The concept, prior to September 2010: if you bought a ULIP and stopped paying premiums after say 5 years, you could choose to continue to have

• Insurance cover continued
• in which case, Mortality charges and policy admin charges would get deducted from fund value.

Now, with the new regulations this is no longer allowed. If you stop paying premiums, you have to take back your money. Subramoney also mentions this in his blog.

What this means now is: there is no way to stop payments and still continue cover. Let's look deeper.

Why did this rule come into place?

ULIPs had horrendous surrender charges, upto 100% of fund value. IRDA said boss, you can't charge more than Rs. 6,000.  And you have to pay back the fund value to the customer, or if five years are not completed, leave it in at 3.5% interest and then give it back. That prompted the question: what, exactly, is a "surrender"? If you stop paying premium, that is equivalent to a surrender.

Now, ULIPs must return the money or move it over to a low grade investment area if you stop paying premiums. What is required, perhaps, is a tweak to the regulation that allows users to continue (at their own behest) the risk cover. The specific wording of the current regulation is:

A policyholder shall be entitled to exercise one of the following options upon discontinuance of the policy:

    (i) Revival of the policy, or

    (ii) Complete withdrawal from the policy without any risk cover.

This could be augmented with (iii) Continue with the risk cover, with mortality charges being reduced from the fund value from time to time, and the option to withdraw completely from the policy under (ii) above at any time.

Is the cover continuance practical?

Most ULIPs had absolutely crappy insurance limits, and in practice, almost everyone took 5x of annual premiums as cover. Many ULIPs provided the sum assured OR the fund value, whichever was higher. For them, the continuance meant very little insurance - probably 3x-4x annual premiums - practically, if you paid Rs. 50,000 you would have cover for about 2 lakhs, which, one must admit was unreasonably small.

Some others offered risk cover of sum assured PLUS fund value, which is where the continuance option may be useful, so let's explore some more.

What happens if risk cover continues?

Let's say you were paying Rs. 100,000 for a sum assured of Rs. 10 lakhs, and after year 5 you decide to stop premiums.

In a cover continuance scenario, you would get the Rs. 10 lakh cover to continue. With age, your mortality charge increases - that's how ULIPs work - and eats into your fund value. From the Rs. 3,000 a  year if you were 35, it will go to Rs. 10,000 a year if you're 55. Even at that, the cost is reasonable.

But think about it - for someone who can afford Rs. 100,000 a year: is a 10 lakh cover worth it? You obviously need more - if you can save 1 lakh a year for insurance, chances are that you spend more than 5 lakhs a year (15% saving) and therefore, the 10 lakh insurance is utterly useless. In current ULIPS, though, you may be allowed to take on a larger insurance cover, and to that extent, there is likely to be a practical need.

By the way, policy administration charges nowadays can be substantial (sometimes, 3% a year, of the premium amount!).

The cover continuance option could be useful for those who are younger, and gives them the ability to stop paying premiums; and I would definitely recommend that it be made available as an option.

With the caveats : This should not be the default option. It should not be allowed less than 5 years from the policy date. It should also let you exit fully at any time.

Other Options

Till then of course, your options are:

• Take the money, buy a term plan and put the rest into an investment like a mutual fund or stocks.
• Invest in a single premium plan if you still like insurance. I don't recommend this but there are those that swear by insurance, or can't get rid of annoying agents.

Overall, the current regulation must be augmented, to allow cover continuance if you stop paying premiums after 5 years.

* I got this information from a survey being conducted by Money Life.

This post is written by Deepak Shenoy, at Capital Mind.

(Posted in entirety)

It was the day they’d talked about 9 years ago. The first day of 2011.

“I’m on my way.”

Ganesh Raghupathi sighed. He had known Arnold would be late. But then, Arnold had two kids, and you always give that species a little more respect, and a little more time.

Arnold D’Souza was looking forward to the meeting. He walked in to the coffee shop, while Ganesh was clumsily switching on his laptop.

“Over here”, said Ganesh, raising his hand.

“Hi Guns!”, said Arnold. “Happy New Year! Let’s get started. To recap – it’s the 1^st of January, 2011 and we are here to compare our retirement choices. I chose a Unit Linked Insurance Plan (ULIP) and you bought something else. Let’s see where we are today.”

“Thanks for the wishes, Arnie, and the same to you.”, said Ganesh. “Let’s see the chart:”

	Arnold	Ganesh
Plan	Invest 50,000 per year for retirement
Option	ULIP	Mutual Fund + Term plan for insurance cover
Insurance	5 lakhs	10 lakhs
Premium	Part of the money paid Ceases when fund>5lakhs.	Separately, Rs. 3,000 per year. 47,000 left for investment
Investment choice	ICICI Pru LifeTime	Zurich India Equity Fund (Now HDFC Equity Fund)

“Let us now compare. Now only with current values of our investment, like we had discussed; let’s dissect and see how each investment has done in different areas..”

“First, let’s look at costs. For the ULIP, the commissions were fairly hefty – 18% in the first year, 7.5% in the second, and 4% every year after that. For the mutual fund, the entry loads were 2.25% till 2009, and after that, zero.”

	Arnold	Ganesh
Upfront commissions	26,750	8,460

Arnold gasped. “Whoa. I paid more in the initial years? That means less of my money compounded itself, and thus would have destroyed my return. Okay, my fund had better have given stellar performance!”

“Look at the NAV comparison in this chart I plotted, mapping both funds together. “

“Purely from an NAV perspective, the mutual fund has done better, with a 35% annualized return, versus 22% for the ULIP”.

“What does that mean, Guns?”

“Well, remember our conversation at that time? That insurance advisor told us that even though the ULIP was a high-cost product, it would do so much better in terms of performance because it was a new fund. The mutual fund I chose was one of the best at that time; it is no longer among the top 10, but it still has beaten the ULIP comprehensively. In the performance area, the fund has returned 15x, while the ULIP, only 6x.”

Arnold whistled. “Wow. Okay, that’s another piece for you. What about insurance?”

“We both decided to take insurance for 5 lakhs. For you, it was part of the ULIP. For the first year, you would pay a risk charge – called a mortality charge – for 5 lakhs minus whatever your fund value was. The minute your fund value reached 5 lakhs, there was no more mortality charge.

“For me, as an investor in a mutual fund, I could not replicate that structure at all, with a reducing cover. And no one would sell me a term plan for 5 lakhs - the premium was too little. The best I got was an offer of Rs. 3,000 for a 10 lakh insurance. It was higher insurance, but it was constant – that means if I died my family would get 10 lakhs PLUS the value of the fund, but in your case it would be only the higher of 5 lakhs or the fund value. Even then, what it means now is that I paid about 27,000 as insurance; you probably paid less than 4,000”.

	Arnold	Ganesh
Insurance costs	3,600	27,000

Arnold half-smiled. “Okay, but the two aren’t necessarily comparable. You had a higher cover, but I admit that the insurance cover was hardly useful to either of us. I mean, if we could put in 50,000 per year, a cover of 5 lakhs was woefully inadequate. Let’s leave those alone. What about taxes, Guns?”

Ganesh replied, “Yeah, that’s where the ULIP scores. My tax saving, at about 30% a year, purely on this product was Rs. 1,000 per year for the term insurance. For you with the ULIP it was Rs. 15,000 per year. The difference, if invested back into the ULIP, would have bumped your returns to much higher levels. But again, we have a problem with reality.”

“Darn. Just when I was showing signs of winning. What reality?”

“The fact that our tax saving potential has been capped under a collective investment limit. See, we both started to get bigger salaries, Arnie. Today about Rs. 8,000 per month for each of us goes to our provident fund account, which takes up most of our tax-saving limits. If you ignore that, your housing loan principal repayment will take it. Or, your children’s school fees. Or the principal repayment on my housing loan. Or, like we mentioned, our insurance was inadequate, so we took on much larger term policies – even that premium may be used under the same tax saving limit, currently of Rs. 1 lakh per year. Effectively, the ULIP didn’t help with saving taxes – reality bites.”

“Guns, you’re right. My accountant laughed when I asked him for tax-saving schemes. I already had too much in them, and the new Direct Tax Code might make the tax angle redundant, he said. There may be no tax saving for insurance schemes like mine, and worse, the maturity proceeds may be taxable!”

“You have till 2012 to withdraw, though. So what’s the verdict, Arnie?”

Arnold let the information sink in. “Look, Guns, it’s not about rupee amounts – in those terms, the Equity mutual fund approach has done far better. In fact, just a rough comparison of the two using their real NAVs shows that one approach has been vastly superior.”

“It’s the Term Plan + Mutual Fund, without doubt. Not only did it have far lower costs – it has provided a far better return. In terms of saving tax, the ULIP might have done me some good initially, but other avenues took over my tax-saving limits, and there was no real tax-saving eventually. Both our approaches were inadequate for insurance. You win - here’s your one rupee.”

Ganesh took the coin and nodded. “But, what happens, going forward”, he asked. “If you had to decide on a retirement strategy today, what kind of product would you invest in?”

Arnie said, “Here’s my four lessons:

1) I won’t bother about tax saving. So much has changed since I bought a product 9 years ago, and so much more will change going forward, all towards taxing of potential gains. The only thing I care about is that I mustn’t be taxed while “accumulating” my growth – only when I exit. In that regard, fixed deposits are out.

2) Costs matter. The more you pay for a product, the more it hurts you later. In fact, a product that costs higher in the initial days seems to destroy your compounding potential.

3) Performance matters. While I might have chosen a badly performing fund and you a great one, in the end the fund that does better will win. But fund performance cannot be taken for granted or assumed, the only thing you must have is the ability to shift out of a badly performing product. With a ULIP you really don’t have that freedom – you can’t just shift to another ULIP without paying huge upfront costs.

4) Don’t mix insurance and investment. The advantage of “insurance” was cursory – it was terribly inadequate with the ULIP in any case.

In that context, I wouldn’t go with any of the ULIPs they have to offer today either – even though some of them offer lower upfront costs, they are not low enough. I might choose a long term strategy of allocating money to different kinds of assets – debt, gold, real estate and stocks, and to get there, I am likely to choose either a mutual fund or go direct. There’s also the New Pension Scheme (NPS) which has even lower costs, though I don’t like the fact that they force you to buy an annuity at the end. There are Exchange Traded Funds that have even lower costs. For insurance, a term plan works best, and it seems like the insurers are reducing costs every month!”

Ganesh was impressed. “You’ve come prepared, Arnie!”

It was now Arnold’s turn to sigh. “I had put aside the one rupee coin a few years ago, Guns. And the strangest thing is – I made a substantially higher return from stock options in a startup that was just acquired. That takes care of my retirement, but wouldn’t it be crazy to discuss that as a retirement strategy?”

More Yahoo Columns:

• Taking Stock of Commissions (Comments)
• Innovations and Curses (Comments)
• Free Money (Comments)
• The Illusion of Low Risk (Comments)
• Tips about the Tipsters (Comments)
• The Good, Bad and Ugly of Credit Cards (Comments)
• The Problem with Multi-Level Marketing (Comments)
• Planning for the Grim Reaper (Comments)
• Of Options and Choices (Comments)
• Riding the Equity Wave (Comments)
• The Art of Picking Stocks (Comments)
• (The Whole Lot)

This post is written by Deepak Shenoy, at Capital Mind.

Hey Deepak,
I am invested in 2 ULIPS.
1) Birla Sun Life SaralWealth : 35800 anually since Feb 2010 ( paid 1 premiums) current fund value is 25629.
2) Birla sun life Dream Plan: 12000 anually since Jan 2009 ( paid 2 premiums) current value is 20762
I also have a term policy of Birla sunlife premium of 7k annually and cover of 50 lakhs.
I was totally shocked to see 11000 deducted as loading charges on SaralWealth.
Please advice what would be the right time to get out of the policies and which policy should I retain.

Birla Saral Wealth Plan

You seem to have the 20 year, 20 pay plan.  From the brochure, this plan has

• 30% charges of the first three years premium. Nothing after that. But they’ve already stolen enough.
• 0.25% per month as admin charges – ridiculous again, that’s a 3% charge over the year, which for you is Rs. 1000 per year more.
• Surrender charges of 1 premium (for you) less than three years, 1/2 a premium in the fourth year, and 1/4th a premium in the fifth.
• No surrender charge after five years

Given that they have already stolen 33% of your money (30% commission, plus 3% admin charges) and you have only 25K left in the fund, let’s see what you can do. You have two choices:

• surrender by letting the policy lapse
• and Invest in the future in a simple mutual fund (the insurance they offer is 2 lakhs cover. That will cost Rs. 800 per year, so let’s take that out and put only 35,000 into the MF)

You can do the above two options this year, or put in one more premium of 35,800 this year and take this decision next year, and so on. Let’s assume both options give you 10% returns, and let’s look at where you will be in five years.

Assumptions:

1. 33% load for next two years, 3% subsequently.
2. Invest 35K in mutual fund, but 35,800 in ULIP.
3. ULIP Mortality charges assumed to be Rs. 700 per year.

Check out the spreadsheet – you can copy it and modify formulas if you like. Tell me if there’s something wrong.

As you might notice, the best options for your money is either to get out now (1.78 lakhs after five years) or stay for five years (1.83 lakhs). Getting out now might be marginally better if you think a mutual fund can do a better job in terms of performance. You’ll get nothing, but mark it to experience – you will end up paying about the same amount as commissions if you stay with the policy. On the other hand, if you want to hold on, pay the next four years premiums – getting out anywhere else in the middle is financially a negative.

Anything else is not worth it. There may be an issue with tax – I have heard it said that if you exit an insurance policy within five years, you have to pay back the 80C exemption (if used) in past years.

Birla Dream Plan

I’ve written about this plan before, and I think it is only useful as a plain term plan, not as an investment at all. Now you will need to do your calculations as I’ve done it above for the saral plan to figure out if it’s better to exit now or wait.

It’s easier to say “don’t buy a ULIP” than to say “exit now”. All exits need to be measured, for opportunity costs and other such details. 

This post is written by Deepak Shenoy, at Capital Mind.

The new ULIP regime is here, and insurers must be balking in fear. The changes? Spread commissions over the lock-in period of the scheme, the minimum of which is now five years from the earlier three; a cap on surrender charges to a maximum of 6% (or Rs. 6,000); a guaranteed 4.5% on pension products and forcing investors to buy annuities on exit; and higher minimum sums-assured on ULIPs.

The one aspect that must trouble insurance companies the most is the cap on surrender charges. For many insurers, this has been a significant source of revenue, since these fees directly line insurer pockets. Prior to September 1, a significant number of ULIPs would charge huge amounts as surrender charges – from 100% of your fund value if you exited in year 1, grading down to 5% in year 5 and so on. The idea was something like:

Phase 1: Entrapment

“Sir, you should invest in this ULIP. All you have to do is pay for three years, and you’ll get a tax-saving, and a fantastic deal! Just 20,000 a month.”

Phase 2: Realization

“Mr. Agent. It’s been a year now, and I’ve paid Rs. 240,000 in premiums. The Sensex has gone up 20% in the last year. So why does my account balance show just 120,000?”

“Well, there was 60% first year premium allocation charges, which meant only 96,000 was left; that grew to 120,000 which is pretty good growth!”

“Good? What good? I pay 240K and am left with 120K and that’s good?”

Phase 3: Exit!

“Get me out of this plan now.”

“Sir, if you stop paying your premium you will lose another 50% of whatever is left, as surrender charges”.

“Oh. Wait. I don’t care. I’ve been cheated!”

People still surrender their policies, sometimes choosing to pay two or three more years of premiums before doing so – and primarily because they had been sold a “three-year” policy, which turned out to be a much longer, 20 year product instead. The surrender charges they paid after three years may be small – of the order of 5% or so - or massive, in some cases losing whatever little was left after commissions. When you’ve lost 90% of your money, you’re unlikely to pay more for a few more years just to recover what’s left (and pay even more commissions).

Insurance companies are seeing tremendous amounts of money leave through surrendered policies. Look at the L-7 (“Benefits Paid Schedule”) of most insurers (eg. ICICI, Birla Sun Life) and you will find that more than 90% of money going out is on account of surrenders. A further look at L-22 (Analytical ratios, Persistency) shows that only about 1/3^rd of customers choose to continue policies after the 36^th month.

We don’t know what the average surrender charge is – but for most policies before September 1, these charges were pretty hefty – let’s say the average is around 10-20% when you consider all surrenders. When this drops to a maximum of 6% (or Rs. 6,000) for policies above Rs. 25,000 premium, this will impact all insurers. The three insurers I checked – HDFC, Birla Sun Life and ICICI – had surrenders of 430 cr, 330cr and  2,400 cr. respectively; the surrender fees are likely to be above 50 crores for each insurer, just for the last quarter.

Consider now that the high salaries in the sector have largely been justified by the high fees. Salaries are sticky – no one likes to take a pay cut – so the obvious impact will be to retrench; and going by the grapevine, that retrenching is already happening. The impact of the Direct Tax Code is also negative, starting 2012, with the loss of tax-saving status of most existing policies (the DTC provides tax-saving coverage to policies with a premium of less than 5% of sum assured – most ULIPs don’t qualify). Plus there’s a tax deduction at source for insurance maturity payments, making them less attractive.

What about agents? They complain that commissions are now sub-10% which is very less. Well, the point is this – no other financial product offers even half the “lower” insurance commissions. So there is really nowhere to run anymore – insurance still provides a multiple of what they would get otherwise.

Why is this relevant to you?

What is important to understand is how the dynamics of the industry changes – and therefore what new spiel you’re going to receive, and how to decode it.

Endowments: We’ll get to hear about traditional endowments – non-unit-linked – as a great way to invest. I wouldn’t even bother – endowments are opaque products with very high but hidden charges. Additionally, surrendering the policy early costs a very large amount – usually you would be happy to see even 1/3^rd of what you’ve paid should you want a premature exit. Endowments might have their uses (for example, a “waiver of premium” rider helps continue a policy in case of disability, or a cheap way to transfer wealth when you die) – but for the purpose of investment, it is a fairly useless product.

Why sell them, you ask? Agents continue to get great commissions and the non-transparency of the product and high fees ensure you get stiffed without your realizing it.

The sales pitch of the ULIP might change – to force you to pay higher premiums, or to disguise the product as something it is not. With bankers who would gleefully sell you a ULIP when you ask for a fixed deposit, you have to be careful! So here’s a set of steps

First, don’t sign a document if it contains the word “insurance” unless you receive the complete detailed brochure for the investment.

Second, check for phrases that steal your money away from you: Premium allocation charge means they’ll take that much away. Policy Administration Charge is another premium stealing measure; earlier it used to be miniscule but now they have “tweaked” the policies around. “Administration” charges can add up to 5% of your fund value per year and what you will see is 0.4% per month, another dirty way to hide theft. Fund management charges apply at about 1.5% per year, which is okay – this is charged even by mutual funds. Mortality Charges are, again, okay because this is what the real charge of insurance is – what they take to give you the sum assured in case you die.

Lastly, add up the charges (other than mortality). Most policy charges will add up to 10-15% in the first year. Then, throw all these documents away.

I would invest in a long-running, diversified mutual fund instead; because paying 10-15% for investing your money is financially stupid, when you’ll pay only management fees in a mutual fund. (For funds like HDFC Top 200 or HDFC Equity, the total recurring fees, including trustee, registrar and other fees, adds up to 1.8%)

Yes, you will ask me about insurance – for that, I would buy a term plan; online term plans are available from ICICI Prudential and Aegon Religare for extremely low premiums. (A policy of 1 crore for a 35 year old will cost less than Rs. 25,000 per year) More insurers will offer low cost term plans, and as our life expectancy grows with better medical care, we will find premiums coming down over the next few years. I don’t like ICICI and Religare Claim payout ratios are horrible so I’ll wait.

My method does not help the profitability of insurers either, especially those who wanted to make money stealing it from us. The good old method of making profits from the practice of insurance must take center stage; the method of making money without killing us in the process.

• ULIP Surrender Charge Limited to Rs. 6,000
• On Yahoo: The ULIP War
• Beat ICICI ULIPs by Upto 77%, the Do-It-Yourself Way
• More on ULIPs

This post is written by Deepak Shenoy, at Capital Mind.

If you stop payment on your policy – regardless of when you do so – your policy will be considered “discontinued”. An insurer can contact you to continue the policy within 30 days of the premium date, but should you not respond, the policy is considered discontinued.

Then, the fund value is frozen in the account, and paid out only after the “lock-in” period, which is a minimum of 5 years from the start of the policy. The money earns 3.5% in the interim. They can deduct a maximum of Rs. 6,000 as charges for such “surrender”.

Plus, there no such charges on top ups or single premium policies.

This compares very well to current norms where insurers charge even 100% of the fund value as surrender charges. Awesome.

This is effective immediately, only for new products issued from now on. That means older products will still have onerous surrender charges.

Mint reports this screws up Insurance companies:

The insurance regulator’s move to cap surrender charges on unit-linked insurance plans, or Ulips, will hurt life insurers where it hurts the most. Insurers’ income could drop by as much as half because of the move, which may require them to infuse more capital and delay their break-even, industry executives and experts say.

When half their business depends on customers discontinuing their policies, what can you say?

This is a sea change in IRDA – a clear choice they have taken in the investors benefit while forcing the business providers (insurers and agents) to rethink business plans. Much required, and I’m sure, much appreciated.

This post is written by Deepak Shenoy, at Capital Mind.

My answer till now has been a canned “Please contact a financial advisor” reply, primarily because I don’t have the time to help each person individually. It takes between 15 minutes to an hour to research and understand what a person has done, and then perhaps longer to work out what that person actually requires – there is no one-solution-fits-all.

In this context, I wonder if my reply is useful. Most “advisors” are not really advisors, they are product distribution agents. They don’t really want to work to the benefit of the customer. They only want to sell a product. How do you find out if an advisor is truly working for you?

I can suggest that you tell him you will only pay him for his advice. But you will buy products from someone else. (say a family member is an agent or something). The reaction will tell you if the person cares – if he quotes a price, and says ok, he’s probably honest. If he refuses for any reason, then he doesn’t want to represent you – just the end customer.

Advice can be at various levels, from “what should I do with this product?” to a full investment plan containing goals, allocations and tracking. At a cost level, I imagine that a service can cost:

• Rs. 200-500 for a single time advice.
• Eg. I invested in this ULIP, what should I do now?
• Answer comes with – If you exit now, this is the cost. In one year, two years, five years, this is the cost. Also here is the comparison with putting the money in a mutual fund instead, going forward. Recommended exit after X years only. With an Excel sheet.
• Rs. 3,000 per year for a detailed financial plan, with a monthly analysis of your performance (“tracking”).
• Eg. I am 35 years old, I have X EMIs monthly. I need to buy a car in 2 years. Need to plan education needs for my 2 year old. Need to plan for a week in Disneyland or Europe every year, starting six years from now. Need to plan for my retirement. My monthly expenses are Y, I made Z rupees etc.
• Answer should come with a plan segregating how much you need for each goal, and in order to get there, how much you need to save per month. Should have an allocation for emergency buffer for 6 months, a short term plan (assuming 6-7% return) for anything less than 5 years, a longer term plan (assuming 12% returns) for retirement/child education options and an insurance term plan suggestion. Comes with a tracking plan to help see where you SHOULD be every month, so you can track versus where you are. And so on.

This I imagine would apply to portfolios involving just mutual funds and insurance. It’s more complex if you add stocks, bonds and all that.

But the real question is – will people pay? I think the cleanest and most honest method is only if the customer pays for advice. The cost should not be a percentage of investment – advisors don’t work harder for 5 lakhs invested versus 1 lakh. And the advisor should not require the customer to buy the product from him – one way is to mark mutual fund investments “DIRECT”.

When I ask this: I have got multiple responses – most people say “No”, most advisors say No, and some others do say yes. While I’ve evaluated some business plans that specifically charge the customer, I’m not sure that will work. So I thought I’ll ask you – will you pay for such advice with the above prices?

Please comment below or mail me at deepakshenoy [at] gmail.com. I appreciate all responses.

There are multiple reasons for this question – one, to understand if there is a business model in providing advice at a cost; I am interested in this space, and any responses will help.

Another reason is to help honest advisors understand if there is a business model too. A lot of smart individuals run away from this field because the economics don’t make sense, unless they get commissions. Charging customers is something people shy away from. It’s also less effort to get commissions, you don’t have to make a detailed financial plan, etc. – but if there is decent monetary reward, there is space for a cleaner and better business model.

Also, there’s a way to leverage technology in this space. Like auto-calculating where one should be, tracking and maintaining portfolios, providing investment feedback, decoding ULIPs. But till now all such services are free, and that model makes me cringe. Free is good, but free does not sustain; but if there is willingness to pay a cost for a complete package, then the technology will help in lowering the cost of delivering the service. I’m a tech person, and I can see how technology can help this space – but if the only expectation is to get this for free, then why bother.

Lastly, paying for advice allows people to rate a product negatively. Advisors usually know which product is horrible and which is good. As a private distributor of mutual funds (something I set up only for family stuff) I get emails of sudden 2% commissions “just for this month” etc. The minute I get this, I know the product is screwed up, because they will somehow extract that commission from the product. But will an advisor tell a client this, if his biggest source of income is commissions?

Note: there still needs to be hand-holding for people who don’t know where else to buy products. But there are many “honest” places nowadays – from online brokers to “DIRECT” investments. 

This post is written by Deepak Shenoy, at Capital Mind.

The turf war between the Insurance Regulator (IRDA) and the Securities Regulator (SEBI) is finally over. The government, on June 19th, passed an ordinance that granted full regulatory control of the Unit Linked Insurance Product (ULIP) market to IRDA, foxing many financial commentators. To an outsider, the brouhaha seems strange, but there's a history to it. (Isn't there always?)

Insurance has meant that you pay a certain amount of money so that if there is damage or a demise, there is a cash payout to compensate. If nothing happens, you lose the 'premium' paid.

In India, life insurance, in particular, has seen a different twist. People are sold products that return money even if they survive. So you pay Rs. 100,000 per year for 20 years, and you can get Rs. 50 lakhs back if you survive, and should you die, you have 'insurance' of 5 lakhs during this period. A part of your premium goes to cover the 'risk' of the 5 lakhs of insurance. Another part goes to cover fees and charges. What is left goes into an investment fund that will be invested and will grow over time.

Such products mix investment and insurance, and traditional 'endowment' products have been opaque offerings. An insurance company would only take the premium from you, and not tell you how much of that was fees or risk premium or investments-they would announce a 'bonus' every year, which would range from 4% to 9%, and you knew that was how much your total premium had grown that year.

Unit Linked Endowment products came in, promising more transparency, segregating and revealing costs, insurance and investment pieces. Additionally, you could choose the broad categories in which your money was invested-from risky avenues like stock markets, to very safe avenues.

This should have been good, compared to the traditional endowment market. But not the way it was implemented. ULIPs started confusing customers with complex products, where the costs weren't obvious. For example, some brochures mention 'Premium Allocation Charges' of 30% - meaning, they charge you 30% of your premium as this particular charge, and after taking out all other charges, the remaining is invested. Another product would mention a 'Premium Allocation Rate' of 30% - meaning only 30% of your premium was invested. And sometimes they would move the costs into a Policy Administration Charge, as the IRDA, the insurance regulator, looked the other way.

Read my other articles on ULIPs. Comments are deeply appreciated.

This post is written by Deepak Shenoy, at Capital Mind.

Two Irda officials told Mint on Monday the regulator will soon declare stringent norms on front-loading of commissions, surrender charges, risk cover, top-up benefits, and fixed gains or sum assured for Ulips.

The most significant reform will be a cut in the commissions that insurance companies pay agents selling Ulips—from the current 57.5% over five years to 30-32%.

…

“The insurers were playing a trick with the policyholders by offering the benefit of Ulip charge limits only at the maturity of the product. We will now order the insurers to maintain a difference of at least 3.3 percentage points between gross yield and net yield on Ulip investments through out the duration of the policy and not only at the maturity,” said one of the Irda officials on condition of anonymity.

“Our proposal should bring down the first-year agent commission from 35% to 10-15%,” added the official. For pension plans, the first-year commission, will come down from 7.5% to about 5.5%.

Surrender charges, too, will be reduced to curb mis-selling.

…

The insurers were pushing for a hike in these [surrender charge cap] limits, but the regulator now plans to tighten it further. It will order insurers to deduct 10-15% of the annual premium only as the surrender charge and return the entire remaining fund value to the policyholder even in case of premature withdrawals.

In yet another significant proposal that will not only make Ulips attractive, but also distinguish them from mutual funds, Irda intends to increase the life insurance component in Ulips substantially and make it mandatory.

…

According to the plan, the life insurance component has to be at least 10 times the premium paid for policies up to 10 years and at least 1.05 times the annual premium for policies of 20 years and above.

For policies between 10 and 20 years, there will be yet another option—insurance cover of 0.5 times the policy term, multiplied by the annual premium. If the insurers are not comfortable with either of this, they will be required to provide a health cover of at least Rs1 lakh for each year of Ulip.

In yet another significant move, Irda is set to pass an order for insurers to have a guaranteed yield of at least 4.5% on the total premium paid for every equity-linked pension plan in the industry.

Emphasis mine.

I’m not sure this will work.

• Commissions of >2% a year are the upper limit, compared to any othe product. These guys are trying to bring it down to 32% over  five years – or 6% a year. For pure insurance I get it, but not for insurance.
• Gross yield versus net yield maintenance over the term of the policy will be useful in curbing bullshit like taking away your first year’s premium and then giving it back to you at the end of the policy.
• The life insurance component part is hazy. 10x premium for upto 10 years, but only 0.5xterm for 10-20 years? That means a 11 year policy should have at only 5.5 times the premium – not very different from today’s 5 year default. Guess which one gets sold, the 10 year or the 11 year?
• And what is 1.05 times the premium for >20 years? That makes no sense at all. Might be 1.05x term x premium, and the 10-20 year time frame should have 1.5x the term multiplied by premium. That makes sense. But we’ll know if it’s a typo or IRDA opening a back door, only after the actual rules come out.
• Guaranteed yield in equity products? Oh this is so much fun. Guess what will happen. They WON’T put money into equities if they have to guarantee anything.

My verdict: They are not doing enough to curb misselling, just bringing commissions down a little bit, but not enough to make them comparable with other financial products. The above mentioned changes make ULIPs as a product less attractive also with guaranteed yields, and weird insurance requirements.

This post is written by Deepak Shenoy, at Capital Mind.

The government has brought down curtains on the two-month long tussle between two regulators by ruling that Unit-linked Insurance Products (Ulips) will be governed by the Insurance Regulatory and Development Authority (Irda).

Ulips account for more than 50 per cent of the life insurance business in the country. The money collected is invested in equities.

An amendment favouring Irda over the Securities and Exchange Board of India was signed by President Pratibha Patil on June 18.

On Friday, the law ministry issued an ordinance amending the RBI Act 1934, Insurance Act 1938, Sebi Act 1992 and Securities Contract Regulations Act 1956, clarifying that life insurance business will include any unit-linked insurance policy or scripts or any such instruments. This has thus settled the issue of regulating Ulips.

The ordinance is also likely to nullify a case filed in the Bombay High Court by an investor seeking to get clarity on the jurisdiction of Ulips. A public interest litigation filed in the Allahabad High Court on mis-selling of Ulips is scheduled to be heard on July 8.

The insurance regulator, headed by J Hari Narayan, now plans to come up with new guidelines on this investment- cum-insurance product on June 21, an Irda official said. Irda will now approve all new Ulips.

Of course, the issue wasn’t really jurisdiction, to most of us. It was that SEBI was a better regulator, and that ULIPs have stiffed people all along. And they continue to do so.

ULIPs collected 46,000 cr. of premium last year, and the commissions will be a reasonably big chunk of it. Plus, it contributes to pseudo-employment. So taking it out won’t be very easy. Still, it’s unproductive – money stolen of our pockets really – and such avenues, like real estate broking, have only resulted in high transaction costs (which, to the economist, is highly displeasing). Deepak Parekh of HDFC – which owns both a mutual fund AMC and an insurance company – even said that ULIP commissions needed to be slashed.

Where India is definitely going is – you will have to pay advisors for advise, and commissions will not be built into products. What that means is a) you can do the work yourself and pay nothing or b) you can get someone to do it for you and pay something.

But till that happens, IRDA will dictate ULIPs. As I mentioned in the Direct Tax Code update, you will be missold ULIPs like nobody’s business till March 2011. I suggest you charge for every call received.

This post is written by Deepak Shenoy, at Capital Mind.

Like all insurance products, the returns earned by ULIPs are free of income tax. However, the returns from the investment part of these products (and some of them are close to 100 per cent investment with negligible insurance) is also tax-free simply because these products come in the garb of insurance.

This is a puzzling anomaly in the way the Indian tax authorities treat investments. There is actually no basis for treating returns from market-linked, risk bearing investments the same as any other payout from an insurance company. In effect, returns from ULIPs are treated the same as the payout that beneficiaries get when an insured person dies. Quite separately from the issue of whether ULIPs should be regulated as an investment, the tax authorities should wake up and plug this hole and start treating ULIP returns as the investment income that they are.

While I don’t particularly like ULIPs, anyone would agree it’s unfair to have offered them a tax saving return of all gains, regardless of what they invested in. Buy a mutual fund that invests in debt – you pay 10-20% capital gains tax on exit; but an insurance fund that invests in debt gets you money without tax. (That’s before the DTC; after the DTC in its current form, most current ULIP proceeds will be taxed)

Note also I’m very much in favour of both reintroducing long term capital gains taxes in the equity and mutual fund markets, and in removing 80C exemptions for both insurance and mutual fund investments; both are options proposed in the DTC.

It does two things – first, it levels the field for equity markets versus other forms of risk investments (like investing in a friend’s company). Second, it increases tax revenues for the government which does not have easy options like spectrum auctions every year. Our stock markets might grow 15-20% every year, which is about 10 lakh crores; and if the government can see 5% of it, it’s equivalent to half the broadband/3G spectrum auction proceeds.

While I’m not in favour of the government making truckloads of money, they better make money where we can afford to pay them, otherwise they will do things much worse.

This post is written by Deepak Shenoy, at Capital Mind.