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ULIPs will necessarily have to be sold as long-term protection cum savings products

We are in for some very interesting times from the next financial year. Let us analyse the impact of the recent regulatory changes on the ULIPs.

Harsh Roongta

07 Jul 2010

With the inter-regulatory spat over ULIPs being firmly settled in its favor, IRDA has taken very little time in announcing sweeping new regulations that will change the very essence of how ULIPs are structured and sold today.

So what are the significant changes and how will it change how ULIPs are sold. The changes are both from the regulator side as well as the proposed changes in the DTC that will become effective from the year beginning on April 1, 2011.

First let's look at what the current draft of the DTC says.

Under the DTC all receipts from any life insurance policy is treated as revenue. However full deduction is allowed for any receipts from a life insurance policy if the amount is received at the completion of the original period of contract or death and

the capital sum assured is at least 20 times the premium payable in any year.

In simple words it means that under the DTC (effective next year onwards) tax exemption will be available for sums received under the insurance policies only if those sums are received on maturity (or earlier on death) and also if it has a certain minimum level of death protection. Since tax is a major driver for buying insurance policies (a rather unfortunate situation) this single change itself will make sure that any potential mis-selling around the tenure of the policy will be limited.

Combine this change with the fact that a 5 year compulsory lock in period has been introduced by IRDA will make sure that this is perceived as at least a 5 year product. In the other very significant change IRDA now requires charges to be spread over the first five years (and not front loaded as is the case currently) and has additionally introduced a maximum spread of 4% between the gross yield and the net yield at the end of 5 years. These two changes when combined will ensure that the commission structures and other charges are kept reasonable.

On the pension front the revised discussion paper on the DTC, in a surprise announcement, has also promised an EEE treatment for approved annuities. It is not very clear which kind of annuity plans will be approved but in any case it will breathe new life in the moribund annuity market. If, as is being speculated, the approval of the annuity plan is linked to the corpus coming only from the NPS then it will sound the death knell for accumulation pensions plans (for example those being offered by Life insurance companies) offered outside the NPS system.

If all the changes proposed above (especially those in the Direct Taxes code) which are yet to be finalized and legislated, are actually enacted then it would change the investment landscape in the country.

At the risk of sticking my neck out let me do a bit of crystal gazing for the next financial year:

  1. It goes without saying that commissions on ULIPs will reduce significantly and be spread over a longer period. This will force the much-needed professionalisation of the financial services distribution industry, which will contract as the non-serious players leave the industry. However the serious challenge of consumers paying for advise separately from execution will continue to remain (this is a subject matter of another article) and hence mis-selling though reduced will continue to be driven by the products that offer relatively higher fee to the distributors.

  2. At some point (and I am really sticking my neck out here) SEBI will have to relent and allow for fees to be paid to intermediaries upfront as well. Maybe this may take time but I think there may not be an alternative if the retail MF industry is not to become extinct.

  3. We will see an increase in the mortality charges in ULIPs as these are not taken into account while calculating net yield and thus can be used to pay some additional commissions to the distributors.

  4. 5 year or more single premium plans will become popular as they are currently- but collections will not be as high as they are today simply because of the high life protection required to make the plans tax exempt. This requirement will prevent too many applications coming in from the high net worth band. They will do some circumvention by putting in applications in the name of their younger children etc. but the high cost of the protection plus the difficulties in doing financial underwriting for large insurance polices will ensure that the maximum investments are kept in check.

  5. There will be an increased focus on risk products (term insurance as well as Income protection plans)

  6. There will be a big focus on online distribution of products (or telephone assisted online distribution) with simple products specifically tailor made for online consumers as the insurance companies look for cost effective channels for distribution.

Of course there will be lots of other ramifications as well.

We are in for some very interesting times from the next financial year. I would welcome readers views on what they expect will happen next.