Costs reined in, Ulips win in the long term

The new Ulip is a better product and works over the long term. Issues of benchmarking and disclosure still left

The day has arrived for the revamped unit-linked insurance plans (Ulips) to hit the stands. Till now, the Insurance Regulatory and Development Authority (Irda) has cleared around 45 Ulips for conforming to the new norms.

“We have a total of 75 policies to be cleared of which around 45 have already been cleared and the remaining will be cleared shortly. Every insurer has about 2-3 Ulips,” says J. Hari Narayan, chairman, Irda.

There are broadly three defining features of the new improved version of Ulips that Mint Money likes.

Cap on charges: For each year, Irda has defined a separate cap in charges in terms of the difference between the gross yield and the net yield. For instance, now Ulips will charge evenly during the lock-in period of the policy, which is five years.

At the end of five years, the reduction in yield (due to costs) should not be higher than 4 percentage points. This means that if the fund is growing at 10%, then the charges should not reduce the net yield by more than 4%. In other words, the rate of return or the net yield at the end of five years can’t go below 6%. The reduction in yield would keep decreasing every year till it becomes 2.25% in year 15 and remains at that thereafter.

However, mortality charges may reduce the yield further as that has been kept outside the cost caps. Says G. Murlidhar, chief operating officer, Kotak Life Insurance: “For a young individual, mortality charges will not impact the yields in any major way, but for an investor who is old, mortality charge can bring down the yield further.”

Long-term nature and increased insurance element: Till now, agents could pitch a Ulip as a mutual fund wrapped with free insurance. Now, Ulips have acquired a distinct place in the insurance space with their minimum lock-in period going up from three years to five years.

Also, if you are below 45 years of age, the minimum sum assured will now be either 10 times the annual premium or 0.5 times the policy term multiplied by the annual premium, whichever is higher. For investors above 45 years of age, the sum assured will be higher of seven times the annual premium and 0.25 times the policy term multiplied by the annual premium. However, under the proposed Direct Taxes Code (DTC), to get tax deduction of `50,000, the minimum sum assured will have to be 20 times the annual premium. Adds Hari Narayan: “We made it 10 times and now the new DTC has proposed 20 times the annual premium as cover. We will take this up and lobby for 10 times the annual premiums as the minimum sum assured so that there is parity.”

Surrender benefits: Surrender charges are no longer exorbitant. While you can decide to surrender your policy any time during the policy term, if you do so during the initial five years, you get the surrender value only after five years.

As per the new norms, the surrender charges have been capped at `6,000. This charge goes down every year and becomes nil from the fifth year onward.

For unit-linked pension plans (ULPP): The regulator has rationalized even pension plans. Taking a cue from the architecture of the New Pension System, ULPPs too will now introduce strict lock-ins.

As per the new guidelines, if you buy a pension plan you will need to stay with the pension plan till maturity. If you wish to surrender your policy mid-term, you will get only one-third of the corpus as lump sum; the rest will go into buying an annuity or a pension product that provides regular income for lifetime.

That’s not all. ULPPs will now have to offer minimum guaranteed returns on maturity. For now, the insurance regulator has fixed it to 4.5%; this will be subject to change from time to time.

While earlier, most insurers had two-three ULPP products, the pace has now slackened with the guarantee norm being introduced. “As of now, we have received only two ULPPs (for clearance)—one from LIC (Life Insurance Corp. of India) and another from a private insurance company,” says Hari Narayan.

If you like Ulips, rest assured—the new set of guidelines have transformed them into long-term investor-friendly products. And our numbers confirm that. Assuming an investor has `1 lakh to invest, we chalked out two combinations. One a mutual fund plus term plan and second a type II Ulips, which gives the fund value as well as the sum assured to the beneficiary upon the death of the policyholder.

While over a period of 10 years, the mutual fund and term plan combination stays on top, after that Ulips begin to gain a clear advantage.

So, a 30-year-old investor with an investment horizon of 30 years will be richer by `2.6 lakh at the end of the tenor if he invests in Ulips. However, if he withdraws early, say, within 10 years, he will lose out to mutual funds and term plans put together.

This is because, even now, Ulips are primarily front-loaded and begin to gain advantage only later. On the other hand, in a mutual fund, the costs are evenly spread out.

If you plan to stay invested for the long term, you can consider buying Ulips. Remember that Ulips still have a short-term disadvantage, hence do not go for early withdrawals.

Also, invest in the fund option that has performed well in the past. While most funds will have a benchmark against which you can compare performances, it is not a mandatory condition. So, some insurers may not have benchmarks at all. Find out from your agent if the fund that you are investing in has a benchmark. “Most insurers give benchmarks. In fact, we also communicate to our investors, the benchmark return. However, as the market evolves, disclosing the benchmark will become common practice,” says Murlidhar.

The other concern is portability. While you can switch between funds offered by your Ulip, you can’t exit a Ulip and hop on to another. Buying a new Ulip would mean downsizing your funds by the fat charges that gets levied in the initial years. Says Pankaj Mathpal, financial planner, Pankaj Mathpal and Associates, a Mumbai-based financial planning firm: “Ulips have certainly become more attractive. While earlier I didn’t recommend Ulips, now Ulips can be taken as long-term products. However, how effective the guidelines have made them will be clear once we start seeing the products that get launched. Mortality charges have been kept out and that could change the game.”