The Sensex is well above 15,000 points. And there is clear consensus among experts that that whether the market goes up or down, there will be a serious element of volatility in the days to come.

Recently, a reader brought a report to my notice that said Unit Linked Insurance Plans (ULIPs) of private life insurers have outperformed the Sensex over the last six months and three months as well.

Clearly, more and more insurance companies would love to prove this point that ULIPs can now be construed as a successful investment product vis-a-vis mutual funds and stocks. The use of the same benchmark, that is the Sensex, is a clear indication of that.

The report uses the data of six months from December to May and says that while the Sensex has gained only 5. 24 per cent in the December-May period, ULIPs of most private insurers have gained in the range of 6-17 per cent.

Come to think of it, it does sound great. But it does not really answer the basic question that whether one should start using both insurance and investment through the same products. But for the sake of argument, let us forget that the insurance and investment needs of an individual should be done through different instruments, simply because the financial goals that they have to achieve are different.

So let us look at the ULIP as an investment avenue and interpret the above statement properly. What the statement means is that the NAV of some ULIPs have appreciated more than the Sensex and hence beaten the Sensex. Now does it mean that those investors in ULIPs have got higher returns than the Sensex? No, I would not think so.

Let us look for the reasons:

The obvious culprits would be the high initial allocation charges or sales costs or commissions. The charges can be as high as 12 per cent to 65 per cent.

These charges are deducted from the units allocated to the investor and not from the NAV. So though the NAV might see some appreciation, the overall fund value is the

NAV * number of units, which will give you the true picture and show you that you have, in fact, not made any money but lost money or just about made some money. For instance, X has been paying a premium of Rs 25,000 per quarter or Rs 1 lakh (Rs 100,000) per annum.

• Sum assured: Rs 5 lakh (Rs 500,000)
• Plan start date: 28/6/2005
• Maturity date: 28/6/2015

X has been paying a premium of almost Rs 1 lakh for the last two years in an all equity fund ULIP and guess what the current value of his Rs 2 lakh (Rs 200,000) is? Despite a roaring bull market, the current market value is Rs 2.06 lakh (Rs 206,000).

This means a growth of 1.4 per cent per annum. On paper one sees a NAV appreciation of almost 30 per cent a year and this gentleman was shocked to see the statement that the appreciation was just 1.4 per cent.

The reason for this is clear and as we mentioned earlier, the culprit is higher upfront charges. Insurance companies recover most of the costs upfront and hence, it is important to check the ULIP for what the initial charges are.

Insurance companies themselves say, "In the long term, the key to build great maturity values is a low fund management charge (FMC)."

I say besides a low FMC, a very low upfront charge or premium allocation charge is also very important. If the premium allocation charge is high, the results are right in front to you.

Now we compare the situation if Y had opted for a pure term plan and a diversified equity fund with a good track record.

• Age of Client: 43
• Risk Cover: Rs 5 lakh (Rs 500,000)
• Premium: Rs 2,850 per annum

This leaves around Rs 97,150 to be invested. Considering an entry load of 2. 25 per cent we assume that this leaves Rs 94,963 to be invested. If Y is paying quarterly premiums and making quarterly investments of Rs 23,740 to be done on the same date.

If this investment was made in an equity linked saving scheme like HDFC [Get Quote] TaxSaver or diversified equity schemes such as Reliance [Get Quote] Growth, SBI [Get Quote] Magnum Contra or others, the investments would have grown to around Rs 2.6-2.7 lakh (Rs 206,000-Rs 207,000). There is a huge gap of Rs 54,000-55,000 between the ULIP and the mutual fund.

So far, we have only considered markets going up. ULIPs might beat the Sensex again but what will be your investment's performance after the high initial expenses and a down market? Considering an average cost of 30 per cent in a ULIP, a premium of Rs 1 lakh is down to Rs 70,000.

Even if we leave all the other costs out, a simple 30 per cent erodes your wealth greatly. And if markets were to fall by 30 per cent, your investment value will be down to Rs 70,000 - 21,000 = Rs 49,000. By now you are down by 51 per cent. A bit of common sense will show you that you need more than 100 per cent to just break even. This is one of the biggest risks that such products face.

ULIPs have a long way to go in terms of being useful for individuals. The first thing that insurers must do is that all charges should be deducted from the premiums paid and not from the units. The units must remain the same after allocation. Till then, whether ULIPs have beaten the Sensex or not have no relevance to unitholders.

The author is director My financial advisor.