Safe and sound

Inside LIC Zindagi Express - Exhibition on Wheels at Chennai Central railway station. It was superfast growth for the insurance industry in 2007.-M. VEDHAN

Investment linked to insurance is increasingly becoming popular as it promises high returns and the security of insurance cover.

Unit linked insurance plans (ULIPs) have become an increasingly popular investment option. They provide investors with insurance cover and offer higher returns than traditional insurance policies. Of course, they carry the risk that is associated with any stock market-related activity. Basically, ULIPs are linked to the stock market. They are like a combination of normal insurance policies plus mutual funds. So popular is the concept of earning on ones life insurance that most advertisements nowadays for life insurance products offer ULIPs.

There are many reasons why ULIPs are preferred over endowment policies. They offer investors the power of playing the stock market. Basically, when an investor chooses a ULIP, he gives the insurer the right to invest up to 100 per cent of the corpus in equities. Normally, ULIPs come with options to suit the individual investors risk appetite. Investors can choose balanced schemes that offer 50 per cent investment in equity and the remaining in fixed income instruments. Equities are generally preferred; historically, compared with other asset classes, they have delivered superior returns.

ULIPs offer the flexibility to shift the investment favouring equity or debt anytime during the course of the investment. In other words, you can change from being an aggressive investor with 100 per cent investment in equity to being a conservative with just 25 per cent exposure to equity. In the recent market meltdown, ULIP insurance spectrum investors chose to move into schemes with higher equity component as they thought the falling market was the best chance for them to get into equity-based schemes.

Another advantage of ULIPs is that investors can keep track of the performance of schemes as the Net Asset Values (NAVs) of the company are declared periodically. Even at the time of investing, the investor gets the full details of the fees and expenses that are deducted from the premium he pays and the money available for investment after that. Furthermore, ULIPs regularly disclose the portfolio of their schemes so that the investor knows how his money has been invested. These are the most visible changes that have come with the entry of ULIPs and which were not available in the case of traditional endowment and money-back policies.

ULIPs offer liquidity to the individual. There is, however, a lock-in period of three years; there is a surrender charge for any withdrawals made before that time. The principle behind the lock-in period is that ULIPs are long-term investments unlike mutual funds, which offer short-term gains.

The attractions of ULIPs may be many, but traditional policies still merit attention. While ULIPs are subject to fluctuations of the stock market and can lead to an erosion in the value of the portfolio in the short-term, this risk is limited in endowment and money-back policies. It would be prudent for investors to analyse their risk profile and choose a mix of endowment and ULIP policies. The age of a person is another factor that is to be taken into consideration while choosing the fund that is suitable to him or her. A young person may invest in a fund with a higher equity component, but this may be a risky proposition for an older investor for whom it is safer to invest in a balanced fund (debt and equity).

One of the criticisms against ULIPs has been that they are opaque to customers. In an effort to ensure transparency, the Insurance Regulatory and Development Authority (IRDA) told life insurers in January to list all charges that policyholders will have to bear along with the amount available for investment in each year specific to each policy. To ensure a connect between the insurer and the customer, the IRDA also said that the policyholders would have to sign a document stating that they have understood the terms and conditions of the policy. This new practice came into effect from February 1.

This system is expected to curb inappropriate transactions. Earlier, agents could misrepresent advantages of the policy, promising prospective customers returns of more than 70 per cent. The new system will standardise the manner in which companies and clients interact. Therefore, though there is technically more paperwork, it actually amounts to a streamlining of the system.

Furthermore, the new procedure eliminates the possibility of deception by the agent. Despite the existence of an official circular that stated that insurance companies were allowed to show returns based on 6 per cent to 10 per cent rates, agents used to offer their own calculations to customers. There was no way of ensuring customer safety in this respect a problem that no longer exists.

The provision in the recent Union Budget bringing ULIPs on a par with mutual funds could lead to higher cost of ULIPs. Asset management companies that manage ULIPs have been brought under the service tax net and the rate is 12.3 per cent a year. Though the impact of service tax is yet to be assessed, asset management companies fees are expected to go up.

Thanks to the booming market, a large volume of insurance sales shifted to ULIPs. However, the traditional insurance sector held its ground as seen in the performance of the life insurance industry. It was a gallop for the industry in 2007. Spearheaded by the Life Insurance Corporation (LIC), the industry registered a growth of 110 per cent in fiscal 2006-07, raking in new business premium of Rs.75,406 crore from Rs.35,897 crore the previous year.

The question that had been uppermost on most insurers minds was whether this high growth was sustainable. Their fears were not unjustified; the strong growth in the last fiscal was followed by a slump; between April and October 2007, the industrys growth slowed down to just 6.4 per cent at Rs.38,614.67 crore in new business premium. This was Rs.36,290 crore in the year-ago period.

Insurers cite several reasons for the slowdown. One of these is that growth would end up being lower on the basis of last years high base. The dip has also been attributed to market leader LICs slump this year. At the end of the first seven months of the fiscal, LIC showed a negative growth of 10.39 per cent at Rs.25,901 crore from Rs.28,906 crore in the previous year.

The decisive shift in LICs path came last fiscal when it decided to wholeheartedly enter the investment-oriented ULIPs segment vis-a-vis traditional plans such as term and endowment policies. As a result the average premium per policy jumped from Rs.4,400 to Rs.6,800, contributing to LICs unusually high growth in fiscal 2007.

Private players, however, remain optimistic about their prospects in the next few years. While the industry is expected to grow at 30-40 per cent in the next 2-3 years, private industry could see a growth of 50-60 per cent. Expanding the branch network, hiring agents and pursuing more tie-ups with banks have been part of the private industrys strategy for ramping up business.

Scaling up has meant that promoters of private companies have had to continuously pump in capital even as they made statutory losses. Capital is increasingly becoming a challenge for private companies as the Bill seeking to increase foreign direct investment (FDI) in insurance from 26 to 49 per cent is yet to get parliamentary approval. The year saw some new ideas emerge with the ICICI Bank group and State Bank of India proposing to float intermediate holding companies for their life and non-life insurance and asset management businesses.

The holding company structure, however, has run into trouble; the Reserve Bank of India believes that the issue needs detailed examination from legal and prudential perspectives and is in the process of putting out a second discussion paper. Speculation has been rife about whether ICICI will individually list its insurance companies to raise capital. ICICI Prudential has in fact been giving its employees stock options for the past three years.

The issue of acturially funded products (products with complex charge structures) is another area of concern. The IRDAs decision to ban these products seemed harsh for the two companies that offered them Aviva and Bajaj Allianz Life.

Scaling up has also brought with it the challenge of human capital, which insurers see as the biggest challenge in the years to come. They say that the attrition in the case of frontline sales staff could be as high as 30-50 per cent, with new players such as IDBI Fortis, Aegon Religare, Bank of Baroda, Legal & General, Bank of India, Union Bank and Dai-Ichi Mutual Life Insurance joining the fray.

With many banks entering the life insurance business, life insurers could see a significant dip in the revenues they earn from bancassurance, the sale of insurance and other similar products through a bank. It may take the banks some time before they are able to earn income through the bancassurance model.

The overall outlook for the industry, however, is good. Among the positive factors are the rising income levels and an insurable population; increasing awareness about the need for insurance; enhanced competition with aggressive growth plans of insurers in the interior parts of India; and the stated focus of policymakers on pension and health insurance provisions.

The Indian life insurance sector has come a long way. The share of life insurance as a percentage of the gross domestic product shot up from 1.2 per cent in 1999 to 4.1 per cent at the end of March 2007. This is still a far cry from this sectors performance in countries such as the United Kingdom and Japan where insurance penetration stands at 13.1 per cent and 8.3 per cent of the GDP, respectively. But India is still ahead of China where insurance accounts for just 1.7 per cent of the GDP.