With stringent cost caps and clipped surrender charges, unit-linked insurance plans (Ulips) are reformed products now. But thanks to the mortality cost, that sits comfortably outside the cost cap, Ulips continue to be expensive.
The mortality cost, or the cost of insurance, in a Ulip is higher than that in a pure term plan, leading us to reiterate our conclusion: you are better off keeping the two financial needs of insurance and investment separate.
Why is mortality cost higher in Ulips?
Relaxed underwriting: In a Ulip, your premium gets hacked by what is called a premium allocation charge. After that, the insurer deducts mortality cost, fund management and administration costs, among others; the remainder gets invested in the funds of your choice. Last year, the Insurance Regulatory and Development Authority capped all the charges, except mortality cost since it was not considered viable. The rationale was that if an older person chose a higher sum assured, the mortality charge would have to be higher.
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The basic idea of introducing cost caps was to contain commissions and expenses of the insurer to ensure customers are able to invest more. But lower commissions meant lower incentive for the agent to push Ulips. In order to drive sales, insurers began relaxing underwriting norms in Ulips. This, in turn, increased the risk for the insurer and thereby the mortality cost.
Says Subrat Mohanty, senior vice-president (strategy and product), HDFC Standard Life Insurance Co. Ltd: “Term plans are fully underwritten plans, whereas our type-II Ulip has simplified/limited underwriting options. In all term plans, we exactly know what mortality risk we are underwriting. In Ulips, for a lot of cases, we are using a simplified underwriting norm to ease the purchase of the product for the customer. This way we take additional risk on the life insured that is reflected in the charges.”
With increasing awareness about insurance, mortality costs have gone down; this gets reflected in term plans but not in Ulips. Says Yashish Dahiya, co-founder and CEO, PolicyBazaar.com, an insurance portal: “Term plan rates have come down in the last two years by almost 60-70%, but that’s not the case with Ulips and traditional plans, barring few companies. It’s just inertia and not helpful to customers.”
Cap on surrender: Even the cap on surrender charges have led to an increase in the mortality costs in Ulips. Surrender charges can be Rs 6,000 in the first year tapering off to zero in the fifth year. When there was no such cap, the insurer was able to recover expenses in case of surrender.
But since the insurers are unable to recover their costs through the surrender charge now, some of this cost is parked under the mortality cost head. Says an official, who did not want to be named: “Ulips are bought not for insurance purpose but for investment purpose and depending on the market conditions the chances of surrender are very high and this increases the insurer’s risk. Hence, to recover costs in the new regulatory regime, some of the costs are passed on to mortality charge.”
However, some experts lay the onus of difference in pricing on the product portfolio. Says Sanket Kawatkar, practice leader (life insurance), Milliman India Pvt. Ltd, an insurance consultancy firm: “High mortality costs in a Ulip does not always mean the insurer is overcharging. It could also be due to the fact that these products have different capital requirement, costing structure and the experience of the two products portfolios are completely different. However, for a customer a product with lower charges makes sense.”
How the costs pan out
We scanned around 20 insurers for a type-II Ulip, which pays the sum assured as well as the fund value on death. Only 11 had Ulips whose mortality costs were comparable with that of a pure term plan.
Since a type-II Ulip gives both the sum assured and the fund value to the beneficiary on death, it charges for mortality for the entire tenor. On the other hand, a type-I Ulip, which gives the higher of the sum assured and the fund value, charges for mortality till the time the fund value equals the sum assured, thereby reducing the sum at risk to naught. A term plan also assures the payment of sum assured to the beneficiary on the death of the policyholder throughout the term and therefore charges the mortality cost for the entire term.
Out of the 11 Ulips, only one’s mortality cost was cheaper than that in a term plan in absolute terms.
But we cannot stop at absolute price comparison. The cost structures of term plans and Ulips are different. A term plan charges the same premium (typically, about 85-90% is mortality cost and the rest goes into administration and other costs) every year during the policy term. On the other hand, Ulips fix mortality cost at each life stage during the policy term; as you grow older the risk that the insurer takes on you increases and so the mortality cost, too, increases proportionately. The advantage with Ulip’s cost structure is that you pay more only as you grow older and not upfront like in a term plan.
So, for a fair comparison of costs, we need to look at the net present value (NPV) of the two cost structures. NPV reflects the present value of all future cash flows. NPV is arrived at by discounting all future cash outflows to their current present value. We discounted all cash flows (mortality costs) at an assumed rate of 6%. In NPV terms, only four Ulips were cheaper than term plans (see table).
Interestingly, when we compared the mortality costs of a Ulip with online term plan premiums, which don’t include commissions and other expenses, the difference was stark. For instance, Aviva Life Insurance Co. India Ltd’s i-Life (a term plan) charges Rs5,432 per annum or around Rs1.09 lakh in total from a 35-year-old for a sum assured of Rs30 lakh over a term of 20 years, but Aviva LifeSaver Advantage’s (a type-II Ulip) mortality cost is around Rs3.20 lakh in total. In absolute terms, the difference in this case is Rs2.11 lakh, but discount it by 6% and in terms of present value the difference still remains a huge Rs94,283. In a similar example, the gap was larger. ICICI Prudential Life Insurance Co. Ltd’s type-II Ulip was costlier by Rs2.78 lakh in absolute terms than the company’s term plan.
Insurers, however, attribute this difference to aggressive pricing for their online term plans. Says Gaurav Rajput, director (marketing), Aviva India Life: “The customer segment and the risk classification parameters are quite different between Ulips and online term plans. The quality of life is considered better as the customer is using a sophisticated medium of purchase where all purchase decisions are being made by himself as he is buying the policy unassisted. The disclosures are better. Hence, the experience of such lives in terms of mortality is better. Also, sometimes a Ulip’s mortality charge includes the cost of accidental cover, which is not there in online plans.”
Mint Money take
In their current form, Ulips are not efficient multi-functional vehicles that can cater to your insurance as well as investment needs.
In fact, Ulips’ mortality cost is in sync or lower than that in term plans only when the sum assured is minimal, usually 10-12 times the annual premium. But as the sum assured goes up, so does the mortality cost. Says Mohanty, “A typical buyer of our Ulip is 25-35 years old who takes it for 10-15 years. For a sum assured that is 10 times the premium, a mode chosen by most of our customers, the total mortality charge of the Ulip is actually comparable or slightly lower than the mortality charge of the term product. However, this equation changes for a higher sum assured or a longer term. But this accounts for a very small part of our business.”
Ulips are not cost-effective if your aim is to insure yourself adequately. For that, you need a pure protection plan. And by that logic, it makes sense to keep your investment and insurance needs separate. Buy a term plan and invest the remainder in a mutual fund or a pure investment vehicle of your choice.
Graphic by Ahmed Raza Khan/Mint