After being witness to rampant misrepresentation of ULIPs (unit linked insurance plans), the regulator -- the Insurance Regulatory and Development Authority (IRDA) finally introduced some much-needed guidelines to lend an element of insurance to an otherwise investment product.
However, we maintain that there is still more to be done to make ULIPs more transparent and make it even more insurance oriented.
First some background -- ULIPs made an entry at a rather opportune time for insurance companies. The mood in equity markets was very pessimistic; however, at those levels (BSE Sensex less than 3,000 points) markets could go in only one direction -- up.
And take off they did in an unprecedented manner. From 3,000 points, the BSE Sensex surged furiously to over 12,000 points leaving investors breathless.
Why are we talking of stockmarkets in an insurance article where we propose to discuss the latest ULIP guidelines?
Because unfortunately, not just fund managers, even insurance companies were rather excited by the sharp rise in stockmarkets.
When you come to think of it, insurance companies should be more concerned about insuring lives than the vagaries of stockmarkets. However, in ULIPs, they had a product that was more geared towards 'offering a return' than insuring lives.
And this anomaly was put to good use by insurance agents. ULIPs were spoken of in the same breath as mutual funds. In fact, many agents even went as far as projecting ULIPs superior to mutual funds because they attract tax benefits (under Section 80C) on all options, unlike mutual funds where you get a tax benefit only on the ELSS (equity-linked savings scheme) category.
Moreover, ULIPs were shown to be a short-cut investment/insurance avenue - for instance, investors were encouraged to pay premiums only for the first 3 years and not necessarily over the entire tenure of the policy.
The reason is because the expenses in the initial three years' premium are so high that insurance companies recover the entire cost of the policy (including life cover charges) and can 'do without' the remaining premiums.
While these marketing gimmicks were glaring, the IRDA, to their credit, did intervene at regular intervals to infuse some much-needed sanity. But as we, at Personalfn, have seen on the mutual fund side, at times the regulator must come down heavily as financial service providers can take quite a while to get the hint.
On July 1, 2006, the IRDA introduced revised ULIP guidelines to correct "some" of these anomalies, we say some because much is yet to be achieved, but more on that later.
For one IRDA has given the new ULIP a 'face', in insurance a face can be taken as the sum assured and the tenure. The old ULIP lacked both and individuals did not have an inkling about either even after taking the ULIP. The latest guidelines dictate that:
1. Term/Tenure
The ULIP client must have the option to choose a term/tenure.
If no term is defined, then the term will be defined as '70 minus the age of the client'. For example if the client is opting for ULIP at the age of 30 then the policy term would be 40 years.
The ULIP must have a minimum tenure of 5 years.
2. Sum Assured
On the same lines, now there is a sum assured that clients can associate with. The minimum sum assured is calculated as: (Term/2 * Annual Premium) or (5 * Annual Premium) whichever is higher.
There is no clarity with regards to the maximum sum assured.
The sum assured is treated as sacred under the new guidelines; it cannot be reduced at any point during the term of the policy except under certain conditions - like a partial withdrawal within two years of death or all partial withdrawals after 60 years of age. This way the client is at ease with regards to the sum assured at his disposal.
3. Premium payments
If less than first 3 years premiums are paid, the life cover will lapse and policy will be terminated by paying the surrender value. However, if at least first 3 years premiums have been paid, then the life cover would have to continue at the option of the client.
4. Surrender value
The surrender value would be payable only after completion of 3 policy years.
5. Top-ups
Insurance companies can accept top-ups only if the client has paid regular premiums till date. If the top-up amount exceeds 25% of total basic regular premiums paid till date, then the client has to be given a certain percentage of sum assured on the excess amount. Top-ups have a lock-in of 3 years (unless the top-up is made in the last 3 years of the policy).
6. Partial withdrawals
The client can make partial withdrawals only after 3 policy years.
7. Settlement
The client has the option to claim the amount accumulated in his account after maturity of the term of the policy upto a maximum of 5 years. For instance, if the ULIP matures on January 1, 2007, the client has the option to claim the ULIP monies till as late as December 31, 2012. However, life cover will not be available during the extended period.
8. Loans
No loans will be granted under the new ULIP.
9. Charges
The insurance company must state the ULIP charges explicitly. They must also give the method of deduction of charges.
10. Benefit Illustrations
The client must necessarily sign on the sales benefit illustrations. These illustrations are shown to the client by the agent to give him an idea about the returns on his policy.
Agents are bound by guidelines to show illustrations based on an optimistic estimate of 10% and a conservative estimate of 6%. Now clients will have to sign on these illustrations, because agents were violating these guidelines and projecting higher returns.
While what the IRDA has done is commendable, a lot more needs to be done. At Personalfn, we have our own wish list with regards to ULIP portfolios:
Regular disclosure of detailed ULIP portfolios. This is a problem with the industry; for all their talk on being just like (or even better than) mutual funds, ULIP portfolios are nowhere near their mutual fund counterparts in frequency as well as in transparency.
On the same lines, other data points like portfolio turnover ratios need to be mentioned clearly so clients have an idea on whether the fund manager is investing or punting.
ULIPs (especially the aggressive options) need to mention their investment mandate, is it going to aim for aggressive capital appreciation or steady growth. In other words will it be managed aggressively or conservatively? Will it invest in large caps, mid caps or across both segments? Will it be managed with the growth style or the value style?
Exposure to a stock/sector in a ULIP portfolio must be defined. Diversified equity funds have a limit to how much they can invest in a stock/sector. Investment guidelines for ULIPs must also be crystallised.
Our interaction with insurance companies indicates that there is little clarity on this front; we believe that since ULIPs invest so heavily in stockmarkets they must have very clear-cut investment guidelines.
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