ULIPS : RAISING THE BAR

In a short time-span, ULIPs (market-linked plans from insurance companies with a risk cover) have managed to draw retail investors in droves and emerge as a larger force than mutual funds in managing long-term money.

In the best interests of investors, it is now imperative to raise the bar on the disclosure and marketing practices for ULIPs, which appear to be leagues behind those for mutual funds in some respects. There appears to be no harm in IRDA taking a few leaves out of SEBI's book. Thanks to an evolutionary process spanning two decades, SEBI's mutual fund regulations today present a fairly watertight framework for market-linked products.

Assured returns, again?

Consider the recent string of ULIPs that ‘guarantee' payment of the fund's highest NAV for the first 7 or 8 years, at maturity. Scanning their product literature gets you plenty of information on the insurance part — the premium payment options, risk cover, death benefit and the host of charges attached to the plan. But look for details on how exactly they will manage to “guarantee” the highest NAV — in short, the investment strategy — and these are quite sketchy!

Many plans stop with the sweeping statement that they may invest 0-100 per cent in debt/gilt instruments, 0-100 per cent in short term debt instruments and 0-100 per cent in equity shares.

What investors need to infer from this is that they shouldn't expect equity-related returns from these ULIPs, as they may juggle debt and equity to ensure that the NAV doesn't suffer very sharp blips. (Message: Don't mistake highest NAV for highest returns!)

Nor is there complete disclosure on how the insurer will meet any shortfall between promise and performance, if there is any, at the scheme's maturity. Shouldn't these facts be stated more directly?

Transparency please

Most ULIP products in fact seem to operate on the premise that investors should place faith in the insurer for the long term and not worry too much about how the returns are being managed. That is certainly healthy from a broader market perspective. However, not when investors are unclear about what they are buying or where the returns are coming from.

History has showed that keeping investors completely in the dark about the actual risk profile of an investment can sometimes backfire in a spectacular fashion. Multitudes of investors in the infamous Unit Scheme-64 lost their savings simply because they mistook a balanced fund (with an equity component) for a regular income fund, just because it paid yearly dividends like clockwork. Seasoned investors will also recall the popular ‘assured return' mutual funds of the late 1990s that couldn't quite manage annual payouts because debt market conditions changed dramatically.

These episodes prompted SEBI to crack down sharply on mutual funds using the words “guarantee” or “assured return” in their marketing efforts several years ago. It has taken a long time for retail investors in mutual funds to accept the fact that returns always carry a trade-off with risk. Is it really necessary to go down that road all over again with ULIPs?

Complexity

Then, there is also the needless complexity that accompanies the structure and marketing of ULIPs. Even a seasoned investor may be flummoxed by the sheer number of technical terms that are thrown into a ULIP brochure. Understanding the return profile of a product means getting to the bottom of terms such as ‘sum assured, fund value and surrender value'.

The costs you incur are stashed under multiple heads — premium allocation charges, mortality charges, policy administration charges and fund management charges. Helpfully, some of these charges are expressed in percentage terms while others are presented in terms of Rs/1,000 or Rs/month. The ‘benefit illustration' that IRDA has mandated thankfully helps to simplify these costs; but it still leaves investors no wiser about a product's return potential.

All ULIP illustrations are based on the product's NAV edging up by an orderly 6 or 10 per cent each year; but how realistic is this assumption for equity products? And does the insurer's track record support this assumption?

Avoidable confusion

The multiple points of difference in the way ULIPs and mutual funds define their NAV, charge expenses and operate also creates avoidable confusion for investors. Investors in a mutual fund can gauge how the fund performed by tracking its NAV appreciation.

Whereas, using the NAV alone can be misleading for ULIPs, as some of the expenses are adjusted in the balance of units you hold.

Or take the cost aspect — SEBI specifies that a mutual fund may charge no more than 2.5 per cent of its assets towards expenses each year. IRDA, however, defines the ULIP charges on the basis of the difference between gross and net yields over the policy term (capped at 300 basis points for sub-10 year plans). Mutual funds are not allowed to reward their agents out of the money collected from investors after SEBI recently cracked down on this practise; but ULIPs still pay commissions out of the premium collected.

As the IRDA and SEBI sit together to hammer out their differences over the next few weeks, it would help if they could commence a dialogue on some of these issues.

A common set of ground rules that govern all market-related products, irrespective of who markets them, would not just simplify the chore for both the regulators.

It would also leave investors a whole lot better equipped to make wiser choices and assert their rights, whether they are inclined to buy ULIPs or mutual funds.