Abhinav Jain has decided to break the vow he took three years ago. In 2007, two years after he bought an insurance-cuminvestment plan, the Jaipur-based production manager realised that the features of his Ulip were loaded against him. "The charges in the first two years were so high that barely 30-40 per cent of the premium was invested," says Jain. He felt cheated by the insurance company and the broker and swore never to invest in a market-linked insurance product again.
However, Jain has gone back on his word and is shopping for a Ulip once again. This is because the recent regulatory changes in Ulips and those expected in the future promise to reduce or remove some of the drawbacks of the hottest selling insurance product. For instance, Ulips have been widely castigated for the high premium allocation and other charges that leave very little of the premium for investment. In some plans, these charges gobble up 60-80 per cent of the premium in the first year, a fact that has irked many Ulip investors, including Jain.
However, in August 2009, the Insurance Regulatory and Development Authority (Irda) imposed a limit on the charges by capping the difference between the gross yield and net yield of a Ulip to 2.25-3 per cent. The gross yield is what a Ulip would earn if no charges are deducted, while the net yield is what it would earn after all charges are deducted. If the difference between the two yields is capped at 3 per cent, it means insurance companies will have to reduce the charges on Ulips or distribute them evenly over the term of the plan. To do this, they would also have to launch longer duration plans. Right now, 10-15 years is the norm, but the change might lead to the launch of 25-30-year plans. "The capping of charges is a far-reaching regulation and promises to remove a major flaw from Ulips," says Deepak Yohannan, CEO and co-founder of the Mumbai-based iGear Financial Services Pvt Ltd, an online aggregator and distributor of insurance policies.
Lower costs are only one of the several changes that have made Ulips more attractive. The revised draft of the Direct Taxes Code released on 15 June clarifies that investments (including life insurance policies) made before 1 April 2011 will continue to be governed by the existing tax rules till maturity. This means that income from all Ulips bought before the DTC comes into effect will continue to be tax-free.
The other major investor-friendly proposal is the cap on surrender charges. Till now, besides the heavy deductions in the initial years, Ulips also levied fat surrender charges. These acted as a strong deterrent for anyone attempting to surrender in the first three years. So, instead of surrendering their policies, most customers just allowed their Ulips to lapse and waited for the lock-in period of three years before withdrawing the balance. The quantum of the charge and the method of computation also varied across insurers. Surrender charges were either levied as a percentage of the paidup premium or as a percentage of the fund value.
Now, Irda proposes to standardise the surrender charges and impose a limit (see table). This helps because the investor gets a clear picture at a glance and comparing plans becomes easier. However, there is no reason for elation. Ulips are a long-term investment and surrendering them early is not a good idea. Moreover, most Ulips still have high upfront charges and would probably give negative returns in the first three years. Add to this the surrender charges and the disincentive to surrender is almost as strong as before.
However, if an investor's circumstances don't allow him to pay the premium any more, the regulator has ensured that he recoups at least some of his money. "In exceptional circumstances, if the customer chooses to surrender, he will benefit since he will receive a higher fund value," says V. Srinivasan, CFO, Bharti AXA Life Insurance.
In another investor-friendly move, Irda has proposed that if a policy lapses because of non-payment of premium, the corpus will earn a nominal interest of 3.5 per cent per annum till it is withdrawn by the policyholder. While 3.5 per cent per annum may seem low, given the high number of policies that lapse (according to Irda, 91 lakh policies lapsed in 2008-9), the gains for investors work out to a gargantuan amount.
Irda also wants the minimum lock-in period of three years for Ulips to be increased to five years. On the face of it, this seems an unfriendly move for the investor as it curbs the liquidity for the policyholder. But this actually helps investors by cutting down on chances of misselling. The lure of high commissions often motivates unscrupulous agents to push Ulip investors to stop paying premiums and withdraw the amount after three years. This is a costly strategy for the investor because he has already suffered high charges levied in the initial years. By increasing the minimum lock-in period to five years, Irda has aligned Ulips with a long-term horizon. "Distributors will no longer be able to push Ulips as three-year plans," says Yohannan. Insurance companies are also happy with the change. "Exiting prematurely from Ulips is not beneficial for investors. Increasing the minimum lock-in period to five years will promote the long-term investment and financial protection characteristic of Ulips," says Srinivasan.
That's not all. Distributors may also have to clearly state how much commission they will pocket for selling the policy. Irda plans to make it mandatory for insurance agents to state this in the benefit calculation they give to potential investors. This is expected to bring in greater transparency but there are doubts whether the average investor understands the calculations at all. Besides, insurance agents brazenly violate Irda guidelines on the maximum returns to be assumed in such calculations. While Irda has stipulated 6 per cent and 10 per cent, agents generally use a higher rate of 15-18 per cent in their calculations, thus making the result more attractive for potential buyers.
In many of the changes proposed by Irda, the underlying objective is to increase the insurance cover. For instance, top-up contributions in Ulips, which do not attract any charges because they are pure investments, will also be used to buy a life insurance cover for the policyholder. What this also means is that a small proportion of the top-up investment will go into mortality charges. This will make top-ups more complicated, while providing only a small insurance cover to the policyholder. "Though every top-up will give added protection to the customer, including a mortality component might require underwriting and perhaps medical tests, which could take away from the convenience," says Srinivasan.
In its zeal to expand insurance coverage, Irda also proposes to make it compulsory for unit-linked pension plans to offer life or health cover. This is bad news for investors. A compulsory mortality charge in the pension plan will reduce the amount of investment flowing into retirement savings. Till now, pension plans were cheaper than Ulips because they didn't have an insurance component. If the proposal goes through, pension plans will become just as costly.
However, despite these proposed measures, Ulips as a product have not changed. Read the following story to know what to look for when you buy a Ulip.
How the cap on charges helps
