One has heard the famous saying “Change is the essence of life”. Unless a financial product evolves itself to stand the test of time it will soon disappear into oblivion. The Unit linked insurance policy was heavily marketed by insurance agents and purchased blindly by customers without a thorough understanding of the product. The fault was on both sides. The result was rampant mis-selling which brought a bad reputation to the insurance industry and a deep anger and mistrust on one’s part towards the unit linked insurance policy. Steps had to be taken to save the face of the insurance industry and also protect one’s financial interests. The result was a drastic set of reforms brought about in September 2010 which changed the face of this product. Reformation ends not in contemplation but in action.
What are the changes introduced in order to make the unit linked insurance plan a better buy?
One knows that reforms were introduced in the unit linked insurance plan in September 2010 in order to protect one’s financial interest and save these products from total oblivion.
- Raise in the lock in period: One knows that unit linked insurance products had a lock in period of 3 years. These products were marketed as a get rich quick scheme. One pays the premium for 3 years and investments were made in equity or in debt. What was not mentioned was that these products entail high charges in the first couple of years. As per new reforms the lock in period was raised to 5 years. This converted the view on these financial products from a short term to a long term approach. With charges being reduced and equity giving gains with a long term horizon these products started regaining their lost shine.
- Cap on the charges in Ulip Plans: Before September 2010 unit linked insurance policies would charge one a premium allocation fee which was about 25% of the first 2 years premium. Adding up other charges such as a mortality cover charge, policy administration charges and the fees for the fund manager most of one’s premium paid in the first two years was eaten away. Whatever remains of one’s premium is invested in either equity or debt. The returns one gets are not much to be spoken of. Commissions as high as 35% go to the agents pocket as an incentive. According to new rules one is charged a total fee of only 3% on the premiums paid. One has the difference between the gross yield namely the returns generated by the Ulip if there were no charges and the net yield where the charges are taken into consideration cannot exceed 3% on the Ulip premiums paid. The fund management fee cannot exceed 1.5% of the premiums and is included in the 3% cap. These rules apply only for a unit linked insurance policy with a 10 year maturity. If one purchased a unit linked insurance plan with a maturity period greater than 10 years the maximum charges are 2.25% of the premiums and 1.25% is the upper limit of the fund management fees which are included in this 2.25% limit.
- A better mortality cover: As one knows a unit linked insurance policy has an investment protection as well as a mortality cover. In the period prior to September 2010 a small nominal charge was deducted towards this mortality cover .The mortality cover was insufficient as most of one’s corpus which was left behind after charges were deducted was used for an investment purpose. As per new rules one gets a health cover or a mortality cover sufficient in size to cover the emergency. As a result the unit linked insurance product is forced to give a mortality cover instead of just masquerading as a twin benefit policy, while it was actually functioning as a pure investment product. This rule is applicable to all unit linked insurance products other than a pension or an annuity product.
- Increasing of the sum assured: Unit linked insurance products now have an enhanced or a better sum assured thereby focusing on the core need of insurance. Unit linked insurance products masqueraded as insurance and investment products whereas they offered hardly any insurance cover. They functioned purely as an investment product. One could procure better investment benefits just by taking up a mutual fund which has minimal charges. A term life plan would provide the insurance cover. This is because the unit linked insurance products actually provided almost no insurance with very high charges. According to new rules if one is below 45 years of age the sum assured is enhanced to 10 times the premium paid from 5 times the premium paid prior to the reforms. If one is over 45 years of age the sum assured is 7 times the premium paid. This assures a true mortality cover if one opts for a unit linked insurance plan.
- Surrender value of a unit linked insurance policy: If one had purchased a unit linked insurance product in the period prior to September 2010 and one surrenders this policy the surrender charges are 100% or nothing is returned. Post this period if one were to pick up a unit linked insurance product the maximum surrender charges are INR 3000 if the premium charged is under INR 25000 . If the premium paid is over INR 25000 then it is INR 6000.
- Tax benefits: Premiums paid for the unit linked insurance plan are tax deductible up to a limit of INR 1 Lakh under Section 80 C and the maturity benefits are tax free under Section 1010(D).
So why did one fall for a unit linked insurance policy?
In India the focus has always been on value for money. Unit linked insurance policies as well as endowment products known as traditional life insurance products advertise twin benefits namely insurance as well as investment benefits. As one wants value for money he falls into the trap of a unit linked insurance product. One should never mix insurance with investments. One should purchase a pure protection policy which is a term life insurance policy with rider benefits at a low cost. Investments should be in equity diversified mutual funds if one has the ability and willingness to take risks. If one is risk averse he can invest in a fixed income product like a fixed deposit or a public provident fund. This is because traditional life insurance products such as endowment plans give huge commissions to insurance agents to sell these products paid from one’s premium. Unit linked insurance policies also have charges which are higher than mutual funds. So think, Insurance and Investment should be term insurance with riders and an investment product depending on one’s risk profile. This can give better returns than any twin benefit insurance product.
There is a famous saying “Avarice cause’s injury to the person who displays it. One purchases a unit linked insurance policy to satisfy his greed and satisfy’s the insurance agent’s greed. Reforms in a unit linked insurance plan can best be a band aid for this product .It sure has its benefits but only as a product of last resort and not of choice. So think sharp. Think pure life insurance. Think term life insurance.