Comparison of two products is to be done on multiple parameters like safety, liquidity, flexibility, suitability, etc. Today we take up one of these aspects, cost. The ultimate return is net of the costs charged by the product manufacturer. Since the market movement and efficiency of the fund manager is in nobody’s control, cost gives us some perspective.
Mutual fund costs
In mutual funds (MFs), there is only one cost, the total expense ratio (TER). This includes fund management expenses, overheads of the asset management company (AMC), brokerage cost in regular (i.e., non-direct) plan, etc. The maximum TER for a fund is defined as per SEBI rules. It is defined as per AUM of the fund; the lower the AUM, the higher is the TER allowed. At the lowest AUM bracket, i.e., higher TER slab, it is 2.25% for equity funds and 2% for debt funds. As AUM increases, the maximum TER allowed decreases progressively. The limit being the maximum, AMCs charge lower expenses, particularly in debt / liquid funds.
Access to the data on expenses charged by MFs is easy. If you want to know how much an AMC is charging to a particular fund, it is declared on a daily basis on the website of the AMCs. The monthly factsheets of the fund include this data, if you do not need to access data on a daily basis.
Unit linked insurance plan costs
Unit linked insurance plan (Ulip) costs are more complicated than MF expenses. There are multiple heads of expenses: Premium Allocation Charge (an upfront charge on your premium to be paid to the intermediary who sold you the product, lower for online sales), Policy Administration Charge, Fund Management Charge, Mortality Charge, and certain other smaller charges. Of these, Fund Management Charge is capped at 1.35% by Insurance Regulatory and Development Authority of India (Irdai). For our discussion, we will keep Mortality Charges out, in the context of comparison with MFs, since it is the cost of insurance per se, i.e., the coverage provided.
For comparison with MFs, what matters is the combined cost of Premium Allocation Charge (PAC), Policy Administration Charge (Admin), Fund Management Charge (FMC) and the other small charges. FMC being capped at 1.35% doesn’t really matter as you have to pay the totality of the charges, by whatever name called. Earlier days, PAC used to be on the higher side.
Irdai limits on ULIP charges
Irdai has put caps on Ulip charges by defining the maximum difference between the gross returns (as earned by the underlying fund) and the net return (to the policyholder, net of all charges). This differential is known as reduction in yield (RIY) as that is the extent to which your annualised return or yield is lowered due to charges. The maximum RIY is defined as per the tenure of the Ulip; as a ballpark, it is 4% per year for a 5-year ULIP, 3% per year for a 10-year Ulip and 2.25% for a 15-year Ulip. This doesn’t include mortality charges. The cap on RIY puts a natural lid on charges, including PAC which used to be much higher in the earlier days before this rule was brought in.
Various insurance companies charge at various levels within the maximum limits. It is not as transparent as MFs declaring it every day on the website or every month in the factsheet. The Ulip illustration given to you while you purchased the policy, at assumed rate of return of 4% and 8% per year, does not clearly mention the charges. The only way to locate it is the product brochure on the insurance company’s website, where it may be mentioned, particularly if they are charging much lower than the defined limits.