The investment part of any insurance product can be adequately addressed by mutual funds, which are much less expensive and also rank much higher in disclosure levels.
Choosing life insurance products such as ULIPs as an investment option may not be a wise thing to do, as complex fee structures may eat into your returns. Insurance products should be chosen only for risk cover; all other features of insurance products are available in mutual funds at a much cheaper cost.
Just sample this set of charges a typical unit-linked insurance policy may levy on you — premium allocation charge, policy administration charge, mortality charge, fund management charge, top-up charge, switching charge, partial withdrawal charge and surrender charge.
All these charges could eat into your investment returns substantially, which makes the case for insurance policies as an investment option weak. Add to this the problem of mis-selling by insurance agents.
Does that mean you should avoid all life insurance policies? No! They serve two basic purposes:
First, the risk of death of the insured and resultant loss of income for the dependents; this risk can be covered with an appropriate ‘term insurance’ plan; and
Second, the risk of the insured living longer and, hence, a need for pension for self and family. This can be covered with an appropriate pension plan.
Insurance policies should be chosen to address these two basic risks. Beyond these, the policies serve very limited purpose.
The investment part of any insurance product can be adequately addressed by mutual funds, which are much less expensive and also rank much higher in disclosure levels — be it the charges they levy, the periodic disclosure of the portfolio of their investments or the ease of access of net asset values (NAVs).
Besides, comparison of charges, past performance and asset composition are much easier in the case of mutual funds than unit-linked policies offered by insurance companies.
Conventional insurance products — non-ULIP products — are even worse than ULIPs in disclosure levels, making them much more complex to understand.
The insurance regulator can do much more to improve disclosure standards of both conventional and ULIP products, which is beneficial in the long term both for the industry and the investors.
What are these charges?
The typical charges a life insurance policy may entail, and the broad range for each of these charges are given below; a few policies and promotional schemes could fall outside this range.
Premium allocation charge: This is the charge levied by the insurance company to cover its expenses — agent commission, marketing and selling expenses, etc.
This is usually the largest charge levied on the insured and can range from 5 per cent up to even 60 per cent of the first year premium, and typically about 5 per cent of the annual premium thereafter. Compare this with the 2.5 per cent entry load typically levied by the mutual funds, and you get the drift.
Policy administration charge: This is the charge levied for the administration of the plan — printing and stationery, postage, maintaining customer call centres, etc., are covered by this charge. Usually this is a small fee — about Rs 20 — levied every month.
But beware of some policies which levy policy administration charge as a per cent of sum assured, while charging an apparently low premium allocation charge. A pure marketing innovation to make the policy charges appear low, when in reality they are not.
Mortality charge: This is the charge that is levied to cover the risk of early mortality of the insured, the very purpose why an insurance policy is taken. Ironically, this cost is among the smallest charges levied — typically ranges from 0.2 per cent to 0.5 per cent of the sum assured per annum, depending on your age.
Some policies offer a fixed per cent throughout the life of a policy, while others offer a variable per cent, increasing every year till the life of the policy. The variable rates, while starting low, could grow to very high levels, as one reaches advanced ages.
Fund management charge: This is the charge levied for managing your funds by investing in equity markets, debt markets, government securities, etc., as per your choice of funds.
Typically, this charge could be 1-2.5 per cent of the funds managed. Insurance companies claim that their fund management charges are lower than those levied by mutual funds.
But in the absence of appropriate disclosures, and lack of uniformity even within the same insurance company across products, such claims can neither be confirmed nor denied.
Other charges, such as for top-up, switchin, partial withdrawal and surrender, are levied only when the insured opt for any of these modifications to the original contract. Some of these charges are punitive to ensure continuity of the policy and to deter frequent change requests.
Take, for instance, top-up charge. This provides some avenue for savings. Many policies have high premium allocation charges, but low top-up charge. An investor could choose a low initial premium, and opt for top-up to minimise the expense.
But then, why choose insurance policy as an investment, and then try to optimise your costs, when mutual funds offer much better flexibility on all these fronts?
The mis-selling menace
Having interacted with almost all major insurance companies and a host of agents across the spectrum, I have come across several mis-selling techniques adopted by agents to lure unsuspecting investors. Here are some:
Selective disclosure of past performance: In the absence of appropriate disclosures and rigorous comparisons of past performance by independent agencies (such as mutual fund awards for the mutual fund industry), comparison of past fund performance becomes a challenge in the insurance industry.
This leaves large scope for the insurance agents to selectively quote periods when their fund performance was superior to an index performance and, thereby, hoodwink the investor.
Indicating much higher returns than permitted by regulator: The insurance regulations permit benefit illustrations with returns only between 6 per cent and 10 per cent per annum.
However, many agents provide illustrations with much higher returns with impunity — some even as high as 30-40 per cent returns in equity schemes citing performance in 2006 and 2007.
Even a small 2 per cent variation in annual return can show widely divergent terminal benefits when compounded over long period of time, luring gullible investors into believing they will be crorepatis in just a matter of time.
Promoting the policies that earn them highest commission: With scant regard for the needs of the insured, some agents promote only policies that can earn them the highest commission. Premium allocation charges are substantially lower in single-premium products (as per regulation) and, hence, commission earned by agents are the lowest in this class of policies.
Suggesting deliberate discontinuity in premium payments: Few unscrupulous agents even suggest discontinuing existing policies and opting for new ones, because that earns them much higher commissions. In fact, one large insurance company had policy forfeitures of up to 30 per cent of new policies in their second year, prompting an investigation and reprimand by the regulator.
Promising kickbacks: The oldest trick in the book, many agents still promise to pay the insured some portion of their commission earned, despite stringent regulations prohibiting this practice. While this will apparently reduce the ‘charges’ borne by the investor, little do they realise it is their own money coming back to them illegally, subverting the good intentions of the regulator.
What can be done?
The regulator can ensure standardisation of some of the charges — for surrender, policy administration, switching, etc., and disclose ceiling on other charges — fund management charges, policy allocation charges, etc.
The regulator can also engage in more proactive regulation — dialogue with insurers on specific regulatory provisions will yield better results, than making the regulation more and more complex to address every possible mis-selling situation.
The insurance industry can promote a self-regulatory organisation (SRO) that compiles and discloses NAV and periodic portfolio (like AMFI does for the mutual fund industry).
Insurance companies can promote ‘risk cover’ as their key offering, and give more thrust for term assurance policies (where none of these charges are pertinent as the entire premium belongs to the insurance company).
Insurance companies can also modify their incentive schemes for agents to maximum the ‘sum assured’ — which is the main purpose of an insurance product, rather than maximising the charges earned by the insurance company. In fact, even shifting to ‘employee’ model rather than ‘sales agent’ model and reducing variable pay could help insurance industry in the long run!
Insurance company angle
The accusations that are being made are not new to the insurance companies. And they do put up a stiff argument to defend these. Some common lines of defence are:
Higher charges in insurance (when compared to mutual funds) are because insurance is a complex product and takes effort in selling.
Despite these charges, long-term investors may benefit more from insurance policies than mutual funds because fund management charges in insurance products are lower than mutual fund products.
Insurance policies discourage easy redemptions and help investors stay invested for long term in a disciplined manner.
Mis-selling is beyond their control in a situation of rapidly expanding base of agents.
While there is merit in some of these arguments, insurance companies, regulators and the intermediaries can do much more for the long-term health of the insurance industry.