THE NEW AVTAAR OF ULIP

[Dr. Sanjiv Agarwal]

One of the most popular products to dominate the financial landscape in India in recent years, unit-linked insurance plans (ULIPs) now exudes a new look and feel. The Insurance Regulatory and Development Authority (IRDA) recently issued a new set of guidelines, effective for all ULIPs launched on or after September 1, 2010.

Accordingly, agent's commission are down and the overall cost structure has been standardized. Moreover, efforts have been made to simplify the product further, rendering it more transparent and comparable. The new regulation lay greater emphasis on raising the insurance (risk protection) element, or sum assured, besides ensuring that investors stay invested for longer period in ULIPs.

A ULIP is two-in-one product, comprising insurance and investment rolled into one. From a policyholder's perspective, the new ULIP has certainly become a better product and far less complicated than what was sold to him until three years ago. Over the last 2-3 years, IRDA has attempted to improve the product on many counts, including rationalizing costs, de complicating product design, and reducing product disparity. Now, its latest guidelines are likely to have a major impact on the insurance industry, considering that ULIPs have accounted for more than 80% of the incremental premium in recent years.

Commissions, which were overwhelmingly front loaded, will henceforth be evenly distributed over the entire lock-in period. ULIPs had been widely criticized because of the premium allocation and other charges being  quite high in the first years, leaving very little for investment. In fact, until three years back, the charges were as high as 50-70% for the first year, which  was later reduced to an average of 30% but still quite high. Now, by evenly distributing the charges over the entire lock-in period, a significant proportion of the premium gets invested in the initial years, thereby enhancing the effective return for the policyholder.

In August 2009, IRDA imposed a cap on the overall costs that can be charged on ULIPs by limiting the difference between gross yield and net yield to 3% for tenure of up to 10 years and 2.25% for tenure of more than 10 years. Gross yield is defined as the total return if no charges are deducted, whereas net yield is what a ULIP will earn after all charges are deducted. According to the new regulations, the cost is now capped from the fifth year onwards. This provision means a lower cost structure for investors if they want to exit from the ULIP after the fifth year. Moreover, a lower cost structure means that both the average premium and the tenure of the policy are likely to rise in future.

The lock-in period has been raised from three years to five years. The limited premium payment term, too, has been extended to five years. This will encourage policyholders to look at ULIPs as a long term insurance product rather than as a short term investment option.  The new lock- in along with the lower cost structure should benefit both the policy holder and the industry, as it will now tend to attract serious long term investors looking for a combination of wealth accumulation and risk protection.

Earlier, a minimum insurance cover of five times the premium was allowed. According to the new regulations, the risk cover has been raised to a minimum of ten times the premium for policyholders below 45 years and minimum seven times for those above 45 years. Surrender charges have been capped for any premature closure of the policy. Earlier, ULIPs had very heavy surrender charges in the initial three years. Besides the recurring charges and calculation of the net yield, the advisor's commission will now be disclosed in the benefit document.

During the five years lock-in period, no residuary payments on lapsed, surrendered or discontinued policies will be made. If a policy lapses due to non- payment of premium, then the fund value will earn a nominal 3.5% every year for the remaining lock-in period or until it is withdrawn by the policyholder.

Policyholders can now avail of loans against ULIPs. This facility will ensure that the policyholder remains invested in the product for the long term with the objective of wealth accumulation along with risk protection. A unit linked pension plan, or ULPP, will now have to offer a minimum guaranteed return of 4.5% per annum, assuming that all premiums have been paid.

The new regulations will have a far-reaching impact on the insurance sector, considering that ULIPs constituted more than 80% of the incremental annual life insurance policy premiums in recent years. From an insurer's perspective, the new regulations will be positive for the industry over the long term, although there will be pain over the short term.

From an investor's perspective, ULIPs have certainly become a much better product today. Investors should look at adding the new ULIP in their portfolio, over and above channeling their money into various other avenues, including term plans, mutual funds, stocks, debt instrument and gold, among other. In fact, ULIP should be looked upon as a long term protection and investment option and it will largely benefit those investors who do not have the necessary financial discipline. And if you are one of those, then you can be happy  in knowing that you are certainly not in a minority.