The rules of the game for unit-linked insurance plans (Ulips) are fast changing; the latest are the new guidelines announced by the insurance regulator.
In order to give Ulips a long-term character, the Insurance Regulatory and Development Authority (Irda) has extended the partial withdrawal period from three years to five years. This means that partial withdrawals can be made only after five years. Moreover, to ensure that insurance remains at the helm, all unit-linked insurance products, including pension plans but excluding health policies, will now have to give an insurance cover to its customers. These guidelines, among others, are set to kick in from 1 July this year.
The move acquires significance as it comes at a time when Irda is fighting the capital market regulator, the Securities and Exchange Board of India, to keep its independent jurisdiction over Ulips. While the guidelines make Ulips incrementally better, they seem a dampener for unit-linked pension plans (ULPPs).
What we like
Long-term nature: Ulips are front-loaded—in the initial years, a large chunk of your premium goes into meeting charges with little left to be invested—and, so, begin to work for you only after 8-10 years. Since the front-loaded structure also means high commissions in the initial years, often agents and banks encourage customers to churn either by surrendering or making partial withdrawals.
The Insurance Act mandates that a policyholder gets the surrender value only after three years of the policy. So, while Irda can’t stop people from surrendering their policies after three years, it has put a stop to partial withdrawals for five years. It has said that partial withdrawals will be allowed only after five years.
Considering that Ulips begin to give returns only after four to five years (see graphic), the move will ensure customers don’t touch their money before five years. This automatically lends a long-term nature to the product. Higher returns after five years may even help customers resist the temptation of redeeming or making a partial withdrawal for a short-term need.
Says Sumeet Vaid, founder and managing director, Ffreedom Financial Planners, a Mumbai-based financial planning firm: “The advantage is that now Ulips will acquire a long-term nature and will be in sync with tax laws that make a lock-in of five years mandatory to avail section 80C benefits.”
More insurance: Though Ulips fall in the regulatory domain of Irda, they are largely investment products with a little bit of insurance thrown in. This remains a serious flaw in Ulips. Little wonder then that even after holding several Ulips, people remain under-insured. The regulator has sought to address the problem.
Experts are unanimous that one’s insurance cover should be around 10 times one’s annual salary. This means that a person earning Rs5 lakh per annum would need to have at least Rs50 lakh as his sum assured.
The minimum sum assured that one can opt for in Ulips is five times the premium and the maximum is, typically, 20-25 times the premium. The industry average is 10 times the premium.
If the same person were to take a Ulip with the same sum assured, he would have to shell out his entire salary in premiums, considering a 10 times multiple. Even if he opted for a 25 times multiple, he would have to pay Rs2 lakh to fund his Rs50 lakh Ulip. At the same time, a term plan with the same sum assured would cost him around Rs10,000, assuming he is 30 years old.
Irda tried to address this issue in 2005 when it made it mandatory that any top-up investment beyond 25% of the premium would be used to buy additional insurance cover.
Irda has now said that the entire top-up, irrespective of the amount, will also go into buying an insurance cover.
Longer horizon in pension products: Taking a cue from the way the New Pension System is structured, the regulator has enforced a lock-in period for ULPPs till maturity. As per the guidelines, the option of partial withdrawal will not apply for pension plans.
If you surrender the policy before maturity, you will get only one-third of the surrender value as lump sum; with the remaining you would have to buy an annuity, in simple words, a pension product. Of the maturity amount, too, only one-third will be given as a lump sum.
What we don’t like
Combination of insurance and pension: Bundling insurance and pension products seems an apparent attempt by Irda to protect its turf from Sebi’s intervention. But the move to make insurance mandatory along with pension products has made the product even more complex.
Till now, most pension policies gave you the option to opt out of insurance, while some came as pure investment plans. Given the fact that pension plans can charge only up to 7.5% as commission and have no insurance charge, ULPPs were better products than typical Ulips.
By making the insurance component mandatory, Irda has only made products more expensive. Says Pankaj Mathpal, chief financial planner, Pankaj Mathpal and Associates, a Mumbai-based financial planning firm: “Mortality charges will be adjusted from the premium so the investible premium will reduce further. This will have a negative impact on the pension amount. Also, if the customer can’t satisfy the medical underwriting requirement due to his poor health, negative medical history or habits, such as drinking and smoking, he may not be able to buy the plan, which is not justified.”
Moreover, the move discourages goal-based investment. Says Mathpal: “Pension plans should be bought with the sole objective of getting regular pension during old age. It is strictly an investment product and there is no need to club two goals— buying insurance and investing for retirement. There are term plans for one’s insurance needs.”
Will it affect existing customers?
For existing customers, it is business as usual. Any policy bought before 1 July 2010 needn’t conform to the new Irda guidelines.
While these reforms are incremental steps in the right direction, the issue of commission structure and other product-related problems remain unresolved.