What makes Ulips controversial

Joydeep Ghosh | 2010-04-14 01:16:00

Insurance and investment are two different needs. Then, there are Ulip pension plans with no sum
assured. No wonder, there is confusion.

Fresh battle breaks out over Ulips

For three action-packed days, the Securities and Exchange Board of India (Sebi) and Insurance
Regulatory and Development Authority (Irda) have been engaged in a tussle on unit-linked
insurance plans (Ulips). And the battle rages on with the Sebi issuing a statement today that new
launches post-April, 9 will need its nod.

Sebi’s main grouse: Since Ulips are investment products as well, they should follow its guidelines. But
Irda Chairman J Hari Narayan says there is no case for dual regulation of Ulips.

Why Sebi feels it just has to regulate Ulips

Between the two regulators are 70.3 million Ulip policies (as on March, 2009) and premium of Rs 90,
645 crore – certainly, not a small amount.
 PROS AND CONS

Plus

Fund managers get more time to hold stocks because of the lock-in period

Returns from Ulips are EEE (Exempt-Exempt-Exempt)

Four free switches in a year between 100 per cent debt to equity schemes

Minus

High costs like premium allocation charge, policy administration charge, mortality rate

Knock-off units (High NAVs do not mean high returns)

Costs are front-loaded

For investors, Ulips have been a way to get insurance-cum-investment benefits. Typically, an Ulip works
in this manner. A policyholder puts in an ‘X’ amount of money for certain years. His money gets
invested in both equities and debt, depending upon his risk appetite.

There are plans where the sum is assured, thereby assuring policyholders of a certain sum if they were
to survive the policy period. But the premiums are extremely high. Here’s an example: If a 30-
year old were to buy a 20-year Ulip with a sum assured of Rs 10 lakh, his premium would vary
from Rs 25,000 to as much as Rs 2 lakh (sum assured = five times the premium).
Round 1 to Irda: Ban on sale of Ulips lifted

On the other hand, a term plan which is the purest form of insurance would cost a mere Rs 3,370. The
only problem: If one survives, he/she stands to lose the entire amount of Rs 67,400 (3,370x20)
paid as premiums in a term plan.

From a personal finance perspective, if one were to invest the difference – Rs 21,630 (Rs 25,000 - Rs
3,370) in any instrument that gives 8 per cent returns (from Public Provident Fund), the returns
would be the same at Rs 9.8 lakh. That too, after losing the entire term plan amount of Rs 67,
400. If one were to invest the entire Rs 25,000 in a PPF, the returns would be higher at Rs 11.44
lakh.

ULIP investors are safe: IRDA

And that’s not all. As Gaurav Mashruwala, certified financial planner puts it, "Insurance is bought so that
if a family member dies, the family is assured of a certain amount. Ulips, being market linked,
defeat this purpose because of the uncertainty in the eventual benefit." In case of an untimely
death, the family of the policyholder gets the higher of the sum assured or market value of the
scheme.

Also, there are too many options. For instance, there are numerous variants that offer you covers like
five times initial premium, two times initial premium and so on.

Then, there are products that give you the option between sum assured and returns based on the
market value. There are many Ulip pension plans that do not give you any cover or sum assured.
It's business as usual for insurers from today

As a buyer, there is quite a lot of confusion about the plan to be purchased. In a good market condition,
the net asset value (NAV) can look really high. However, some costs like the policy
administration charge and mortality rate are deducted from the units. The returns, obviously,
get reduced because of lower units.

Of course, there are additional costs, in terms of premium allocation charge that are deducted in the
initial two-three years itself. This can range between 15-80 per cent, sometimes even 100.

There are some benefits of these policies as well. They provide Section 80C benefits. In addition, when
the corpus is accumulated, there is no taxation on it because of the EEE (exempt-exempt-
exempt) policy. But if the investor surrenders the policy within the first three years, the 80 C
benefits will go away.

Finance Ministry to discuss SEBI-IRDA tussle

Also, these schemes allow investors four free switches to different variants of debt and equities
composition schemes. So in a rising market or a falling market, an investor can move his money
without any charges. P Nandgopal, MD & CEO, IndiFirst Life, said, "Ulips offer a combination of
benefits bundled into one, for the convenience of the investors. It also gives access to a specific
asset class and asset allocation as per the changing risk profile of the individual without any
extra cost."
Irda asks insurers to ignore SEBI ban on Ulips

However, as most financial planners always advise, investment and insurance should be kept separate.
And the fact that policyholders become investors in insurance schemes contradicts the basic
principle of financial planning.

Battle between SEBI AND IRDA

Round two of the spat between Irda and Sebi has gone
to the former. An ordinance passed late last week hands
over the control of Ulips to Irda; jurisdiction over these
hybrid products will now clearly lie with the insurance
regulator. To remove any kind of ambiguity, the
government is also understood to be amending portions of
the Sebi Act, relating to collective schemes, such that
these will not include Ulips or any other schemes that
combine investment and insurance. This is not confirmed
yet but that’s clearly the way forward; dual reporting can
be a terrible thing and the last thing we need is for mutual
funds and insurance companies to be confused about who
they’re regulated by and investors getting jittery about
their savings.

By amending the legislation, which needs to be ratified

by Parliament, the government is putting an end to
unseemly squabbles between financial regulators. Indeed,
the manner in which Sebi passed an order, in April this
year, asking 14 private-sector life insurers to take its
permission before they launched any new schemes, was
quite shocking. It’s true that Ulips are nothing but mutual
fund schemes with an added element of an insurance
cover whose risk cover is limited to a minuscule share of
the premium. But the capital market regulator could have
called for a white paper on the subject or initiated some
kind of discussion on who should be regulating Ulips.

While Sebi and Irda squabbled, the High Level Co-

ordination Committee on financial markets (HLCC), chaired
by the RBI governor, didn’t really do much; watching
helplessly since it doesn’t have executive powers. The
HLCC could have looked into the commission structures for
Ulips in order to ensure a level-playing field for financial
intermediaries but didn’t really come up with any ideas.
However, it seems unlikely now that this committee will
get teeth since a high-level committee, to be headed by
the finance minister, and comprising the RBI governor and
heads of Sebi, Irda and PFRDA, is to be set up. That has
been in the offing—the Financial Stability and
Development Council (FSDC) was announced some time
back. Ultimately, it doesn’t really matter which committee
has the powers, as long as nothing falls between two
stools. What the FSDC must ensure is a level-playing field
across financial instruments; Irda has allowed agents to
charge exorbitant commissions of anywhere between 20%
and 40%, at the cost of investors. The mis-selling, too,
needs to be stopped.
 Irda has been talking of bringing down commissions on
Ulips, but just bringing them down is not enough; they
need to be brought down sharply, given that entry loads
for mutual funds are now banned. Life insurers, too, need
to bring down their expenses and this needs to be
monitored the way costs and mutual funds are tracked. So
far, it would seem that Irda has been a rather liberal
regulator while Sebi has been a strict one. This is evident
from the kind of money that life insurers have been able to
pick up from investors; in 2009-10, they are estimated to
have mopped up some Rs 2.6 lakh crore as insurance
premium and four-fifths of this was accounted for by Ulips.
In contrast, mutual funds have seen outflows from equity
schemes in all but three in the last 10 months since entry
loads were banned. In the last one year, barely Rs 3,000
crore have come into equity schemes; total

AUM in equity schemes is just over Rs 2 lakh crore.

 This clearly has to change and while Irda has made the
right noises ever since Sebi attacked its turf, it needs to do
much more. It has already brought down surrender
charges and upped the risk cover, and there is talk that life
insurers will offer guaranteed returns so that those
investors who are willing to settle for lower returns, have a
choice. Pension funds have to be bundled with either a life
cover, health cover or annuities. Also investors in Ulips
need to have access to a variety of investment options; for
instance, life insurers could offer them Index Funds. If
commissions come down, then premium collections will
also come down. However, since there will be some
commission, Ulips will be pushed more than mutual funds.
It’s possible that because the government wants the state-
owned life insurer not to lose out, too—it has yielded
ground to private sector players. Had the jurisdiction of
Ulips been handed over to Sebi, and commissions been
done away with, LIC would have suffered. So, in that
 sense, it’s fine that Irda will supervise Ulips. This is possibly
the best solution. But the FSDC needs to keep an eagle eye
on what is happening, otherwise investors will lose out.

Irda to end upfront commissions, set on major changes for

Ulips

Anirudh Laskarand N. Sundaresha Subramanian

Mumbai: Fresh from its victory in the regulatory turf war over
unit-linked insurance policies (Ulips), the Insurance
Regulatory and Development Authority (Irda) is set to
overhaul the norms governing these popular financial
products.

Ulips are hybrids that combine elements of mutual funds and

insurance, and have drawn regulatory attention because of
fears that they have been pushed down the throats of
 investors by selling agents who earn fat commissions from
insurance companies.

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 Economic Times had reported on Monday that the

regulator will introduce new rules to make these products
attractive to investors.

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%.

In January, Irda asked insurers to manage expenses in such a

way that the difference between the amount paid to
 policyholders and the fund value should not be more than
3 percentage points for Ulips up to 10 years.

For policies above 10 years, it was capped at 2.25 percentage

points. The move, however, could not prevent insurers
from paying hefty commissions to the agents upfront.

“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%.

Cut in surrender charges

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

Currently, policyholders hardly get any money if they withdraw

their policy prematurely.

On the other hand, the insurers, too, stand to lose if the

surrender charges are drastically reduced as insurers
spend on customer acquisition and product development.

Irda wants to strike a balance by capping surrender charges as a

percentage of annual premium to benefit the
 policyholders and allow insurers to charge 15-20% of the
premium as so-called amortization cost when a policy is
surrendered.

Amortization is an accounting practice of spreading the cost of

selling and managing a policy over its lifespan. Till now,
there is no limit on amortization in case of a surrender.
The combination of hefty surrender charge and
amortization cost leaves virtually nothing for the
policyholder in case of premature withdrawal.

In May, the regulator had proposed to cap first-year surrender

charges at 12.5% for Ulips with a term of less than 10
years and 15% for those above 10 years.

The charges were proposed to be capped at 10% and 12.5%,

respectively, of the fund value for surrenders in the second
year, while the seventh year onwards there would be no
surrender cost.
The insurers were pushing for a hike in these 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.

Compulsory cover

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.

Currently, there are a number of Ulip schemes where either

there is no insurance cover or the maximum insurance
 cover is only five times the premium paid. The regulator
plans to make the insurance cover 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.

“The Ulip as we know will no longer exist. All stakeholders such

as insurers, agents and policyholders need to wake up and
 adjust themselves to this new reality. Till now, the focus
has been on investments and returns. Now, we could see a
shift towards life cover and protection,” said an insurance
consultant who did not want to be identified as he is
closely associated with Irda.

Pension plans

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.

At present, linked pension plans do not come with

guaranteed sum assured. “The plan is to offer investors
something more than 3.5% that is offered by savings bank
deposits. To start with, we will ask insurers to offer a
guaranteed return of at least 4.5%,” added the official.
MF houses sweat over insurance ordinance

Muthukumar K

Posted: Tuesday, Jun 22, 2010 at 2259 hrs IST

Mumbai: The government ordinance on the life insurance

business has ruffled up mutual fund houses. Echoing the
industry's resentment, a CEO of a large fund house asked,
“Why are we being given a step-motherly treatment?”
However, fund houses are grudgingly coming to terms
with the fact that two competing products are being
treated in different fashion.

“We welcome these steps and the institutional mechanism

(with various market participants) to address common
issues and ensure that competitive products co-exist with
healthy competition among them,” said AP Kurian,
 chairman of the Association of Mutual Funds of India
(Amfi). On Friday night, the government had issued an
ordinance, saying that the life insurance business will
include any unit-linked policy or scrips or any such
instruments. MFs have been hit by recent regulations of
Sebi to ban entry loads, while none such exist for Ulip
products. After August 1, 2009, there has been an outflow
of Rs 7000 crore.

“After removal of entry loads, the commissions have clearly

reduced,” said Alpesh Shah, partner and director of Boston
Consulting Group. Usually, the industry practice is to pass
on the entry load collected from investors to distributors
as commissions. He added that now mutual fund housess
are compensating for it from their own pockets.

The greater worry for the MF industry is the shying away of a

large component of the distribution channel, the
 Independent Financial Advisors (IFA), who numbers stand
at one lakh and contribute 29% of the overall assets of the
mutual fund industry.

“Some of the small IFAs (many of whom are part-timers) are at

risk of running out of business,” said Shah. He reasons that
today large IFAs (with Rs 1 crore and above of assets under
management) constitute bulk of the IFA assets. And if
these small IFAs are not nurtured, there will no large IFAs
in future. If that happens, it would be an advantage for life
Insurers.

Private life insurance players started operating in the country

seven years after the first private mutual fund was
incorporated. Yet, life insurers are far ahead on following
metrics – agents, branches and employees. While there
are close to a lakh agents for mutual funds, it is 29 lakh for
life insurance companies. Mutual funds in all have 17,000
 employees, while life insurers have hired 250 times that
number

PRESS INFORMATION BUREAU

GOVERNMENT OF INDIA

******

President of India promulgates an Ordinance; issues regarding

ULIPs between IRDA and SEBI settled.
New Delhi, Jyaistha 28, 1932

June 19, 2010

The President of India has promulgated an Ordinance late

last evening amending the RBI Act 1934, Insurance Act
1938, SEBI Act 1992 and Securities Contract Regulations
Act 1956, thereby clarifying by way of an explanation that
Life Insurance business shall include any Unit Linked
Insurance Policy or scripts or any such instruments. This
would set at rest all the issues regarding ULIPs between
two financial regulators i.e. Securities Exchange Board of
India (SEBI) and Insurance Regulatory Development
Authority (IRDA)
 Further, for sorting-out all issues of jurisdiction regarding
hybrid products, a high level Committee under
Chairmanship of Union Finance Minister has been
constituted. Finance Secretary to Government of India,
Secretary, Department of Financial Services and the Chiefs
of four Financial Regulators viz. Reserve Bank of India
(RBI), Insurance Regulatory Development Authority (IRDA),
Securities Exchange Board of India (SEBI) and Pension Fund
Regulatory Development Authority (PFRDA) will be the
members of the aforesaid Committee.

DSM/BY/GN-194/10.