Some time back, Regulatory and Development Authority (IRDA) came up with guidelines that placed upper limit on the various charges in Unit Linked Insurance Plans (ULIPs). Let’s understand what the limit is, and what it means for you.
Unit Linked Insurance Plans (ULIPs) have been notorious for the variety of front loaded charges – charges that are deducted from the initial few years’ premium amount. This leaves less money to be actually invested on your behalf, resulting in lower returns for you.
(To know the full details of the problems with ULIPs and how IRDA is working to resolve them, please read “Making ULIPs better – The problems, the corrective steps taken by IRDA and their implications for you”)
One of the most important things that IRDA has done (effective 1st October, 2009) is to put an upper limit or cap on the various charges levied on ULIP customers. However, this is a provision that has not been understood very well by investors.
Let’s try to understand what exactly the cap is, and how it would impact your returns.
The upper limit on various charges
The maximum amount of charge that can be levied depends on the tenure of the insurance policy.
For ULIPs having a term of less than or equal to 10 years, the total charges levied can not be more than 3%. Out of this, fund management charges (FMC) can not be more than 1.5%.
For ULIPs having a tenor of more than 10 years, the total charges levied can not be more than 2.25%. Out of this, fund management charges (FMC) can not be more than 1.25%.
How is this total charge calculated?
The charge is calculated as the difference between gross and net yields of the ULIP fund. Here, the net yield is the gross yield adjusted for all charges.
This is as defined by IRDA – but what exactly does this mean?
When you pay the premium for a ULIP, a small portion from it is deducted as “mortality charge” – this is the money that gets used to get the life insurance for you. The remaining amount is invested on your behalf, most times after making some further deductions like policy administration charge, premium allocation charge, etc. These are deductions made from your premium before investing it for you. Let’s call them Deductions A.
Now, the money invested on your behalf grows as per the market performance, and the fund value of your ULIP (the total value of all your units) grows. However, every year, some amount is deducted from this fund value – usually by deducting some units from your balance. These charges are most commonly known as fund management charges or FMC.
These are deductions made from your fund value. Let’s call them Deductions B.
The cap: What IRDA has mandated is that the sum of these deductions (Deductions A and Deductions B) can not be more than 2.25% of the fund value (or 3% if the ULIP tenure is for less than or equal to 10 years).
That is, the sum of all charges put together can not be more than 2.25% (or 3%). Please note that this maximum limit includes the mortality charge as well.
The charges that are not counted towards this limit
There are some charges, however, that would not be included in this overall limit. These are:
- Any additional mortality charge levied due to your adverse health condition
- Amount deducted towards various riders
- Service tax
- Any kind of investment guarantee charge explicitly mentioned in the policy (this is applicable mostly for “Guaranteed NAV” ULIPs)
Bringing transparency – How would you know the gross and net yields
IRDA has mandated some disclosures so that you as a customer know what the gross and net yields for your fund are.
- The gross yield and the net yield need to be explicitly mentioned in the ‘benefit illustration’ for the ULIP.
- At the time of maturity of the ULIP policy, the insurer needs to issue a certificate to you. This certificate would show your year-wise contributions, charges deducted, fund value and final payment made to you, taking into account any partial withdrawals made by you. This certificate would also show the actual gross yield and net yield taking into account the actual charges deducted.