ULIP

Says Mint:

Two Irda officials told Mint on Monday the regulator will soon declare stringent norms on front-loading of commissions, surrender charges, risk cover, top-up benefits, and fixed gains or sum assured for Ulips.

The most significant reform will be a cut in the commissions that insurance companies pay agents selling Ulips—from the current 57.5% over five years to 30-32%.

…

“The insurers were playing a trick with the policyholders by offering the benefit of Ulip charge limits only at the maturity of the product. We will now order the insurers to maintain a difference of at least 3.3 percentage points between gross yield and net yield on Ulip investments through out the duration of the policy and not only at the maturity,” said one of the Irda officials on condition of anonymity.

“Our proposal should bring down the first-year agent commission from 35% to 10-15%,” added the official. For pension plans, the first-year commission, will come down from 7.5% to about 5.5%.

Surrender charges, too, will be reduced to curb mis-selling.

…

The insurers were pushing for a hike in these [surrender charge cap] limits, but the regulator now plans to tighten it further. It will order insurers to deduct 10-15% of the annual premium only as the surrender charge and return the entire remaining fund value to the policyholder even in case of premature withdrawals.

In yet another significant proposal that will not only make Ulips attractive, but also distinguish them from mutual funds, Irda intends to increase the life insurance component in Ulips substantially and make it mandatory.

…

According to the plan, the life insurance component has to be at least 10 times the premium paid for policies up to 10 years and at least 1.05 times the annual premium for policies of 20 years and above.

For policies between 10 and 20 years, there will be yet another option—insurance cover of 0.5 times the policy term, multiplied by the annual premium. If the insurers are not comfortable with either of this, they will be required to provide a health cover of at least Rs1 lakh for each year of Ulip.

In yet another significant move, Irda is set to pass an order for insurers to have a guaranteed yield of at least 4.5% on the total premium paid for every equity-linked pension plan in the industry.

Emphasis mine.

I’m not sure this will work.

• Commissions of >2% a year are the upper limit, compared to any othe product. These guys are trying to bring it down to 32% over  five years – or 6% a year. For pure insurance I get it, but not for insurance.
• Gross yield versus net yield maintenance over the term of the policy will be useful in curbing bullshit like taking away your first year’s premium and then giving it back to you at the end of the policy.
• The life insurance component part is hazy. 10x premium for upto 10 years, but only 0.5xterm for 10-20 years? That means a 11 year policy should have at only 5.5 times the premium – not very different from today’s 5 year default. Guess which one gets sold, the 10 year or the 11 year?
• And what is 1.05 times the premium for >20 years? That makes no sense at all. Might be 1.05x term x premium, and the 10-20 year time frame should have 1.5x the term multiplied by premium. That makes sense. But we’ll know if it’s a typo or IRDA opening a back door, only after the actual rules come out.
• Guaranteed yield in equity products? Oh this is so much fun. Guess what will happen. They WON’T put money into equities if they have to guarantee anything.

My verdict: They are not doing enough to curb misselling, just bringing commissions down a little bit, but not enough to make them comparable with other financial products. The above mentioned changes make ULIPs as a product less attractive also with guaranteed yields, and weird insurance requirements.

It’s final. The government has decided that the ULIP turf war will be decided in favour of IRDA.

The government has brought down curtains on the two-month long tussle between two regulators by ruling that Unit-linked Insurance Products (Ulips) will be governed by the Insurance Regulatory and Development Authority (Irda).

Ulips account for more than 50 per cent of the life insurance business in the country. The money collected is invested in equities.

An amendment favouring Irda over the Securities and Exchange Board of India was signed by President Pratibha Patil on June 18.

On Friday, the law ministry issued an ordinance amending the RBI Act 1934, Insurance Act 1938, Sebi Act 1992 and Securities Contract Regulations Act 1956, clarifying that life insurance business will include any unit-linked insurance policy or scripts or any such instruments. This has thus settled the issue of regulating Ulips.

The ordinance is also likely to nullify a case filed in the Bombay High Court by an investor seeking to get clarity on the jurisdiction of Ulips. A public interest litigation filed in the Allahabad High Court on mis-selling of Ulips is scheduled to be heard on July 8.

The insurance regulator, headed by J Hari Narayan, now plans to come up with new guidelines on this investment- cum-insurance product on June 21, an Irda official said. Irda will now approve all new Ulips.

Of course, the issue wasn’t really jurisdiction, to most of us. It was that SEBI was a better regulator, and that ULIPs have stiffed people all along. And they continue to do so.

ULIPs collected 46,000 cr. of premium last year, and the commissions will be a reasonably big chunk of it. Plus, it contributes to pseudo-employment. So taking it out won’t be very easy. Still, it’s unproductive – money stolen of our pockets really – and such avenues, like real estate broking, have only resulted in high transaction costs (which, to the economist, is highly displeasing). Deepak Parekh of HDFC – which owns both a mutual fund AMC and an insurance company – even said that ULIP commissions needed to be slashed.

Where India is definitely going is – you will have to pay advisors for advise, and commissions will not be built into products. What that means is a) you can do the work yourself and pay nothing or b) you can get someone to do it for you and pay something.

But till that happens, IRDA will dictate ULIPs. As I mentioned in the Direct Tax Code update, you will be missold ULIPs like nobody’s business till March 2011. I suggest you charge for every call received.

Dhirendra Kumar makes a useful point:

Like all insurance products, the returns earned by ULIPs are free of income tax. However, the returns from the investment part of these products (and some of them are close to 100 per cent investment with negligible insurance) is also tax-free simply because these products come in the garb of insurance.

This is a puzzling anomaly in the way the Indian tax authorities treat investments. There is actually no basis for treating returns from market-linked, risk bearing investments the same as any other payout from an insurance company. In effect, returns from ULIPs are treated the same as the payout that beneficiaries get when an insured person dies. Quite separately from the issue of whether ULIPs should be regulated as an investment, the tax authorities should wake up and plug this hole and start treating ULIP returns as the investment income that they are.

While I don’t particularly like ULIPs, anyone would agree it’s unfair to have offered them a tax saving return of all gains, regardless of what they invested in. Buy a mutual fund that invests in debt – you pay 10-20% capital gains tax on exit; but an insurance fund that invests in debt gets you money without tax. (That’s before the DTC; after the DTC in its current form, most current ULIP proceeds will be taxed)

Note also I’m very much in favour of both reintroducing long term capital gains taxes in the equity and mutual fund markets, and in removing 80C exemptions for both insurance and mutual fund investments; both are options proposed in the DTC.

It does two things – first, it levels the field for equity markets versus other forms of risk investments (like investing in a friend’s company). Second, it increases tax revenues for the government which does not have easy options like spectrum auctions every year. Our stock markets might grow 15-20% every year, which is about 10 lakh crores; and if the government can see 5% of it, it’s equivalent to half the broadband/3G spectrum auction proceeds.

While I’m not in favour of the government making truckloads of money, they better make money where we can afford to pay them, otherwise they will do things much worse.

A comment from Raju on my ULIP post:

I am [an] NRI.I invested 5 lacs in Bajaj Alliance shield plus plan.Which requires only one payment. And insurance is 1.1 times rather than five times of investment. I have been told that expenses are minimal.

I am a retire. I do not need insurance.Is it a good investment.Also I have been advised that it is tax free for NRI, if money came from NRE account.Is it true? Because most policy requires three payments and not one. Also most company requires you to buy life insurance policy for five times the value of your investment.

Please advise.I am still within two week look over period.

Dear Mr. Raju,

Do not buy this ULIP. If you have bought it, RETURN IT IMMEDIATELY.

Note that I don’t know much else about you, so don’t consider this financial advice. A doctor may not prescribe a medicine for you without knowing your complete condition, but if you ask him whether you should eat cyanide, the answer, regardless of your condition, will be NO. Ulips are financial cyanide for you. Just don’t do it.

First, you don’t need insurance.So the insurance part is useless for you.

Second, As investments, ULIPs are crap. In comparison with the other options you have, such as mutual funds, it is much much worse. Why?

Let’s look at the Shield Plus plan: It’s a 10 year single premium plan with 1.1x to 5x the premium as sum assured (no use to you, so you’ll take 1.1x). They offer one sub-plan as a guaranteed 70% flat return over 10 years, or market linked funds with equity or debt exposure.

• The 70% guaranteed return is utterly ridiculous. (When they say 170% of unit price, that is what they mean. Another case of mis-selling using twisted language) If you get just 6% post-tax return on your money, that itself will give you 80.61%, or 10% MORE than their “guarantee”.
• Apart from Fund management fees of 1.35%, you will pay a policy admin charge of 2% in the first five years and 1% after that.
• You’re luckily not charged premium allocation charges (since the premium is 5 lakhs), but had the amount been less than 2.5 lakhs, that will hit you too.
• Surrender charges of 6% in the fourth year, and 3% in the fifth (you can’t surrender earlier than that).

This is OBSCENE, for charges. Consider the charges for 10 years, and assume a growth of 8% for your five lakh premium, and ignoring the dysfunctional insurance:

With the Birla Shield Plus plan you make 7.88 lakhs. With a mutual fund charging 2.5% annually (the maximum chargeable, the real values are usually lesser) you make 8.38 lakhs. You are losing 10% of your money, or Rs. 50,000, to invest in this plan.

Lastly, consider the fact that you’re about to retire and might need the money anytime, for an emergency or otherwise. In the ULIP, you can’t exit before three years, and in the fourth and fifth year you have a huge penalty. Mutual funds have minimal exit loads, in comparison. And worse, if the ULIP performs badly, you have no option but to stay with it – in a mutual fund, you have the option of exiting.

I am not a tax lawyer, but it seems that you get 80C tax benefits only for 20% of the sum assured. (see this DNA article) The Tax Free for NRI business sounds like plain lying to me; there is no such thing as far as I know.

I wouldn’t even say mutual funds are the right thing for you – I don’t know if you’re looking at steady income, capital appreciation, capital security or bits of each. But I would recommend taking a hard look at all the choices; government bonds or state loans, term bank fixed deposits, debt or equity mutual funds or corporate bonds/debentures. ULIPs are just not worth it for you.

Read Manish Chauhan’s excellent post on Agents misselling LIC Wealth Plus. The product promises the highest NAV in the next seven years, and some agents are trying to sell this by using the NAV of a different policy (that does not have such a guarantee) and thus offering ridiculous rates like 40%!

This is hardly surprising for ULIPs – a substantial amount of misselling happens there. But is the highest NAV product not worth it anyhow? Deepti Bhaskaran in Mint says that you may get the highest NAV, but not the best returns.

The way it’s done is straightforward. Let’s say you have Rs. 100, which you have to guarantee highest NAV for seven years. I can put Rs. 63 in a seven year bond yielding 7%, and the remaining 37 can go into equity. (The Rs. 63, in seven years will grow to Rs. 100, so even if the equity portion goes to zero, you’re ok). After a year, assume the equity portion increases to Rs. 67. The New NAV will now become Rs. 135 or so (some returns will happen on the debt portion as well). Now you must guarantee 135 – so you move more money into debt – perhaps now it’s Rs. 100 debt, rest equity.

What happens if the market goes down? The allocation to equity does not increase, because that will introduce risk to the guarantee. Yet, the right thing to do for a product that is supposed to yield high returns is to keep a healthy equity portion.

With guaranteed products, that is simply not going to happen. So you might get a stroke of luck and a decent return, but in a market that goes down a lot and then revives, chances are you will seriously underperform. LIC’s wealth plus and other insurance company ULIPs won’t tell you this; unfortunately most buyers will find out only the hard way. It could be a useful product, though, for someone who understands the risk and still wants the guarantee; but the costs are fairly high.