ULIPs: From A Chequered Past To An Unsure Future

The recent proposal to make mandatory 25% of ULIPs investment in government securities (g-sec) has left many surprised and disheartened. ULIP funds are market-linked insurance products wherein a portion of the premium is invested in funds of a policyholder’s choice. As of now, it permits a minimum investment of 80% in equities. However, the current proposal, if accepted, will change the dynamics. Investors will have to be content with limited choices and lower returns. The intention behind the proposal might be noble – financing long-term projects – but the repercussions might not be.

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ULIPs were revived after the 2010 regulatory changes that turned around the product and made it more investor-friendly. From overcharging investors to becoming one of the low-cost investment products, the turnaround was remarkable. They allowed investors to merge investments with insurance at a low premium. And then there were the tax benefits an investor could avail under Section 80C. Now again, ULIPs are set to be “reformed”.

How will the recommendations affect you the investor?

The proposal will whittle down choices available to you as a policyholder. Many of us who look for pure equity funds may not be interested to continue with ULIPs. The proposed recommendation will force investors into a product that is likely to generate less than 8% returns. When equity market is slow, government securities’ exposure could provide cushion. However, in a scenario when the market is rising, 100% equity exposure can help generate good returns.

How will it affect ULIP as an investment instrument?

ULIPs have had a jerky track record. They never were the first thing on an investor’s mind and had only recently picked up speed. But if the draft proposal is accepted, ULIPs’ sale will be hit. The proposal aims to curtail investment in equity funds that tend to offer the highest returns across all asset classes. Mandating a minimum investment in government securities will lower investor returns from funds, making it one of the least-liked insurance products.

As part of ULIPs, insurance companies offer four main fund options — debt, balanced, secured and equity funds. But if each fund has to comply with the mandated 25% investment in government securities, there will be no equity funds. As a result, a lot of investors will be dissuaded from buying ULIPs and insurers will find it tough to sell the product to investors wanting 100% equity exposure. Currently, insurance companies invest in approved securities, including bonds that are rated ‘AA’ and higher bonds that are secured by assets. On the equity side, ULIPs can invest in companies having a track record of paying 4%-5% dividend for at least nine years. By mandating 25% exposure to government securities, limited investment options will be available.

Conclusion

The IRDAI proposal has been drafted keeping in mind the interests of the government and not the consumer. The mandatory 25% investment in government securities does limit the risk but this may have other repercussions as many policyholders who are looking for pure risk cover may not find it attractive anymore. If a majority of policyholders want to invest in equity funds, fund managers won’t be able to comply with their wishes. The proposal is, therefore, going to push people away from ULIPs toward investment instruments that offer pure equity fund option or higher returns. Ideally, a customer should be allowed to make an investment in funds of their choice, a practice followed around the globe. Forcing companies to invest money in certain types of securities is not a good idea. Further, when there are traditional plans that offer the guaranteed return option, there is no need to have a separate 25% investment clause.

In order to create finance long-term projects, the government can alternately directly approach the people by listing government bonds on the stock exchange. The move will garner lots of cheer as the investors will be in control of their money and will choose to invest. Plus, ULIPs will remain undisturbed and continue to be attractive.

First published in The Finapolis Magazine on August 1, 2015

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