Unit linked insurance policies or ULIPs as they are popularly called have gained huge traction with investors since their launch in 2004. The favorable tilt of investor interest towards ULIPs was however not because of ULIPs being outstanding product, but was because Insurance agents hard sell and often mis-sell ULIPs to unsuspecting investors.
By saying this, we do not wish to undermine the importance of ULIPs. ULIPs can be a good long term investment instrument. However, agents often mis-guide you to go for ULIP investment even if you need any other Insurance or Investment product to suit your financial plan.
Role of Insurance Agents
Conventionally an insurance agent’s role is to help you select the right insurance policy, picking up the premium payments and arranging for receipt of the maturity proceeds. However ULIPs require a far greater degree of expertise and participation from the agents.
But sadly, agents sell the ULIP to you for all the wrong reasons.
- Ignoring your risk appetite
- Not revealing the expenses to you
- Positioning ULIPs as a short-term avenue
- Encouraging non-payment of premiums, so that they can sell new ULIPs to you
Why Agents mis-sell ULIP?
Agents receive commission as high as 25-30 per cent in the first year of a ULIP policy compared to single premium policies that give only 2 per cent commission. Hence, insurance agents push for regular policies and pay little attention to renewal of these policies. They concentrate more on selling new ULIP products that will get them more commission.
How Agents mis-sell ULIP?
In an article Vivek Kaul, DNA India have listed out common pitches that the agents make to you while selling ULIPs and what they actually mean. These would be really helpful to you to keep in mind and avoid mis-selling of insurance.
Mutual funds with free insurance
This pitch draws on two things. The traditional love that we Indians have for insurance as a tax-saving device and the new love we have developed for mutual funds. If an agent makes this pitch, he is most probably trying to sell you a unit-linked insurance plan (ULIP) and not a mutual fund with free insurance.
ULIPs are insurance policies that club insurance and investment. Usually an individual taking an ULIP has 4-6 choices while choosing his investment fund. These choices range from funds investing 100% in equity to those investing 100% in debt securities. Other than this, the policyholder gets an insurance cover. But there are no free lunches. For the insurance, a mortality charge is levied. So the insurance isn’t free even if the agent says it is.
No details on the expenses involved
Most agents, while trying to sell insurance, do not tell you that Ulips have very high upfront charges. These charges are referred to as policy administration charges and usually vary from 15% to 71% of the premium paid in the first year.
So if you pay Rs 30,000 as an annual premium and the Ulip has a premium allocation charge of 30%, then only Rs 21,000 (70% of Rs 30,000) is invested. The remaining Rs 9,000 is deducted as the policy administration charge. Most or all of this money is passed onto the agent as commission.
And since the commission involved is so high, insurance agents do not like to tell you about the high upfront charges. So the next time an insurance agent comes visiting, do ask him what is the commission he is making on the sale. And if he is unwilling to reveal, ask him for the brochure of the product and look for a table titled ‘premium allocation charge’.
If the agent knows that he is likely to earn a very high commission, he may make you a ‘cashback’ offer. Let us see how this works. In the above example, the policy administration charge is 30% in the first year or Rs 9,000 on a premium of Rs 30,000. The agent might offer to pass on one third of this to you, as a cashback.
So you might get Rs 3,000 back. Should you invest in this ULIP just because he is returning some money to you?
No. That would be being ‘penny wise and pound foolish’. Remember that he is giving you a cashback only in the first year of the policy and not every year. If the policy spans 20 years, for a one-time payment of Rs 3,000, you are putting at stake Rs 6 lakh (Rs 30,000 x 20). The performance record of most ULIPs remains untested because they haven’t been around long enough.
Money doubling in three years
This is the pitch that fools most people. Who wouldn’t want his or her money to double in three years? But for this to happen, the investment fund will have to generate a return of 26% per year for a period of three years.
While this is not impossible, remember that returns in case of ULIPs are not guaranteed. If the insurance agent says your money will double in two years, he will get you to invest in a plan that has an equity component of 80-100%. Thus, the returns will depend on the kind of stocks that your fund manager chooses to invest in. so returns are not guaranteed.
This is how this pitch works. The insurance agent may show you an illustration which assumes that annual returns of 25-26% are generated year on year. So the money is doubled in three years. Such illustrations are illegal. Industry regulator Insurance Regulatory and Development Authority of India (IRDA) only allows illustrations that assume a return of 6% and 10%. So the moment you see an illustration that is neither 6% or 10%, you know that the agent is mis-selling and making assumptions about returns.
Pay premiums for three years only
Most ULIPs have a cover continuance option which ensures that even if the individual is unable to continue paying premiums anytime after the first three years, the policy continues. The insurance agents turned this into a selling point, giving an impression that individuals have the option to stop paying premiums after three years.
This isn’t the case at all. It doesn’t do you any good to stop paying premiums after three years as after this period, the expenses are low and more of the premium is invested. With a lower amount being invested, a lower initial corpus can have a huge impact on the corpus that the individual ultimately accumulates.
So the next time an insurance agent walks in through your door and makes a sales pitch mentioned above, you know he is trying to mis-sell.
The charges associated with the funds during the first 2 or 3 years is usually high in almost all funds and it is important to stay invested at least for 7-10 years in the ULIP to reap the benefits of the equity markets and also to recover the costs that were deducted from our investments. Most agents sell them as short term products but in most cases the market value of our investment is not even as much as the amount we paid them. So it is advisable to stay invested throughout the policy duration to achieve maximum benefits out of our investments.
Source : Your insurance agent is mis-selling if… by Vivek Kaul
What is the Regulator doing to curb ULIP Mis-selling?
In 2007, Insurance Regulatory and Development Authority (IRDA) had issued a norm that allowed insurers to reduce the premium in ULIPs, provided a certain amount is maintained throughout the policy term. But this norm seemed to be misused by insurance agents to sell ULIPs like single premium plans. This norm when introduced was done with the intention of bringing in more flexibility.
But insurance agents misused this clause blatantly and hence IRDA has now asked them to conform to the new norm beginning April 1, 2009. According to the new norm, the regulator has now asked insurers to pay back the commission back to policyholders if the premium is less than 75 percent of the first year’s premium.
This will help in reducing mis-selling of ULIPs by agents as a single premium plan, for the new policies sold from now on. However, still a lot remains to be done by the regulator to effectively curb mis-selling of ULIPs by agents. So, you need to be extra vigilant to avoid the trap laid by agents to mis-sell ULIPs to you.