30 December, 2010

Consider the total charges in ULIPs

It is an unnerving experience, getting admitted in the hospital. One is ofcourse, the fear of what tortures they will put you through… the other scare is entirely financial. When you get admitted in a hospital, you would not really be clear as to what all they will charge you for. You will not even know how much the bill will come to. In short, it is a huge amount of uncertainty & the consequent anxiety.

People investing in ULIPs are also finding themselves being subjected to anxieties, when they start getting to know the various charges. There are many charges in a ULIP, which an investor is supposed to know, before investing. But, many are not really aware. The most common charge that investors worry about is Premium Allocation Charge. But there are products which do not have any premium allocation charge, at all. It is not as if the milk of human kindness is being manifested through such a policy. There are other charges, which can compensate – like Policy Administration Charges. As the name suggests, it should be only to defray the expenses incurred to service a policy and should consequently not have anything to do with the amount of premium paid.

For instance, what will be the difference in servicing a policy where the annual premium is Rs.15,000/-, vis-à-vis another, where premium paid is Rs.30,000/-. Hence, as a rule, Policy admin charge is a fixed sum like Rs.40 Per month. What exactly they are doing on a monthly basis to warrant the charge, is ofcourse a mystery. But, the plot really thickens when the Policy Administration Charges are linked to the premium paid. Some policies link to the first annual premium, if the policy allows the premium to vary from year to year.

Now, there are two problems. Let us understand with an example. If the annual premium is Rs.15,000/- and if the Policy Administration Charge is 0.5% pm, the annual charges come to 6% pa. In this case, it will come to Rs.900/-pa. Now if the premium were Rs.30,000/-pa, then this charge would be Rs.1,800 pa. If the premium is much higher, like say Rs.3 Lakhs, the charges would be Rs.18,000/-pa. Now, you see the problem? Does the company really spend more for servicing a policy paying higher premium as opposed to another paying a much lower premium – enough to warrant Rs.900 pa charges in one policy and Rs.18,000 pa, in another? The problem is that most ULIP investors look only at the final figure that they may get after the tenure, as explained by the agent. The agent does tell in most cases that there are charges. The charges are spelt out in the brochures too. The client needs to ask the questions to understand what he would be paying in all, instead of being satisfied by “there are no Premium allocation charges” bit.

There is another problem with Policy Administration that is not apparent at first. This charge will continue even if you have stopped paying the premiums. In the example shared, if an investor has stopped paying the premium after three years, Policy Administration Charges would continue uninterrupted, maybe for the lifetime of the policy or for whatever time, the policy conditions envisage. This is particularly troubling… for this charge alone can become the hole in the vessel that holds their corpus.

Nor, are these the only charges. There can be a guarantee charge for highest NAV plans from 0.1% pa to 0.5% pa. Another charge is a Fund Management Charge. Depending on which fund one is putting the money into, there are charges. The charges would be about 1.3%pa today for Equity funds. In the past, it used to be upto 2.25%pa.

The other charge is the Mortality Charge. This is the risk premium that they are levying you to assume the risk. It is important to note what you are being charged here. Most ULIPs charge very competitive rates on this front. Though, you need to look into this too, as Mortality charges do not come under any overall cap. Creativity on the charges cannot be ruled out and it is a good idea to check the mortality rates and assure oneself that it is in line with their normal charges. Else, one would have a very costly insurance product, which may not even be a good investment product.

The other charge is the surrender charge. Surrender charge will be charged on the Fund value. The charges have come down dramatically from September 2010. It used to be extremely high in the first three to five years. In some cases, one could not even surrender in the first three years.

Insurance is a long-term product. Whether an ULIP or an Endowment product, it should be bought after careful thought. ULIPs are transparent and the charges revealed upfront, . Other products are opaque, which make them worse. Insurance should be bought for risk coverage. If ULIPs are looked at as investment vehicles, one should be willing to stay invested for 12-15 years or more. Only then it will make sense.

In summary, the following are what an investor needs to look at while going for a ULIP plan–

• What are all the charges that will be levied and for what period of time? Are these justified?
• What are other competitive products charging?
• On what will be the charges levied ( Surrender charge is on the fund value, Mortality charge is on Sum Assured and Premium Allocation Charge is on modal premium )?
• What is the tenure for which you would want to invest there?
• Performance of the funds under that company
• Would you be better served by some other option?

In the case of a hospital, you may go there based on references of the doctor or a friend. In case of ULIPs, your friends may not be able to guide you properly as they themselves may not be aware about the various charges. Do some homework yourself; or consult a proper advisor to assist you in this process. Else, it will be a costly decision, which you can repent at leisure!

Published in Business Standard on 19/12/2010

No comments: