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Will buying ULIPs earn higher returns now?

The tussle between the insurance regulator IRDA (Insurance Regulatory Development Authority) and the stock market regulator SEBI (Securities Exchange Board of India) over ULIPs (unit linked insurance plans) has only ended with the ruling going in favour of IRDA. And this did not stop ULIPs to fade away from the limelight. IRDA quickly came up with new norms aimed at making ULIPs more investor friendly.

Here's a quick look at the likely changes which will be effective from September 1, 2010 and how they will impact investors.

Changes proposed and impact analysis:

Proposed change 1

Lock-in period of ULIPs has been extended to 5 years as against 3 years currently. This will also increase the mandatory premium payment term from 3 years to 5 years.

Impact

This is a good move. We have reiterated that ULIP is a medium to long term product and one should not be looking at it with an investment horizon as short as 3 years. This move by IRDA will curtail mis-selling to a large extent.

ULIPs are often projected as a 3-year product, and this would undergo a significant change. It is to be seen if the insurance companies will provide any premium holiday option which will enable the client to take a breather after 3 years of premium payment and revive the plan when there is enough liquidity.

Proposed change 2

Overall charges are to be evenly spread out over the lock-in period

Impact

This would mean that those insurance products with very high front-end charges in the initial years will have to shed their existing form to even out the charges such that more amount is deployed into the investment in the initial years itself. This will help investors benefits from the power of compounding.

Proposed change 3

Life covers of ULIPs which was a minimum of 5 times of sum assured, is now hiked to minimum of 10 times of sum assured.

Considering that the minimum multiple cannot be kept at 10 times across all age groups, IRDA reduces this to 7 times annualised premium for policyholders who are aged above 45 years.

For single premiums, the minimum sum assured is fixed at 1.25 times of premium for investors aged below 45 years and 1.1 times for policyholders who are 45 years or more.

Impact

This would in turn mean that there is more money deployed towards life cover and lower amount is set aside towards investments. This would also impact the charges; the mortality charges would increase significantly.

Proposed change 4

Pension plans have been on the government's radar for a long time. The direct taxes code proposes to make annuity tax-free, which will be a major booster, with other investment linked insurance becoming taxable on maturity.

IRDA only supports this initiative, by fixing an assured return for pension plans; the minimum guaranteed return is currently fixed at 4.5 per cent per annum. This, interestingly, is applicable for ULIPs as well. IRDA reserves the right to revise this.

Impact

This could be a game changer. ULIPs / ULPPs (Unit linked pension plans) until now offered fund choices which provided up to 100 per cent exposure in equities. With the fixed return norm, there has to be a certain percentage dedicated towards debt / government securities.

This would lower the yield in the long term. Clearly, ULIPs will no longer be on the same platter as mutual funds. Hence, finally the argument of one over the other may rest.

Investor perspective

On the face of it, the new norms are good for the investors. It will clearly curb mis-selling to a large extent. However, the challenge will still be how one could educate the investor about these initiatives.

SEBI did a great thing by wiping off entry load on mutual funds. The objective was to get additional investors on board. However, unfortunately this did not happen, there aren't too many sellers / distributors afloat to provide service. This has been a major deterrent in getting funds into the system over the past two years since the abolishment of entry load was implemented. Will ULIPs see a similar fate?

Insurers are already working out their numbers. Since the current agency commission structures may not sustain, a long-term commission model will be devised, which will provide a regular income stream to distributors. This would leave the best in the industry to operate. Furthermore, the financial planning industry is considerably fragmented; this is one step towards building an organised sector.

The road ahead...

There are a host of initiatives in pipeline to be implemented. On various facets affecting the 'aam aadmi'. The governing bodies, SEBI, IRDA, and Government of India are working their separate ways to achieve a common goal, bring in more transparency, investor friendliness and simplicity to investments and taxes.

Clearly, the direction is right. We hope that regulators would provide a long-term roadmap, look at the practical aspects and create a paradigm shift for the industry. We also hope that the regulators conduct an independent market research to truly assess the impact of policy decisions.

The ULIPs are today an important savings for several investors. ULIPs also contribute significantly to the inflows into markets. We hope this becomes a good long-term asset class for the investor and a complementary instrument to other asset classes.

Anil Rego is the founder and CEO of Right Horizons , an investment advisory and wealth management firm that focuses on providing financial solutions that are specific to customer needs.