 6,000.
• No surrender charges are applicable after 5 policy years.
• Charges should be evenly distributed during the lock-in period so that the expenses are not excessively front-ended. (The stored page splices this bullet into the preceding one about an additional payment being treated as a single premium, so the first half of that sentence is incomplete in the source and is not reproduced here.)

And the case where the charge buys nothing. Section 2.3 closes the ULIP-versus-term-plus-fund comparison with the point that matters most to an adviser: if insurance is not required, the mortality charge — the insurance premium part of the ULIP — becomes an additional cost. The workbook notes that large investments typically come from relatively older investors who may not need large cover, and who find it difficult to qualify for the 10-times cover anyway. Its conclusion: a ULIP should be considered in place of a term policy plus mutual fund only where insurance cover is required in the first place.

The rupee charges below are illustrative. The workbook states the mechanism, the 4% and 8% illustration scenarios and the Rs 6,000 discontinuance cap, but does not price a mortality or administration charge.

Mrs Nanda holds a ULIP with a fund value of Rs 12,00,000 at a NAV of Rs 20, so 60,000 units. Assume the insurer levies Rs 2,400 a month of mortality and policy administration charges.

What one month looks like.

Rs 2,400 ÷ Rs 20 = 120 units cancelled. The NAV did not move. Her holding fell by Rs 2,400.

Over a year, with the market flat.

Charges for the year        = 2,400 x 12       = Rs 28,800
Units cancelled             = 28,800 / 20      =     1,440 units
Units left                  = 60,000 - 1,440   =    58,560
Fund value at NAV 20        = 58,560 x 20      = Rs 11,71,200

An investor watching only the published NAV sees Rs 20 and no change. The Rs 28,800 is invisible there. It shows up only in the unit count.

Why that matters for comparison. Suppose an equivalent mutual fund charged the same Rs 28,800 on a Rs 12,00,000 holding — a 2.4% expense ratio. Because a fund's costs sit inside its NAV and units cannot be cancelled to pay them, its published NAV would have fallen to about Rs 19.52 while her 60,000 units stayed intact, giving the same Rs 11,71,200. The outcome is identical; only one of the two routes lets the investor read the cost off the published return.

What the illustration she signed does and does not tell her. Under section 1.8.2 she was shown two benefit illustrations, at 4% and at 8%, and she signed them. Those set out the gross assumptions and the charges for each policy year. They do not hand her a single post-expense return figure — which is exactly the difficulty the workbook names.

And if she stops paying in year 3. A discontinuance charge applies, capped in absolute terms at Rs 6,000. The balance moves to the discontinuation policy fund. Had she instead reached the end of 5 policy years, no surrender charge would apply at all.

Chapter 19 (Comparison of Products across categories), section 19.2.3 Mutual Funds v/s Unit Linked Insurance Plans, row 3, is the one-line statement: charges are regulated by IRDAI, and mortality and other charges are deducted from fund value, making post-expense return calculation difficult. Chapter 2, section 2.3, gives the mechanism twice — the premium-deduction wording in the introduction to unit-linked insurance, and the unit-cancellation wording in row 6 of the Mr Jeevan case study, along with the bonus-units subsidy point. Chapter 1, section 1.8.2, gives the regulatory detail: charge information for each policy year, the 4% and 8% benefit illustrations, the signed illustration, the cap on charges from the 5th year, the three-way cap on discontinuance charges, and no surrender charges after 5 policy years. Section 2.1 gives the Rs 6,000 absolute cap.

Expect a question on the two benefit illustration scenarios, a question on why a ULIP's post-expense return is harder to compute than a mutual fund's, and a comparison question naming SEBI for one product and IRDAI for the other.

• The charges come out of the fund, not out of the NAV. Units are cancelled. That is why the published NAV can be flat while the holding shrinks, and why the workbook says the post-expense return is difficult to calculate.
• The workbook describes the deduction two ways. Section 2.3's introduction says risk cover charges are deducted from the regular premium; the same section's case study and section 19.2.3 say charges are debited by cancelling units. Answer from the section the question cites.
• IRDAI regulates ULIP charges; SEBI regulates mutual fund charges. Swapping the two regulators is an easy mark to lose.
• A cap on charges is not a disclosure of return. Charges are capped from the 5th year onwards, and the illustrations show 4% and 8% gross scenarios — neither of those is a post-expense return figure.
• 4% and 8% are illustration scenarios, not returns the insurer promises. The prospect signs the illustration precisely because it is an illustration.
• Discontinuance charges are capped three ways — as a percentage of fund value, as a percentage of premium, and as an absolute amount of Rs 6,000. Surrender charges are a separate thing and disappear entirely after 5 policy years.
• Bonus units are not free. The workbook says creating them for loyal investors means newer contributors subsidise older ones, and that this too makes comparison across schemes difficult.
• If the cover is not needed, the mortality charge is pure cost. That is the workbook's stated reason for saying a ULIP replaces a term-plus-fund combination only where insurance is genuinely required.