Buying ULIPs? Read on. . .

The last few months have been action packed for insurance companies having a ULIP (unit-linked insurance plan) product in their portfolio. This, primarily on account of a cap levied by Insurance Regulatory and Development Authority on the total expenses that can be charged by insurance companies on such products with effect from October 1, 2009.

For insurance products with a tenor of less than or equal to 10 years duration

• Fund management charge cannot exceed 150 bps (1.50%)
• The difference between gross yield (yield generated before all charges are deducted) and net yield (yield after all charges are deducted) cannot exceed 300 bps (3%)

For insurance products with a tenor of more than 10 years duration

• Fund management charge cannot exceed 125 bps (1.25%)
• The difference between gross yield and net yield cannot exceed 225 bps (2.25%)

Objective

IRDA's has taken this step to increase transparency and help consumers to have a clear understanding of the product. IRDA explains the bias towards longer tenure insurance products by maintaining that insurance products should be long term saving vehicles and hence investor opting for it, should benefit.

Also, this will encourage investors to look at longer tenure products.

What difference does it make?

Arun, aged 31, took a ULIP plan from XYZ insurance company of Rs 20 lakh (Rs 2 million) for tenure of 20 years with premium of Rs 3 lakh (Rs 300,000) to be paid in the first three years only.

The various charges that would be levied would include premium allocation charge (for commission, renewal and other expenses), mortality charges (insurance coverage depending on age, amount of coverage, health, etc), fund management fees (fees on management of the fund before arriving at the NAV), administration charges, surrender charges (premature partial or full encashment of units), fund switching charges and service tax (deducted from the risk portion of the premium).

Before the change in policy, the gross yield on his product was 10% and the net yield 6.35% which means 3.65% was going toward expenses.

But now, with the change in regulation, the same insurance company can at worse give him a net yield of 7.75% - a surplus of 1.4% over the old policy which means a higher amount is going towards the investment fund which is a benefit to the investor.

Impact

Insurance companies

• The change in regulation required products that did not meet specified requirements to be either withdrawn from the market or modified by December 31, 2009. Hence the exercise of re-launching products has already begun by insurance companies. As per the latest reports, IRDA has been flooded with ~240 new product applications for 'file and use' -- launch of product after 30 days if no query is received from IRDA.
• Making the most of the situation, some insures have also discontinued ULIP products that were not doing well. 
• In order to reduce the impact on them, Insurance companies have started lowering commission to agents.

New Investors

New investors will benefit from this move of IRDA because the investible sum will increase. But one needs to also keep in mind that most of ULIP products had their expenses front loaded with significant reduction in the latter years.

If the new move of IRDA results in insurance companies charging higher expenses in the latter years (but within limit), the benefit to consumers may not be as much as is anticipated.

Existing investors

There is no clarity on what it means for existing ULIP customers who are already paying expenses much higher than that stipulated by IRDA.

Market information suggests that insurance companies will provide existing customers an option to switch to the new scheme without any additional charges.

So it's time to act now. Just as in the case of mutual funds when entry loads were eliminated, you the investor had to be alert and apply for removal of the same to ensure lower costs, here also you will have to be proactive and act.

Contact your agents/ insurance companies and make sure you exercise the option when it is announced. The investment is yours and returns will make a difference to you.