An expensive proposition

One of the few disconcerting features of the Union Budget was the extension of service tax on all the charges of unit-linked insurance plans (Ulips).

Initially, the impression was that this service tax would only be on fund management charges, but it has become clear that the tax has been extended to all the other charges such as premium allocation charge, policy administration charge, switching charges and others. Currently, service tax is being collected on the mortality charges only, but in all insurance policies.

Clearly, the introduction of an additional hike will lead to differentiation between traditional policies and Ulips, which insurers are not happy about. After all, about 75-85 per cent of the policies sold these days are the latter. Also insurers are not sure if they can absorb the costs.

Insurance is after all a long gestation business and such additional costs will further push the break-even point for them. Though there are no clear indications if the service tax will be passed on, some calculations will give you an idea of the impact on the cost of Ulips.

Let's take the case of a Ulip where the premium paid is Rs 10,000 a year, which is to be paid for 10 years. The sum assured for this policy is Rs 1 lakh. Mortality charges are assumed to be Rs 146 per lakh at the age of 30 and reaching Rs 248 per lakh at 40.

We are assuming an increase of 5.44 per cent per year in premium. Also it is assumed that the investment is made in a fund which has 80 per cent equity and 20 per cent debt component, which is growing at 12 per cent a year.

With the above numbers, let's work out the costs. In the first two years, there is a premium allocation charge of 20 per cent for the first year, 7.5 per cent in the second year and 4 per cent thereon.

There is no policy administration charge here. Fund management charge for this fund is 2.25 per cent.When the service tax is made applicable for these aforesaid charges, the final corpus is 2.65 per cent lower.

The final corpus is Rs1,53,190, instead of Rs1,57,347. That is a loss of Rs 4,157, if it is assumed that the entire service tax burden will be passed on.

The costs become more if the premium allocation charges are heftier in the early years. Also, policy administration charges have not been made applicable in this example, which could make Ulips much more expensive.

For an Ulip investor, there is a small reduction in the final corpus. But it could become higher when the sum assured increases and other charges are included. However, in an Ulip, the investor can switch into a debt fund when markets are on a free fall without a charge. It means some relief for investors.

The writer is a certified financial planner