What is Insurance?

An insurance contract provides risk coverage to the insuree. A purchaser

of insurance pays a fixed premium in exchange for a promise of compensation in the
event of some specified loss. Insurance is bought because it gives peace of mind to the
holders. This comfort level is important in personal and business life. Though the primary
purpose of insurance is to provide risk coverage, when the contract period extends over a
long time, as in the case of life insurance, premium other towards savings. This
bundling together of risk coverage and savings is peculiar to life insurance and is more
common in developing countries like India. In the industrially advanced countries, this is
not necessarily so and short duration life insurance contracts without a savings
component are equally popular. In the developing economies because of the savings
component and the long nature of the contract, life insurance has become an important
instrument of mobilizing long-term funds. The savings component puts the
lifeinsurance in direct competition with other financial institutions and savings
instruments.

Essay About Insurance

Insurance and Growth

Insurance and economic growth mutually influence each other. As the economy grows,
the living standards of people increase. As a consequence, the demand for life insurance
increases. As the assets of people and of business enterprises increase in the growth
process, the demand for general insurancealso increases. In fact, as the economy widens
the demand for new types of insurance products emerges. Insurance is no longer
confined to product markets; they also cover service industries. It is equally true that
growth itself is facilitated by insurance. A well-developed insurance sector promotes
economic growth by encouraging risk-taking. Risk is inherent in all economic activities.
Without some kind of cover against risk, some of these activities will not be carried out at
all.

Also insurance and more particularly life insurance is a source of long term savings and
life insurance companies are thus able to support infrastructure projects which require
long term funds. There is thus a mutually beneficial interaction between insurance and
economic growth. The low income levels of the vast majority of population has been one
of the factors inhibiting a faster growth of insurance in India. To some extent this is also
compounded by certain attitudes to life. The economy has moved on to a higher growth
path. The average rate of growth of the economy in the last three years was 8.1 per cent.
This strong growth will bring about significant changes in the insurance industry.

At this point, it is important to note that not all activities can be insured. If that were
possible, it would completely negate entrepreneurship. Professor Frank Knight in his
celebrated book Risk Uncertainty and Profit emphasized that profit is a consequence
of uncertainty. He made a distinction between quantifiable risk and non-quantifiable risk.
According to him, it is non-quantifiable risk that leads to profit. He wrote It is a world
of change in which we live, and a world of uncertainty. We live only by knowing
something about the future; while the problems of life, or of conduct at least, arise from
the fact that we know so little. This is as true of business as of other spheres of activity.
The real management challenges are uninsurable risks. In the case of insurable risks, risk
is avoided at a cost.

Assessment of Risks

An important function of an insurer is to assess the average level of risk borne while
offering a product. This assessment depends upon a variety of factors and actuarial
calculations become necessary. This is a highly technical area involving theories of
probability. The premium charged by an insurer is based on the calculated average risk.
Obviously this premium will be high for people who perceive themselves to be in a low
risk category. However, for insurance as an activity to succeed, the population to which a
product is offered must consist of categories with different degrees of risk. That is why
the larger the coverage, the lower the average risk and lower the premium. Diversification
is the way to reduce the average risk.

Regulatory Framework

As in the case of all financial institutions, insurance is an activity that needs to be

regulated. This is so because the smooth functioning of business depends on the trust and
confidence reposed by the customers in the solvency of the financial
institutions. Insurance products are of little value to customers, if they cannot trust the
company to keep its promise. The regulatory framework in relation to the insurance
companies seeks to take care of three major concerns

(a) protection of consumers interest,

(b) to ensure the financial soundness of the insurance industry, and
(c) to help the healthy growth of the insurance market.

So long as insurance remained the monopoly of the Government, the need for an
independent regulatory authority was not felt. However, with the acceptance of the idea
that there can be private insurance entities, the need for a regulatory authority becomes
paramount. With the passing of the Insurance Development and Regulatory Act in 2000,
the insurance regulatory authority has become a statutory authority. Protecting consumer
interest involves proper disclosure, keeping prices affordable, some mandatory products
and standardization. Most importantly, it has to make sure that consumers get paid by
insurers. From the consumers point of view, the most important function of the
regulatory authority will be to ensure quick settlement of claims without unnecessary
litigation. With respect to solvency and financial health, regulations will have to be
introduced to ensure that insurance companies follow appropriate prudential norms such
as solvency margins. Large funds are under the custody of the insurers and they get
invested to produce additional returns. The management of these funds is important to the
insurer, the insured and the economy. Entry into the insurance industry must also be
regulated with suitable capital adequacy norms. The third role should be one of
development. The insurance industry in India has a large potential and the framework of
regulation must enable the industry to tap this vast potential.

IRDA over the last decade has brought into force a number of regulations which are well
conceived. They have received wide spread appreciation. The recent decision of IRDA to
move to a free tariff regime for several general insurance products is welcome. The
prescription of tariff is contrary to market principles and insurance products need to be
priced based on market forces.

The reform of the insurance sector is part of the overall economic reform process that is
underway. The basic philosophy underlying the new economic policy is to improve the
productivity and efficiency of the system. This is sought to be achieved partly by creating
a more competitive environment. The growth of the real economy depends upon the
efficiency of the financial sector. A greater element of competition is being injected into
the financial system as well.

All regulators need to keep in mind that there is a fine distinction between regulations and
controls. Regulations lay down norms while controls have a propensity to micromanage
institutions. Regulators must take care to ensure that regulations do not slide into
controls.

The insurance industry in our country underwent a big change in 2000 when private
participants were allowed into the industry along with a streamlined regulatory and
supervisory regime. There are at present 14 private life insurance companies along with
LIC and 12 entities in non-life sector. There is evidence to show that competition has
done good to insurance industry. The rate of growth of the industry in the post
liberalization period has been faster. It has also developed in terms of product innovation
and the use of alternative distribution channels.

Conclusion

The insurance sector has a vast potential not only because incomes are increasing and
assets are expanding but also because the volatility in the system is increasing. In a sense,
we are living in a more risky world. Trade is becoming increasingly global. Technologies
are changing and getting replaced at a faster rate. In this more uncertain world, for which
enough evidence is available in the recent period, insurance will have an important role
to play in reducing the risk burden individuals and businesses have to bear. In the
emerging scenario, the insurance industry must pay attention to

(a) product innovation,

(b) appropriate pricing, and
(c) speedy settlement of claims.

The approach to insurance must be in tune with the changing times.

Insurance should be extended to coverage a larger section of the population and a wider
segment of activities. The three guiding principles of the industry must be to charge
premium no higher than what is warranted by strict actuarial considerations, to invest the
funds for obtaining maximum yield for the policy holders consistent with the safety of
capital and to render efficient and prompt service to policy holders. With imaginative
corporate planning and an abiding commitment to improved service, the mission of
widening the spread of insurance can be achieved.

ULIP ESSAY

Insurance products have been typically used for indemnification which thereby meant
that it was used for risk management. Since the money gets tied up for long, the prospect
of using insurance for investments came into existence. To serve this purpose ULIPs were
born.

ULIPs (Unit Linked insurance plans) are life insurance policies with the added feature of
investments. They thus behave like Mutual funds, to some extent, and thus are also traded
like mutual funds. Their value is represented in terms of NAV (net asset value). Since
these units are tied to an underlying, their value depends on the value of the underlying at
any point of time.

Just like in mutual fund, a pool of the funds collected through the premiums is created,
the charges are reduced from it. The policy has the terms for the required returns and
risks. The underlying is decided upon keeping this in mind. These funds are compared
and traded in the capital markets. Thus, their performance is a function of the
performance of the capital markets. Like in case of equity funds, an investor can diversify
his portfolio by investing across a wide range of funds. The risk is, after all, borne by the
investor.

ULIPs provide the investors the flexibility in choosing their investment style. They can
pay a lump sum or making premium payments, be it annual, half yearly or quarterly. They
can also the premium amounts during the tenure of the policy. This way, if during the
tenure an investor has excess funds he can enhance the value of his investments, and on
the flip side, a crunch situation allows him to invest lesser amount. He can also shift his
funds across various plans like balanced funds, debt funds etc. the cost of doing so is
nominal.

Expenses Charged in a ULIP

Premium Allocation Charge: A percentage of the payments made by the investor are
appropriated towards the initial and renewal expenses. The balance is then transferred for
the policy.

Mortality Charges: These are charges appropriated for the insurance cover. It depends on
the factors like amount of coverage etc. basically the factors are identical to a normal
insurance cover.

Fund Management Fees: Fees levied for management of the fund and is deducted before
arriving at the NAV.

Administration Charges: This is the charge for administration of the plan and is levied by
cancellation of units.
Surrender Charges:Deducted for premature partial or full encashment of units.

Fund Switching Charge:Usually a limited number of fund switches are allowed each year
without charge, with subsequent switches, subject to a charge.

Service Tax Deductions:Service tax is deducted from the risk portion of the premium.

Types of ULIPS

ULIPS can be categorized on multiple parameters ranging from the risk of the underlying
securities on which investment is made to the target profile of the ULIP product. We have
done our analysis on a couple of these parameters which are most frequently used.

Based on Risk Profiles

ULIPS are often measured in terms of the risk associated with them. This categorization
in turn depends on the profile of the underlying instruments that the ULIP plans intend to
invest in. A subjective guideline could be as shown below:

General Description

Nature of Investments

Risk Category

Equity Funds

ULIPS invested in company stocks with the aim of capital appreciation

Medium to High

Income, Fixed Interest and Bond Funds

Corporate bonds, government securities and other fixed income instruments

Medium

Cash Funds

Also called Money Market Funds: Invested in cash, bank deposits and money market
instruments

Low

Balanced Funds

A combination of both Equity and Fixed Interest Bonds

Medium

However, it is very rare to find ULIPS which follow a pure Equity or Fixed Income
Bonds and most of the schemes going around in the market are a combination of both of
the investment options available.

Based on Terms of Payment at Maturity/Death

Based on the amount reimbursed and the time of re-imbursement of the same, Unit
Linked Insurance Plans can be divided into two distinct categories namely:

Type I ULIPS: These plans payback either the fund value as on date or the assured sum,
whichever is higher, upon the death of the investor(policyholder) during the term for
which insurance cover is sought
Type II ULIPS: These return both the sum assured and the fund value on the death of the
policyholder. These are generally costlier than Type I ULIPS

In both scenarios the policyholder gets only the fund value on maturity i.e. if he survives
the complete term of investment assurance. [2]

Based on the Target Customers (Demographic ULIPS)

All the major ULIP market players provide a host of these products tweaking them to
make them attractive to a wide segment of the population Most of these are positioned to
cater to differing financial requirements in a typical individual's life, hence we have
customized ULIPS catering to Children's Education, Retirement, Health Expenses etc.

For eg: If we have analyze the ULIP products offered by ICICI Prudential in the market
we get a view of the age wise demographic profiling done to appeal to all motives of
investors as depicted in the illustration below:

The identification of the motives as shown above then leads to creation of products
catering to these motives. In the case of ICICI Prudential the product portfolio provided is
as follows:

Retirement

Retirement plans accumulate fixed savings over a period of time and guarantee a steady
income post the retirement of the policy holder. These retirement plans usually have two
phases:

Accumulation Phase: Pre-retirement phase in which the policy holder is required to invest
a fixed amount regularly
Withdrawal Phase: Annuity benefits over the course of the policy holder's life span
beyond his retirement.

The pension plan might allow lump sum payment or fixed yearly contributions. The
amount collected is then invested in funds selected by the plan holder after reducing
surcharges and payment towards insurance cover. This plan also allows tax-exempted
withdrawal up to 33% of the fund at retirement. These plans are especially beneficial if
investments begin at an early age as investments are compounded over time.

Wealth

These plans are targeted at young investors who have are looking for long-term financial
requirements like purchasing houses. The added element of life cover serves to make
these plans a wholesome financial investment option. [4] These can be further classified
as

Single Premium/Regular Premium Plans: Plans with one time lump sum payment or
regular installments

Guarantee plans - Non guarantee plans: Wealth creation ULIPs are generally non-
guarantee plans which are exposed to market risks but lately a new category of high
market return and low to negligible risk guarantee plans have been introduced. These are
ideal for investors looking for high returns but averse to market risks. However, these are
available only in the very long run investment horizon. The non-Guarantee plans,
however, are more flexible and allow multiple options with varied levels of risk and
return scenarios.

Life Stage based - Non life Stage based: Life Stage Based ULIP plans are customized to
change the investment portfolios as well as the premium with varying stages of life.
Initially the investment is higher in risky assets like equities whereas with age the
portfolio is changed into a debt dominated instrument.
Children Education

These ULIPS are customized to pay returns at important junctures of a child's education,
Also, the term insurance of the parent is inbuilt into this plan which ensures that the child
receives timely payments for all educational requirements in case of the death of the
parent.

These plans are often modified to add incentives like disability riders which take care of
financial requirement in case of any such eventualities of the policyholder. [5]

Health

Health Care industry has seen booming business in the last decade or so and
simultaneously the cost associated with health care has also spiraled. This has opened up
demand for investment cum insurance funds which take care of these emergency cash
flows.

Health ULIP has been the latest innovation to have emerged as a consequence of this
demand from the health insurance industry. The health ULIP assigns a fixed proportion of
the amount invested into savings that build a health fund that takes care of any future
health related expenses whereas the rest of the amount is invested in other available
investment options. The health fund is essentially a long term savings plan whereas the
rest of the money is invested in equity/debt instruments to drive margins. A major benefit
of using these health plans is that withdrawals at any stage for medical reasons are liable
for tax benefits under the section 80 C. [6]

Despite the IRDA taking steps to educate consumers, there's a lack of knowledge about
this product. An online survey on life insurance shows that over 50% of the respondents
own a ULIP; most of them, however, had no clue about the amount of life cover they had.

The benefits of ULIPs can be presented as:

Long term investment plans

Insurance and investments combined together

With the cap on commission and pricing coming into picture, they become nearly as fair
priced as MFs

Like warren Buffet said, it is good to start early. The ULIPs help you to start investing
early on itself

Once you clearly understand the fine print of any ULIP policy, it becomes a useful
product for long term investments.

The dividend payout tax sometimes discourages policies from paying out dividends. But
this does not affect the returns for an investor because the retained amount gets reinvested
and ultimately goes to the investor himself

The premium ULIP charges for providing insurance cover is considerably lower than
what you would have to shell out for taking an independent policy with LIC. For
instance, for a target amount of Rs 50,000 in a ten-year plan, assuming that you enter it at
26, ULIP deducts Rs 55 towards annual insurance premium. Whereas the annual
premium for a similar fixed-term life cover from LIC would be in the range of Rs 1,000.

Drawbacks of ULIP

Liquidity: The ULIPs lead to a lack of liquidity since the funds once invested in the fund
get locked in for a period of at least 5 years. Withdrawing before this means you would
be foregoing the tax benefit attached to the schemes. Some claim that this lock in period
is less than PFs, however it is also a much larger period than other schemes. Plus even
beyond this, a penalty of 0.5% of the target amount is deducted for early withdrawal after
5 years. To improve this situation, a new policy to allow investors to withdraw after 7
years in a 10 year policy and after 10 years in a 15 year policy. They just need to maintain
a minimum balance of rupees 5000.
Performance: ULIPs were offering a return of 13% under the previous method of
administered pricing. But now with the switch to NAV based system, this becomes
irrelevant since it has become a dunction of the unit's fund management skills and also
the debt market conditions.

Size: The size of the funds (5000 crores in 2001) becomes a handicap for the fund
managers as it impedes the maneuverability of the portfolio. It had invested 46% in
equity which amounts to around 2200 crores. This made it the largest equity oriented
fund in operation. This made it impossible to indulge in transactions without impacting
the price of the stocks. Given the lack of depth in the debt market, the debt portfolio of Rs
2,679 crore, could prove to be even more of a white elephant. Moreover, as of December
2000, around 6 per cent of the NAV was set aside for non-performing assets.

Insurance cover: What's it worth?

Several tax saving plans are available in the market. Assuming that they are all at least as
efficient as the ULIPs, the only differentiating factor remains is the insurance cover
provided by the scheme. Out of the annual payments a small amount is deucted each year
for the insurance premium and the remaining is invested into the fund.

Ulips are not easy to understand. Not many investors know about extrapolation of returns
and can use spreadsheets to see how well their Ulips stack up. Besides, comparing Ulips
is almost out of the question, no matter what the agent says. But investors don't seem
particularly bothered about these negatives. The person who seeks advice, opinion and
second opinion when he's buying a camera, blindly signs any form his agent hands out as
long as he hears the magic words good returns .

Luckily, the industry and the regulator are concerned about this lack of knowledge, and
they are doing what they can to improve investor education. Till a couple of years ago,
Ulips were shrouded in mystery; nobody knew how the insurers charged for expenses,
how the policies worked or what benefits were offered. Nobody seemed to want to know
either. Investors were happy to believe the overzealous agents, who claimed the plans
would give at least 30% returns. That led to rampant mis-selling, but investors remained
blissfully ignorant.
To check mis-selling,

The regulator insisted on a 15-day free look period, allowing buyers to return policies that
did not suit them. Today, several insurance companies offer this feature for a month.

Then IRDA also insisted on the agents providing the investors a policy illustration with a
6% and 10% return, standardising all charges across insurers, and a sales guideline that
every agent had to follow. This is a first as no other financial product comes with an
industry sales guideline.

Restrictive Terms.

One, it is restricted to the tenure of the plan.

Two, you will be eligible only to 50 per cent of the target amount, in the first six months
of your entry into the plan.

Three, the insurance cover at any given time is equal to the difference between the target
amount and the contribution paid. The contribution you paid will be received in the form
of units to your credit, which you would be entitled to, in any case.

Four, women without an independent source of income are eligible only for a cover of Rs
40,000.

Comparison between balanced fund and ULIP

What is a balanced fund?

A balanced fund is a mutual fund that invests in equities as well as debt instruments. The
purpose of the balanced funds is that it combines best of both worlds. It ensures a fixed
and permanent flow of income through the debt investment side and benefits of capital
appreciation through the equity investment side.
A balanced fund usually invests 40-60% funds in the equities and the remainder in the
debt markets.

Comparison

The major benefit of a balanced fund over the ULIP is that it is low cost compared to the
ULIP. It has a cap on its capital at 2.5%.

ULIP on the hand has a lot of charges accruable to it. The charges have been mentioned
above. The utility of ULIPs is high only if u plan to remain invested for 8-10 years.

ULIPs have a short history and returns can vary hugely between one scheme and another.
In the case of balanced funds, you can choose to take a shorter-term approach, without
worrying about the impact of costs.

Most of the ULIPs are sold because of the three year lock in period. This facilitates
continuation of life coverage till there is enough fund in your account to cover the
mortality charges. Keep in mind that you may lose some or all of your money if you
stop paying regular premium at least for ten years

Here is some data on how balanced funds and ULIPs have performed.

Balanced Fund

The HDFC Prudence Fund and HDFC Balanced Fund have provided robust returns of
16% over the past three years. The Canara Robeco Balance Fund, DSP BlackRock
Balanced Fund and the Birla Sun Life 95 Fund have also yielded decent returns of 13%
over the past three years. The average expense ratio of these funds is 2.5%.

ULIPs

HDFC Balanced Managed Investment-Life has yielded 11% returns over the past three
years. ICICI Prudential Balancer II has yielded 11.75% over this period. Factoring the
annual charges associated with these plans, the actual returns are much less. If you want
life cover, you should, instead, opt for a pure term insurance policy. But if you are on the
lookout for relatively safe and steady returns, you would be better off with a balanced
fund rather than a ULIP

Comparison between mutual funds and ULIPs

Mutual Funds

Mutual funds are financial instruments wherein the funds are invested collectively and
are managed professionally by fund houses. The investments are done in securities. These
funds are purchased by investors so that their portfolios can be managed and monitored
by the fund managers. The mutual funds invest funds in a collection of stocks which
helps in diversifying the risk. Also, the presence of a collection of stocks helps in
reducing the transaction costs.

Below diagram shows the basic working of MFs:

That generates

Which is invested in

Given back to

Pool their Money in

Basically the mutual funds can be categorised on the basis of the assets (Equity Stocks,
Fixed-Income Funds and Money market funds). In case of equity funds which are the
most popular type of mutual funds, the funds are further classified by the size of the
companies and the investment style of the managers. The companies are categorized on
the basis of their P/E and price to book value ratios. Other funds present are Global
International Funds, Speciality funds and Index Funds
There are two kinds of costs attached with MFs. These are basically the ongoing fee and
the transaction fee.

The mutual funds have a major advantage of being easily available and are thus easy to
buy or sell. They can be easily bought from mutual funds companies or through third
parties.

ULIPs VS Mutual Funds

ULIPs and Mutual Funds are two different financial instruments both serving separate
functions. ULIPs act as both a market linked investment instrument and also as a life
insurance instrument and are medium to long term in nature. Whereas, Mutual Funds are
purely for investment and are short to medium term in nature. However they do have
certain similarities as well. Both of these instruments are market linked for returns, and
also they carry some market risk. Depending on the investor's selected stock
performance, the returns will turn out to be similar. The major differences between the
two instruments are:

Regulator:

Mutual Funds are regulated by SEBI, while, ULIPs are regulated by IRDA.

Entry Investment:

To enter into the MFs, a minimum investment amount is specified by the fund house.
While, ULIP investment amounts are decided by the investor and can be varied. An
investor having excess funds can increase the amount of premium he is investing. And an
investor with a liquidity crunch has the option to reduce the amount of his premium.

Initial Expenses:

During the initial phase, ULIPs turn out to be an expensive proposition. This is because
of an entry load which varies from 5-40% of the first year premium. Whereas, there is no
such load on MFs. The expenses charged on MFs are usually management and
administration fee and have an upper ceiling limit prescribed by SEBI. In case of ULIPs,
there is no such ceiling by IRDA. The only restraint placed is on the fee charged towards
the regulator. Due to these high expenses, lower amounts get invested and small corpus is
accumulated.

e.g. Let the premium is Rs.10,000.

Let the Morality Charges deducted for insurance cover be Rs.1000.

The agent who sold the premium will get 25% of the first premium = Rs.2500

Hence, the premium cost left for investment will be Rs.6500

If (Net Asset Value) NAV of the fund rises, let say 30% in the first year, the portfolio
worth will be Rs.8450, which is lesser than the premium.

In MF the total amount is invested.

Transaction fees are applicable Rs.30 or 1.5% of amount invested per transaction
whichever is lower.

Transparency:

MFs have higher transparency as compared to ULIPs. They have to statutorily declare
their portfolios on a quarterly basis and hence, investors get the opportunity to see where
their monies are being invested and how they have been managed by studying the
portfolio. On the other hand, ULIPs lack transparency.

Maturity:

ULIPs have a maturity period of around 5-20 years. They have a minimum lock in period
of 3 years. Hence, ULIPs do not allow money to be withdrawn prematurely and levy a
penalty on such withdrawals. MFs (except Equity Linked Saving Scheme, 3 years) do not
have a lock-in period. They are more liquid. The open ended MFs, the liquidity is very
easy.

Tax Benefits:

Irrespective of the plan chosen, ULIP investments help in attaining a tax benefit under
section 80C of the Income Tax Act. Also, the maturity is tax free. The proceeds from
ULIPs are tax-free under section 10(10d). While only the tax saving MFs such as ELSS
attract such a tax benefit and the proceeds attract capital gains tax.

Flexibility in Asset Allocation:

ULIPs provide a greater flexibility in terms of altering the asset allocation. Insurance
companies allow inventors to shift investments across various plans/asset classes either at
a nominal or no cost. As a result, investors are given the option to invest across asset
classes as per their convenience in a cost-effective manner. This is very useful for
investors. For example, in a bull market when the ULIP investor's equity component has
appreciated, he can book profits by simply transferring the requisite amount to a debt-
oriented plan. In case of MFs, the flexibility is not there. In order to move from one type
of investment to another, an entry and an exit fee is applicable which can make it quite
expensive for the investors to move across portfolios.

The Conflict Between IRDA & SEBI

There are two major regulators involved in the regulation of the funds. SEBI & IRDA.
Recently there was a major tussle between the two regulators about the authority over the
regulation of these Funds.

SEBI

Securities and Exchange board of India was setup by Indian government in 1992 through
SEBI Act as a regulator for securities market in India. Sebi takes care of interest of
issuers of securities, the intermediaries and the investors.
SEBI is active in setting up regulations and pushing systematic reforms aggressively. It
regulates all organizations involved in offering products based on investments in equity
as well as debt market. It has introduced regulatory measures, norms, code of conduct and
obligation to intermediaries like banks, brokers, portfolio managers, etc. It has structured
the clearing houses of the stock exchanges. [7]

IRDA

The Insurance Regulatory and Development Authority (IRDA) was setup by the
Indian government by IRDA Act 1999. The mission of this agency is "to protect the
interests of the policyholders, to regulate, promote and ensure orderly growth of the
insurance industry and for matters connected therewith or incidental thereto." [8] The
agency regulates the companies offering insurance products and makes sure to protect the
interest of policy holders.

The Conflict

SEBI regulates all stock market related activities. It manages mutual funds and other
investment schemes that gain value by investing in the stock markets. ULIPs are a mix of
investment and insurance. ULIPs are similar to mutual funds which invest in stock
market with a part of insurance added.

When ULIPs were introduced they promised transparency, segregating and revealing the
costs of insurance and investment components. But being a complex product it confused
the policyholders by the structure of costs which is the part of the premium they paid.
Different products defined various costs differently like "Premium Allocation Charges",
"Premium Allocation Rate", "Policy Administration Charge", etc. All this along with mis-
selling by the agents because of the high commission paid to them by the issuer
companies caused the SEBI to take some action.

The ULIP are doing investments in the share market, hence, SEBI should have a control
over these plans and should also have say in regulation of ULIPs.

SEBI's Actions
The market regulator issued a show cause to fourteen Insurance companies. It asked these
companies why should not an action taken against them for selling investment based
products without the permission of SEBI. As ULIPS are partially investment products,
hence should also come under SEBI regulation as per the law.

Finally in April 2010, SEBI imposed a ban on issuing fresh Unit Linked Insurance Plans
by these 14 insurance companies in India. The companies which received the order from
SEBI include:

ICICI Prudential Life

Reliance Life Insurance

TATA AIG

HDFC Standard Life

Birla Sunlife

Max New York Life

SBI Life

Aegon Religare Life

Aviva Life

Bajaj Allianz

Bharti AXA

ING Vysya Life

Kotak Mahindra Old Mutual Life

Metlife India

The order didn't include state owned firm Life Insurance Cooperation (LIC). Also the
order didn't include any change in existing product.

IRDA's response

After the ban the IRDA chairman J Hari Narayan assured the policy holders that the
ULIPs are safe and secure. It asked the fourteen companies to ignore the ban and
continue selling ULIP products. After few days SEBI modified its order and exempted all
from the ban but made prior permission for new ULIPs mandatory. In the meanwhile the
Finance ministry tried to settle the dispute and asked both to regulators to consult the
court for clarification. SEBI asked the Supreme Court to hear to the petition. The apex
later sent notices to all 14 companies and the center to transfer all cases to the Supreme
Court. [9]

Resolution

The government finally ended the two-month long conflict between the two regulators by
ruling that Unit-linked Insurance Products will be governed by the Insurance Regulatory
and Development Authority. An amendment stating the above was signed by the
President of India.

The ministry of Law stated that any unit-linked insurance policy and any such similar
products are included in life insurance business and issued an ordinance to amend the
RBI Act 1934, Insurance Act 1938, Sebi Act 1992 and Securities Contract Regulations
Act 1956.

Present state of Laws and Regulation

The regulation of the financial industry in India is split among many organizations. This
has resulted in many inefficiencies and tussle between these organizations like this one
over ULIPs.

In the future, government needs to reorganize itself to fit the regulatory requirements of a
sophisticated financial system, instead of trying to force financial firms to reorganize
themselves to fit the almost accidental regulatory architecture that prevails in India today.
[10] There is a need to have a combination of the Insurance Act, the IRDA Act, the SEBI
Act and the SC(R) Act such that complex products like ULIPs which spans multiple
domains can be regulated effectively.

Government Initiatives

Financial laws in India are in a bad shape and require a comprehensive rewrite. There has
been 3 expert committee reports in the last three years -- the Percy Mistry report, the
Raghuram Rajan report and the Jahangir Aziz report. In order to implement the plans for
rewriting these laws, the budget speech by the Finance Minister announced the creation
of the "Financial Sector Law Reforms Commission" (FSLRC) which should rewrite these
laws into a small, modern, internal and a consistent set. [11]

Another need of the hour is the inter regulatory coordination so that issues like these can
be handled and resolved internally. The budget announced setting up Financial Stability
and Development Council (FSDC) which will try to foster better inter-regulatory
coordination.

Recently two inter-regulatory matters have worked out comfortably:

Launch of exchange traded funds on gold

With cooperation of RBI, FMC and SEBI

Launch of currency futures

With cooperation between RBI and FMC

The FSDC should be put into place so as to play the important role in identifying and
resolving these tussles and frictions that will increase as markets in India becomes more
sophisticated and complex.

Analysis

Advantages

ULIPS have dual benefit of feeling of safety and they help investors remain invested.

They provide flexibility; investors can choose their term of insurance, the insurance cover
they want, and pay premiums for a limited period if they wish to stop payments, or
continue the payment.

They are transparent; investors know what amount they are paying for various benefits.
The amount paid by investors is divided into three parts: the expenses, mortality premium
and the investment amount. The expenses are those of the life insurance company and a
major portion of that is the commission paid to the agent. Hence, in the initial years
investors pay a huge amount. The mortality premium is the amount of money they will be
paying for enjoying the life insurance cover. What remains is then invested. The investors
can know the division of the amount among the given three categories.

Tax free returns; the returns from ULIPS is 100% tax free. Hence, it is a good tool to
invest one's savings as against going for short term trading. The tax benefits are provided
under section 80(C)

The investors can also switch between various options during the term of their contract,
and can increase or decrease their cover amount or the amount they want to invest.

Disadvantages

ULIPS like several other investment products are subject to market risks. The money is
invested in equities. Equity market is subject to fluctuations and thus the returns on this
policy can't be assured. However it can be assumed that if a person stays invested for a
long period of time in equity markets, the results will be positive.

Initial costs are very heavy. 15-20% is paid in the first year, while 5% is paid in the next
two years.

ULIPS have a lock-in period. This is done in order to ensure that the costs don't weigh
heavy on investors and the investment management becomes easy. However, this ties up
an investor's capital, which creates problems in case investor requires money before lock-
in period ends.

ULIPS are still at a nascent stage compared to other investment and life insurance
options. People are not educated properly and the agents give a rosier picture in order to
get clients for their commission. Many investors go for ULIPS since the agents tell them
that they have the flexibility of not paying premium after three years. However, when
premium is stopped after three years, most of the money is used for mortality premium
and expenses. The amount actually invested is very less in this case. Hence, the returns
are very low and often people don't understand the reasons behind this.

Although ULIPS provide for premature surrender, but there are high withdrawal charges
which in effect reduce the returns an investor gets from the investments. Hence, this
flexibility isn't advantageous in the real sense and is meant to be used by investors as last
option for sourcing immediate need of funds.

In case the investor dies, ULIP gives the higher of value of investments and the insurance
cover, not the both. So, in most cases, the investment is lost if the person actually dies
and only the insurance cover is paid to the beneficiaries.

A Numerical Example

Let's take an example of someone (say Amit, 30 yrs old) who has Rs. 50,000 to spare.
This will include investment amount plus premium for an insurance policy, sum assured
of Rs. 250,000. Let's say Amit has no problem locking his money in for three years, but
wants to exit after three years.
In a ULIP, Amit would pay (taking the Prudential ICICI Life Link 2 as an example):

- Entry load of 6% = Rs. 3,000

- Administration charges of Rs. 20 p.m. = Rs. 240 per year

- Mortality charges of Rs. 360 per year

- Fund management charges of 1.5% = Rs. 750.

This means the amount that is paid out as charges is: Rs. 4,350. Money actually
invested using ULIP is Rs. 45,650/-

Now if Amit decided to use Equity linked saving scheme, ELSS for investment and a
term plan for insurance.

Term plan cost (@Rs. 300 per lakh for 2.5 lakhs, the industry standard) = Rs. 750.
Though some plans may have a minimum value more than this, but we can use it for
illustration here.

Money left for investment = Rs. 49,250. If Amit puts this in an ELSS he gets charged:

- 3% entry load = Rs. 1,477.5.

- Fund management @1.25% = Rs. 615.6

So money invested using ELSS is Rs. 47,156.9/-

That means if Amit uses the ULIP route, around 2.5% LESS of his money is invested.

There's another disadvantage in case of type-I ULIPS, which has been considered in the
above case. Let's say Amit dies in the third year - How much does his family get?
In ULIP case, the limit is the HIGHER of invested units or the sum assured, in this
case: Rs. 2, 50,000.

In ELSS + Term Plan case, ELSS is recovered in full, around Rs. 50,000 (Assuming
terribly low growth in three years of the invested amount) Term plan pays out full sum
assured of Rs. 2,50,000. What this means is the family gets Rs. 3, 00,000.

In case of type-II ULIPS, the expenses are much higher than type-I ULIPS.

Conclusions and Recommendations

Investment in ULIPS requires patience. ULIPS are ideal for young people who can keep
their money locked in for a longer period of time. It is an ideal product for children who
may need a substantial amount of money for their education in the later part of their life.

ULIPS have high costs in early years. It is not a short term investment. It is also not
meant for people with a short term goal. If an investor has a short term goal, he should
prefer going for mutual funds or equity linked saving scheme along with a term
insurance.

A substantial part of this is agent's commission. As fees and expenses are reduced in later
years, the agents are not interested. In fact, most of the agents tell their clients that they
don't "need" to deposit premium. Investors should guard themselves from such
misconceptions as most of the premium paid later is invested into equities.

Investors should avoid all withdrawal options except in cases of serious cash flow
constraints.

ULIPS is meant only for investors who have limited exposure to the world of investing,
those passive investors who don't believe they can make the right decisions in choosing
financial instruments. For financial-savvy investors, there are better options.
 Order Now! Get text

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