We look at the upcoming changes in ULIP regulations, their effect on the product, the subsequent benefits for IFAs and investors.
How IRDA was lead up this path?After the recent turf-war between the SEBI and the IRDA over the regulation of unit linked insurance policies (ULIPs), according to a majority the verdict was, `SEBI lost out!` as most viewed the ULIP ordinance passed by the government as a loss for the capital market regulator. Despite this, there are some sure signs that the insurance industry`s cash cow, often called the ULIPs will see some changes that will help everybody except the insurance industry.
Most experts turn up their noses when they talk of ULIPs and for good reason. Not only are ULIPs inefficient investment vehicles, they are also inefficient insurance vehicles (in the form that they have been till now). How can the insurer really position ULIPs? It can`t be sold as a pure risk product as there are better (term insurance) products and neither can it be sold as a pure investment product since mutual funds are cheaper, more transparent with better options and have a track record of performance. As a result, ULIPs have been positioned as a hybrid product with high distribution commission. Hence, agents and distributors push such products for the high upfront commission they generate. The fact remains however, that ULIPs sell and like hot cakes too.
Mis-selling
Another aspect that the SEBI-IRDA dispute brought out in the public domain was - the big question of mis-selling. Sure, mis-selling happens everywhere, from soaps to financial products, but it is a serious issue in financial products since they are of the `sold` variety as against the `bought` variety. `Sold` basically means financial products are not actively selected by investors but need to be pushed for sales to occur. So for an agent who is marketing financial products, the product that gives the highest commissions is pushed more as has been prevalent in the ULIPs. As the illustration alongside shows, the cost structure is such that the charges are the maximum in the first few years and as a result, beyond the initial phases, the agent has no need to pursue the investor. This is why lapsed policies in ULIPs are such a heavy chunk of the total policies. In a recent interview, J Hari Narayan, the IRDA chief, accepted that mis-selling has been one of the major concerns.
How IRDA was lead up this path?After the recent turf-war between the SEBI and the IRDA over the regulation of unit linked insurance policies (ULIPs), according to a majority the verdict was, `SEBI lost out!` as most viewed the ULIP ordinance passed by the government as a loss for the capital market regulator. Despite this, there are some sure signs that the insurance industry`s cash cow, often called the ULIPs will see some changes that will help everybody except the insurance industry.
Most experts turn up their noses when they talk of ULIPs and for good reason. Not only are ULIPs inefficient investment vehicles, they are also inefficient insurance vehicles (in the form that they have been till now). How can the insurer really position ULIPs? It can`t be sold as a pure risk product as there are better (term insurance) products and neither can it be sold as a pure investment product since mutual funds are cheaper, more transparent with better options and have a track record of performance. As a result, ULIPs have been positioned as a hybrid product with high distribution commission. Hence, agents and distributors push such products for the high upfront commission they generate. The fact remains however, that ULIPs sell and like hot cakes too.
Mis-sellingAnother aspect that the SEBI-IRDA dispute brought out in the public domain was - the big question of mis-selling. Sure, mis-selling happens everywhere, from soaps to financial products, but it is a serious issue in financial products since they are of the `sold` variety as against the `bought` variety. `Sold` basically means financial products are not actively selected by investors but need to be pushed for sales to occur. So for an agent who is marketing financial products, the product that gives the highest commissions is pushed more as has been prevalent in the ULIPs. As the illustration alongside shows, the cost structure is such that the charges are the maximum in the first few years and as a result, beyond the initial phases, the agent has no need to pursue the investor. This is why lapsed policies in ULIPs are such a heavy chunk of the total policies. In a recent interview, J Hari Narayan, the IRDA chief, accepted that mis-selling has been one of the major concerns.
The major changesIn more ways than one, the failings of ULIPs are being addressed:
> The commission structure is being changed to become more transparent
> The guaranteed returns on certain ULIP plans are to be made mandatory
> The distribution channels are being strengthened
The question is, with all these steps and more being taken by the IRDA to tackle the problems faced by investors and the insured, how much of an effect will it have on the industry? Some suggest that September 2010 (when the regulations will come into force) will be to the insurance industry what August 2009 was to the mutual fund industry. The only silver lining is that at least the IRDA unlike its capital market counterpart is going about the reforms process in a gradual manner.
Consider the major changes in the ULIP space that are expected:
- Offer guaranteed returns of at least 4.5%
- Deter mis-selling (all literature used for marketing will have to be approved by the IRDA)
- Change in Commission structure. The charges will now be levied evenly over the term of the product, where today the bulk of the charges are levied in the initial years
- Make Life cover mandatory as part of the ULIP product
- Allow partial withdrawals only after 5 years
The way ahead
What these steps will do is to bring focus on the returns provided by the ULIP scheme, the engineering of the product will become more important, finally and most importantly, the focus on the sales force will reduce. Rumours of layoffs in the sales force in insurance companies are already doing the rounds.
The product is more important than the sales pitch. This is the basic message that the regulator has been trying to put across. An investor buying insurance and mutual fund scheme separately should make sure he/she gets the best of both worlds. The intermediaries would also benefit and it would make sure that the distributors are educated enough about both sides of the coin. Quoting J. Hari Narayan once again, ``anything done pro-investor is good``. These changes will go a long way in making the entire market environment easier for the investor. From the IFAs` point of view managing both types of products could become a task but online platforms are the best bet in such circumstances including cost-effectiveness and streamlining of service irrespective of the Assets under Management of the IFA.
DTC EffectThe DTC will come into effect essentially in 2012. However, notwithstanding the changes that could happen till then, the current provisions make it a bittersweet scenario for the ULIPs industry. The bitter part mainly is that ULIPs will give the monetary advantage as they do today over a long term (15 - 20 years). The sum assured is now a function of premium to attain favourable tax deductions (sum assured should be greater than or equal to 20 times the premium). The one advantage that ULIPs will still have is that if held to maturity they will not be taxed. Due to the earlier lock-in period of three years, which has now become five years, ULIPs were compared to mutual funds. With the new regulations and the DTC kicking in, investors of ULIPs would have to consider longer term investment horizon. Where once the ULIPs were sold a a part investment and mainly tax benefit based product, now the investor would have think twice before putting money in ULIPs and understand that they are essentially investing in an equity linked insurance plan. The other disadvantage is that the total tax exemption for insurance products will now stand at Rs. 50,000. This will include the medical and life insurance premia. T. Vijayan, the Chairman of LIC made an important comment that the new regulations will undoubtedly slow down the ULIP collections but make the product better in the long-term and draw sustainable inflows.
To a certain extent, the combination of the DTC and the IRDA regulations does address the MF industry`s concerns of having a level playing field against ULIPs.
Conclusion
Overall, the deficit of trust between the intermediaries and the investors would do with a good deal of patching and these changes are important in this context. On the one hand, those professionals in the financial services industry who for better earnings have focused on insurance will need to sell products with their sole purpose in mind. With commissions expected to fall to around 8-10% instead of the previous range of 18-20%, the trail and upfront commissions paid by the AMCs based on the AUM will tend to be more rewarding and will benefit advice that makes money for the investors in the long run. Mutual Funds have long blamed the scrapping of commissions in mutual funds since August 2009 for the lackluster investments into schemes. With the leveling of the playing field for the insurance and mutual fund industry to some extent, one would expect that money will go where the product deserves. Noises coming from the Industry sound similar to what was heard a year back from Fund Houses. Instead of hurting one industry over the other, the value of the advisory and the positioning of products should now take centre stage.
> The commission structure is being changed to become more transparent
> The guaranteed returns on certain ULIP plans are to be made mandatory
> The distribution channels are being strengthened
The question is, with all these steps and more being taken by the IRDA to tackle the problems faced by investors and the insured, how much of an effect will it have on the industry? Some suggest that September 2010 (when the regulations will come into force) will be to the insurance industry what August 2009 was to the mutual fund industry. The only silver lining is that at least the IRDA unlike its capital market counterpart is going about the reforms process in a gradual manner.
Consider the major changes in the ULIP space that are expected:
- Offer guaranteed returns of at least 4.5%
- Deter mis-selling (all literature used for marketing will have to be approved by the IRDA)
- Change in Commission structure. The charges will now be levied evenly over the term of the product, where today the bulk of the charges are levied in the initial years
- Make Life cover mandatory as part of the ULIP product
- Allow partial withdrawals only after 5 years
The way ahead
What these steps will do is to bring focus on the returns provided by the ULIP scheme, the engineering of the product will become more important, finally and most importantly, the focus on the sales force will reduce. Rumours of layoffs in the sales force in insurance companies are already doing the rounds.
The product is more important than the sales pitch. This is the basic message that the regulator has been trying to put across. An investor buying insurance and mutual fund scheme separately should make sure he/she gets the best of both worlds. The intermediaries would also benefit and it would make sure that the distributors are educated enough about both sides of the coin. Quoting J. Hari Narayan once again, ``anything done pro-investor is good``. These changes will go a long way in making the entire market environment easier for the investor. From the IFAs` point of view managing both types of products could become a task but online platforms are the best bet in such circumstances including cost-effectiveness and streamlining of service irrespective of the Assets under Management of the IFA.
DTC EffectThe DTC will come into effect essentially in 2012. However, notwithstanding the changes that could happen till then, the current provisions make it a bittersweet scenario for the ULIPs industry. The bitter part mainly is that ULIPs will give the monetary advantage as they do today over a long term (15 - 20 years). The sum assured is now a function of premium to attain favourable tax deductions (sum assured should be greater than or equal to 20 times the premium). The one advantage that ULIPs will still have is that if held to maturity they will not be taxed. Due to the earlier lock-in period of three years, which has now become five years, ULIPs were compared to mutual funds. With the new regulations and the DTC kicking in, investors of ULIPs would have to consider longer term investment horizon. Where once the ULIPs were sold a a part investment and mainly tax benefit based product, now the investor would have think twice before putting money in ULIPs and understand that they are essentially investing in an equity linked insurance plan. The other disadvantage is that the total tax exemption for insurance products will now stand at Rs. 50,000. This will include the medical and life insurance premia. T. Vijayan, the Chairman of LIC made an important comment that the new regulations will undoubtedly slow down the ULIP collections but make the product better in the long-term and draw sustainable inflows.
To a certain extent, the combination of the DTC and the IRDA regulations does address the MF industry`s concerns of having a level playing field against ULIPs.
Conclusion
Overall, the deficit of trust between the intermediaries and the investors would do with a good deal of patching and these changes are important in this context. On the one hand, those professionals in the financial services industry who for better earnings have focused on insurance will need to sell products with their sole purpose in mind. With commissions expected to fall to around 8-10% instead of the previous range of 18-20%, the trail and upfront commissions paid by the AMCs based on the AUM will tend to be more rewarding and will benefit advice that makes money for the investors in the long run. Mutual Funds have long blamed the scrapping of commissions in mutual funds since August 2009 for the lackluster investments into schemes. With the leveling of the playing field for the insurance and mutual fund industry to some extent, one would expect that money will go where the product deserves. Noises coming from the Industry sound similar to what was heard a year back from Fund Houses. Instead of hurting one industry over the other, the value of the advisory and the positioning of products should now take centre stage.
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