Just under two weeks ago, the Ministry of Finance had placed the ball in the Insurance Regulatory Development Authority’s (IRDA’s) hand clearly making IRDA the sole regulator for Unit Linked Insurance Plans (ULIPs).
In a circular issued on Monday, June 28 2010, the regulator notified a number of changes to the structure and framework of ULIPs that are generally beneficial to customers, but with some caution.
These changes, that will be effective in all ULIP sales from September 1 of this year, aim to address the issues that were being highlighted by critics and customers alike.
Move away from high upfront charges: Earlier this year IRDA had stipulated that charges in Unit Linked Plans be capped at 3% and 2.25% for policies less than/equal to 10 years and more than 10 years respectively. These limits are calculated as being the difference between the returns on investments minus the net return you earn after taking into account all charges sans mortality. However, this limit was required to be met only at maturity. This allowed products to have higher charges during the initial years resulting in fairly high charge structures if the customer was to exit prior to maturity. The recent set of guidelines now prescribe limits on charges to be met starting the 5th policy year – such limits ranging between 4% at the end of 5th year going down to 3% in the 10th. For policies with term greater than 10 years, this limit is to be 2.25%. The change will effectively ensure an even distribution of charges during the policy period and remove any high front ending of charges.
Having to meet these guidelines from the initial policy years itself will necessarily mean a reasonable reduction in the overall charges of Unit Linked Plans, far lower than those currently in place. The new products on offer from September 1 will therefore surely be with lower charges and offer better returns. These products will also substantially reduce the burden of charges for someone who needs to exit earlier than maturity for any unforeseen reasons. So where does that leave existing policyholders invested in ULIPs? This change does not impact those who remain invested till maturity since the return on your existing ULIP will be no different than the new ones on their way. The major impact is for those who exit their policies prior to maturity. Under the new products the charges on exit will be lower. But that should not mean that customers exit current ULIPs to purchase a new ULIP later since an early exit would attract surrender penalties. The best option would be to continue with existing plans to maturity.
Lock in period increased to 5 years: The lock in period for all Unit Linked Plans has been increased from the existing 3 years to 5 years, in line with the long term nature of these plans and to allow for the move of capping charges starting the 5th year onwards. Correspondingly all products that have a limited premium payment term will need to have a minimum premium paying term of 5 years. One needs to bear this mind while purchasing a ULIP – you cannot exit these plans prior to the end of 5 years and should be considered only if your investment horizon is for a period greater than 5 years.
Higher Risk Cover: The guidelines require all ULIPs, other than Pensions and Annuities, to carry a Sum Assured (amount payable in case of policyholder’s death) at a minimum level that is higher than those prescribed as of now.
For Regular premium policies, the revised cover levels will need to be at least 10 times the annual premium for an entry age of policyholder below 45 years and 7 times annual premium for an age of entry 45 years or above.
For Single premium policies, the revised cover levels will be 125% of the single premium for an age of entry below 45 years and 110% of single premium for an age of entry 45 years and above.
This change will ensure higher risk coverage when you purchase a ULIP (the current minimum level being 5 times of annual premium). So if a person aged 35 were to purchase a ULIP with an annual premium of Rs. 30,000, his minimum Sum Assured under the new set of products will be Rs. 3,00,000 as compared to Rs. 1,50,000 as per the existing framework.
Guaranteed Returns for Pension products: Unit Linked Pension/Annuity products will need to offer a minimum guaranteed return of 4.5% per annum. This percentage can be reviewed and specified by IRDA from time to time and is directed towards providing protection to the life time savings of pension policyholders. This is the only change that should be viewed with caution by customers.
The guaranteed return on Pension Funds is payable only on maturity for policies where all due premiums have been paid.
While this step may provide a protection from any market fluctuations but can considerably reduce the upside on capital appreciation – in an attempt to meet this guarantee, insurance companies will need to invest a higher proportion of the portfolio in debt and debt related instruments.
In addition, no partial withdrawals will be allowed in Unit Linked Pension Plans during the term of the policy and on maturity, only a maximum of one-third of the accumulated value can be withdrawn while the remaining will have to be used to purchase an annuity. Pension plans should thus be considered purely from a long term retirement planning perspective.
In addition to the above mentioned changes already notified, there are draft regulations that aim to rationalise charges being deducted in the event of a policy being discontinued any time within the lock-in period of 5 years. In such an event, the policy will stand discontinued after levying the revised and considerably lower charges but paid only at the end of minimum lock in period i.e. 5 years.
Most products are currently charging as high as 40%-100% surrender charges in the first few years. This is set to change with the proposed surrender charges being limited not only in percentage terms but also subject to a maximum absolute amount. The maximum that can now be charged in case the policy is discontinued in year 1 is Rs. 3,000 and Rs. 6,000 for policies with premiums upto Rs. 25,000 and greater than Rs. 25,000 respectively. This amount goes down to Rs. 1,000 and Rs. 2,000 respectively in the 4th policy year.
There will be no surrender charges applicable on surrender of a policy after the completion of the 5 year lock-in period. This will provide you with the flexibility to exit your Unit Linked Plan after the completion of 5 years at no additional cost/charge.
While these changes are, no doubt, beneficial for the customer it remains to be seen what impact these guidelines would have on insurance companies and the distribution models for these products.
It is clear that insurance companies will face pressures on margins and profitability and that distributor commissions will also likely reduce. Insurance companies will have to drive cost efficiencies and effectiveness in their operating models and seek alternate and more efficient ways to reach out to customers.