Charges on ULIPs and Traditional Insurance Plans

While the commissions on Ulips have gone down due to the cost caps, those on traditional plans continue to remain high

Deepti Bhaskaran, Mint 13/3/2012

source: http://www.livemint.com/2012/03/12220033/With-Ulip-costs-capped-insure.html

Tremors were first felt by unit-linked insurance plans (Ulips) in 2009, when the Insurance Regulatory and Development Authority (Irda) decided to clean up the product to make it cost effective. In 2010, a full-fledged earthquake hit Ulips with the regulator cutting costs drastically. The Ulips’ loss, however, became traditional policies’ gain.

Back to traditional

According to Irda’s FY11 annual report, almost 60% of the first-year business was concentrated in traditional plans or what the insurers call non-linked business.

First-year premiums are indicative of the new business or policies procured by the insurers; a tilt towards traditional plans indicates that companies are selling more traditional policies. Agrees Gaurav Rajput, associate director marketing, Aviva India Life Insurance Co. Ltd: “Before the reforms, Ulips constituted 80-90% of the business but since then have come down to about 40-50%.”

The possible reasons: This return to traditional plans has been attributed largely to the consumer psyche of shying away from the volatile stock market and wanting the safety of guaranteed returns that traditional plans offer.

But there is another less visible truth—traditional plans offer agents higher commissions as compared with Ulips. Accepts G.V. Nageswara Rao, managing director and chief executive officer, IDBI Federal Life Insurance Co. Ltd: “The costs in Ulips are capped, hence commissions have shrunk considerably. Relatively speaking, traditional plans fetch higher commissions.”

Commissions in Ulips

In 2010, Irda capped the costs in Ulips as a percentage reduction in yield. So for Ulips with a tenor of at least 10 years, the cap was 2.25 percentage points. In other words, if the fund is performing at say 10% per annum, the final return should not be less than 2.25 percentage points for policies with a tenor of 10 years or more. Further, in order to give you more surrender value in case you decided to hop off mid-way, Irda announced cost caps during each year of the policy tenor.

Also See | The Commission Shift (PDF)

As a result of such strict cost caps, the commissions in Ulips shrunk considerably. According to Irda’s annual report, the average commission in Ulips as a percentage to premiums collected in Ulips was around 9% for the private sector in FY09 as compared with just around 4% in FY11.

Commissions in traditional plans

Compare the Ulip commissions with those of traditional plans and the trend has almost reversed: the average commission in traditional plans as a percentage to premium was around 8.47% in FY09 for the private sector; this increased to around 12% in FY11.

Says Kapil Mehta, managing director, SecureNow Insurance Broker Pvt Ltd: “Since these numbers are as a percentage of total commissions to total Ulips, the difference does not look very huge. But if you were to compare first-year premiums and first-year commissions, this trend will be more stark since commissions are highest in the first year.”

Unlike the cost cap that keeps commissions in Ulips low, commissions in traditional plans are guided by the maximum limit on commissions as defined in section 40A of the Insurance Act, 1938. According to this Act, an insurance company which is less than 10 years old can pay up to 40% of the premium as commission in the first year to an agent. In the second and the third years, the insurance company can pay a renewal commission up to 7.5% of the premium and 5% for the rest of the term of the policy. For companies that are more than 10 years old, the first-year commission is capped at 35%.

While the average first-year commissions in Ulip is about 5-8% because of the cost cap, in traditional plans it can go up to 40%.

Explains Rao: “Typically, short-term policies of less than 10 years have low commissions of up to 15%, but longer term policies typically up to 20 years have a higher commission of up to 35%. This is because the average ticket size of long-term policies is small and it is more difficult to sell long-term products.”

Focus on traditional policies

Since insurers have shifted focus from Ulips (which are not as profitable as they used to be) to traditional policies, it will not be incorrect to say that insurers are now selling high-commission products.

“The traditional portfolio has increased and since insurers are now focusing on long-term products they are selling long-term traditional products. Commissions in long-term products are higher than short-term products,” said an industry source, who didn’t wish to be named.

What it means for you?

Sadly, for traditional plans that double up as investment plans, the costs are not mentioned. But the data establishes a point: commissions in traditional plans are much higher and as insurers continue to do more business in traditional policies, commissions as a percentage to the traditional premium will continue to look up.

Traditional products are expensive investment products that usually give returns less than the inflation rate. In fact, in 2006-07, when the markets were witnessing a bull run and Ulips became very popular, the insurance industry largely condemned traditional products as those with low returns. But now that they are back on the popular demand of “guarantee seeking investors”, you should know that not only are you settling for lower returns but also paying a higher commission.

***

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