The introduction of the new guidelines for expenses on unit linked insurance plans (ULIP) will mean that investors will benefit from the lower cost. This is good news, as it will ensure some control over the expenses charged on these products. This step will come with an element of work for the investor in understanding the exact details.
This is required, as there is a limit to the difference between the gross and net yield that will be allowed. In such a situation, there has to be some look at the manner in which several items of expense actually incurred by the investor in the insurance policies will not form a part of the total expense considered for the net yield.
YIELD
The gross yield is the figure earned from the scheme without considering any expenses. This is the normal amount that would come to the investor if there were no cost and this is different from the actual amount earned.
The figure actually earned when the expenses are considered will result in the investors net yield. There has to be a specified limit between the gross yield and the net yield and now this cannot be more than 300 basis points or 3 per cent for a Ulip of 10 years or less and 225 basis points for a Ulip over 10 years.
Consider a situation where there is an insurance policy where the investor pays a premium of Rs 25,000 for 15 years. The expenses include a 20 per cent allocation expense in the first year, 10 per cent in the next and 3 per cent for the remaining period.
There are further expenses of Rs 1,000 per year for mortality and administration charges. Management fees are not considered, for ease of calculation in our example. In such a situation, if the gross yield for the growth in the value comes to 11.2 per cent, then the net yield considering the expenses will work out to 9.9 per cent. The situation will change for the investor when other items like those below are considered.
EXTRA PREMIUM
There are several situations where the insurance company will be charging an extra premium from the customer. This happens, for instance, because there is a health condition and this will require a higher premium to offset the situation.
This can involve a situation where a person is vulnerable to higher risk and could involve symptoms shown earlier that could reoccur or a past accident or event that leads to vulnerability. All this ultimately results in a higher risk for the insurance company.
This will necessarily mean an additional cost through charging a higher premium. For example, a person who would normally pay Rs 12,000 for an insurance cover of Rs 150,000 might find that this has risen to Rs 13,500 due to existing diseases. Such an additional premium of Rs 1,500 would not be counted for the purpose of calculating the net yield and hence would be outside the limit present for the scheme.
RIDERS
There are other benefits in the form of riders available from the insurance policy. This includes a critical illness cover or even an accidental cover benefit that is available by paying an extra amount. Other riders include the waiver of premium and income benefit.
The extra premium that has to be paid again becomes an expense for the policyholder. So, a normal cover for Rs 2 lakh might be available for a 15-year policy at Rs 10,145, which might rise to Rs 12,675 due to a particular rider.
Such a facility allows the individual to get the required insurance cover, plus the extra benefit, without having to buy an additional policy. This might seem a cost but once again, would not have to be considered for calculating the net yield.
SERVICE TAX
Additional expense would come to the investor in the form of taxes to be paid for taking the insurance. One common element that has found its way through to the process is the service tax on charges.
This is to be paid depending upon the eligible charges covered under the service tax rules and hence it raises the overall cost for the investor. This figure, currently at 10 per cent, plus the educational cess of 3 per cent (totalling 10.3 per cent) will not be included in the expense figure that will be used for the calculating the net yield.
This again makes it a factor that has to be paid by the investor and would be in excess of the limit set for the overall expenses.
COST OF GUARANTEE
Several policies are present in the market that will give an assured return or a guarantee for the investor. This is a good point but there is also a cost involved in the entire process.
For, often the guarantee comes at an extra cost that has to be paid to ensure the guarantee is complied with. This might put an additional burden on the investor and they would find their cost for the policy is rising. In times when there is an explicit cost for the purpose of such a guarantee, then the investor has to understand that this figure would not be used for the purpose of calculating the net yield and hence has to be kept separate.
IMPACT
Assume that in the example used for the Rs 25,000 premium policy for 15 years, the additional factors mentioned earlier, like the service tax and additional premium come to around Rs 4,000 a year. In such a situation, the overall yield for the investor, considering the additional investment, drops to 8 per cent from 9.9 per cent.
If the additional premium comes to Rs 2,000 a year, then the yield for the investor is 8.9 per cent. However, since these expenses are not considered in the net yield, the insurance illustration will show the expenses are within the limits set by the insurance regulator.
The author is a certified financial planner.
