A month and a half back, Vipul Mahadik purchased a universal life policy (ULP). Had he waited for a few more months, he would have saved a considerable amount on his first-year expenses.
On October 22, the Insurance Regulatory and Development Authority (Irda) suspended the sale of ULPs. It also proposed new guidelines, which will be imposed after discussions with the insurers. Under these guidelines, first-year expenses will be capped at 25 per cent. And, the second year onwards, the charges will be five per cent.
At present, there are four companies offering these products, including Max New York Life, Aviva Life Insurance, ING Vysya life Insurance and Reliance Life Insurance.
ULPs are sold to investors who are not very aggressive in nature. Thus, they invest mostly in debt instruments. Max New York’s Secure Dreams guarantees a minimum of 3.5 percent annually, but paid 6.5 per cent in the first year, while the Reliance Traditional Super Invest Scheme offered 7.5 per cent.
In comparison, State Bank of India is offering 7.75 per cent on 10-year fixed deposits. The Employee Provident Fund and the Public Provident Fund are offering 9.5 per cent (for financial year 2010-11) and eight per cent, respectively.
Some of these products offer a sum assured. Aviva Life Insurance’s Dhan Sanchay offers a sum assured of 10 times the first-year premium. New Best Years, a ULP pension product offered by ING Vysya, does not offer a sum assured or any insurance coverage.
Even costs are an issue. The first-year charges are much higher, as against the charges in the following years. Among the current ULPs, charges vary from 20-80 per cent. For instance, Mahadik who purchased a 15-year ULP with an annual premium of Rs 36,000 paid 61 per cent or Rs 21,960 as his first-year charges. The draft guidelines by Irda, if implemented, will cap his costs at Rs 9,000. The total costs include the premium-allocation charge and policy-administration.
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High first-year cost
Since most of these policies are heavily front-loaded, especially in the first year, it may not make much sense to exit now, or even in the next few years due to low returns. “The acquisition costs are the highest in the first year. If those in their first year surrender, they may be net losers,” says V Srinivasan, chief financial officer, Bharti Axa Life Insurance.
The fund value after the first year’s hit, say, in Mahadik’s case, is substantial. Since Mahadik will have only Rs 14,040 in the fund plus the interest payout at the end of the first year, exiting makes no sense. Also, there will be surrender charges levied when he exits. A better choice would be to hold on till one at least recovers the money.
There are loyalty additions offered by policies that come into effect after the first few years. For instance, the Reliance Traditional Super Invest Assure offers one every five year.
Customers could use partial withdrawal and loyalty-addition facilities offered by their schemes to recover costs. Avani Shah, insurance manager, business advisory services, KPMG, feels it would be best if customers waited and evaluated the new products before exiting.
Low first-year cost
Then, there are opportunities to exit. Say, you have purchased a policy that charges you 20 per cent in the first year, recovering the initial cost will not be difficult. Look at exiting in the next few years to recover costs.
If the policy has been bought as an insurance product, one can still hold on for the entire term. But purchasing a term policy of the same sum assured and investing the rest in more aggressive products like mutual funds can be more beneficial.