OPINIONS OF INSURANCE COMPANIES ON NEW REGULATIONS

INTRODUCED ON ULIP

1) The new regulations issued by the IRDA emphasises on returns to

policyholders as against the current practice of high agent commission
paid by the companies that tends to squeeze bonuses of policyholders.

2) the new regulations on unit-linked products are likely to put pressure on

both agent commission and company profitability. Companies will have to
streamline cost management, distribution and commission. Earlier, the
agents used to make approximately 57.5% as the commission over a
period spanning three years. With the new regulations, this will be
reduced to 30-32% spanning a period of 5 years, with minimum
guaranteed returns @4.5%.

3) Financial services firm Edelweiss Capital has estimated profit from new
unit-linked insurance business to drop to 10-11 per cent from the current
level 16-21 per cent.

4) Solvency requirements of insurance companies could rise 40 per cent and

25 per cent, respectively, on higher new business strain and expense.

5) Unit-linked insurance accounts for 54.8 per cent of business in the life
insurance sector ion India. Unit-linked business grew 35.33 per cent in
2009 against the industry growth of 25.83 per cent.

POLICYHOLDER’S FAVOUR

The new provisions

IRDA has prescribed a minimum sum assured equal to 50 per cent of the total annualised premium
during the entire policy term or five times the annualised premium, whichever is higher. This
regulation is aimed at maintaining the basic characteristic of a life insurance policy, where life cover
should be the primary benefit. Till the policyholder turns 60 years old, the sum assured cannot be
reduced by partial withdrawals. This is aimed at protecting the life insurance cover.

1) Premium Holiday: If the policyholder stops paying premium instalments after paying
premiums for three years, the risk premiums and the applicable charges can be adjusted from
the balance in the account value, till such time as the balance in the account reduces to one
year's premium. This would help policyholders who are unable to pay premiums owing to a
temporary disruption in income because of change in employment, or any other sudden drop
in income. The premium holiday option ensures continued insurance protection by
 transferring the risk premium and charges due from the account value, which is built up over
a period. But the policy would lapse and this benefit would not be available if premium
payments are stopped within three years.
2) Top-up Premiums: Top up premiums are irregular dump-in amounts allowed in a ULIP. Up
to now, there were no restrictions; it was possible, for example, to dump in Rs1 crore in a
ULIP and invest the entire amount in the market. But this vitiates the basic characteristic of
the policy by making the insurance component insignificant. To plug this loophole, IRDA
has prescribed that a sum assured must back any dump-in that exceeds 25 per cent of normal
premium, which will be constant throughout the term of the policy. Any appropriation
towards a dump-in can take place only if the normal premiums are paid.
3) Withdrawals from ULIPs: Earlier, withdrawals from ULIPs were possible even within a year
of issue. Depending on the option selected, they were reduced from the sum assured,
resulting in dilution of death benefits to the nominees. Now, withdrawals will be allowed
only after three years. The new guidelines provide that except for withdrawals made during
the two years immediately preceding death, no other withdrawals can be reduced from the
sum assured. But once the customer is past the age of 60, all withdrawals can be reduced
from the sum assured.
4) Lock-in period: A top-up premium cannot be withdrawn for three years. This places ULIPs
on par with mutual fund contributions under Section 80C of the Income Tax Act, 1961. The
only relaxation in this condition is on withdrawal of top-up premiums made during the last
three years of the policy contract.
5) Settlement options: The policyholder has settlement options, to receive the policy benefits in
various forms, rather than a lump sum. For example, the company can give the policyholder
an option to receive the maturity benefit in the form of a monthly pension. IRDA has
restricted such extended periods of settlement to five years from the date of maturity. The
company should also make clear the inherent risk involved in extended periods of settlement.
6) Date of unitisation: The invest-able portion of the contributions (after deducting risk
premium, charges, etc) is invested based on net asset value (which reflects the average
market value of the invested contributions). So far, insurance companies were unitising on
the date of placing of the policy, which could be much later than the date on which the
customer gave the cheque towards the first premium, renewal premium or dump-in premium.
This often resulted in loss to policyholders, as the market moved up between the date of
receipt of the cheque and the date of placing the policy. To resolve this anomaly, the IRDA
has prescribed the following guidelines:

• Contributions by local cheque / DD: If the payment is received up to 4.15 pm, payable at par
at the place of receipt, the same day's closing NAV will be applied. After 4.15 pm, the next
day's closing NAV is applicable.
 • Contributions by outstation cheque: The closing NAV on the date of realisation of the
outstation cheque is applicable.

This provision ensures that the company banks the cheques on time. The company will make good
any loss on account of delays on its part. This rule is applicable for redemptions too.

7) Charges: Charges are costs appropriated by insurance companies from ULIP premiums. The
IRDA has listed the charges that insurance companies can levy on policyholders, as well as
laid out the standard definitions for use in policy contracts. This is aimed at clarity and to
enable customers to understand and compare costs between different insurance companies.
8) Statement of Account: A statement of account, which forms part of the policy document,
must be issued at the end of each policy year and also when a transaction takes place, giving
complete information on the nature of the transaction (investment / switch over, etc), the
NAV on the date of transaction, number of units before and after the transaction, etc. The
annual statement must give the number of units in the account and the NAV on the date of
the statement, besides other relevant information.
9) Market Conduct: There is an inherent risk in investing in ULIPs, as the performance of the
funds underlying the ULIPs governs their returns. To address these risks, the IRDA has
authorised the Life Insurance Council to formulate a Code of Conduct for sale of ULIPs. This
includes mandatory training for agents before they are authorised to sell ULIPs,
documentation to enable the customer to understand and acknowledge the risk involved in
buying ULIPs, a code of conduct for their sale, educating policyholders on risk factors,
terminology, charges, etc.
10) Disclosure norms: To prevent misleading information, the IRDA has prescribed
norms for mandatory disclosures. All promotional materials must specify all fund options
(like equity funds, debt funds, balanced funds, etc), the minimum and maximum percentage
of investments in fund options, all charges with limits, and the risk profile. All promotional
materials and policy documents must carry a clear statement that the investment risk is borne
solely by the policyholder. The size of the fonts used in disclosures must be the same as that
used for other purposes in promotional materials and policy documents.

All advertisements for ULIPs must clearly address the question of risk and distinguish ULIPs from
conventional life insurance products. They must disclose all charges and guarantees, if any, and
include a statement that the fund name and the company name do not indicate the performance of the
fund. Advertisements must be simple, understandable to policyholders and avoid legal and financial
jargon, to avoid misleading sales.

Past performance can be given only on completion of one calendar year from the introduction of the
fund. Emphasis on past performance should be minimal. Under no circumstances can there be any
justification for projecting or suggesting future performance based on past performance; there should
be a clear-cut statement that past performance is no indication of future performance.

CHANGES IN ULIP

Look before ULIP

However the disclosure norms was a cause of concern, as people buying ULIPs were often not informed
about all the risks.

They were promised phenomenal returns, without being informed that ULIPs might prove risky if the
timing of exit happens to coincide with a bearish market phase, because of the inherently high equity
component of these schemes.

Many agents convinced gullible investors on the basis of past growth in the stock indices, which is totally
misleading and illegal not only for insurance but also for mutual fund products.

The insurance industry regulator IRDA also expressed concern that ULIPs were being aggressively sold
more as investment than that as insurance products. Also, the products were being sold at high costs,
many of which were hidden.

Regulator reacts

After persistent complaints regarding both the quantum and number of charges associated with ULIPs,
the insurance regulator — IRDA — has brought in new regulations to rationalise the cost structure of
these products. Effective from January 1, 2010, the new guidelines are primarily aimed at preserving the
long term nature of the product, provision of fair insurance coverage and disclosures to facilitate informed
decisions by customers.

Prior to this, there was no fixed cost structure for ULIPs or any insurance products, that is, there was no
capping on the costs associated with the products. The cost could vary in the range of two per cent to 4
per cent of the premium amount.

With the implementation of these guidelines, all ULIPs will be structured in a manner so that the difference
between the total return and post cost return, that is, the cost of the product, cannot be more than three
per cent of the premium for policies with a tenure upto ten years and 2.25 per cent for those more than
ten years.

That is, IRDA says that if 10 per cent is the gross yield in the market, the net value yield to the customer
should be at least 7.75 per cent. So, excluding mortality and guarantee related charges, all costs have to
be capped within 2.25 per cent.

As Bajaj Capital Executive VP Vinay Taluja puts it “Fund management charges (FMC) of the insurance
companies is now low at 1.35 per cent which will have a big positive impact on returns for the investor as
compared to other investment products where the FMC can go up to 2.25 per cent.”

Pro-customer move

The new guidelines incorporate changes that are beneficial to the customers in more ways than one.
Insurance companies expect that now that the customer is assured of a certain yield, as internal rate of
return (IRR) or the returns to the investor is now mandated by the regulator, ULIPs will now be more
attractive from the customer’s perspective.

The changes are very customer centric. They particularly protect the interests of customers with long term
savings objectives. As Aviva India Director Marketing Vishal Gupta states, “The customer will get a better
deal as far as the IRR is concerned. It will improve by anywhere from 50 basis points to 300 basis points,
depending on the products.”

Earlier, most ULIPs typically had a surrender charge up to six years. The new cost rules bring with them
zero surrender charges from the fifth year onwards.

Also, there is no surrender penalty if an investor wishes to exit the policy after five years. Another
advantage to the customer is that he will now have more clarity regarding the charges that he is paying in
the policy. This is because now, since the costs have to be specified by insurance companies on issuance
of the policy, there is more transparency. The IRDA has also mandated customer centric benefit
illustrations that provide indicative returns to customers. Commenting on the new move, ICICI Prudential
Life Insurance Company Limited Senior Vice-President & Head (Products & Sales) Pranav Mishra said
“The changes would ensure uniformity in product comparison across the industry. Also, customers will
now have more clarity regarding the charges that they are paying in the policy.”

Company perspective

Even though some players believe that the industry will benefit in the long run as the reduction in charges
will attract more customers, companies will have to take measures to balance the loss in income from
these changes.

The new cost caps will push insurance companies to ensure policy persistence since they will only make
money if the customer stays the policy term. Commenting on this, Taluja “As a company, the challenge is
now to sell more for the long term as the fund management charges will be higher here, thus helping
companies balance the loss in income from these changes.”

He added that long term policies are beneficial both for the investor and the insurance company as the
regulator has stated that costs associated with long term policies will be lower and also no renewal
premium charges will be levied after a period of five years to encourage investors to continue with the
same policy free of additional cost.

These new guidelines and regulations will force companies to bring more efficiency in processes and
leaner structures. As Mishra said “Companies will have to create cost effective models of distribution to
ensure that the cap on charges does not hurt the bottom line.”

Long term bet

Even agents will be encouraged to sell long term policies as their commissions will get linked to the term
of the policy.

Companies will look to create more innovative products and encourage long term behaviour for
customers. All the companies have gone in for loyalty additions and guaranteed maturity additions
encouraging customers to stay invested over long-term. Gupta added “Our company has also introduced
loyalty additions in all our unit linked products after January 1 which will incentivise the customers to stay
longer.”

However, in spite of the many changes, some aspects that remain the same like costs are still front
loaded, that is, a large portion of the initial premium goes towards payment of costs and consequently
only a small amount of that is invested.

Commenting on this, Taluja said “Insurance in India is still solicited and not bought, so the distribution
costs are higher. In order to meet those costs, companies have to recover costs upfront or over a
maximum period of three years, otherwise it becomes a burden on the company’s capital.”