11 June, 2010

ULIPs and what you need to know...

There are regulatory changes galore. The latest is the lowering of the charge structure of ULIPs. They had come up with a formula restricting the difference between Gross and net returns ( after charges ) to 2.25 – 3%, at the end of the tenure. That looked like it will bring about a sea change in the way ULIPs are structured. It was felt that charges will be really down and will be good for the investor. Let’s find out.
Have the charges come down? Yes. But not as much as expected. The July 22nd 2009 circular from IRDA states… “ For insurance contracts which are of a tenor of less than or equal to 10 years duration, the difference between gross and net yields shall not exceed 300 basis points, of which fund management charges shall not exceed 150 basis points. For other contracts, i.e., those whose contract period is above 10 years, the difference between gross and net yields shall not exceed 225 basis points, of which the fund management charges shall not exceed 125 basis points.” A careful reading shows that this compliance is to be shown for the term and there are no caps, on a year by year basis. This is a trap door left open. This means that charges in the first few years can still be substantial. When we looked at a couple of products, this was borne out.
If we examine the changes that insurance companies have ushered in, taking a couple of products that have been launched now, it becomes evident that the charges are not that low. In ICICI Pru Maxima, premium allocation charges for year 1 is 7.5% & 3% for year 2 & 3 respectively. After that it becomes zero. These charges are indeed much lower than it used to be in the past. In case of another product – HDFC Endowment Supreme Suvidha, the first year premium allocation charges are 30%, 2 & 3rd year charges are 15% & 10%; After that, there are no premium allocation charges. However, there is another charge- policy administration charge, which can make all the difference. In case of ICICI Pru Maxima, policy administration charge ( as a % of Annual premium ) is 0.9% pm, charged for the first five years. In HDFC Endowment Supreme Suvidha, the policy administration charge ( as a % of Annual Premium ) is 0.4% pm for the entire term of the policy. In the earlier era, Policy Admin charges used to be a flat Rs.40- 70 pm, irrespective of the premium amount. Now, higher the premium paid, higher will be the policy administration charge. The work on the policy administration front is no different whether the premium paid is Rs.20,000/- or Rs.2 Lakhs, but in these products an investor will be paying higher charges for higher premiums, which is not justifiable. There are Surrender charges in both cases, till completion of five policy years. Fund Management charges are a flat 1.25%pa, chargeable on a daily basis in HDFC’s case and ranges between 0.75% to 1.35% in case of ICICI Pru Maxima.
On the plus side, ICICI Pru Maxima gives a 2% extra allocation from 6th year onwards and in HDFC’s Supreme Suvidha, they allocate 5% from 6th year onwards for every year of premium paid from 6th policy year onwards. Also in case of HDFC ‘s policy, they allocate a bumper addition of between 50- 100% of the annual premium ( something akin to the loyalty addition ) at the end of the tenure.
The charges are down compared to earlier times. There were products earlier charging upto 70% as Premium allocation charges in the first years. Now, that is not possible. But, there are still a whole lot of charges which are charged in the first few years. That brings me to the next point.
Front loaded charges creates a problem… By charging everything in the first three to five years and having surrender charges till five years, the insurance company is ensuring that all charges due to them come in and the policy holder cannot exit or can exit and get grievously hurt. Also, it presents an churning opportunity to the agents, some of whom will exploit to their benefit. The new regime does not address this pernicious problem, often reported against insurance advisors. A good idea would have been to impose caps on what they can get as commissions year-on-year, as also staggering the commissions, over a much longer tenure ( like 10 years ). An even better idea would have been to have a metric to ensure persistency of policies of the insurance advisor by having a differential remuneration – higher for those with high persistency and lower for those who show lower persistency. That way, there will be lesser incentive for misspelling & churning.
Rule applies only for policies held for the term - If an investor surrenders in between, the formula ( of difference between gross yield to net yield being a certain number ) does not apply to them. This means that investors should really treat ULIP investments as longterm investment vehicles. My experience on this is that people tend to exit after a few years ( with substantial inducement to move to another policy ).
Your yield can be different- The yields on the plans can be lower than the indicative yield. As per the same IRDA circular – “ Extra premium due to underwriting emanating from extraordinary health conditions, cost of all rider benefits, service tax on charges (as applicable) and any explicit cost of investment guarantee shall be excluded in the calculation of net yield”. This means there will be other charges like Service tax and cost of investment guarantee, which can be outside the purview of yield calculations. This obviously means that the net yield that an investor gets may be lower than what the plan illustration shows.
Is it all negative then. No really. The point is that the charges are down, but not substantially down. Also there are quite a few loopholes that can be cleverly exploited. The direction is good. But, there is scope for tightening, in the interest of investors. Insurance advisors still have traditional products, these rules don’t apply. It is hence a much more lenient treatment for insurance advisors especially as compared to their brethren in MF industry, where there are no entry loads and they have to charge a fee for services rendered. Probably, since there may be a reduction of the earnings compared to the period earlier, the agents may choose to sell traditional products more. Having such differentials in remuneration between MF & Insurance is not a good idea as many times the same person sells all these products. He could easily divert from MFs to Insurance products. Such imperfections in the financial services landscape is not good for the industry as a whole as it will ensure an unhealthy tilt towards Insurance products. It has been happening for sometime now. The investor needs to be aware of these and weigh the options before investing.

Published in Money Mantra in March 2010

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