Reining In The ULIPs

The decision taken by the Insurance Regulatory and Development Authority (IRDA) about the capping of unit-linked insurance policies (ULIP) charges is a step in the right direction. It will bring in more transparency and will help the customer take a more informed buying decision. With a cap on the reduction of net yield, the charges of products which are over this benchmark may also reduce and hence it would provide better returns to the policyholders. Additionally, net yield can now become one standard yardstick for comparing different products. As per the new rules there has to be a specified limit between the gross yield (amount earned from the scheme without considering any expenses) and the net yield (gross yield minus expenses) and now this cannot be more than 3 per cent for a ULIP of 10 years or less and 2.25 per cent for a ULIP over ten years.

For the end consumer this is excellent news as insurance companies will not be able to go overboard when it comes to charging the customer. However, one disadvantage in this scheme of things is that the customer will have to make a conscious effort in understanding the nitty-gritty before proceeding with their investment as under the new rules several items of expense actually incurred by the investor in the insurance policies will not form a part of the net yield calculation. Consider a situation where there is an insurance policy for which the investor pays a premium of Rs 25,000 for 15 years. Let’s say the expenses include a 20 per cent allocation expense in the first year, 10 per cent in the next and 3 per cent for the remaining period. There are further expenses of Rs 1,000 per year for mortality and administration charges.

In such a situation, if the gross yield for the growth in the value comes to 11.2 per cent, then the net yield, considering the expenses, will work out to 9.9 per cent. However, the situation will change for the investor when other items like those below are considered.

1. Additional Premium: This maybe charged if a person has higher risk weightage and will mean an additional cost by charging higher premiums. For example, a person who would normally pay Rs 15,000 for an insurance cover of Rs 1,50,000 might find that this has risen to Rs 17,000 due to existing diseases. Such an additional premium of Rs 2,000 would not be counted for the purpose of calculating the net yield and hence would be outside the limit present for the scheme.
2. Riders: Critical illness and accidental riders are some of the popular riders available. Other riders include the waiver of premium and income benefit. The extra premium that has to be paid again becomes an expense for the policyholder. So, a normal cover for Rs 2 lakhs might be available for a 15-year policy at Rs 10,000, which might rise to Rs 13,000 due to a particular rider. Such a facility allows the individual to get the required insurance cover, plus the extra benefit, without having to buy an additional policy. This cost is not considered for calculating the net yield.
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   Service tax has to be paid depending upon the eligible charges covered under the service tax rules and hence it raises the overall cost for the investor. This figure, currently at 10 per cent, plus the educational cess of 3 per cent (totalling 10.3 per cent) will not be included in the expense figure that will be used for calculating the net yield. These charges paid by the customer would be in excess of the limit set for the overall expenses.
   
   
3. Guaranteed Returns: These days there are various policies in the market which give an assured return to the investor. The guarantee has an attached cost wherein extra premiums have to be paid for the underlying guarantee. The cost for the purpose of such a guarantee is not to be used for the purpose of calculating the net yield and hence has to be kept separate.
4. Take Home: Assume that in the example used for the Rs 25,000 premium policy for 15 years, the additional factors mentioned earlier such as the service tax and additional premium come to around Rs 4,000 a year. In such a situation, the overall yield for the investor, considering the additional investment, drops to 8 per cent from 9.9 per cent. If the additional premium comes to Rs 2,000 a year, then the yield for the investor is 8.9 per cent. However, since these expenses are not considered in the net yield, the insurance illustration will show that the expenses are within the limits set by the insurance regulator and hence an individual needs to keep an eye so as to ensure one is taking the right decision.