In 2008, the Insurance Regulatory and Development Authority (Irda) made it mandatory for every insurance agent to explain a unit-linked insurance policy (Ulip) through a customized benefit illustration before selling it. The illustration took the customer through various charges that the policy would deduct from the premium invested and show how this would impact the final fund value.
The notification followed rampant mis-selling of this complex insurance-cum-investment product. In fact, for most part of their lives, Ulips have been sold as mutual funds offering a “free” life cover. Through illustrations, the regulator sought to make buyers understand what they were buying.
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Earlier this year, Irda took another step in the customer’s interest by containing the charges and making the illustrations more transparent. Now, in addition to showing the year-on-year increase in the fund value, illustrations also show the commissions and net yield.
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The purpose is good, but the improved version of illustrations has unwittingly left a loophole for insurers. They are “misrepresenting” the net yield without bending the rules really. The regulator has allowed insurers to calculate the net yield without factoring in some of the costs.
The new illustrations by the insurers show all the charges and the actual fund value as mandated by Irda. However, while calculating the net yield, which is printed upfront, they exclude cost heads such as mortality charge, service tax and guarantee charges, if any. The disclaimer is hidden on the same sheet—to make sure they are within the rules—but is too small and remote to be readily noticed.
Says Kamesh Goyal, country manager and chief operating officer, Bajaj Allianz Life Insurance Co. Ltd: “Net yield as mandated by Irda is the yield on investment and does not factor in the cost of life cover depicted by mortality charge. Hence, mortality charge and costs on account of taxes have been kept outside the purview of calculating the net yield.”
What illustrations show
There are a few cost heads that are important for any illustration. A typical Ulip has four major cost heads. These costs are stated upfront on the illustration along with additional cost heads such as service tax and charges for guarantee, if any.
Premium allocation charge (PAC): The first charge you encounter and, hence, recognize is PAC. This is a straight deduction from the cheque you write as premium before even a rupee goes to work for either insurance or investment. It is higher in the initial years, it tapers off towards the end of the term and in most cases becomes nil.
Mortality charge: This is the cost of insurance that, typically, gets deducted from the invested corpus. It depends on the sum assured you choose and your age.
Fund management charge: It is now capped at 1.35% (per annum) of the fund value and is deducted throughout the policy term.
Policy administration charge: This takes care of expenses incurred by the insurer. It includes cost of paperwork, stamp duty, welcome kit, and policy brochures, among other such things. It is again deducted throughout the policy term.
Fund value: After deducting these charges and assuming your fund grows at 6% and 10% at the end of each year, the illustration shows how much money you actually make. This is the return on your investment or the fund value in rupee terms.
Net yield: Apart from the fund value, you would also see a net yield. By definition, it is the final return on your investment and should factor in all the costs in the policy that impact your fund value.
The fact that the net yield does not take into account costs such as service tax, mortality charge or any charge on account of a guarantee makes a huge difference. The true picture of net yield will only emerge if you factor in all the costs. Mortality charge, which increases with age and the sum assured, and a guarantee charge can seriously dent your returns. The illustration usually doesn’t show the final yield and exclusions are carried as fine print.
Let’s understand through an example. Assume a 30-year-old buys a 10-year Ulip with a capital guarantee and pays an annual premium of Rs 1 lakh for five years for a sum assured of Rs 10 lakh. At the end of 10 years, the fund value that he gets is Rs 8.63 lakh, the published net yield on the illustration is 7.84% on an assumed gross return of 10%. However, if you calculate the return on investment, taking in to account all the costs, the actual return comes down to 7%. The published net yield keeps the taxes, capital guarantee charge of 0.5% per annum and mortality charge outside the calculation. In the same example, increase the policyholder’s age to 40 years and the actual return on investment comes down to 6.80%, while the published net yield remains 7.84%.
What you need to see
Some insurers such as HDFC Standard Life Insurance Co. Ltd go beyond the mandatory and give you a comprehensive indication of how the costs drag down your returns. Their illustration carries two separate tables: net yield as mandated by the regulator and a final return on investment, which factors in all the charges. The final return on your investment is what you need to look at.
Since there is no standard format that all insurers are following, there is room to manipulate the net yield by excluding charges. However, there is no scope of playing around with the illustration, which shows year-on-year growth in the fund value and charges. Till the time a standard format evolves, look at the fund value to compare products.
Says Gaurav Rajput, associate director (marketing), Aviva Life Insurance Co. India Ltd: “IRR (internal rate of return) comparison is not the right way to compare across products. The fund value at the end of the term is the right way to compare the illustration of similar policies. The guidelines allow us to keep mortality charge, charge on capital guarantee outside the calculation on net yield and we follow the guideline. However, the fund value is inclusive of all the charges and that is the point of comparison. Also, it is simple for the customer to compare.”
The good news is you needn’t depend on your agent to show you this illustration; most insurers now offer customized illustration on their websites. Just log on and choose your premium, sum assured and term. Based on your age, the website will throw an illustration.
Illustration by Jayachandran; Graphic by Ahmed Raza Khan