Pre-2010 Ulips a bitter pill you can’t stop taking

If you bought into the earlier generation of unit-linked insurance plans, or Ulips, (pre-September 2010) chances are you now feel like the chickens are coming home to roost. Buying those Ulips may not have been the smartest decision and with most policies completing or recently completed the three-year lock-in, you may be tempted to pull out of the policy.

No doubt, agents will encourage you to surrender the Ulip and move to a new policy. But keep this in mind: most Ulips of the pre-2010 era are front-loaded (most of the costs are recovered in the initial years) and have a steep surrender penalty. Heavy costs in the initial years and a penalty for discontinuance make surrendering a Ulip a bad idea.

But this rule may not apply to all. You need to go beyond the charges and look at the fund performance, too. Read on to know when it makes sense to surrender a Ulip.

Numbers game

Why surrender doesn’t make sense: Since pre-2010 Ulips were front-loaded, it is only in the later years that more money would go towards investment. Surrendering in the early years would, therefore, mean you pay upfront before the policy is able to efficiently invest your money. If this doesn’t sound worrying enough, here is another cost blow: you also pay a surrender charge for exiting. Says N. Varadarajan, executive director, Edventus Business Enhancers Pvt. Ltd, a human capital management firm: “Surrender charge is influenced by the policy charges. Ulips were front-loaded products, so if an insurer chose to charge less in the initial years, he would ensure that he is able to recover his money through steep surrender penalty.” Unlike Ulips that are sold now, there was no cap on surrender charge for Ulips earlier.

Let’s take an example. Suppose a 30-year-old buys a Ulip for a sum assured of Rs10 lakh and pays an annual premium of Rs1 lakh. Considering a policy allocation charge of 25% in the first two years and 3% in the third year, the fund value after paying for other charge such as the fund management charge, mortality cost and policy administration cost will only amount to Rs2.81 lakh. This is assuming a growth of 10% per annum. Fund value of Rs2.81 lakh on an investment of Rs3 lakh is a negative return of 7%. This will be hit further by paying an exit penalty of 8% of the fund value.

Also See | Why you shouldn’t surrender (PDF)

Now let’s suppose the person decides to buy a term plan of Rs10 lakh and decides to invest the balance every year in a mutual fund (MF) growing at 10% with an annual expense ratio of 2%. By investing the surrendered value along with Rs98,224 (the remaining part of the Rs1 lakh investment after paying for the term plan—the cost of an online term plan for a 33-year-old is around Rs1,776 per annum) in the first year and subsequently Rs98,224 every year for the remaining 17 years, the MF will return a corpus of Rs44.35 lakh. If you didn’t surrender after three years, on maturity the same Ulip would have returned Rs47.39 lakh, assuming the same rate of growth. Says Suresh Sadagopan, a Mumbai-based financial planner: “Whether it makes sense to surrender a Ulip will need to be evaluated on a case to case basis, but since Ulips are front-loaded, surrendering in the initial years does not make sense for most Ulips.”

Why switching doesn’t make sense: Even switching to a reformed Ulip will not make sense for the same reason. Costs in the new Ulips are relatively more spread out and surrender penalty is limited to Rs6,000 in year one and nil from the fifth year, making them a better financial product but over a long-term horizon the returns from both the plans would be similar. Just that the costs in new Ulips can’t eat away into the returns beyond a limit. Adds V. Viswanand, director and head, products and persistency management, Max New York Life Insurance Co. Ltd: “Usually, in most situations that we have seen, the policyholder is best advised to remain invested post the mandatory three-year lock-in period and enjoy the reduced charge regime of the old Ulip rather than incur an exit cost and get into a new plan which has a fresh set of charges (though lower than the old Ulip) and the uncertainty of insurability.”

Adds Anand Pejawar, executive director (marketing), SBI Life Insurance Co. Ltd: “You have to look at other benefits that you will be surrendering. Also the lock-in will increase from three to five years. The customer will need to be sure he has the appetite of an increased lock in.”

When does it make sense to surrender?

Even as surrendering a Ulip in the initial years may not make sense purely on the strength of numbers, your homework is not limited to numbers alone. You will also need to look at the fund performance. It is better to cut your losses in case your fund is underperforming consistently. Suggests Viswanand: “Look at the gross performance of the fund vis-a-vis its benchmark over one year, three years and since inception, which are all easily available on the company’s website. If the fund is underperforming consistently surrendering may be beneficial.”

But comparing the returns on funds to its benchmark may not be easy, simply because of lack of transparency and unavailability of data. Says Sadagopan: “One of the things we face when evaluating the performance of a Ulip is lack of a benchmark. We then look at the underlying securities and asset allocation and compare performance. It is a tougher exercise. A simpler exercise would be to compare charges. If the ongoing charges in a Ulip is much higher than an MF then the customer is better off surrendering.”

Take the help of a financial planner if you are not able to understand the charges or the performance of the funds before taking any decision.

Even as experts and insurers don’t recommend continuing your policy as a blanket rule, they agree that Ulips are long-term products in which the costs are front-loaded. So unless you are stuck with a horribly performing fund, you are better off continuing.

deepti.bh@livemint.com