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Why it is better to be a man than a Superman

What is the difference between a Super man and an ordinary man. The answer is ordinary man would wear his briefs first and then the trouser. But the order is reverse in the case of Superman. He would wear his trouser first and then the briefs on the top of trouser. This was one of the famous jokes during my college days. Though it’s merely a fun, it exactly fits to the context of this discussion.

Life insurance plays an important role in any individual’s financial planning process. For it is life insurance that helps secure the financial future of the family members. Mere endowment plans may cover your life but not the future financial needs such as Higher Education, Marriage etc., of your children. Of course you can either combine these two goals or plan separately. That’s a separate bout. I don’t want to go into that in this discussion.

Suppose, you have made up your mind to combine your savings and insurance, again you have two options.

1. Life Insurance products combined with investments in the equity popularly known as ULIP (Unit Linked Insurance Plan) which is offered by many a host of Insurance Companies

2. Mutual Fund Schemes offering Life Insurance coverage for an investment of a fixed amount each month (known as SIP) in the equity.

First Option: (ULIP)

If a nice guy going for the first option viz., ULIP after tempted by the ads in the media, I say he has chosen himself to be a Superman. As you know pretty well, covering of a Superman is apparent and obviously he has to spend an extra amount for frills in the garment. Likewise, ULIP involves number of charges such as initial administration charge, regular administration charge, policy administration fee and investment management charge. Most companies recover these costs in the first 2 or 3 years. That is why policies are heavily front-loaded. All these charges put together can eat up to 30-70% of your premiums in the first year, depending on the company you choose. From the second year onwards the charges can be in the range of 5-10%. That means, if you are paying an annual premium of Rs 10,000, in the first year up to Rs 7,000 can be deducted as charges and only Rs 3,000 would be invested. From the second year onwards, the investment amount would be in the range of Rs 9,000. Let us take a look at the different charges in a ULIP.

an name Profit Plus Lifetime Gold HDFC Unit link UnitGain Plus Gold
Premium allocation 24% 20% 70% 25%
Mortality Charges (/1000 ) 1.80 for age 35 1.46 for age 30 NA 1.74 for age 30
Fund Management Charges 0.75% for Bond

1.50% for growth

0.75 % for preserver to 2.25% for multiplier 0.80% 0.95% for Bond, 1.75 % for growth
Policy Charges Rs 60 per month in first year, Rs 20 after that. No other charges, but FMC can be raised to 3.5% Rs 20 per month for administration Rs 600 per annum inflating at 5% per annum
Switching charges 4 free, Rs 100 after four 4 free, Rs 100 after four 24 in a year free, Rs 100 after that. 3 free, Rs 100 after that
Miscellaneous charges Rs 50 for alteration Switching can increase to Rs 200 Charges for revival, withdrawal, etc at Rs 250 per request. Rs 100 per transaction for revival, etc

I really dislike the heavy premium allocation being charged. Out of the Rs 100 you pay to your Insurer, only Rs 70 odd goes to your investments (Rs.30 in case of HDFC!!). This charging pattern obviously makes an impact in your fund value. Your initial investment amount is very important because of the impact of compounding. So the lower the initial investment, lower will be the fund accumulation.

The bottom line is whether our Superman will be having more than human powers just for the sake of extra frills he is having in his briefs? I don’t thing so.

Second Option: (Mutual funds offering Life insurance cover)

Now, let’s have a look at the second option. Folks like me always like to be an ordinary man. So, we do not have any extra frill in the garment as it’s hidden inside. Still we get the covering we actually needed. I mean to say charges towards Insurance element involves in the mutual funds offering life insurance are very less (to the tune of 1% of fixed amount invested by us each month)

The way it works is very simple. The facility allows you to invest through a systematic investment plan (SIP) on a monthly basis. An individual can invest a minimum of Rs 1,000 every month and has an option to choose an SIP over a period 5 years, 10 years, 15 years or 20 years. To come to the insurance benefit, at any point of time, the cumulative unpaid SIPs after one year are insured. Incase something goes wrong nominee will get the remaining unpaid SIP as insurance benefit The amount already paid in SIP is also returned on the basis of market value.

Let us say an individual chooses to take the SIP option of 15 years and invests Rs 5,000 every month over that period. After completion of one year and having invested in the first 12 SIPs, if the individual dies, then amount for the remaining SIPs would be handed over to the child nominee.

So, in this case the SIPs would have been paid for only one year. Hence the SIPs for the next 14 years would have remained. At the rate of Rs 5,000 every month or Rs 60,000 ever year, the total amount for a period of 14 years, works out to Rs 8.4 lakh (Rs 60,000 x 14). This is the amount that the Mutual Fund will hand over to the child. Other than this, the child can also withdraw the amount that has accumulated in the investment fund till date on the market value.

The insurance comes with an extra cost. The extra cost in this case is in the form of a higher entry load of 3.25 per cent of the amount invested. The entry load in normal mutual fund investment would be 2.25 per cent. So, for an extra charges of Rs.50 per month (viz., 1% of Rs. 5000 taken for illustration) we get a life cover of Rs.8.4 lakhs if the SIP is proposed for 15 years.

The product looks very attractive for individuals who have some kind of financial goal. They can ensure that they achieve that goal, by just paying an extra 1 per cent entry load and thereby insuring the unpaid SIPs. It’s a very small risk premium to pay for the insurance you get.

To meet out your long term goal SIPs are the best way as it effectively utilizes the Power of compounding, the Benefit of averaging etc. I discussed these aspects in my earlier articles posted in the GConnect.

As an icing on the cake, we get income tax exemption also for the entire amount we invest each year if the Mutual fund scheme (with insurance benefit) we choose is an ELSS (Equity linked Saving Scheme).

I also noticed certain minor drawbacks in this scheme. If the individual dies within the first year (after the first 30 days) of taking the policy, the amount of insurance is limited to ten times the monthly SIP. Also, at the time of opting for the facility if the insurance cover goes beyond Rs 10 lakh then the individual needs to undergo a medical examination. This scheme also contains certain restrictions. A person above the age of 45 can not invest in this scheme. Also, children of the applicant only can be nominated for receiving the life insurance benefit.

At present, Kotak Mutual Fund is offering two schemes (Kotak Tax Saver (ELSS) and Kotak 30) with insurance benefit. To my knowledge, DSP Merrill Lynch was another Company came with this offer.

Now, which option is the best one? Option I (Superman) or Option II (ordinary man)? Decide yourself! But, I have already chosen to be an ordinary man!