The huge interest in mutual funds among retail investors over the past several years, specifically the SIP (systematic investment plan) mode, which allows small sums to be parked periodically in schemes, has spawned a new rival.

As asset management companies roll out new fund offers (NFOs) periodically, life insurance companies, too, have been on a launching spree. These insurers have been coming out with their own ‘NFOs’ in recent months, perhaps hoping to gain from the positivity around mutual funds.

Insurance companies are offering active and passive products to investors via factor-driven or index-based offerings. Unit-linked insurance plans (ULIPs) are now packaged in NFO avatars.

While insurers cannot offer mutual funds, they can release products with an underlying equity index or factor strategy. While there is no regulatory issue here, investors must understand insurers’ offerings that sound deceptively similar to mutual fund products.

Specifically, ULIPs vary greatly in terms of charges, lock-in periods, and disclosures from mutual funds.

Read on to learn what you must understand before getting into funds offered by insurers.

ULIPs with equity strategies

Over the past several months, many insurers have rolled out products that sound like mutual funds. PNB MetLife, Max Life, Bajaj Allianz Life, and Ageas Federal Life, among others, have launched NFOs. From momentum indices, insurers are offering small caps, multicaps, and even balanced advantage funds. These companies offer active and passive investments.

The foremost point for investors to note here is that insurance companies offer these ‘fund’ options as part of their ULIP product line. Therefore, the ULIP product itself would be different, and the funds (NFOs and existing funds) would be offered as options for policy buyers. Thus, multiple ULIPs with different names can offer the same fund.

For example, when it was rolled out in January 2024, Max Life offered the Nifty Midcap 150 Momentum 50 index investing option with the Max Life Online Savings Plan, Max Life Fast Track Super, and Max Life Platinum Wealth Plan, among a few others.

Met Life offered a small cap fund (NFO) with the PNB MetLife Smart Platinum Plan, PNB MetLife Goal Ensuring Multiplier plan and PNB MetLife Mera Wealth Plan.

And these ULIPs themselves, we know, have an insurance component and an investment portion.

In a mutual fund, on the other hand, the underlying investment is true-to-label. So, a Nifty fund will have the Nifty as the underlying index, while a small-cap active fund will have small-cap stocks. You invest directly in mutual funds and not indirectly as with ULIPs, where there is a policy name, which in turn allows you to invest in an underlying equity strategy—index, factor-based, active market-cap-based, etc.

A mutual fund NFO is offered at ₹10 per unit, and investments after the initial offer period can be made via lump sums and SIPs.

Charges, lock-in and taxation differ

Meanwhile, mutual funds have a single expense ratio. A typical index fund is available for the direct plan at 15-30 basis points. Regular plans of the same funds would have an expense ratio of around 35-75 basis points. ETFs are even cheaper.

The NAV of a mutual fund includes all charges levied, and portfolio holdings are usually disclosed every month. Return calculations remain straightforward.

A ULIP has multiple charges associated with it. Apart from the fund management charges (maximum limit of 1.35 per cent) for the underlying scheme chosen, from the options such as those mentioned earlier.

So, there would be charges related to policy administration, mortality, premium allocation, riders, premium redirection, switching, and a few other heads. There would also be GST levied.

Mortality charges vary with age, sum assured and so on.

Therefore, gauging the final returns post these charges is challenging.

With these charges, if index funds are taken as underlying, there is likely to be significant underperformance vis-à-vis the benchmark. In the case of active funds, the outperformance has to be that much stronger to generate significant alpha over a benchmark.

Unit-linked plans have a minimum lock-in of five years, whereas apart from equity-linked savings schemes (ELSS), all other open-ended equity mutual funds can be liquidated at any time.

Gains made on mutual fund sales after a holding period of one year are taxed at 10 per cent beyond ₹1 lakh. Short-term gains are taxed at 15 per cent.

In the case of ULIPs, if the premium paid per year is more than ₹2.5 lakh, gains are taxed at 10 per cent beyond ₹1 lakh if the underlying investment is an equity instrument.

What should investors do?

For new and uninformed investors, it is important to understand the fundamental difference between the two products and their purpose.

For all practical purposes, most people need only two insurance policies: term and health.

It is best not to combine insurance with investments and complicate things unnecessarily.

Mutual funds chosen with care after taking proper advice based on your risk appetite, goals, time horizon, and surplus can vastly improve your financial health, provided you stay put for the long term.

Though some ULIPs have done well over the years, your primary focus in terms of financial planning must be to take health and term insurance and start SIPs in mutual funds for specific goals.

In fact, even when mutual funds roll out NFOs, the advice is often to invest in them only after they develop a reasonable track record. That cautionary note goes up several notches with ULIPs, given their high charges (at least in the initial years) and limited disclosures.