It was when the din over costs got to a deafening pitch that the insurance regulator brought in cost caps for unit-linked insurance plans (Ulips). Not only were the quantum of charges under fire (up to 70% of the first year’s premiums was deducted in some policies as cost), the number of charges (four at the last count) looked too many.
In July, the Insurance Regulatory and Development Authority (Irda) brought all costs under one head by putting a cost cap in place.
From 2010, all Ulips will be structured in such a manner that the difference between the total return and post-cost return is not more than 3% for policies with a tenure up to 10 years and 2.25% for those with a longer duration.
Illustration: Jayachandran / Mint
What this means is that if your Ulip’s total return is 10% a year, its post-cost return should not be less than 7% if its duration is up to 10 years and not below 7.75% for Ulips with a tenure of more than 10 years.
All policies will have to follow this cost cap. However, the life of existing customers, who may be with older policies having a higher cost structure, remains unchanged.
Says Kamesh Goyal, country manager and CEO, Bajaj Allianz Life Insurance Co. Ltd: “The focus for us will now be to encourage customers to invest for longer terms because servicing short-term policies will be difficult. In fact, even the agents will now be encouraged to sell long-term policies as their commissions will get linked to the term.” Here’s how cost caps will affect you.
It takes a financially literate person to figure out the cost cap and most agents are unwilling to decode it for you. After almost 10 years of Ulip sale and media push, you may have figured out something called the premium allocation charge (PAC) or the upfront deduction from your first-year premium in commissions and other costs to the extent of 70%.
You will now see policies with zero PAC or a tiny upfront cost. What you may not see is the padding up on something called a policy administration charge. Even if your policy comes under the cost cap, it may be more expensive than other offerings.
The trend to offer guarantees started more than a year ago to attract customers who did not want market risk on their money. Though the markets have recovered, guaranteed products are still being launched. From guaranteeing the highest net asset value (NAV) to offering loyalty additions for every year you stick with the policy, they are all there.
Sounds good, but did you know that giving a guaranteed return is one way to escape the cost cap? Ulips with guarantees are able to circumvent the regulatory rulebook as the cost of guarantees doesn’t come under caps. What you also need to know is that the guarantee comes at a cost, is not available on death or premature surrender and is available only if you have an unblemished premium paying record.
Bigger Ulip ticket size
The ticket size of the Ulip premium is going to increase because insurers will find it difficult to service low-ticket policies. But all policies won’t get affected. Depending on the number of Ulips sold, the increase in the minimum ticket size would be in the range of 20-30%.
Says Manik Nangia, vice-president and head (product management), Max New York Life Insurance Co. Ltd: “Policies that are sold in rural or semi-urban areas through partnership models may not see any increase, but those sold largely by agents in urban areas will be affected. At present, our minimum ticket size for these policies is Rs24,000 up from Rs20,000 earlier.
No surrender charges
Insurance policies were charging you to enter as well as exit. The front-end costs were understandable. Typically, most Ulips had a surrender charge up to six years, some of them levied it even later. While the aim was to keep the policyholder invested for a longer duration, it took away the flexibility of moving from a grossly underperforming fund. The new cost rules bring with them zero surrender charges from the fifth year.
However, Money Matters strongly recommends that you stay invested for at least 10 years (for a well-performing fund) or better still, for the whole course since you have already paid upfront costs for the entire life of the policy.
To make you stay
Even now, the life insurance industry is being run by agents and distribution channels such as banks, most of whom are keen on making their first-year commission (Irda allows up to 40% of the premium) and do not care about policy continuation.
The new cost caps push insurance companies to ensure policy persistence since they will make money only if the customer stays the policy term. Adds Nangia: “The costs are a set of fixed and variable charges. For instance, the fund management charge can bring in profits only when there is a large asset under management.”
To collect this pool of money the insurer will not only focus on long-term products, but will also discourage frequent withdrawals or limited premium payments. For instance, HDFC Standard Life’s Endowment Super Ulip charges policyholders if they don’t pay regular premiums for at least five years. On the other hand, ICICI Pru’s Lifetime Maxima lets you withdraw funds only after five years. Says Gaurang Shah, managing director, Kotak Life Insurance Co. Ltd: “With the cost caps, persistency of a policy has become the most important factor. Expect products designed to encourage persistency.”
What should you do?
Overall, you stand to gain. The reforms clearly are directed at making life insurance products long term. However, there is a very long way ahead before you get a product that is fair and transparent.
What you can do is to check the illustration that every agent is now mandated to carry. The illustration shows how each premium instalment is broken up into various charges and what finally gets invested. If a reduction in yield is more than 2%, you may want to think twice before buying.