The circular will be effective from October 1, so all products approved by Irda on or after October 1 will be governed by the provisions of this circular. All existing products that do not meet the requirements of this circular should be withdrawn or modified by December 31, 2009.
 

Let's review a couple of illustrations to see the various charges. As seen in illustration A, where the initial charge is 54 per cent in the first year, the gross yield of 10 per cent gross yield translates into a net yield is around 5.55 per cent. In illustration B, where the initial charge is 14 per cent in the first year, the gross yield of 10 per cent yield, leads to a net yield is around 7.56 per cent.

Even in terms of total charges, policy B that follows Irda guidelines (because the differential between the gross and net yield is less than 3 per cent) is less. That is, in illustration A, a policyholder pays Rs 212,105 as total charges whereas, in illustration B, the numbers add up to Rs 160,189 – a difference of Rs 51,916.

Obviously, the initial cost of 54 per cent in illustration will have to come down substantially.

The complaint, though, is this – most people will not understand the concept of gross yield and net yield as applicable to life insurance products and will think that 3 per cent is the charge for a 10-year product, whereas in reality this is not true. The PAC in the first year is the highest and often causes big damage to the returns, as this varies from 15 per cent to 81 per cent across life insurance companies. There is no doubt this move could reduce first-year PAC dramatically to below 30 per cent in the first year for Illustration A, but the PAC will continue to be as high as 20 per cent or more in the first year.

Additionally, Premium Allocation and Product Administration charges, which are the main charges, will continue to be different and this will continue the confusion among policy buyers. A better structure would have been to cap the PAC and Premium Administration charge to not more than 5-10 per cent in the first year and 2-4 per cent in the second year (just an example). Mortality rates and Fund Management charges can vary, as most these charges do not vary substantially across insurance companies. This would at least standardise the costs across insurance companies and a policy holder would understand that whatever policy he buys, costs would remain the same.

Though there is some reason to cheer, a lot needs to be done by Irda to lower charges further and address the issues raised above. At the same time, Irda should make insurance companies disclose costs of traditional policies such as endowment, money back and whole back policies, and lower cost further for such products, as the costs in these are extremely high for the very paltry returns (4-5 per cent simple interest) that they deliver.

The writer is director, My Financial Advisor