Whenever a new product such as a Smartphone is launched in the market what is the first thing one does? One wants to check it out. If the product is marketed excellently through advertisements or a catchy package or a cover then one may purchase the product blindly. The Unit linked insurance plans was launched amidst much fanfare by insurance agents marketing them in such a manner using one of the oldest tricks in the book. Speak what the customer wants to hear. In India value for money plays a very important role and getting bang for the buck is the norm. Two in one benefits? Investment and insurance? The customer was hooked.“Lesson number one: Don’t underestimate the other guy’s greed.”
The Unit linked insurance policy was a game changer for insurance agents and the insurance industry in general in the pre September 2010 period. Considering the large number of people who purchased such a policy it is not a surprise if one fell for such a policy. So why was purchasing such a product a bad idea? As one knows unit linked insurance plans were complicated products mainly mis-sold because these policies were misunderstood and an investment was made in them without thorough research. Surely the devil is in the details.
Shock Number 1:
Charges in a unit linked insurance plan: One of the main costs in the unit linked insurance policy is the premium allocation charge. These costs were charged mainly for expenses related to medical tests and underwriting costs. However a bulk of the amount under premium allocation charges went as a commission to insurance agents serving as a motivation for them to sell these products at any cost Irrespective of one’s real insurance needs. One would be charged over 20-25% of his first year’s premium towards the premium allocation charges if a policy was purchased in September 2008 and the period just after this. One would have deductions from the premium paid on a monthly, quarterly or a yearly basis depending on how one pays the premium towards this charge. When one checks his balance at the end of the year needless to say he is shocked. However since these policies have a lock in period of 3 years one has to either continue paying the premium or surrender the policy which has a high exit cost or a surrender charge. Talk of being caught between the devil and the deep blue sea.
Shock Number 2:
As one knows a ulip provides a mortality cover as these are twin benefit products namely investment as well as insurance. These charges are nominal or very less and are deducted from the premium. What mortality or life insurance coverage can be provided with such nominal amounts. Needless to say there is no mortality cover worth mentioning and the insurance cover is just a hogwash and proves insufficient as a death benefit amount.
Shock Number 3: A unit linked insurance policy had a compulsory lock in period of 3 years before September 2010.Insurance agents marketed this lock in period as a time to make a good investment which would rapidly multiply after the expiry of the lock in period. Insurance rewards those who make right decisions ,think term plan and thrashes those who make wrong decisions ,think ulips in the pre September 2010 era. After deducting charges what is left behind is invested in the market mainly the purchase of units of the unit linked insurance plan. Since a huge sum is lost as charges it is difficult to procure a good return even if the fund does well. If one surrenders the policy the exit charges are huge due to a surrender penalty charged if one makes a beeline for the exit.
Shock Number 4: A unit linked insurance plan has a fund manager who manages the corpus invested. Fees were charged which were quite high and this resulted in a considerably high expenses which was deducted from one’s premium.
One needs to realize that unit linked insurance policies were heavily mis-sold in the period prior to September 2010 after which rules were framed by the IRDA to regulate this segment and prevent mis-selling. If one has purchased the unit linked insurance policy before this period then he certainly needs to check out his options and make a decision whether to surrender this policy or not. One has already paid a hefty sum as charges which are deducted from the premium over the 3 year lock in period. If one surrenders the policy at this stage he will have to pay surrender charges as high as 8-10% of the fund value.
Let us consider Mr Ravi who is 35 years of age purchases a unit linked insurance policy paying INR 75000 per annum as a premium for 3 years .He pays a net total of INR 225000 over 3 years. Mr Ravi is charged premium allocation charges of 25% which is deducted over a period of 2 years from the premium. He is charged only 3% as premium allocation on the third years premium .There are other charges such as policy administration charges, fund management charges, mortality cover charges which are deducted. What is the surrender value Mr Ravi gets after 3 years?
Mr Ravi suffers a loss of 12% on his investment if he surrenders the unit linked insurance policy.
Surely surrendering a policy just after the 3 year lock in period is not a good idea. One needs to take a call especially if one’s fund is underperforming on a continuous basis and surrender the policy if he wants to cut his losses. One needs to note that charges reduce drastically after a period of 4 years to as less as 2% of the premium and if the policy charges reduce to this level one must consider holding the Ulip till maturity. The amounts accrued would provide a good investment benefit. If one’s Ulip charges are over 2% of the premium at this point then surrender is a good option. Another good option would be to convert this policy into a paid up policy where the policy is continued without any further premium payments. The sum assured reduces corresponding to the premium. If one had to make 10 premium payments for a sum assured of INR 5 Lakhs and he makes only 3 payments he gets 30% of the sum assured as a death benefit namely INR 150000.One can withdraw a majority of the invested amount when surrender charges are close to zero and continue with the policy and enjoy a life cover.
There is a famous saying “The snake which cannot cast its skin has to die” .This basically means in order for a product which has deficiencies to survive the vagaries of time modification and reform is necessary. This lead to a series of reforms post September 2010 which meant that unit linked insurance products had reached the next level and had become a force to reckon with in the insurance and financial market in India. Stay tuned for the next article where one can learn about the reforms in unit linked insurance policies. Remember stepping unto a brand new path is difficult but not as difficult as remaining in the same situation.
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