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a">With the latest guidelines, new products may appear more attractive than older ones. But investors may stand to lose if they change policies. The Insurance Regulatory and Development Authority (IRDA) has continued its drive towards reforming the most criticised insurance product. In comparison to its earlier guidelines, the latest circular is likely to have far-reaching impact on the way ULIPs are sold in the market.

The most notable change in the recent guidelines pertain to surrender charges, five-year lock-in period, a cap on difference between gross yield to net yield for investment periods less than 10 years and a minimum guaranteed return on pension products. First, the details on the changes:

Surrender charges that punished policyholders for early discontinuance have undergone substantial changes. IRDA has recommended two slabs, one for an annual premium up to Rs 25,000 and other for investment above this threshold. For an annualised premium of up to Rs 25,000, the first year surrender charges are capped at 20 per cent of the premium or fund value subject to a maximum of Rs 3,000, while this goes down to as low as 5 per cent or Rs 1000 for surrendering in the fourth year. From the fifth year, ULIPs will not suffer any surrender charges.

Surrender charges

Policies with annual premium of above Rs 25,000 will suffer lower charges but the maximum charges are almost twice that in the other case. The new rule is far superior to the practice of deducting 30-40 per cent of the first year's premium when the policy holder discontinues the premium within the first three years.

The minimum three-year lock-in period in ULIP, which actually triggered this episode, would henceforth be extended to five years. The biggest advantage of the change is that policyholders, instead of suffering higher upfront charge, would henceforth pay the distribution charges evenly till the lock-in period, thereby a higher amount of the premium will go towards investment.

Continuing its macro management of the net yield to policyholders, the regulator has fixed net yields for periods less than 10 years. In its earlier guidelines it has prescribed the difference between gross yield (return) to net yield at 300 basis points (3 percentage points) for a policy maturity of 10 years and 225 basis points for maturity above 15 years. Now, a difference of 400 basis points has been prescribed for five years, which gradually reduces to 300 basis points in the tenth year. The charges still appear higher in comparison to mutual funds that are allowed annual expenses of 2.25 per cent (mortality charges, if added, will further increase charges).

According to the new regulation, unit-linked pension plans would carry a minimum guarantee of 4.5 per cent (if all premiums are paid) and no partial withdrawal will be allowed during the accumulation period. It appears attractive but there is catch, IRDA retains the right to review this guaranteed rate according to macroeconomics developments. This means that the return can vary over the term of the policy and investors will not be sure of the maturity value. On vesting date policyholders can commute up to one-third of the accumulated value as lump sum. As insurers are required to guarantee the return, major portion of the premium may find its way into debt instruments.

If the pension plan without any rider is not generating a minimum return of at least 8 per cent that has been guaranteed under PPF (it has favourable tax treatment in the proposed Direct Taxes Code compared to these pension plans) investor interest in pension plans is likely to wane at least for those investing up to Rs 70,000 towards retirement.

What to do?

With the new set of guidelines, new products may appear more attractive than older ones. Investors who bought ULIPs in earlier years may be tempted to surrender their products in favour of new ones. Should they? It may not be prudent to close the existing policy in favour of new products that are likely to be launched from September mainly on account of charges.

Consider this, an investor invested Rs 1 lakh on June 2009. After deducting premium allocation charge of 30 per cent, the rest would have been invested in equity. Assume in the one year the investment has grown at 30 per cent and the current value is Rs 91,000 (risk charge is ignored for the calculation). If the policyholder surrenders it he would suffer a charge of 30 per cent of the first year premium - Rs 30,000. The fund value of Rs 61,000 will be transferred to suspense account for next two years without any accretion, after which he will be paid the sum. Alternatively if he is continuing the existing policy for another 9 years and if it earns 10 per cent net of charges, the maturity value will be Rs 16.4 lakh.

As it's too early to predict the product structure, let's look at a case where he buys a new ULIP for a nine-year term and it has a 20 per cent premium allocation and other charges for first two years. If the ULIP earns 10 per cent net of charges, the maturity value will be Rs 13.7 lakh.

If he invests the old policy proceeds of Rs 61,000 after two years at a net interest of 10 per cent the maturity value will be Rs 1.20 lakh. His investment would then be worth Rs 15 lakh, still short of the sum he would made on his older policy. Hence it is advisable for the investors to continue with the current policy since it has already suffered charges.

Source: Business Line