Unit-linked plans: More lip service

The proposal to cap surrender charges may ensure buyers get back some — just some — of their investment.

Last week, the Insurance Regulatory and Development Authority (Irda) put up draft proposals fixing surrender charges for unit-linked insurance plans (Ulips) and the revival period for lapsed polices on its website.

Irda proposed that surrender charges be capped. For policies of less than 10 years, the charges might be capped at 2.5-12.5 per cent of the fund value in the first five years. For policies with tenures of more than 10 years, the charges could be fixed at 2.5-15 per cent of the fund value for the first six years. After the fifth (for policies of less than 10 years) and sixth (for more than 10 years) years, the charges would be zero.
 

HIGH COSTS, LOW RETURNS
PREMIUMS: Rs 1 lakh per year; Policy: 10 year
RATE OF RETURN: 10 per cent per annum

YearTotal cost*
(Rs)Fund value
(Rs)Surrender
charge (%)Amount
received (Rs)# 160,00044,00012.538,500 215,000141,90010.0127,710 315,000249,5907.5230,870 410,000373,5495.0354,871 510,000509,9042.5497,156 *Total fund value at year-end, including returns
#Withdrawal at year-end

On the face of it, the charges look nominal. But, the operative word here is ‘fund value’. This is to be arrived at after deducting all the costs. According to the draft guidelines, “The surrender value of the policy is the amount remaining in the fund account less applicable surrender charges which is refundable to the policyholder.” That is, surrender value is equal to fund value minus surrender charges.

Here’s the catch. Given that Ulips front-load their policies in the first few years, the fund value itself will be low. For instance, there are charges under various heads like premium allocation and policy administration. The costs can be as high as 60-100 per cent in the first year itself.

As a result, even if the guidelines come into effect, buyers of these policies will not get much of their money. Rahul Aggarwal, chief executive officer of Optima Insurance Brokers, said, “The entire premium will be initially used for various costs applied on the policyholder. Therefore, there will be no premium left for any surrender charge to be levied in the initial years.”

Let’s understand this with an example. Let’s say the first year’s premium that you have paid is Rs 1 lakh for a policy of less than 10 years. Assuming the first year charges at 60 per cent of the premium (Rs 60,000), the fund value of the policy is Rs 40,000. Also, returns are being assumed at 10 per cent a year.

Even at this rate of return, the buyer of the Ulip is unlikely to get back even his principal of Rs 5 lakh if he exits the policy in the fifth year (see High costs, Low returns). In fact, if the investor exits at the end of the first year, he may get only Rs 38,500. If he does so before the end of the first year, the number could be much less.

As far as returns go, though it has been assumed that the policy is earning 10 per cent a year, it will depend on market conditions. In a bad year, you may not get anything. “With policies with high front-end costs, you stand to get back nothing from the capital invested,” said Suresh Sadagopan, a certified financial planner.

“Things could improve slightly. Most insurers deduct all the remaining amount (Rs 40,000 in the first year, in this case) if the investor withdraws in the first year, to recover costs,” said an executive of a top life insurance company, who did not wish to be named.

The good part: The amount will be completely tax-free, because the product will be treated as an insurance plan by the income tax department. In case of a pension plan, both capital invested and returns are taxable if the policy is surrendered in the interim.

Insurers said since Ulips were long-term products, withdrawals or surrender charges should not worry policyholders. G V Nageswara Rao, MD and CEO, IDBI Fortis, said, “With recent regulatory changes, Ulips have become more attractive. These are best suited for the long term.”