IRDA regulations – Policyholders to be benefitted

The recent spat between IRDA, the Insurance Regulator and SEBI, the Capital Market Regulator created an outcry in the market with each party holding its supremacy over the much sought and widely circulated insurance product, Unit Linked Insurance Products (ULIPs) in India. The Government of India in quick solution passed an ordinance to support the IRDA regulation over ULIPs ending the market speculation that SEBI might make Ulips in line with Mutual Funds.

Fresh from its victory in the regulatory turf war over ULIPs, the IRDA announced a set of regulations. With the expansion of insurance sector and more innovative insurance products, particularly Unit Linked Insurance Products (ULIPs) entering into Life Insurance products list, IRDA has been sensitive to the changing scenario. In the past, IRDA has come out with various steps to bring in changes in the regulatory framework to address various concerns of the policyholders.

IRDA in a note stipulated that insurers must provide the prospect/policyholder all relevant information regarding amounts deducted towards various charges for each policy year so that the prospect could take an informed decision. IRDA also raised the concerns of mis-selling and Distance Marketing which require guidelines from the insurance regulator. Further, IRDA set up an exclusive Customer Affairs Department that focuses on consumer related issues and initiatives including grievance redressal and consumer education through Insurance Awareness Campaigns. It is perhaps the most important step in the interests of policyholders.

Recent Regulatory Proposals

ULIPs are hybrid instruments that combine elements of mutual funds and insurance. In most cases, the insurance amount is capped to 5-times of initial insurance premium. Recently, IRDA came out with guidelines governing ULIPs – how such products are sold/bought; how ULIPs can be better financial instruments for providing risk coverage and many more. Some of the ULIPs related regulations are as given below:

1) Level Paying Premium

All regular premium /limited premium ULIPs shall have uniform/level playing premiums. Any additional payments shall be treated as single premium for the purpose of insurance cover.

2) Compulsory Cover

Currently there are a number of ULIPs schemes where there is maximum insurance cover up to five times of the premium paid or no insurance cover. Now it has been recommended that 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.

3) Lock in Period increased to Five Years

IRDA has increased the lock-in period for all ULIPs from three years to five years, including top-up premiums, thereby making them long term financial instruments which basically provide risk protection.

4) Minimum Premium Paying term of Five Years

All limited premium ULIPs, other than single premium products shall have premium paying term of at least five years

5) Even Distribution of Charges

Charges on ULIPs are mandated to be evenly distributed during the lock-in period, to ensure that high front ending of expenses is eliminated.

6) Pension Plans to have Guaranteed Return

As regards pension products, all ULIP pension/annuity products shall offer a minimum guaranteed return of 4.5% per annum or as specified by IRDA from time to time. This will protect the life time savings for the pensioners, from any adverse fluctuations at the time of maturity.

7) Rationalization of Cap on Charges

With a view to smoothen the cap on charges, the capping has been rationalized to ensure that the difference in yield is capped from the 5th onwards. This will not only reduce the overall charges on these products, but also smoothen the charge structure for the policyholder.

Though these regulations have been rolled out for the benefit of common policyholders, the insurers will have a level playing field with other players and will benefit in the long run.

Invest in ULIPs – A good Wealth Creator tool in long term

Out of the blue, the Indian insurance industry is the talk of Dalal Street as it has become a major contributor of investment in the equity market. Though premium collection slowed to some extent in early 2009, it has been gaining pace with the overall healthy market sentiment. Premiums collected under ULIPs are a major driver in boosting equity investment. Renewal premium of the industry in the ULIP category increased from Rs.26,638 crore to Rs.37,543 crore, an increase of 41 percent year-on-year. Insurance companies invested Rs.44,358 crore in equity between April and December 2009.

The practice of mis-selling ULIPs has largely been curbed after the insurance watchdog, the Insurance Regulatory and Development Authority (IRDA) introduced investor-friendly rulings, capping charges up to three percent and 2.25 percent for ULIPs with maturities of up to 10 years and those beyond 10 years, respectively. Moreover, the IRDA ruling on solvency ratio, corporate governance, public disclosures, payment made to intermediaries and allowing unit-linked health insurance plans, have greatly benefited the insurance industry.

How do ULIPs perform well in the long-term?

The major objective of ULIPs is to build wealth, steadily in the longterm as well as providing insurance cover, though investors must be clear that, investing in ULIPs is not to get high insurance cover. A fund manager in insurance companies can hold stocks for a longer period than his counterparts in other industries. Hence, churning in portfolio stocks, measured by Portfolio Turnover Ratio (PTR) is relatively less or negligible. Since churning involves costs, it has a major impact on a fund's performance. Higher the Portfolio Turnover Ratio, higher is the cost involved. Moreover, IRDA's cap on charges including a cap on Fund Management Charges (FMC) in case of ULIPs, bring more benefits to policyholders in the form of increased returns. A close look at the performance of other market related products vis-à-vis ULIPs throws up a startling fact. Other market related products lag ULIPs' returns by a large margin in the long run, which confirms that ULIPs are an ideal investment vehicle for wealth creation in the long term. On an average, the historical FMC in other market related products are lower. For mutual funds they come to about 2.1 percent whereas for ULIPs, the maximum FMC is capped at 1.35 percent.

For example, a periodic investment of Rs.1 lakh in a diversified equity linked fund (ELSS) for 15 years grows to Rs. 28.54 lakh at an assumed growth rate of 10 percent, giving a net yield of 7.69 percent

(Considering an average FMC of 2.1 percent). The same amount invested in ULIP for the same period may range from Rs.28.63 lakh to Rs.31.59 lakh at an assumed growth rate of 10 percent, giving a net yield ranging from 7.97 percent to 9.03 percent. The final value falls further if we consider other tax-saving instruments such as PPF, which gives a return of eight percent a year. An investment of Rs.1 lakh a year in PPF for 15 years grows to Rs.27.15 lakh.

So, clearly, ULIPs score over other products in terms of returns and additional benefit such as insurance cover. But it scores below PPF as an investment in ULIPs involves high risks. Returns on ULIPs rise due to lower FMC if the investment choice is a debt fund and assumed rate of return is 10 percent (in debt funds, the FMC is generally about 0.75-1 percent). The table shows the different returns.

However, the high entry costs and operational costs mar the performance of ULIPs on shorter maturity periods. Thus, we see that ULIPs appear to be the obvious choice for investments for creating considerable wealth in the long term.