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Business News/ Opinion / Online-views/  Is the Ilip the old Ulip in another cover?
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Is the Ilip the old Ulip in another cover?

Is the Ilip the old Ulip in another cover?

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The recent draft guidelines for traditional products announced by the insurance regulator, Insurance Regulatory and Development Authority (Irda), in a communication to insurance companies have three changes that insurance buyers in India must take note of. One, it has provisions that could announce the return of the old unit-linked insurance plan (Ulip) with all its concomitant problems of high costs in the form of a new product category defined as the index-linked insurance plan (Ilip). Two, it provides for a higher guaranteed surrender value. Three, there is no mention of prohibiting the sale of the “highest net asset value (NAV) guarantee product" that had been there in the previous draft. Irda has been trying to rationalize product structures in insurance for the last two years and this draft is a part of that exercise.

The Ilip

The current draft looks at the Ilip as an index-linked insurance plan that has the mortality cost (the cost of ensuring your life) explicit but leaves all other costs embedded in the product. Costs will get reflected as reduction in yield in the table of benefits. For example, take a policy that pegs the annual return to your policy account to an index. If the annualized yield of the index in the first year is 5%, the insurer will credit, say, 3% of the premiums paid to your policy account. The difference of two percentage points is the cost (see table). Remember just like Ulips, these products can also tailor the death benefit to give either the death benefit and the additional account value, both or the higher of the two. One way to see this draft is that it is a step in the right direction as it collapses all charges (other than mortality) into one expense ratio, but the draft does not mention what the cost caps are leaving room for misuse by the companies.

To understand this better let’s look at the Ulip structure and that of mutual funds. The Ulip works on a reduction of yield principal where the costs of a Ulip cannot drag the net return—return after all costs are deducted—below a certain threshold, defined by the regulator. For a 15-year product, this reduction in yield is 2.25%. Mutual funds use expense ratios (an expense ratio is the percentage of the fund value every year that is deducted as cost) and the regulator defines this charge. It is currently 2.5% and is likely to become around 3%. Irda will have to announce cost caps for Ilip to get the product structure right. The industry is worried about the structure for another reason. “Any product even in case of Ulips allows us acquisition cost. So in the beginning, the costs caps in a Ulip are fairly relaxed to allow us for acquisition cost. But the way Ilip are structured, it only allows for recurring cost. It resembles a mutual fund more than an insurance product," says V. Viswanand, director and head, products and persistency management, Max Life Insurance Co. Ltd.

Surrender charge

After rationalizing surrender costs—the cost that an insurer can levy if a policy holder decides to terminate his policy midway—in Ulips, the regulator has now turned its focus on traditional plans. While the previous draft shortened the time frame to get a guaranteed surrender value, the current draft has explicitly mentioned the guaranteed surrender value. According to the draft you will be eligible for a guaranteed surrender value after two years if the premium paying term is less than 10 years and three years if the policy tenor is more than 10 years.

Further if the policy holder surrenders in the 2nd or the 3rd policy year, the policy holder will get half of the premium paid till then. It becomes three-fourths if surrender happens in the fourth year and the full amount after the eighth year. In addition to this, a policy holder will also get a surrender value of all the bonuses accrued so far.

Currently, a policy holder becomes eligible for a guaranteed surrender value usually after three years. This guaranteed surrender value is usually around one-third of the entire premiums paid minus the first year premium.

However, the industry has not welcomed this proposal as they fear it will lead to lower returns for the persistent policy holder. “Increasing the guaranteed surrender value means an insurer will have to account for that guarantee. In other words, reserving for the policy goes up to maintain a balance between asset and liabilities. Any free asset will get blocked which means depressing the bonus. The prescribed minimum guaranteed surrender value could reduce returns on maturity for a persistent policy holder by nearly 15%. So, the balance will tilt towards a policy holder who surrenders midway during the policy term, rather than a patient, persistent person," explains Viswanand. In other words, a higher guaranteed surrender value means that more assets will need to be reserved to honour the guarantee.

In case of Ilips, the maximum surrender charge is capped at 10,000 for the first three years. It becomes nil thereafter. In case of a Ulip, the quantum of this charge slides down from 6,000 in the first year to 2,000 in the fourth year and becomes nil thereafter.

Are highest NAVs back?

An unusual omission in the latest draft is the mention of prohibiting the sale of highest NAV guaranteed products. In the previous draft guidelines, the regulator had banned the sale of such products since they were misleading. A highest NAV product also invests in debt, but the nomenclature gives the illusion of highest return of the stock market. Irda proposed to ban the marketing of such products since they misrepresented the benefits.

However in the current draft, there is no explicit mention of banning the marketing of such products, though the regulator has mentioned that products that mislead and misrepresent the benefits through the name of the product will not be allowed.

The current draft guidelines don’t have an implementation date and are still being debated upon. Track this space for more updates.

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Published: 20 Aug 2012, 11:54 PM IST
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