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Making ULIPs better – The problems, the corrective steps taken by IRDA and their implications for you

For past few months, the Insurance Regulatory and Development Authority (IRDA) has been taking some steps to make Unit Linked Insurance Plans (ULIPs) more transparent and user friendly. This article lists these positive changes and discusses their implications for you.

The tussle between the Insurance Regulatory and Development Authority (IRDA) and the Securities and Exchange Board of India (SEBI) for regulation of Unit Linked Insurance Plans (ULIP) has been much publicized.

However, due to this controversy, the positive steps taken by IRDA to make ULIPs better have gone unnoticed by many. Let’s have a look at what steps IRDA has taken, and how they impact you.

But before that, some background about ULIPs and why they created so much confusion in the first place.

Unit Linked Insurance Plans (ULIPs) – The bad and the ugly

ULIPs have been promoted as products that give you two benefits in a single product – insurance and investment. You just make one premium payment, and you get life insurance cover as well as benefits of investment.

However, there were many issues with ULIPs that made them very costly for consumers. Here are some:

Huge upfront charges

ULIPs came with front loading of all sorts of charges. This meant that all costs incurred by the insurance companies in selling the ULIP policies were deducted from your premium in the initial 2-3 years.

This was done in various names – policy administration charge, premium allocation charge, processing fee, etc. This meant that in the first 2-3 years, a large chunk of the premium (as high as 80% at times) was deducted due to these charges. Consequently, very little of your money was actually invested on your behalf, lowering your overall returns from your ULIP policy.

Short-term focus

Life insurance is a long term product. Within various life insurance products, ULIPs are the products where it makes most sense to stay invested for 10 years or more to reap the highest benefit (this is because as we see above, all the charges are front loaded – you pay all the fees upfront irrespective of the time you hold the policy).

However, the law mandated minimum policy term to be only 3 years. Due to this, many agents prompted customers to change ULIPs every 3 years – this meant more commissions for the agents, but huge losses for the investors.

Surrender Charges

Many times, people bought ULIP policies, and surrendered them after paying premiums for 2-3 years if they realized that it was not right for them.

In this case, the insurance companies deducted huge sums before paying out the accumulated corpus / fund value to the policy holder. This used to be arbitrarily set by the life insurance companies, and was as high as 60% of the fund value in some cases. Thus, if you had Rs. 1,00,000 as fund value, you would get only Rs. 40,000 when you surrendered the policy!

Lapsation of ULIP Policies

When you don’t pay the premium for your insurance policy, the policy lapses and you are no longer covered by insurance.

There was no clear definition of when a policy lapses – the exact time of premium non-payment after which the policy lapses was different for different life insurance companies. Also, the time upto which such lapsed policies could be revived was also different for different life insurance companies.

Want to read more about ULIPs? Check out:

The changes brought-in by IRDA – and what it means to you

Lately, IRDA has taken many steps to change these negatives associated with ULIPs. Here are the steps taken so far (some of which are already applicable, and some are to be applicable from 1st July, 2010):

Disclosure of agent commission

It is now mandatory to disclose the commission that the agent would get for selling you the ULIP policy. Thus, you would know how much your agent is making, and can judge if she is pushing the policy due to the commission.

You can also demand service in line with the commission she is getting from you!

Cap on overall charges

The various fess / charges that are levied now have an upper limit – IRDA has capped this at 3% for policies of less than ten years, and at 2.25% for policies of more than ten years.

This percentage is calculated as the difference between the net yield and gross yield for the fund, and includes the fund management charge, which has been limited to a maximum of 1.5% for policies of less than ten years, and to 1.25% for policies of more than ten years.

(Please read “Cap on charges levied by ULIPs – What IRDA has mandated and how it impacts you” for a full discussion on the cap on ULIP charges)

Minimum term of 5 years

The minimum term of a ULIP policy would now be 5 years (as against 3 years earlier).

As we saw, all the charges are paid by you upfront in a ULIP plan, and therefore, it makes sense to have a ULIP for a longer duration. Also, life insurance should not be bought for shorter durations anyway.

Thus, this is a very welcome change. However, this should be further increased to 10 years so that people can take maximum benefit of ULIPs.

Partial withdrawal only after 5th year

Going forward, partial withdrawals can be made from your ULIP plan only after completing 5 years (against 3 years earlier).

This means you would not be able to withdraw your money even if you are tempted to – your money stays invested for more number of years, earning you better returns. This is necessary for a long term product like ULIP.

However, no partial withdrawal would be allowed from Unit Linked Pension Plans (ULPPs). This is to ensure that people are able to accumulate more money through the term of the plan, resulting in a large corpus at the end that can provide a good pension to you.

For ULPPs, the insurer would convert the accumulated fund value into an annuity at maturity. However, at the time of maturity, you would have the option to commute up to a maximum of one-third of the accumulated fund value as a lump sum. The remaining amount would be used to purchase an annuity for you, which would provide you with a regular pension.

Some minimum fixed death benefit / sum assured

All ULIPs (and unit linked pension plans) would have a minimum sum assured payable on death of the policy holder.

All top-ups to have associated life cover

Till now, it was possible for you to pay a top-up premium for a ULIP and invest it fully without getting any extra life insurance cover.

Now, all top-up premium payments would be treated as single-premium ULIP policies, and would result in an increase in life insurance cover (sum assured) for you. This additional insurance cover would be 1.10 – 1.25 times the top-up amount.

Every top up premium would also have a lock-in period of 3 years. However, top-up premium payments would not be allowed during the last three years of the policy.

No loans against ULIPs

No loans can be granted against ULIP policies. Again, this ensures that you cannot succumb to temptations and use your ULIP funds unwisely – even indirectly!

Unit Linked Pension Plans (ULPP) to have life cover as well

Currently, there are unit linked pension plans available which are pure investment plans – they have no associated insurance cover. Now, IRDA has made it mandatory for all ULPPs to include an insurance cover as well.

Like ULIPs, the minimum cover would be 5 times the annual premium paid by you (this would be 1.25 times the premium amount for single-premium ULPPs). Thus, if you pay a premium of Rs. 15,000 per year, the minimum life insurance cover would be Rs. 75,000. Of course, you would be able to opt for a higher insurance cover if you want.

(However, it would not be mandatory for Unit Linked Health Plans or ULHP to offer an insurance cover)

Standardized definitions for lapsation, and revival of policies

All ULIPs would come with a grace period of 30 days (15 days for ULIPs with monthly premium payments). Thus, you would get 30 (or 15, as the case may be) extra days after the premium payment date to pay your premium.

If you do not pay the premium by the premium payment date, the insurance company would send a notice to you stating the 30-day grace period. You would have 3 choices:

  • Totally stop the policy
  • Continue the policy with only insurance (no investment component)
  • Continue the policy as it was earlier (insurance plus investment components)

If you do not exercise any of these choices, your policy would lapse. A lapsed policy can be revived anytime up to 5 years from the lapse. However, the insurer would have the right to reject such revival request on certain grounds like significant change in your health condition, etc.

Cap on surrender fees / charges

It has been proposed by IRDA to limit the first year surrender charges to 12.5% for ULIP policies with a term of less than 10 years, and to 15% for ULIPs longer than 10 years.

The surrender charges for subsequent years would decrease gradually. There would be no surrender charge after the 6th year for ULIPs of less than 10 years, and after the 7th year for ULIPs longer than 10 years.

Here are the year-wise details of the cap on surrender charges:

Year of SurrenderPolicy Tenure Less Than 10 YearsPolicy Tenure More Than 10 Years
6thNo Charge2.50%
7th Year OnwardsNo ChargeNo Charge

This means that when you surrender your ULIP policy, you would get a larger portion of the fund value back – the money that is anyway rightfully yours!

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