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The New ULIP Regime


(This is an article I wrote recently, so here you go!)

The new ULIP regime is here, and insurers must be balking in fear. The changes? Spread commissions over the lock-in period of the scheme, the minimum of which is now five years from the earlier three; a cap on surrender charges to a maximum of 6% (or Rs. 6,000); a guaranteed 4.5% on pension products and forcing investors to buy annuities on exit; and higher minimum sums-assured on ULIPs.

The one aspect that must trouble insurance companies the most is the cap on surrender charges. For many insurers, this has been a significant source of revenue, since these fees directly line insurer pockets. Prior to September 1, a significant number of ULIPs would charge huge amounts as surrender charges – from 100% of your fund value if you exited in year 1, grading down to 5% in year 5 and so on. The idea was something like:

Phase 1: Entrapment

“Sir, you should invest in this ULIP. All you have to do is pay for three years, and you’ll get a tax-saving, and a fantastic deal! Just 20,000 a month.”

Phase 2: Realization

“Mr. Agent. It’s been a year now, and I’ve paid Rs. 240,000 in premiums. The Sensex has gone up 20% in the last year. So why does my account balance show just 120,000?”

“Well, there was 60% first year premium allocation charges, which meant only 96,000 was left; that grew to 120,000 which is pretty good growth!”

“Good? What good? I pay 240K and am left with 120K and that’s good?”

Phase 3: Exit!

“Get me out of this plan now.”

“Sir, if you stop paying your premium you will lose another 50% of whatever is left, as surrender charges”.

“Oh. Wait. I don’t care. I’ve been cheated!”

People still surrender their policies, sometimes choosing to pay two or three more years of premiums before doing so – and primarily because they had been sold a “three-year” policy, which turned out to be a much longer, 20 year product instead. The surrender charges they paid after three years may be small – of the order of 5% or so – or massive, in some cases losing whatever little was left after commissions. When you’ve lost 90% of your money, you’re unlikely to pay more for a few more years just to recover what’s left (and pay even more commissions).

Insurance companies are seeing tremendous amounts of money leave through surrendered policies. Look at the L-7 (“Benefits Paid Schedule”) of most insurers (eg. ICICI, Birla Sun Life) and you will find that more than 90% of money going out is on account of surrenders. A further look at L-22 (Analytical ratios, Persistency) shows that only about 1/3rd of customers choose to continue policies after the 36th month.

We don’t know what the average surrender charge is – but for most policies before September 1, these charges were pretty hefty – let’s say the average is around 10-20% when you consider all surrenders. When this drops to a maximum of 6% (or Rs. 6,000) for policies above Rs. 25,000 premium, this will impact all insurers. The three insurers I checked – HDFC, Birla Sun Life and ICICI – had surrenders of 430 cr, 330cr and  2,400 cr. respectively; the surrender fees are likely to be above 50 crores for each insurer, just for the last quarter.

Consider now that the high salaries in the sector have largely been justified by the high fees. Salaries are sticky – no one likes to take a pay cut – so the obvious impact will be to retrench; and going by the grapevine, that retrenching is already happening. The impact of the Direct Tax Code is also negative, starting 2012, with the loss of tax-saving status of most existing policies (the DTC provides tax-saving coverage to policies with a premium of less than 5% of sum assured – most ULIPs don’t qualify). Plus there’s a tax deduction at source for insurance maturity payments, making them less attractive.

What about agents? They complain that commissions are now sub-10% which is very less. Well, the point is this – no other financial product offers even half the “lower” insurance commissions. So there is really nowhere to run anymore – insurance still provides a multiple of what they would get otherwise.

Why is this relevant to you?

What is important to understand is how the dynamics of the industry changes – and therefore what new spiel you’re going to receive, and how to decode it.

Endowments: We’ll get to hear about traditional endowments – non-unit-linked – as a great way to invest. I wouldn’t even bother – endowments are opaque products with very high but hidden charges. Additionally, surrendering the policy early costs a very large amount – usually you would be happy to see even 1/3rd of what you’ve paid should you want a premature exit. Endowments might have their uses (for example, a “waiver of premium” rider helps continue a policy in case of disability, or a cheap way to transfer wealth when you die) – but for the purpose of investment, it is a fairly useless product.

Why sell them, you ask? Agents continue to get great commissions and the non-transparency of the product and high fees ensure you get stiffed without your realizing it.

The sales pitch of the ULIP might change – to force you to pay higher premiums, or to disguise the product as something it is not. With bankers who would gleefully sell you a ULIP when you ask for a fixed deposit, you have to be careful! So here’s a set of steps

First, don’t sign a document if it contains the word “insurance” unless you receive the complete detailed brochure for the investment.

Second, check for phrases that steal your money away from you: Premium allocation charge means they’ll take that much away. Policy Administration Charge is another premium stealing measure; earlier it used to be miniscule but now they have “tweaked” the policies around. “Administration” charges can add up to 5% of your fund value per year and what you will see is 0.4% per month, another dirty way to hide theft. Fund management charges apply at about 1.5% per year, which is okay – this is charged even by mutual funds. Mortality Charges are, again, okay because this is what the real charge of insurance is – what they take to give you the sum assured in case you die.

Lastly, add up the charges (other than mortality). Most policy charges will add up to 10-15% in the first year. Then, throw all these documents away.

I would invest in a long-running, diversified mutual fund instead; because paying 10-15% for investing your money is financially stupid, when you’ll pay only management fees in a mutual fund. (For funds like HDFC Top 200 or HDFC Equity, the total recurring fees, including trustee, registrar and other fees, adds up to 1.8%)

Yes, you will ask me about insurance – for that, I would buy a term plan; online term plans are available from ICICI Prudential and Aegon Religare for extremely low premiums. (A policy of 1 crore for a 35 year old will cost less than Rs. 25,000 per year) More insurers will offer low cost term plans, and as our life expectancy grows with better medical care, we will find premiums coming down over the next few years. I don’t like ICICI and Religare Claim payout ratios are horrible so I’ll wait.

My method does not help the profitability of insurers eit
her, especially those who wanted to make money stealing it from us. The good old method of making profits from the practice of insurance must take center stage; the method of making money without killing us in the process.


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