Why Passive Ulips Offer Lower Costs, But May Still Fall Short of Index Funds’ Returns

Passive unit-linked insurance plans (Ulips) track market indices like the Nifty 50 or Sensex directly, unlike traditional Ulips where fund managers actively pick stocks. This means your money simply follows the market’s performance without any human intervention in investment decisions.

In terms of cost structure, passive Ulips generally have lower expense ratios compared to traditional Ulips because there’s no active management involved.

Says Col. Sanjeev Govila (retd), certified financial planner and CEO, Hum Fauji Initiatives, a financial advisory firm: “The cost structure is notably lower in passive Ulips, with fund management charges typically around 0.5-0.8 per cent compared to 1.35 per cent in traditional Ulips. This difference can significantly impact your long-term wealth accumulation.”

“However, they still include insurance-related charges, such as mortality fees, which direct index funds or exchange-traded funds (ETFs) don’t have,” says Swati Saxena, founder and CEO, 4Thoughts Finance, a wealth management firm.

Why Ulips Still Are Costly 

Ulips are often mis-sold in the market. One of the major reasons is that agents earn higher commissions from Ulips, thus creating a potential conflict of interest where the focus may shift from meeting the client’s benefits to maximising commissions.

Ulips also have charges, which include premium allocation charges, fund management, mortality charges, and administrative costs. However, these charges cover both your insurance and investment needs. On the other hand index funds or ETFs come with a low-expense ratio making them a cost-effective way of investment in the market.

“The risks include higher overall costs due to insurance charges, a five-year lock-in period that limits liquidity, and the potential for underperformance if the tracked index doesn’t perform well. Additionally, the added costs of Ulips can dilute returns compared to direct index funds or ETFs,” says Saxena. 

Should You Invest

“One crucial strategy is to maintain a clear separation between life cover (protection objectives) and return on investment objectives. For the primary purpose of life cover, opting for a simple term plan is an effective solution. On the other hand, for investment returns, mutual funds are a better choice,” says Shweta Rajani, head- mutual funds, Anand Rathi Wealth.

The cost of a term plan is marginally lower and more effective as insurance, while mutual funds are low-cost investment products with great risk-adjusted return potential.

According to a study by Anand Rathi Wealth covering 1,600 Ulips across 19 insurance companies, it was observed that over a seven-year period, 84 per cent of the Ulips underperformed compared to a combination of a term plan and investment in the Nifty index.

It was also found that the term plan and Nifty investment strategy can deliver an internal rate of return (IRR) of 13.64 per cent and the same for Ulip is 10.07 per cent.

“Thus, we can conclude that ULIP designs do not provide returns on investment in a cost-efficient manner,” says Rajani. 

The factors that one needs to consider before investing in any product are individual goals, liquidity needs, and risk-adjusted return. One can comfortably diversify across different categories of mutual funds from large-cap to mid-cap to flexicap to strategy-based categories like contra, dividend yield, etc., and create a holistic portfolio that can target a 14 per cent return in the long term without compromising the liquidity needs. 

Keeping everything in mind, passive Ulips are not a great investment option when one goes by the wisdom that investments and insurance should never be mixed.