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Churning your ULIP Insurance Policy

Sun, 10/05/2008 - 06:38 — manoj

For most middle class Indians, the following were sure milestones in one's life -
1. Get a job
2. Marry
3. Take out an insurance policy
The sequence would be 1-2-3, 1-3-2, or whatever combination as long as there was at least a '1', a '2' and a '3' in it. Till recent past, the term 'Life Insurance' in India was almost synonymous to 'Life Insurance Corporation of India', there was no second thoughts, and nor was there an apparent need.

These days, thanks to globalisation and Indian versions of Glasnost and Perestroika and the advent of foreign Banks into India coupled with the fascination of the share-market, today we have umpteen kinds of insurance policies available. Birla Sun Life Insurance pioneered ULIP (Unit Linked Insurance Policies) in India in 2003, and today we have all insurance companies actively promoting ULIP policies. LIC came out with ULIP in early 2005 and today over 80% of its new business business premiums come from ULIP schemes. Under ULIP, up to 80% fund gathered by LIC could have exposure to equity markets in contrast to only 8 to 10% exposure taken for traditional products. 2006-2007, the bulls raged up and down the stock markets, all shares were on fire & everyone minted money off the market. ULIP shot into prominence with various schemes giving annual gains of 20% to 60%.

ULIP is an classic insurance product and a mutual fund rolled into one. The person on whose name the policy is taken out, the Life Insured, pays either a single premium or periodic premiums (in a SIP or Systematic Investment Plan). A part of the premium is deducted towards charges. The remaining is invested by buying units of the product fund at the prevailing rates. The fund manager allocates his funds between the share market equities and debt portfolios to eke out a gain. Based on the performance of the fund, the NAV value of the units go up, or tough luck, down. (Read the fine print: 'the risk is borne by the policy holder'.) At the end of the policy maturity, all balance units are liquidated and presto. So far so good.

Insurance companies have multi-levels of direct sales agents and augmented by private freelancer agents. A prospective customer should be very cautious when dealing with freelancers, as I found out the hard way.

  1. Ask the agent if he is a direct employee of the company whose policy he is marketing. Most freelancers may have official looking business cards with the name of the parent companies, but probably none or weird designations that will imply he is a freelancer.
  2. It would be in the customer's interest to do some homework before meeting an agent. Look up the internet for different schemes and policies available.
  3. The freelancer may try to promote a particular product aggressively. In all probability, it is the one that will fetch him a fat commission. A direct sales-agent may not try pushing a particular product only as it is more likely he will be working to reach his target amount, rather than refining his commission. Suggest an alternate scheme just to see what is the response of the agent.
  4. The Insurance Regulatory authority allows insurance companies to only illustrate policies showing what would be the returns if the policy has an annual gain of 6% and 10%. The agent may demonstrate his policy has given anywhere between 15-80% returns during the previous years. Tell him congrats, and ask him if he can commit you the same in writing. I bet he won't. (Equivalent logic: a child may grow 4 feet tall in 6 years, but he still wouldn't reach 8 feet by this 12th birthday and certainly not any more even if he lives another 100 years.)
  5. There is nothing as a free lunch. All policies will entail a large administration fee cut on the first premium and smaller deductions on the subsequent premiums. There will be fund management charges and policy administration charges and of course you have to indirectly pay the agent his commission. There is no way around. Some companies are smart and might tell 100% premium allocation (like the policy I took bearing the surname of cricketer Tendulkar and a single word for 100 runs). What they (deliberately) forget to tell is the other fund management charges would more than make up for what they didn't charge upfront. There is no shortcut here, tell the agent to give a breakup of charges for the duration of the policy and tell him to sign that.
  6. The insurance companies are straight-forward, its the freelancers who do the dirty works. When you negotiate a policy and finalise on it, put it in writing - either complete the documentation and fill all forms together and cross out all blanks or let the agent write all the policy terms and sign a copy for you on a piece of paper. Freelancers have a strategy - they tend to rush it. Sign here and here and just the address details and they will offer to fill the policy type, amount, duration later offering not to take up too much of your time. I assure you it is worth the time spent if you complete it straight away.
  7. Never sign a blank form. If possible, get a copy of the form before giving it to the agent.
  8. Finally, there is something called churning. The agent will try to convince you that a policy he sold you earlier (and collected his commission) has now accumulated some amount but is not performing as well as another policy he is currently selling. He will convince you to take a loan on the first policy and use it to take out a second policy (and he gets another commission) on your hard-earned money. Maybe two years down the line, he might try to get you to take a loan on the second policy and take out a third policy (and yet another commission for him). Net balance of the three policies: negligible sum accumulated. If there is a recession in the market and the stocks/funds are not performing well the NAV will start heading south. Then the policy will lapse when the net policy value goes below a set value losing both the insurance cover and probably forfeiting any balances. Insured is the absolute loser.
  9. Especially for Non-Resident Indians, check whether the amount payable at maturity is repatriable. Many agents murmer mumbo jumbo on this topic and divert one's attention away. The benefits of most policies are payable in India in non-repatriable funds.

Clippings from the Media regarding such practices

  1. Prudential Life Insurance Deceptive Sales : Churning Insurance policies to worthless paper.
  2. The Sensex should grow 20% every year to return Rs 10 crore after 20 years. Impossible, given the present financial crisis. Lose Rs. 5 crore virtual money and be bankrupt in 20 years. Your agent may not be around then.
  3. Don't be misled by your advisor. 5 tips
  4. What your financial advisor did not tell you about ULIP
  5. ULIP hoax: Make Rs 6 lakh in six years

Life Insurance - Get it Right

The conventional method of buying Life Insurance entails approaching a local insurance agent towards the end of the financial year for a recommendation about the best insurance plan. The agent in all probability suggest a ULIP plan or an endowment plan. The next agenda would be to determine the insurance cover based on the premium one can afford to pay. The paperwork is completed.

The above is the common and conventional method, however it is not necessarily the best method of buying life insurance, due to following:

  1. Buying life insurance should not be an 'end-of-the-year activity'. This only points to how tax-planning dictates terms while buying insurance. Insurance should be part of everyone's portfolio irrespective of tax sops.
  2. For long, insurance has been seen as an investment and counting returns has been one of the important factors. The main goal of life insurance is to provide financially for one's dependents in one's absence. Term plans offer insurance in its cheapest form, and should be one's primary insurance vehicle. Most often, Term plans are given the thumbs down simply because they do not offer any returns if the policy holder survives the policy term. Conversely, ULIP and Endowment plans are preferred because they offer returns whether or not the policy holder survives the policy term. And of course the insurance agent has all the financial motive to aggressively push Endowment & ULIP plans because a percentage of each premium paid on such policies will eventually go into his wallet. Behind the fake smiles & "I wanna help you" attitude, he has his best interests in mind, not yours. No agent would ever tell his client that he can have a Rs. 15 lakh sum assured policy on a Rs. 5,000 premium per annum on a 15-year Term insurance, they will probably rant on how a Rs. 100,000 premium per annum ULIP will double in 3 years. As mentioned before, ULIP has a mutual fund component which is supposed to do the growing. In reality, these funds are not managed as efficiently as mutual fund companies for whom it is their core business and expertise. On any given day, one can take out a Rs. 5,000 term insurance and put the remaining Rs.95,000 into an aggressive mutual fund (Reliance Growth Fund is my personal favourite) and blindly this will outperform any ULIP over 3 years. One should also remember that subscribing to mutual funds directly on the web cuts out the middle agents who would have otherwise added a 2.2% loading on your entry NAV. Similarly, mutual funds retained over 1 year do not have any exit loading nor tax. This means 100% of your money works for you. Whereas in ULIP, at least 15 to 30% of your premium contributions go to the insurance agent's retirement fund. Savvy?