ULIPs – Whose Product Is It Anyway?
Earlier this summer, when IPL frenzy had covered the cricket fanatic nation, teams were battling to win yet another T20 championship, it’s organizers and team owners fighting legal battles off the field, there was another battle unfolding in the financial circles: the tussle between SEBI (Securities and Exchange Board of India) and IRDA (Insurance Regulatory and Development Authority) for the right to regulate ULIPs (Unit Linked Insurance Plans). This episode has brought to fore various issues surrounding this product. The size of the market for life insurance products in India, estimated to be the fifth largest in the world, is over $40 billion and growing at a rapid pace of over 30% per annum. ULIPs account for over 80% of the business in this market. Through this article we will give an overview of ULIPs, the much publicized tussle between the two regulators over this, the recent changes brought about by IRDA and its impact on the life insurance industry and the investors.
So what are ULIPS?
ULIPs or Unit Linked Insurance Plans as the name suggests, are insurance plans linked to investment units. It is a financial product that offers you life insurance as well as an investment like a mutual fund. Part of the premium you pay goes towards the sum assured (amount you get in a life insurance policy) and the balance is invested in whichever investments you desire – equity, fixed-return or a mixture of both.
Why are ULIPS in news now?
In April 2010, SEBI issued a notice asking all insurers to stop the sale of ULIPs, which according to SEBI, should come under its regulations. Insurance regulator IRDA immediately struck down on this call and asked insurance companies to ignore SEBI’s order. What followed was a bitter public spat between the two regulators with the Finance Minister intervening and calling for a joint application before the judiciary.
So why was SEBI, the capital market regulator so concerned about regulating an insurance product – in this case ULIPs?
Well, the genesis of this issue lies in an August 2009 verdict by SEBI which banned the entry loads on Mutual Funds. Entry load is the commission that an investor has to pay while purchasing units of a mutual fund. After this verdict, entry loads on Mutual Funds had to be cut down to as low as 0.5-1%. In contrast, ULIPs had entry loads ranging from 15-20%. One of the biggest assets of MFs is their wide distribution network which can reach out to a large number of investors. However, with the reduction in the upfront commissions, selling Mutual Fund units was no longer a very attractive proposition for the agents in this distribution network. This is where ULIPs came into the picture. As these products still continued to have large upfront commissions, most distributors shifted their attention from selling MFs to selling ULIPs.
Just to give you a sense of how every distributor jumped on to the ULIP bandwagon, fathom this: during the previous financial year, over 1.6 million ULIP policies were sold, with the total premium involved in these products amounting to over $20 billion. Most of these funds are invested in the capital market. To put this figure in perspective, the net FII inflow in the previous fiscal was around $32 billion. The effect that FIIs can have on the movement in the Indian markets has been well documented. So, the burgeoning size of the ULIP products meant that SEBI essentially had no control over a major investor segment in the capital markets. This finally culminated in SEBI’s April 10 order banning 14 private insurers from selling any new ULIP product without registering with SEBI.
Was SEBI justified in putting in place this ban?
The main contention by SEBI was that ULIPs ultimately are investment products. As mentioned earlier, they have a very significant investment in the capital markets. So, it does make sense to bring such products under the purview of the capital market regulator. But a couple of things regarding SEBI’s ban order stuck out. Firstly, it quite conspicuously left out the public sector insurers (read LIC) from the ambit of the ban. Given the size of these insurers, it’s hard to explain why they were treated differentially than the private insurers. Secondly, the manner in which it placed the ban. It should never have been a unilateral decision. The insurance regulator IRDA was not kept in the loop while taking this drastic step which ultimately gave rise to the bitter public dispute between the two regulators.
The central government had to finally step in to resolve this turf war between the regulators. The verdict was finally ruled in favor of IRDA with the government promulgating an ordinance to amend existing laws to include ULIPs under the life insurance business.
So what next for ULIPs?
This highly publicized tussle brought various aspects of ULIPs into limelight. There already were a number of concerns being raised by various stakeholders regarding some of the problems this product had. First of all, it had a significant entry load – as high as 30% in some cases. This encouraged distributors to push the product to the investors and often led to misrepresentation of information related to the product in order to sell more and more of them. Secondly, the surrender charges, imposed on premature encashment of investment units, were exorbitant. In some cases, surrender charges went up to as high as 90% if the policy was surrendered in the first three years. IRDA had already started the process of instituting more stringent rules to overcome these aspects of ULIPs. However, the events over the past few months precipitated in some sweeping changes being suggested by the regulator. Let’s analyze some of the new guidelines it has provided on the product and its possible impacts on the insurers and the investors:
- Increasing the Lock-in Period to five years from the current three. The premium paying term has also been increased to five years.
- To spread out the front end expense evenly over the lock-in period. This is good news for the investors as it would insure that the insurance seller is not ‘mis-selling’ the product to realize short term gains. Also, with rational front end cost, more investors would be able to afford these investments.
- Capping the surrender charges to 15% of fund value as well as in absolute terms. Again, this would be beneficial for the investors as they would now incur a smaller cost while switching from one policy to another. However, this would mean a big loss in revenues for the insurers. According to estimates, around 25-30% of the policies lapse within the current lock-in period of three years with surrender charges ranging from 50%-90%. This combined with the spreading out of the entry load would mean a significant reduction in the revenues of the insurers as well as an increase in their time to break even.
- The risk cover has been increased to at least 10 times the annual premium being paid. This would mean that the insurers would have to set aside larger capital which would dampen their profitability. It would also deter marginal companies from entering in this segment.
- As regards pension products, all ULIP pension/annuity products shall offer a minimum guaranteed return of 4.5% per annum. This will ensure that the life time savings of the pensioners are protected from any adverse fluctuations. Currently, there are some unit-linked pension plans that can invest up to 100 per cent in equities. However, with the guaranteed return clause, exposure in fixed income securities will increase.
So it is quite evident that the new regulations, which the insurance companies are required to comply with by September 1st, would serve to reduce the attractiveness of ULIPs for these companies. However, looking on the positive side, it would create a level playing field for other products like Mutual Funds whose popularity had waned significantly over the past year. And most importantly, the investors will most certainly be better off with these changes. On how the insurance companies would deal with these changes, only time will tell. But I have a strong feeling that after MFs and ULIPs, it’s time for another new kid on the block. A year from now, the dialectic may shift to yet another product. But again, only time will tell.
- Aditya Damani & Priyesh Jaipuriar
References
http://www.business-standard.com/india/news/why-sebi-feels-it-just-has-to-regulate-ulips/391670/
http://economictimes.indiatimes.com/articleshow/6069224.cms
http://www.journaloffinance.in/?p=806
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