Most financial planners and consultants insist that Ulips are costlier than mutual funds, considering the commissions paid to agents. However, this is only true for short-term investments. In the long term, Ulips are cheaper for investors as the commission paid reduces drastically. Ulip commissions can be as high as 20-40 per cent of the premium paid in the first year, but this reduces to 2 per cent from the second year. The commission is a fixed percentage of the premium paid. So, if an investor pays a premium of Rs 1 lakh per year, the commission in the first year is between Rs 20,000-40,000, but only Rs 2,000 thereafter.
Mutual fund costs, including commissions, are generally unknown to investors. Trail commission—what a distributor earns directly from the asset management company (AMC)—is a fixed percentage of your cumulative investment in the fund. It can range from 0.1-1 per cent. Most AMCs pay a competitive 0.4 per cent. For example, if your investment in a fund is Rs 10 lakh and the AMC pays 0.5 per cent trail commission, your agent earns Rs 5,000. As your investment value grows every year, so does the agent's commission. In the long term, fund commissions exceed the Ulip charges.
So, why do agents mis-sell? The cost for the products is such that agents get paid a higher commission on mutual funds in the long term, while Ulips are attractive for the short term (five years). Though the total costs are capped, those on a yearly basis are not, and this allows for high charges in the initial years for Ulips. There are also chances that the agent will encourage the investor to surrender the policy or let it lapse after a few years to sell him/her more financial products. Even though Irda had introduced initiatives to deter mis-selling—limiting the difference between gross and net yield to 2.25-3 per cent for different tenures and increasing the lock-in period for Ulips to five years—the practice continues to be prevalent.
Manish Chauhan is Financial Planning Consultant
