Page 127 - DMGT512_FINANCIAL_INSTITUTIONS_AND_SERVICES

Financial Institutions and Services

Notes
Continuing its macro management of the net yield to policyholders, the regulator has
fixed net yields for periods less than 10 years. In its earlier guidelines it has prescribed the
difference between gross yield (return) to net yield at 300 basis points (3 percentage
points) for a policy maturity of 10 years and 225 basis points for maturity above 15 years.
Now, a difference of 400 basis points has been prescribed for five years, which gradually
reduces to 300 basis points in the tenth year. The charges still appear higher in comparison
to mutual funds that are allowed annual expenses of 2.25 per cent (mortality charges, if
added, will further increase charges).
According to the new regulation, unit-linked pension plans would carry a minimum
guarantee of 4.5 per cent (if all premiums are paid) and no partial withdrawal will be
allowed during the accumulation period.

It appears attractive but there is catch, IRDA retains the right to review this guaranteed
rate according to macroeconomics developments. This means that the return can vary
over the term of the policy and investors will not be sure of the maturity value. On vesting
date policyholders can commute up to one-third of the accumulated value as lump sum.
As insurers are required to guarantee the return, major portion of the premium may find
its way into debt instruments.
If the pension plan without any rider is not generating a minimum return of at least 8 per
cent that has been guaranteed under PPF (it has favourable tax treatment in the proposed
Direct Taxes Code compared to these pension plans) investor interest in pension plans is
likely to wane at least for those investing up to 70,000 towards retirement.

What to do?
With the new set of guidelines, new products may appear more attractive than older ones.
Investors who bought ULIPs in earlier years may be tempted to surrender their products
in favour of new ones. Should they?
It may not be prudent to close the existing policy in favour of new products that are likely
to be launched from September mainly on account of charges.
Consider this, an investor invested 1 lakh on June 2009. After deducting premium
allocation charge of 30 per cent, the rest would have been invested in equity. Assume in
the one year the investment has grown at 30 per cent and the current value is 91,000 (risk
charge is ignored for the calculation). If the policyholder surrenders it he would suffer a
charge of 30 per cent of the first year premium - 30,000. The fund value of 61,000 will be
transferred to suspense account for next two years without any accretion, after which he
will be paid the sum. Alternatively if he is continuing the existing policy for another
9 years and if it earns 10 per cent net of charges, the maturity value will be 16.4 lakhs.
As it's too early to predict the product structure, let's look at a case where he buys a new
ULIP for a nine-year term and it has a 20 per cent premium allocation and other charges for
first two years. If the ULIP earns 10 per cent net of charges, the maturity value will be
13.7 lakhs.
If he invests the old policy proceeds of 61,000 after two years at a net interest of
10 per cent the maturity value will be 1.20 lakhs. His investment would then be worth
15 lakhs, still short of the sum he would made on his older policy. Hence it is advisable
for the investors to continue with the current policy since it has already suffered charges.
Question
Make a critical analysis of new guidelines issued by IRDA form customers as well as
insurance companies' point of view.
Source: http://www.thehindubusinessline.in

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