The unit-linked insurance plans have undergone a complete makeover thanks to a controversy that saw the Securities and Exchange Board of India (SEBI) and the Insurance regulatory and Development Authority (IRDA) fighting for regulatory control over these products.
What ensued was not-so-pleasant exchange of words from both sides in full public and media glare.
Sitting on the fence helplessly watching a duel that was supposed to decide their fate, investors had started getting restless rushing to their respective insurers asking all short of questions.
However, in the end sanity prevailed and so did IRDA over SEBI. But in a trade-off of sorts, IRDA had to bring in changes in the way ULIPs were being regulated. These changes were indeed to have far-reaching implications on the way they were being devised and sold to millions of customers.
Here is a look at the major changes that have been made and the impact they are likely to have on investors:
1) Lock-in increased from three years to five years.
Underlining the long-term nature of ULIPs, IRDA increased the lock-in period from three years to five years. This would make policy holders stay invested for a longer duration– at least five years, thus benefitting from higher compounding effect.
This will curb the practice of insurance agent luring short-term investor into ULIPs, which are not mean for them.
As for insurance companies, it could reduce their lapsation rate. Since the fund managers at insurance companies would have investors’ money for a longer duration, they would be able to allocate the money in a better way and earn better returns.
2) Minimum insurance cover in ULIPs other than pension and annuity products doubled from five to 10 times the annual premium.
ULIPs have long been held responsible for spreading ‘Kam Insurance Lene Ki Bimari’. ULIPs being an insurance product are supposed to offer adequate protection to policy holders. However, insurance companies have always pitched them more as savings plans than as insurance products. To curb this practice, the regulator increased the minimum insurance cover or death benefit being provided through ULIPs.
To make it simple, let’s assume a policy holder pays Rs 50,000 as annual premium, then as per the new regulations the insurer has to provide a minimum death benefit of Rs 5 lakh. That’s the bare minimum, the policy holder can chose higher death benefits as well. Some insurance companies provide death benefits 50-100 times the annual premium.
However with higher cover, mortality charges (fee for getting cover) would increase and hence less money would be available for investment.
For insurance companies, offering higher cover means increased capital requirement. Insurance companies are required to maintain a minimum capital of 150 per cent of total sum assured.
3) All charges to be distributed uniformly over the lock-in period.
Earlier, up to 40-50 per cent (in some cases 100 per cent) of the first-year premium is deducted as allocation charges, leaving very little money for investment in the first year. Now, with charges to be uniformly distributed over five years, a larger portion of the first-year premium will be available for investment. With larger amount available for investment in the first year, investors will get better returns due to the compounding effect.
Another benefit of the move is that agents will now have to service policy holders for a longer period as they will receive their commissions in stages rather than upfront.
For insurers, this means they will have to maintain a high level of persistency to recover the cost incurred in the scheme’s initial period. Usually, the cost incurred in the first year is high. Now, with uniform distribution of charges, companies will have to recover that cost over a longer period.
4) A minimum annual guaranteed return on pension or annuity plans.
Earlier, unit-linked pension plans did not offer guaranteed returns and most of these products used to have large equity exposure so that returns at the end of the tenure of the policy are healthy. However, with the guaranteed return clause, all these are set to change forever.
As per the new regulations, IRDA would specify the guaranteed rate of return (ranging from 3-6 per cent) from time to time. At present, IRDA has kept the arte at 4.5 per cent.
As a result of this clause, insurance companies would be forced to reduce the equity exposure of pension plans, thus making them less attractive for younger investors.
From investors’ viewpoint, while their fear of losing money due to market risks would be completely eliminated, returns from these schemes would come down. For insurance companies, this ruling would mean greater capital requirements and added financial burden.
5) The net reduction in yield for ULIPs should not be more than 3 per cent at maturity
Fees charged for ULIPs (especially the allocation charges) were considered too high, making them the most expensive investment products. IRDA sought to address this issue by capping the difference between gross and net yield at 3(%) per cent for policies with tenure less than or equal to 10 years, and 2.25(%) per cent for policies with maturity over 10 years. It necessarily means that the expenses/charges should not go beyond 3(%) per cent of the maturity value of the policy.
Investors stand to gain as returns/yields are set to improve.
However, insurance companies’ profit margins could decline. Their ability to pay commission to distributors would also get hindered.
6) Standardised surrender charges
Surrender charges are deducted from the fund value if the one stops paying premium during the lock-in period. They are usually expressed in percentage of the total fund value at the time of lapsation of the policy. Earlier, there were no standardised rates for deducting surrender charges and within the life insurance industry, they varied widely.
To put an end to the arbitrary nature of the charges, IRDA came out with a standardised rate chart to be followed by insurer while charging surrender fee.
The maximum surrender fee to be charged if the policy lapses within a year is 12.5(%) per cent for a policy with maturity less than 10 years, and 15(%) per cent with maturity of over 10 years. Subsequently, for the following years the rate drops by 2.5(%) per cent. (See table below)
| Policy period Less than 10 yrs More than 10 years |
| Year |
| 1st year 12.50% 15% |
| 2nd year 10.00% 12.50% |
| 3rd year 7.50% 10% |
| 4th year 5.00% 7.50% |
| 5th year 2.50% 5% |
| 6th year NIL 2.50% |
| 7th year onwards NIL NIL |
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Tags: ULIP, ULIPS, ULIPs Plan, Understanding ULIPs