A Wool-Pulling Exercise
Ali On Content / 01 Mar 2010
While making us believe that the upfront charges of ULIPs have been reduced, the new trick up the sleeve of the insurance companies is the policy administration charge which has been turned into a money-spinner
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ULIPs are insurance plans which are designed around the portfolio management principles used in mutual funds. The premium that is paid is divided under various heads such as allocation charges, mortality charges, investment charges and various other charges. Towards the end of last year, the Insurance Regulatory and Development Authority (IRDA) initiated strictures on capping unit linked insurance plans (ULIP) charges on new launches. As per the notification, the difference between the gross return and net return (gross return minus the charges) for policies with tenure of up to 10 years should not exceed 300 basis points, while this gap is to be restricted to 225 basis points for those over 10 years. The fund management charge for policies across maturities has been capped at 135 basis points.
After the new IRDA guidelines on ULIPs, insurance companies would like us to believe that charges are down. Companies contend that the upfront charges of ULIPs have come down, in line with the new regulations introduced by the IRDA. This is not the complete story. Earlier, insurance companies used to deduct a substantial portion (15-71 per cent depending on the ULIP chosen) of the premium paid in the first year as premium allocation charge. Typically, the schemes used to charge around 25 per cent. So if a policyholder paid a premium of Rs 1 lakh per annum and the premium allocation charge in the first year was 25 per cent, then Rs 25,000 (25 per cent of Rs 1 lakh) would be deducted.
The insurance company would use this money to pay high commissions to its agents. This charge is now in the 0-18 per cent range by and large with companies typically charging around 15 per cent. So if a policyholder paid a premium of Rs 1 lakh per annum and the premium allocation charge in the first year was 15 per cent, then Rs 15,000 (15 per cent of Rs 1 lakh) would be deducted. This is Rs 10,000 lower than earlier. Does this mean the Rs 10,000 you save is invested in equity linked units? The new trick up the sleeve of the insurance companies is the policy administration charge, which insurance companies have lately turned into a money-spinner.
ULIPs are insurance plans which are designed around the portfolio management principles used in mutual funds. The premium that is paid is divided under various heads such as allocation charges, mortality charges, investment charges and various other charges. Towards the end of last year, the Insurance Regulatory and Development Authority (IRDA) initiated strictures on capping unit linked insurance plans (ULIP) charges on new launches. As per the notification, the difference between the gross return and net return (gross return minus the charges) for policies with tenure of up to 10 years should not exceed 300 basis points, while this gap is to be restricted to 225 basis points for those over 10 years. The fund management charge for policies across maturities has been capped at 135 basis points.
After the new IRDA guidelines on ULIPs, insurance companies would like us to believe that charges are down. Companies contend that the upfront charges of ULIPs have come down, in line with the new regulations introduced by the IRDA. This is not the complete story. Earlier, insurance companies used to deduct a substantial portion (15-71 per cent depending on the ULIP chosen) of the premium paid in the first year as premium allocation charge. Typically, the schemes used to charge around 25 per cent. So if a policyholder paid a premium of Rs 1 lakh per annum and the premium allocation charge in the first year was 25 per cent, then Rs 25,000 (25 per cent of Rs 1 lakh) would be deducted.
The insurance company would use this money to pay high commissions to its agents. This charge is now in the 0-18 per cent range by and large with companies typically charging around 15 per cent. So if a policyholder paid a premium of Rs 1 lakh per annum and the premium allocation charge in the first year was 15 per cent, then Rs 15,000 (15 per cent of Rs 1 lakh) would be deducted. This is Rs 10,000 lower than earlier. Does this mean the Rs 10,000 you save is invested in equity linked units? The new trick up the sleeve of the insurance companies is the policy administration charge, which insurance companies have lately turned into a money-spinner.
This charge, which is collected for administering the policy, sending regular statements, etc, was previously in the range of Rs 40-60 per month or around Rs 500-700 per year and was recovered by cancelling units that had accumulated in the investment fund. If this charge is 0.6 per cent per month, or 7.2 per cent of the annual premium (0.6 per cent x 12), it would amount to Rs 7,200 on a premium of Rs 1 lakh. Add that to the Rs 15,000 premium allocation charge and you are still paying Rs 22,200 on a premium of Rs 1 lakh. Now, compared with Rs 25,000 premium allocation fee that was being charged earlier, the total charge apportioned now is only Rs 2,800 lower. So the reduction in the premium allocation charge hasn’t quite brought down the cost for the investor. A random sampling of various policies reveals that the average policy administration charge on a policy of Rs 1 lakh works out to around Rs 5,000-6,000. Earlier, this charge would have varied from Rs 500 to 700 per year. Hence, the otherwise annual charge of Rs 500 has gone up to around Rs 5,500 a year.
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This is one area where the insurance companies are now covering up for the loss of the premium allocation charge. A question being asked by experts is that irrespective of the premium one is paying, the cost of administration remains the same. So, shouldn’t policy administration charge be fixed? Insurance companies seem to have acted in unison to exploit the loopholes and get around the new regulation, which seeks to bring down the overall expense structure of ULIPs. Yet, rather than plug the loopholes, IRDA has chosen to let these policies pass. It seems insurance companies may well be having the last laugh. This brings us to a much broader question — of insurance companies and mutual funds being allowed to compete on equitable grounds.
The Securities and Exchange Board of India (SEBI) has gradually been working on mutual funds and ensuring that the agent commissions keep going down. However, the insurance regulator has done little to bring down agent commissions. Small wonder then that distributors are more interested in selling ULIPs than mutual funds. As for investors, the old combination of tax-saving mutual funds, public provident fund and a term insurance plan would still work better than ULIPs, given that the real charges are still on the higher side.
The Securities and Exchange Board of India (SEBI) has gradually been working on mutual funds and ensuring that the agent commissions keep going down. However, the insurance regulator has done little to bring down agent commissions. Small wonder then that distributors are more interested in selling ULIPs than mutual funds. As for investors, the old combination of tax-saving mutual funds, public provident fund and a term insurance plan would still work better than ULIPs, given that the real charges are still on the higher side.
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