Reduction in yield (RIY), when calculating Ulip returns
Current regulations ensure that you don’t have to worry too much about the costs in unit-linked insurance plans (Ulips). Why? Because regulations now define the maximum an insurer can charge you. In mutual funds, you know this cap as expense ratio, which simply means the maximum that a company can charge you in percentage terms. So an expense ratio of 2.5% means that for a Rs100 investment, the mutual fund company can charge you a maximum of Rs2.5.
In Ulips, the cost caps are defined differently—through a cap on the reduction in yield (RIY). The regulations define this as: the maximum difference allowed between the total return and post-cost return in Ulips. Before we get into the details of how RIY is calculated, let’s understand the different charges in Ulips.
How is Ulip charged?
A basic Ulip typically has four cost heads. The premium allocation charge is a straight deduction from the premium you pay. The balance is invested and the other costs are deducted from this. Fund management charge is what you pay the insurer to manage the investment component of a Ulip. It is reflected in the net asset value (NAV). It is capped at 1.35% of the fund value. Insurers typically charge this maximum in case of equity funds. Then there is the cost for policy administration, which is typically deducted by cancelling units. Even mortality cost, which is the cost of insurance, is deducted in a similar manner. Other than this, insurers can charge you extra if the policy offers a guaranteed return. Remember, you also pay an additional 18% goods and service tax on the charges levied in a Ulip.
How is RIY calculated?
As per regulations, charges should be levied in a manner that the reduction in yield—the difference between gross yield and net yield—is not more than 2.25% on maturity for a policy with a duration of more than 10 years. If the duration is 10 years or less, then the difference between the total return and post-cost return can’t be more than 3% on maturity.
These costs are shown to you through a benefit illustration. Read more about the benefit illustrations here. The illustration indicates your fund value each year, assuming the fund grows at 4% and 8% after deducting all the charges.
So, if you took the fund value on maturity and calculated the net return, you would think that for a policy term of more than 10 years, the post-cost return on your money will be at least 5.75% at a 8% per annum gross return. But here is what you need to know. The RIY cap doesn’t factor in mortality cost, which can really hurt your investments at higher ages and sum assured, taxes and costs of guarantees. So don’t settle for the illustrated reduction in net yield (stated as internal rate of return) which may conform to the regulatory cap, because it hasn’t factored in all the costs. Look at the fund value instead and do your own maths.