ULIPs: No More "Cover Continuance"

It turns out(*) that the new guidelines for ULIPs in 2010 have claimed another victim: Cover Continuance.

The concept, prior to September 2010: if you bought a ULIP and stopped paying premiums after say 5 years, you could choose to continue to have

  • Insurance cover continued
  • in which case, Mortality charges and policy admin charges would get deducted from fund value.

Now, with the new regulations this is no longer allowed. If you stop paying premiums, you have to take back your money. Subramoney also mentions this in his blog.

What this means now is: there is no way to stop payments and still continue cover. Let's look deeper.

Why did this rule come into place?

ULIPs had horrendous surrender charges, upto 100% of fund value. IRDA said boss, you can't charge more than Rs. 6,000.  And you have to pay back the fund value to the customer, or if five years are not completed, leave it in at 3.5% interest and then give it back. That prompted the question: what, exactly, is a "surrender"? If you stop paying premium, that is equivalent to a surrender.

Now, ULIPs must return the money or move it over to a low grade investment area if you stop paying premiums. What is required, perhaps, is a tweak to the regulation that allows users to continue (at their own behest) the risk cover. The specific wording of the current regulation is:

A policyholder shall be entitled to exercise one of the following options upon discontinuance of the policy:

    (i) Revival of the policy, or

    (ii) Complete withdrawal from the policy without any risk cover.

This could be augmented with (iii) Continue with the risk cover, with mortality charges being reduced from the fund value from time to time, and the option to withdraw completely from the policy under (ii) above at any time.

Is the cover continuance practical?

Most ULIPs had absolutely crappy insurance limits, and in practice, almost everyone took 5x of annual premiums as cover. Many ULIPs provided the sum assured OR the fund value, whichever was higher. For them, the continuance meant very little insurance - probably 3x-4x annual premiums - practically, if you paid Rs. 50,000 you would have cover for about 2 lakhs, which, one must admit was unreasonably small.

Some others offered risk cover of sum assured PLUS fund value, which is where the continuance option may be useful, so let's explore some more.

What happens if risk cover continues?

Let's say you were paying Rs. 100,000 for a sum assured of Rs. 10 lakhs, and after year 5 you decide to stop premiums.

In a cover continuance scenario, you would get the Rs. 10 lakh cover to continue. With age, your mortality charge increases - that's how ULIPs work - and eats into your fund value. From the Rs. 3,000 a  year if you were 35, it will go to Rs. 10,000 a year if you're 55. Even at that, the cost is reasonable.

But think about it - for someone who can afford Rs. 100,000 a year: is a 10 lakh cover worth it? You obviously need more - if you can save 1 lakh a year for insurance, chances are that you spend more than 5 lakhs a year (15% saving) and therefore, the 10 lakh insurance is utterly useless. In current ULIPS, though, you may be allowed to take on a larger insurance cover, and to that extent, there is likely to be a practical need.

By the way, policy administration charges nowadays can be substantial (sometimes, 3% a year, of the premium amount!).

The cover continuance option could be useful for those who are younger, and gives them the ability to stop paying premiums; and I would definitely recommend that it be made available as an option.

With the caveats : This should not be the default option. It should not be allowed less than 5 years from the policy date. It should also let you exit fully at any time.

Other Options

Till then of course, your options are:

  • Take the money, buy a term plan and put the rest into an investment like a mutual fund or stocks.
  • Invest in a single premium plan if you still like insurance. I don't recommend this but there are those that swear by insurance, or can't get rid of annoying agents.

Overall, the current regulation must be augmented, to allow cover continuance if you stop paying premiums after 5 years.

* I got this information from a survey being conducted by Money Life.