Author Name:   mini.anshuman

An article examining the tussle between Insurance Regulatory and Development Authority (IRDA) and Securities and Exchange Board of India (SEBI over the control and regulation of Unit-Linked Insurance Plans (ULIPs) and the current position on the subject....

Unit-Linked Insurance Plans-An Indian Perspective

Life insurance is usually bought to transfer risk from an individual to a pool to protect against untoward incidents and to provide for monetary compensation to his family. Traditional policies offer in-built guarantees and define maturity benefits through variety of products such as guaranteed maturity value. The investment risk in the traditional life insurance policies is borne by life insurance companies. Additionally, the investment decisions are regulated to a large extent by Insurance Regulatory Development Authority (IRDA) rules and regulations, ensuring stable returns with minimal risk. Investment income is distributed amongst the policy holders through annual bonus.

However, the insurance sector has evolved over the last few years and a number of innovative products such as endowment, money back, whole-life plans etc. have stormed the market. One product category that is increasingly catching the fancy of individuals is the Unit linked Insurance Plan (ULIP). ULIPs are essentially investment plans which come with a dash of insurance. These plans, a combination of insurance and investment, provide the policyholder with life cover and additionally offer the opportunity to earn a return on the premium paid. These plans have become so hugely popular because the average insurance buyer in India always has the tendency to expect “something” on maturity of the insurance policy. Inevitably, the life insurance industry has been growing at a steady pace over the last few years. From a 2.6% contribution to the GDP figure in 2006 it rose to 3.26% and 4.09% in 2006 and 2007, respectively.

Unit Linked Insurance Plans:
These are hybrid financial products that offer life insurance as well as an investment component like a mutual fund. Part of the premium that is paid goes towards the sum assured and the balance will be invested in whichever investments the policy holder desires, based on the risk taking ability. Private insurance companies on an average earn almost 85 per cent of their business through sale of ULIPs. In 2008-09, ULIPs accounted for 86.74 per cent of private firms’ business. For the entire industry, ULIPs contributed Rs 90,645.78 crore of premiums in 2008-09, more than 40 per cent of total sales.

In an ULIP plan the policy owner can select the mode of payment towards his premiums, which may be in a lump sum amount (singe premium) or he can opt for paying premiums at regular intervals which may be monthly, quarterly, half-yearly or annually. The premium paid by the client is used to buy units in various funds (debt, balanced and equity funds) floated by the insurance companies. The policyholder can also switch among the funds as and when he desires. It must be also mentioned that there are numerous costs in relation to ULIPs like Premium allocation charge, Mortality Charge, Fund Management Charge and Policy Administration Charge. Apart from these there are some hidden costs involved in ULIPs such as surrender and fund switching charges etc.

From the taxation angle, Currently ULIPs come under the EEE (exempt exempt exempt) regime. What this means is that the money invested in ULIPs is tax exempt, the returns earned during the tenure of the ULIP are tax exempt and the amount received at maturity is also tax exempt. The revised discussion paper on the direct tax code suggests that ULIPs will now come under the EET (exempt exempt tax). This means that the amount received at maturity will be taxable.

Tussle between IRDA and SEBI:
The fight over who would control ULIPs became a huge dispute resulting in issue of contradicting directions by SEBI (Securities and Exchange Board of India), regulatory agency for the equity market and IRDA, which is the regulatory agency for the Insurance Sector. The mutual fund industry, particularly, was unhappy. Since ULIPs are heavily skewed on investment, low on insurance and are sold like an investment products, SEBI, on 9th April 2010, banned 14 major private insurance companies of India from raising money from public for any ULIPs on the ground that entities have not obtained any registration from it though the ULIPs launched by them had an investment component in the nature of mutual funds. It may also be mentioned that over the last few months, investments in equity linked saving schemes of mutual funds have dropped drastically. On the other hand, sale of ULIPs have picked up.

It needs to be mentioned here that much before the row between SEBI and IRDA over regulating ULIPs; the Finance Ministry has been considering these unit-linked insurance products “broadly similar” to mutual funds.This may also have encouraged SEBI to pass the said order

However, the IRDA asked the life insurers to ignore the SEBI order and the matter then went to the Finance Ministry, which advised them to move the court and in the meanwhile had asked them to maintain status quo till the dispute is legally sorted out. Therefore, IRDA moved court to challenge a ban on ULIPs imposed by it and the SEBI also did the same to guard against any ex-parte decision. Meanwhile, SEBI, in its order dated 14 April 2010, exempted existing ULIP schemes of these 14 companies from the ban till the matter was legally sorted out.

The Insurance Regulatory and Development Authority (IRDA) issued modifications on guidelines in the month of May relating to unit linked products which will come into effect from July 1, 2010. The Central Government ended the turf war in June, saying ULIPs will be regulated by the IRDA. The ordinance promulgated by the President amended the RBI Act, the Insurance Act, the SEBI Act and the Securities Contracts Regulation Act to bring about clarity on regulation of ULIPs. The ordinance allows the government to constitute a body to resolve inter-regulatory disputes such as the recent ones. ULIPs are a hybrid instrument that combines both insurance and investment.

New Guidelines of IRDA:
After the tussle with SEBI was over, IRDA announced new guidelines in the month of May, with the promise of introducing even more changes subsequently. The changes announced by the regulator are an increase in the risk-based insurance portion and a reduction the high upfront charges, thus vindicating the stand of SEBI.

The most important modification that is to be noticed is the increase in lock-in period from 3 years to 5 years, thereby making them long-term financial instruments which basically provide risk protection. It also provides that linked products including pension/annuity products must have a minimum sum assured payable on death. Pension/annuity products must have insurance coverage. Further, no loan shall be granted under Unit Linked Insurance Products. All top-up premiums made during the currency of contracts must have insurance cover.Partial withdrawal is allowed only after fifth policy anniversary for all unit linked products except pension/annuity products. In the case of unit linked pension/annuity products, no partial withdrawal shall be allowed and the insurer shall convert the accumulated fund value into an annuity at maturity. However the insured will have the option to commute up to a maximum of one-third of the accumulated value as lump sum at the time of maturity. In the case of surrender, only up to a maximum of one-third of the surrender value could be availed in lump sum and the remaining amount must be used to purchase an annuity. Customers will no longer be required to pay agent commissions of up to 40% in the first year of the policy. Such commissions may drop to around 18%.

Further, the contract should highlight its long time nature. The language used should remain simple and transparent. A standard method should be adopted, across the industry, on computation of the Net asset value (NAV).

Decision of the Central Government is questionable:
If we view the current scenario from the perspective that it is the IRDA which best understands the nature of the insurance industry then it should have the final word on the clearance of a ULIP policy. However, when under the cloak of such a policy an insurance company also seeks to manage the investment of an investor, it is engaging in an asset management activity and the policyholder becomes an investor. Under such circumstances SEBI comes into picture, as the equity market regulator is responsible for formulating measures aimed at investor protection. It could be argued that asset management is inherent in an insurance business as premiums paid by policyholders are pooled and invested till claims materialize. If a substantial portion of an ULIP policy is kept preserved for covering the risk and investment component is miniscule and is more like a value-added service, then IRDA should have jurisdiction over such policies. If, however, risk premiums are a minuscule component of the total payments made by a policyholder, then such a policy is an investment product masquerading as an insurance one. Increasingly, insurance companies have been resorting to such an arrangement forcing SEBI to intervene.

We also need to consider whether a person is purchasing an ULIP because he wants insurance or he views it as an investment, and what portion of the premium paid actually goes into insuring his life and what portion into investing in market instruments. The answer to both these questions leads to the conclusion that ULIPs are indeed more investment than insurance.

For the private insurers, ULIPs have been a major growth driver because they offer an investment solution to the financial goals of the common man. Investors are willing to shell out such a hefty premium because they believe the plan's investments will generate a substantially amount of money over a period of time. If ensuring a payout to one's nominees on death was the investor's objective, pure term plans offered by insurers would achieve this at a fraction of the premium that one commits to ULIPs. Barely 1 % of the premium that is being paid on a ULIP policy goes towards insurance cover and the rest is invested. Considering all this, it is indeed difficult to fathom how ULIPs can be considered as insurance products.

Insurance companies have been launching and raising crores in new premium through highest net asset value guaranteed ULIPs. It is grossly unjust that the IRDA clears an insurance plan that has the flexibility to invest up to 100% of the total money it collects in the stock market and yet offer a guarantee? Guarantees and stock markets cannot go together. IRDA seems to serving the interests of industry better than the policy holders. It should be mentioned here that SEBI does not allow mutual funds to use guaranteed returns.

Jurisdiction of SEBI over ULIPs is also desirable from a broader market perspective. Bringing all market-related products under its umbrella is necessary if SEBI is to effectively discharge its duty of protecting investor interests in the securities market. Only a common set of regulations for all market-linked products — whether they are mutual funds, ULIPs or anything else — will establish a level-playing field on rules relating to distribution, selling practices and reward, for financial market intermediaries.

ULIPs are pitched more as an investment product rather than as a risk shield and it is the unit holder who bears the risk of market swings in these products. It also needs to be understood that a ULIP is good for an investor as long as equity markets are good. In a bearish market, an investor will end up paying more than what he bargained for. Even in the more equity-savvy developed countries such as the US and UK, the rapidly growing market for ULIPs got squeezed after the stock market tumbled down.

Lastly, the very fact that the premium of an insurance policy is being invested strikes the root of the basic principles of insurance. With the introduction of ULIPs, the basic premise that insurance is not needed to generate returns but to ensure that your family maintains its lifestyle and does not have to suffer financial hardships if something happens to the insured has been completely forgotten.

Conclusion:
The ordinance has given a free-hand to IRDA which, till the tussle with SEBI, had done very little to protect the interests of the policyholders. However, the new guidelines issued by IRDA on ULIPs are welcome but more actions need to be taken.

IRDA needs stop approving pure investment plans with just a touch of life insurance; initiate steps to develop a good, stable and trained agency force and stamp out all dubious channels of distribution; try to understand that thousands of crores of rupees are being pumped into the insurance industry; and strictly implement the ceilings on expenses as prescribed under the Act, without procrastinating indefinitely.

An ideal situation will be if a joint-regulation mechanism is set up between SEBI and IRDA, the insurance regulator dealing with the insurance component of the plan and the capital market regulator dealing with the investment component. This would lead to a process of harmonization of the market place in which investors win.
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Mini Gautam and Anshuman Chanda, King's College, London

[1] Ulips: tax up, returns down; Livemint, Jun 8 2008

# SEBI, IRDA in turf war over unit linked products, Indian Express, Sun Jan 24 2010

# A straight forward deduction from the premium of the client

# The cost of pure life insurance

# 1.35% needs to be paid to the fund manager in order to persuade him to invest the funds well

# Charged as Rs 50 per month or Rs 600 yearly as a fixed charge for carrying out the work miscellaneous expenses involved such as stamp duty, etc

# 7The companies which were banned were are AEGON Religare Life, Aviva Life, Bajaj Allianz, Bharti AXA, Birla Sunlife, HDFC Standard Life, ING Vysya Life, Kotak Mahindra Old Mutual Life, Max New York Life, MetLife India, Reliance Life. SBI Life, ICICI Prudential and Tata AIG

# According to Association of Mutual Fund India and IRDA data, as on December 31, 2009, mutual funds had Rs 113 crore invested in ELSS whereas insurers had almost Rs 17,900 invested in ULIPs. In financial year 2008-09, 7.03 crore ULIP policies were sold and companies garnered premium of more than Rs 90,645 crore. Till February 2010, the life insurance industry had sold 16.7 lakh policies.

# In a circular issued on February 26 this year, Central Board of Excise and Customs had said, “ULIPs are broadly similar to mutual funds, except that they are required to segregate a certain part of the premium towards the life insurance of the plan holder.”In a previous circular on February 29, 2008, the indirect tax department had said that ULIPs enables the policyholder to take part in the scheme collectively and becoming the beneficiary like mutual funds. This circular followed the then Finance Minister P. Chidambaram announcing in his 2008-09 budget speech that ULIPs should be brought under service tax net to bring asset management service provided under ULIP “on par with asset management service provided under mutual funds.”

9 These guidelines were issued by the IRDA based on the insurance related data as on year ending March 31, 2010, and as a continuation of the ULIP guidelines “Guidelines on Unit Linked Products”, which had issued on December 21, 2005

# 10 Securities and Insurance Laws (Amendment and Validation) Ordinance, 2010

# An explanation has been added in the definition of “life insurance business“ in S. 2 (11) in the Insurance Act which provides that life business also include unit linked insurance policies

# Explanation was also added in S. 2 (h) of the Security Contract Regulation Act expressly excluding ULIPs from the definition of securities.

# In the Securities and Exchange Board of India Act, 1992, in section 2, in sub-section (IB), the following Explanation has been inserted which clarifies that a collective investment scheme or mutual fund shall not include any unit linked insurance policy or scrips or any such instrument or unit, by whatever name called, which provides a component of investment besides the component of insurance issued by an insurer.

# The ordinance has introduced Chapter IIIE in the Reserve Bank of India Act which provides for the formation of a Joint Committee, comprising of the Finance Minister, Finance Secretary, Secretary (Financial Services) to the Ministry of Finance, Governor of RBI and the Chairmen of IRDA, SEBI, PFRDA, to decide the differences of opinion in relation to hybrid instrument. The decision of the Joint Committee is binding on all the regulators

# Circular No: IRDA/ACTL/CIR/ULIP/071/05/2010, dated 3-5-2010, “Guidelines on Unit Linked Products”

# Circular No: 061/IRDA/Actl/March 2008 dated March 12, 2008.

# NAV is the current market value of a fund’s net assets divided by the number of outstanding shares.

# Between April and December, 2009, insurance companies collected Rs 58,714 crore new premium selling around 2.22 crore ULIPs policies, offering a total insurance cover of Rs 2,50,915 crore. The average premium collected per policy was Rs 26,438 and the average insurance cover per policy Rs 1.13 lakh, or around 4.3 times the average annual premium.[17] Put another way, for a cover of Rs 1.13 lakh, the mortality premium (the portion of the premium that goes towards the insurance cover) required would be a mere Rs 300. This means, barely 1.1% (Rs 300 as a percentage of Rs 26,438) of the average premium paid is going towards the insurance cover and the rest is invested. Insurance data proves SEBI’s point, Monday, April 12, 2010, Agency: DNA

# Besides Birla Sun Life, SBI Life Insurance Co. Ltd and Tata AIG Life Insurance Co. Ltd are offering such guarantees in some of their ULIPs. Insurance plans with NAV-based guaranteed returns get popular :Livemint, Jul 10 2009.

# The economic research wing of Swiss Re noted in a study, done in March 2003

The  author can be reached at: mini.anshuman@legalserviceindia.com

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