Ulips still as as ever

2009 was a hectic year, especially for the mutual fund (MF) and insurance industries.

On June 19, the Securities and Exchange Board of India came out with a circular asking fund houses to phase out entry loads starting August 1.

Then, on July 23, the Insurance Regulatory and Development Authority (Irda) came out with a regulation requiring unit linked insurance plans (Ulips) to cap the difference between gross and net yields at 3% for policies of terms 10 years or less, and at 2.25% for terms over that. The changes would apply to new schemes effective October 1, 2009 and to existing ones with effect from January 1, 2010.

There was a feeling that the charges would reduce substantially, particularly in Ulips. On the face of it, they have, considering there were policies levying up to 70% as first year premium allocation charges. But, look deeper, and little has changed.

Low charges are good news, but before you uncork the proverbial bubbly, chew on this. Irda’s July 22, 2009 circular states, “For insurance contracts which are of a tenor of less than or equal to 10 years’ duration, the difference between gross and net yields shall not exceed 300 basis points, of which fund management charges shall not exceed 150 basis points. For other contracts, i.e., those whose contract period is above 10 years, the difference between gross and net yields shall not exceed 225 basis points, of which the fund management charges shall not exceed 125 basis points.”

A careful reading shows that this compliance is to be shown for the term and there are no caps on a year-on-year basis. This is an open trap door. This means charges in the first few years can still be substantial.

Let us sample some products.

In ICICI Pru Maxima, the premium allocation charge is 7.5% for the first year, and 3% each for the second and third years, after which it is nil.
In case of HDFC Endowment Supreme Suvidha, the premium allocation charge is 30%, 15% and 10% for the first, second and third years, respectively, and nil thereafter.

These charges are indeed much lower than seen in the past.
However, there is another charge — policy administration charge — that makes all the difference.

In case of ICICI Pru Maxima, the policy administration charge (as a percentage of annual premium) is 0.9% per month or 10.8% per year, charged for the first 5 years. Add this to the premium allocation charge of 7.5%, and 18.3% of the first-year premium is charged as expense.

In HDFC Endowment Supreme Suvidha, the policy administration charge (as a percentage of annual premium) is 0.4% per month or 4.8% per year, for the entire term. Add the premium allocation charge of 30% and the total charge in the first year is 34.8% of the premium.

Earlier, the policy administration charges used to be a flat Rs 40-70 per month, irrespective of the premium amount. Now, higher the premium paid, higher will be the policy administration charge even though work on the policy administration front is the same whether the premium paid is Rs 20,000 or Rs 2 lakh.

Also, there are ‘surrender charges’ in both cases, till the completion of five policy years.

Fund management charges are a flat 1.25% per annum, chargeable on a daily basis in the HDFC plan and between 0.75% and 1.35% in case of ICICI Pru Maxima.

On the positive side, ICICI Pru Maxima gives a 2% extra allocation from the sixth year, and in HDFC’s Supreme Suvidha, 5% is allocated from the sixth year for every year of premium paid. The HDFC scheme also allocates a bumper 50-100% of the annual premium (akin to the loyalty addition) at the end of the tenure.

Thus, though the charges are lower now, there is still a lot being levied in the first few years.

That brings me to the next point — the ‘five year churn’. By charging everything in the first 3-5 years and having surrender charges till five years, the insurance company is ensuring that all charges due to it come in and the policyholder doesn’t exit without getting grievously hurt. Also, it offers an opportunity to insurance advisors to play the “we have a better plan” game.

The new regime does not address this long-standing problem. A good idea would have been to impose caps on what the advisors can get as commissions, as also to stagger the commissions over a much longer tenure (such as 10 years). Even better would have been a metric to ensure persistency of policies of the insurance advisor by having a differential remuneration.

What happens if an investor surrenders a policy midway? Well, the formula of difference between gross yield and net yield being a certain number does not apply. This means the investor should really treat Ulip investments as long-term investment vehicles. My experience on this is that people tend to exit after a few years (with substantial inducement to move to another policy).

There is a possibility of not receiving the yields as shown. As per the Irda circular, “Extra premium due to underwriting emanating from extraordinary health conditions, cost of all rider benefits, service tax on charges (as applicable) and any explicit cost of investment guarantee shall be excluded in the calculation of net yield.” This means there will be other charges such as service tax and cost of investment guarantee, which can be outside the purview of yield calculations. So the net yield may be lower than what the plan illustration shows.

Is it all negative then? Not really. The point is that the charges are low, but not substantially. Also, there are quite a few trap doors and crevices that can be craftily exploited. The direction is good. But, there is scope for tightening, in the interest of investors. Insurance advisors still have traditional products where these strictures do not apply.

It is hence a much more lenient treatment for insurance advisors, especially as compared with their brethren in the MF industry, where there are no entry loads and they have to charge a fee for services rendered. Such imperfections in the financial services landscape is not good for the industry as a whole, as it will ensure an unhealthy tilt towards Ulips, as has been the case for sometime now. The dictum of caveat emptor continues to apply.

The writer is a certified financial planner who runs Ladder 7 Financial Advisories and can be reached at suresh@ladder7.co.in