IRDA clips ULIP's wings

Unit Linked Insurance: New norms are investor-friendly

Life insurance companies, whose primary aim in business is to provide life cover to the investor in case of a premature death, also dangled the carrot of ‘market-led returns’ quite successfully by selling Unit Linked Insurance Products or ULIPs as they are popularly known. ULIP is a category of insurance products where a part of the customer’s investment goes towards providing life cover for insurance and the residual portion is invested in a fund which in turn invests in stocks or bonds.

The entry of the private sector players in the year 2000 ended government monopoly of insurance in India. The new private players, in order to gain a foothold in the market, started selling ULIP products aggressively as the new premium income of life insurers from ULIPs was higher than the new premium income from traditional life insurance plans. Since this coincided with the bull run in the stock markets which started in the year 2003, the investors also got carried away by the euphoria of market-linked high return.

Look before ULIP

However the disclosure norms was a cause of concern, as people buying ULIPs were often not informed about all the risks.

They were promised phenomenal returns, without being informed that ULIPs might prove risky if the timing of exit happens to coincide with a bearish market phase, because of the inherently high equity component of these schemes.

Many agents convinced gullible investors on the basis of past growth in the stock indices, which is totally misleading and illegal not only for insurance but also for mutual fund products.

The insurance industry regulator IRDA also expressed concern that ULIPs were being aggressively sold more as investment than that as insurance products. Also, the products were being sold at high costs, many of which were hidden.

Regulator reacts

After persistent complaints regarding both the quantum and number of charges associated with ULIPs, the insurance regulator — IRDA — has brought in new regulations to rationalise the cost structure of these products. Effective from January 1, 2010, the new guidelines are primarily aimed at preserving the long term nature of the product, provision of fair insurance coverage and disclosures to facilitate informed decisions by customers.

Prior to this, there was no fixed cost structure for ULIPs or any insurance products, that is, there was no capping on the costs associated with the products. The cost could vary in the range of two per cent to 4 per cent of the premium amount.

With the implementation of these guidelines, all ULIPs will be structured in a manner so that the difference between the total return and post cost return, that is, the cost of the product, cannot be more than three per cent of the premium for policies with a tenure upto ten years and 2.25 per cent for those more than ten years.

That is, IRDA says that if 10 per cent is the gross yield in the market, the net value yield to the customer should be at least 7.75 per cent. So, excluding mortality and guarantee related charges, all costs have to be capped within 2.25 per cent.

As Bajaj Capital Executive VP Vinay Taluja puts it “Fund management charges (FMC) of the insurance companies is now low at 1.35 per cent which will have a big positive impact on returns for the investor as compared to other investment products where the FMC can go up to 2.25 per cent.”

Pro-customer move

The new guidelines incorporate changes that are beneficial to the customers in more ways than one. Insurance companies expect that now that the customer is assured of a certain yield, as internal rate of return (IRR) or the returns to the investor is now mandated by the regulator, ULIPs will now be more attractive from the customer’s perspective.

The changes are very customer centric. They particularly protect the interests of customers with long term savings objectives. As Aviva India Director Marketing Vishal Gupta states, “The customer will get a better deal as far as the IRR is concerned. It will improve by anywhere from 50 basis points to 300 basis points, depending on the products.”

Earlier, most ULIPs typically had a surrender charge up to six years. The new cost rules bring with them zero surrender charges from the fifth year onwards.

Also, there is no surrender penalty if an investor wishes to exit the policy after five years.  Another advantage to the customer is that he will now have more clarity regarding the charges that he is paying in the policy. This is because now, since the costs have to be specified by insurance companies on issuance of the policy, there is more transparency. The IRDA has also mandated customer centric benefit illustrations that provide indicative returns to customers. Commenting on the new move, ICICI Prudential Life Insurance Company Limited Senior Vice-President & Head (Products & Sales) Pranav Mishra said “The changes would ensure uniformity in product comparison across the industry. Also, customers will now have more clarity regarding the charges that they are paying in the policy.”

Company perspective

Even though some players believe that the industry will benefit in the long run as the reduction in charges will attract more customers, companies will have to take measures to balance the loss in income from these changes. 

The new cost caps will push insurance companies to ensure policy persistence since they will only make money if the customer stays the policy term. Commenting on this, Taluja  “As a company, the challenge is now to sell more for the long term as the fund management charges will be higher here, thus helping companies balance the loss in income from these changes.”

He added that long term policies are beneficial both for the investor and the insurance company as the regulator has stated that costs associated with long term policies will be lower and also no renewal premium charges will be levied after a period of five years to encourage investors to continue with the same policy free of additional cost.

These new guidelines and regulations will force companies to bring more efficiency in processes and leaner structures. As Mishra said “Companies will have to create cost effective models of distribution to ensure that the cap on charges does not hurt the bottom line.”

Long term bet

Even agents will be encouraged to sell long term policies as their commissions will get linked to the term of the policy.

Companies will look to create more innovative products and encourage long term behaviour for customers. All the companies have gone in for loyalty additions and guaranteed maturity additions encouraging customers to stay invested over long-term. Gupta added “Our company has also introduced loyalty additions in all our unit linked products after January 1 which will incentivise the customers to stay longer.”

However, in spite of the many changes, some aspects that remain the same like costs are still front loaded, that is, a large portion of the initial premium goes towards payment of costs and consequently only a small amount of that is invested.

Commenting on this, Taluja said “Insurance in India is still solicited and not bought, so the distribution costs are higher. In order to meet those costs, companies have to recover costs upfront or over a maximum period of three years, otherwise it becomes a burden on the company’s capital.”