The changes over the past few months have come one at a time, but in rapid succession. They have far-reaching implications for investors who are considering ULIPs. Here is a look at all the recent changes in the ULIP structure and their implications for investors.

Despite all the changes announced, these products still have a long way to go on transparency and disclosures relating to their investments. Though ‘insurance’ is only incidental to ULIPs and the ‘investment’ component is the key to returns, many insurance companies are unwilling to divulge adequate details on the historical portfolios and investment strategies of the ULIPs they manage.

Changes to costs

Cap on recurring charges: Their high expense structure has been a bone of contention with ULIPs.

The IRDA has sought to remedy this in two ways. First, it fixed caps on the overall costs that can be charged to ULIP investors under two slabs, one for a tenor of up to 10 years and another for tenors of 10 years and above.

It specified that the net reduction in yield (return) to investors from a ULIP should not be more than 3 percentage points for terms up to 10 years and 2.25 percentage points for ULIPs of 10 years or more, effectively capping the total expenses insurers may charge their investors. Then, this was modified, based on the experience of policies lapsing in the initial years.

The difference between the gross and net yield for ULIP-holders is now capped at 4 per cent from the end of fifth year, and this cap progressively declines to 3 per cent by the tenth year. This will mean a lower cost structure for investors, even if they seek exit from ULIPs after the fifth year.

For instance, if you invest for five years in a ULIP that earns a 10 per cent gross return, if you withdraw after the lock-in period, the net yield would drop by four percentage points to 6 per cent. These changes are effective from July 1, 2010.

Surrender charges trimmed: One of the key features that curtailed the liquidity aspect of ULIPs was the high surrender charge levied by insurers for premature closure.

If policy-holders stopped paying premiums after two years, the surrender charges would amount to as much as 30-40 per cent of the first year premium. The surrender charges would thus reduce your overall returns substantially. IRDA has now introduced limits on surrender charges to rationalise them.

If the policy is surrendered in the first year, the charge would be 20 per cent of first year premium or Rs 3,000, whichever is lower, for an investment amount up to Rs 25,000. For an investment above Rs 25,000, the charge would be six per cent of the premium subject to a maximum of Rs 6,000.

The surrender charge progressively reduces to Rs 1,000 in case of former or Rs 2,000 in the latter, if the policy is surrendered in the fourth year. As per the new guidelines, there would be no surrender charges from the fifth year. The implication of this is that investors wishing to exit a ULIP after the five-year lock in would not suffer any additional surrender charges, only the overall expenses mandated by the IRDA.

Commission: The high commissions paid to insurance agents have been often highlighted by critics of ULIPs. The IRDA’s new regulations seek to address this through the cap on overall charges and also through disclosure requirements.

With effect from this month, the advisor’s commission in a ULIP will be automatically disclosed in the benefit illustration (the document that spells out the various charges deducted from the unit-holders premium and quantifies the net yield to the customer). It is now mandatory for the advisor to take the signature of the investor on this document.

Increase in mortality: The insurance component in a ULIP is usually quite small; however, IRDA has now sought to raise this component by specifying that ULIPs should carry a life cover for a minimum ten times of their annual premium (this was five times earlier).

Changes and liquidity

Extended lock-in period: All investments in ULIPs carry a three-year lock-in period. This will be increased to a five years from September 1, 2010. This will clearly weed out the mis-selling of ULIPs as short-term products to investors.

Given the buoyant equity market investors are often persuaded by their advisors to invest in ULIPs on the premise that these are three-year products.

With funds locked up for five years, only investors serious about building a long-term investment portfolio would consider buying ULIPs. Incidentally, ULIPs should be bought only that way, because of their front-ended expense structure.

Investors should also be conservative in deciding their premia as they are committed to the investment for several years at a time.

If they fail to pay the renewal premium and discontinue the policy in the first five years, no payment will be made till expiry of the lock-in period. Hence investors not sure of a regular income should set their premium conservatively.

For excess income, one can always add on single-premium policies.

This ensure that you will not surrender the policy within five years. If a ULIP is prematurely discontinued, your fund value on the date (after adjusting for surrender charges) will earn minimum of 3.5 per cent interest during the remaining lock-in period.

Liquidity: Even while extending the lock-in period on ULIPs the regulator has sought to improve their liquidity by introducing norms for loans against ULIPs.

In any ULIP where the equity accounts for more than 60 per cent of total portfolio, investors can be granted loans not exceeding 40 per cent of the investment’s net asset value (NAV). Where debt accounts for more than 60 per cent of the portfolio, the loan can be upto 50 per cent of NAV.

Returns: While the above changes to ULIP costs may help improve effective returns to investors, the IRDA has also laid out special provisions for pension products fashioned as ULIPs.

As per the new regulation, a unit-linked pension plan should carry a minimum guaranteed return of 4.5 per cent a year if all premiums are paid. Such ULIPs will also carry a longer lock-in period than others and no partial withdrawal will be allowed during the accumulation period.

However, on vesting date, policyholders can commute (choose to receive as lump-sum) up to one-third of the accumulated value of the fund to his credit.

Pension policy holders should ensure that they pay premium till the maturity period. In the event of discontinuation, the policyholder would be entitled for a lump-sum refund of not more than one-third of the fund value, while the remaining amount would be used to purchase annuity to ensure pension payments. You will pay tax for the pension received for your respective slab and it will bring down the net yield on the product.

How ULIPs performed

All the above measures may help lift the effective returns to investors from ULIP products. But how have equity-oriented ULIPs performed so far? Details on ULIP performance or portfolios are not as easy to come by as those for mutual funds.

However, an analysis of equity-oriented ULIPs (80-100 per cent invested in stocks) shows that over a one-year period, 56 of 62 schemes managed to outperformed such indices as BSE Sensex, CNX Nifty and BSE 100.

Over a three-year period, 21 of 28 schemes, and for a five-year period 9 out of 13 schemes, comfortably edged past BSE Sensex.

Over three- and five-year periods, the category average clocked compounded annual returns of 10 per cent and 22.7 per cent respectively, against the 5.5 per cent and 19.2 per cent recorded by the BSE Sensex (Nifty returns are 6.3 per cent and 18.1 per cent).

However, investors should note that their effective returns from ULIPs may be 3-4 percentage points lower than the NAV-based return (as ULIP expenses are adjusted based on the unit balance and not the NAV).

Your premiums are invested in units of the investment fund of your choice, based on the prevailing unit price. On vesting the value of your units will be used to buy your retirement benefits.

What are my Premiums?
You agree to pay level premiums regularly, either quarterly, half-yearly or annually, throughout the term of the policy or a single premium at the start of the policy.

What investment funds can I invest in?
The policy is fully unitised with a range of funds to match your needs and approach to risk. (By risk we mean the likely volatility in the value of units in the fund.) Each investment fund is composed of units. All the units in a fund are identical.

The policy monies and the bonus are payable only to the nominee of the beneficiary upon the death of the policyholder. The policyholder is not entitled to any money during his or her own lifetime, i.e. there is no survival benefit.

Your commitment: You agree to pay a single premium or level premiums with installments due every quarter, half-year or year throughout the deferment period of the policy, after which you will start receiving your pension.

Can I take the notional lump sum as cash on retirement?
Subject to the prevailing legislation and regulations, part of this can be taken as a lumpsum and the rest used to buy an immediate annuity.

■ Payment of cash lumpsums, each of which is a proportion of the basic sum assured, at a regular interval during the term of the policy.
■ On survival up to maturity, a payment equal to the basic sum assured plus any bonus additions less the cash lumpsum paid earlier is provided.
■ In case of the unfortunate death of the life assured within the term of the policy, the basic sum assured plus any bonus additions is provided. This is over and above the earlier payouts.

Term life insurance premiums increase as you age and the policy generally doesn’t offer cash value or paid-up insurance.

If you want insurance protection only, and not a savings and investment product, buy a term life insurance policy.

OTHER BENEFITS OF TAKING INSURANCE

1. Tax Relief:
a. Under Section 80C of Income Tax Act, a portion of premiums paid for life insurance policies are deducted from tax liability. Similarly, exemption is available for Health Insurance Policy premiums.
b. Money paid as claim including Bonus under a life policy is exempted from payment of Income Tax. Under section 10(10D).

2. Encourages Savings: An insurance scheme encourages thrift among individuals. It inculcates the habit of saving compulsorily, unlike other saving instruments, wherein the saved money can be easily withdrawn.
3. The beneficiaries to an insurance claim amount are protected from the claims of creditors by affecting a valid assignment.
4. Life Policies are accepted as a security for a loan. They can also be surrendered for meeting unexpected emergencies.
5. Based on the concept of sharing of losses, the society will benefit as catastrophic losses are spread globally.

To put it simply, ULIPs attempt to fulfill investment needs of an investor with protection/insurance needs of an insurance seeker.

ULIPs work on the premise that there is a class of investors, which regularly invests its savings in products like fixed deposits, coupon bearing bonds, debt funds, diversified equity funds and stocks.

Some individuals take insurance to provide for their family in case of an eventuality. So both these categories of individuals (which also overlap to a large extent) have a portfolio of investments as well as life insurance.
ULIP as a product combines both these products (investments and life insurance) into a single product. This saves the investor/insurance-seeker the hassles of managing and tracking a portfolio of products.

ADVANTAGES OF ULIP:
■ Insurance cover plus savings. To begin with, ULIPs serve the purpose of providing life insurance combined with savings at market-linked returns. To that extent, ULIPs can be termed as a two-in-one plan in terms of giving an individual the twin benefits of life insurance plus savings.

■ Multiple investment options. ULIPs offer a lot more variety than traditional life insurance plans. So there are multiple options at the individual’s disposal. ULIPs generally come in three broad variants:

• Aggressive ULIPs (which can typically invest 80%-100% in equities, balance in debt)

• Balanced ULIPs (can typically invest around 40%-60% in equities)

• Conservative ULIPs (can typically invest up to 20% in equities)

■ Flexibility: Individuals may well ask how ULIPs are any different from mutual funds. After all, mutual funds also offer hybrid/balanced schemes that allow an individual to select a plan according to his risk profile. The difference lies in the flexibility that ULIPs afford the individual. Individuals can switch between the ULIP variants outlined above to capitalize on investment opportunities across the equity and debt.

■ Works like an SIP
Rupee cost averaging is another important benefit associated with ULIPs. Individuals have probably already heard of the SIP, which is increasingly being advocated by the mutual fund industry.

Insurance is the process in which losses of few are shared by many persons who are equally exposed to same risks. It is explained with the help of following examples:

In a city there are 1000 persons who are all aged 63 and are quiet healthy. Expected rate of death during the year is of 10 persons. If the economic value of loss suffered by the family of each dying person were taken to be Rs 70,000, the total loss would be Rs. 7,00,000  (70,000* 10). If each person would contribute Rs. 700 a year the common fund would be Rs 7,00,000 (700 * 1000). This will be sufficient to pay Rs 70,000 to the family of each of the 10 dying persons are shared by 1,000 persons. That is why we can say insurance is a cooperative device to share the sufferings of unfortunate person in a group.