Unit-linked insurance plans: deviating from insurance?

By Sonali Sharma and Bharat Budholia, Juris Corp

There are regulatory arbitrages and then there are arbitrages between regulators. Regulatory arbitrages are not uncommon. What may be uncommon is a regulator mediating to ensure a level playing field for its constituents!

Sonali Sharma Partner Juris Corp
Sonali Sharma
Juris Corp

Deeply concerned with mis-selling and investors being misled into the unnecessary churning of portfolios by distributors, the Securities Exchange Board of India (SEBI) recently implemented a series of measures with regards to Indian mutual funds. This culminated in SEBI mandating in August 2009 that there would be no entry load and exit load on investors subscribing and/or redeeming mutual fund (MF) units. Undoubtedly noble intentions!

Unfortunately what little incentive distributors or financial advisers once possessed has now disappeared. This has resulted in a reluctance on their part to push MF units as an investment avenue. Instead, now they are only mis-selling unit-linked insurance plans (ULIPs).

Over the years, however, ULIPs have themselves begun to look increasingly like MF units with some insurance bundled in (and not vice versa). Investors can decide what part of their “premium” payment they want allocated towards actual risk cover and what part should be used for investment purposes over a specific number of years (subject to charges). Investors can also choose their levels of exposure to equity, subsequent reallocation, etc.

In January, SEBI sent show cause notices to several insurance companies asking them for explanations as to why SEBI permission was not obtained before certain ULIPs were (and continue to be) marketed. According to SEBI, ULIPs are collective investment schemes structured like a MF and therefore fall within their regulatory domain. SEBI has raised this objection after nearly 10 years of ULIPs being traded in the Indian market. This may sound bizarre except that over the years, through incremental changes, ULIPs have become in essence an MF scheme but even better: a dash of insurance and customization of the type offered by a portfolio management scheme (and not by any MF scheme).

ULIPs embody a life insurance policy in as much as they combine investment and risk cover to a lesser extent. An insurance company is entitled to sell such ULIPs under the Insurance Act, 1938. The increase in the value of the fund is passed on to the investor in the form of a higher net asset value. The question is if ULIPs are more of an investment and less of a risk cover, do they still qualify as insurance?

All insurance products (including ULIPs) are approved by the Insurance Regulatory and Development Authority (IRDA). If a MF unit were to embody a risk cover which was underwritten by the MF itself (and not through a bundled insurance policy from an IRDA licensed insurer), would the IRDA object to this unless SEBI approval had been obtained?

Bharat Budholia Associate Juris Corp
Bharat Budholia
Juris Corp

Both MFs and ULIPs grant investors an option of either one-time investment or investing using the systematic investment plan route, which entails commitments over longer time periods. In fact, section 80C of the Income Tax Act, 1961, treats both MFs and ULIPs at par for deductions. However, charges levied in the case of ULIPs are considerably higher than those applicable to MFs. In fact, commission charges loaded on a ULIP may be as high as 30% to 40% of the investment value in the initial phase. However, commission charges on pure term insurance policies are very low thereby creating an incentive for distributors to push ULIPs.

By removing the loads on MF units, SEBI has in fact only further tilted the balance in favour of ULIPs by making them more popular than MF units among distributors. This has in fact worked to the detriment of investors which SEBI is earnestly seeking to protect!

The moot point is whether ULIPs are more of an investment vehicle than an insurance vehicle. In 1938 (when the Insurance Act was enacted) legislators could not have envisaged insurance companies selling hybrid products such as ULIPs. If 70% to 80% of the premium is to be allocated to investment purposes (subject to charges) and if in later years this climbs to 100%, then this is really not insurance.

The IRDA has recently made the charges on ULIPs more transparent and also provided for an overall cap on charges (in particular fund management charges).

In Singapore, insurance companies as a practice farm out the management of funds to asset management companies which are regulated by capital market regulators. Therefore, the question is whether the IRDA should make it mandatory for insurance companies to emulate the practice followed by Singaporean insurance companies. After all, isn’t investor interest supposed to be paramount?

It will be interesting to see how this issue unfolds as it could well be a precursor to a turf war in the future between SEBI and the Pension Fund Regulatory and Development Authority!

Sonali Sharma is a partner and Bharat Budholia is an associate at Juris Corp, a Mumbai-based firm that specializes in banking and finance, foreign investments, private equity, direct tax, bankruptcy and restructuring, M&A, insurance, energy and infrastructure, dispute resolution and international arbitration.

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