The cost differential between unit-linked policies and mutual funds

This study estimates the cost differential between investing in unit-linked insurance policies and investing directly in the same underlying mutual funds, using information from product prospectuses. The cost of investment is measured at the level of the single underlying investment fund by the Reduction in Yield (RIY). Using Monte Carlo simulations, the analysis controls for factors such as fund type, investment amount, holding period and investor age. The main findings indicate that the simulated cost of unit-linked policies is generally significantly higher than that of mutual funds purchased on the retail market, mainly due to higher ongoing costs. The cost differential ranges from 0.5 to 2.5 per cent and is higher when investing in money market funds, ETFs, and policies distributed by financial advisors. Our findings hold when controlling for the actuarial component of insurance policies, possible policy rebates, the costs of portfolio reallocation and the actual portfolio allocation of insurance companies. The extra costs of unit-linked policies may be justified by advisory services and other additional features that insurance companies may offer. It could also reflect information and cost transparency issues or limited competition in the distribution of savings products.