They look attractive but they wilt easily.

Here is why insurance and stocks still don't mix even after the new regulations.

Mutual funds aim to generate returns alone, whereas Unit-linked Life Insurance Products (ULIP) offer an added benefit of insurance. Using this attractive but misleading sales pitch very aggressively, insurance companies have been selling loads of Ulips for the past few years. Some 200-odd Ulip schemes have bloomed in tune with the relentless rise in stock markets and insurance companies are almost entirely depending on Ulips for their growth. Alarmed by this rapid encroachment of their turf, the mutual fund industry started lobbying hard until the Insurance Regulatory and Development Authority (IRDA) woke up and amended the guidelines for Ulips last December. Ulips are now subject to stricter norms. According to the new regulations, Ulips must provide a minimum assurance of 50% of total premium paid over the tenure of the policy, or five times the annualised premium, whichever is higher. Even the existing Ulips must fall in line with this rule on or before June 30th.

What You Need to Know?

Does this change anything? Only some things, and you need to know what these are before insurance agents come knocking to sell Ulips with their newly-formulated sales talk. Here are five things to know if you are buying the new Ulips.

Investment Method:

As far as possible, investing can and should be quantitative. It brings in much-needed and much-lacking discipline (look at our stock screen and fund screen for example. We have substantially reduced the subjectivity involved in stock analysis.) You should always be clear what kind of method you are using to invest and what ought to be your expectations from such method, based on its historical results. Unfortunately, while it is usually possible to figure out the investment methods of a mutual fund, do you know the method insurance companies follow in their investment decisions? Does that method have an edge over the mutual funds ? Insurance companies simply lack the expertise of experienced fund managers. They can't procure the expertise from outside either under the IRDA regulations. No wonder Ulips struggled to match the returns of most diversified mutual funds last year.

Transparency:

In most mixed products like Ulips, investors have little idea information on which part of the money goes towards insurance and what goes towards insurance premia. So, you are neither able to figure out whether you are getting insured at a reasonable price nor are you able to figure out what the return on your investments would be. The guidelines have provided the applicability of net asset value (NAV) in respect of applications for surrender, maturity claim and switch-out. IRDA's new rules have improved transparency. Portfolios will be published and the charges for premium allocation, fund management and mortality have been specified under the new rules.

Dubious Practice & Costs:

Expenses of Ulips are higher than mutual funds. Insurance agents have been getting a very hefty percentage of your premia as commission, which is several times what a mutual fund distributor gets. This is sick. If the commission is 20%, your investment in down by 20% on day one! Investment products are not consumer products and simply cannot be sold at such high commissions. A fund manager would have to be extremely skilled or extremely lucky to come out a winner if he is down by 20% to start with.

Liquidity:

The new regulation forces Ulips to be locked in for three years. We have mixed feelings about this. This is good in theory for two reasons. One, it is desirable that insurance be a long-term contract. A three-year lock-in will remove the sword of redemption over the heads of treasury managers and they will be able to plan their investments better. Two, the riskiness of stocks does get reduced as you increase the tenure of your holding increases. But lock-in also eliminates liquidity. And liquidity is a key feature of good investment options. Smart investors simply cannot allow their investments to be locked in for a long period or for any period at all. Even if you are a long-term investor, why should you forego the option of being able to encash your investment when you want to? By the way, this argument also applies to Equity-linked savings scheme which have three year lock-in. Flexibility: Ulips have none of the flexibility of mutual funds. You can change the amount of your investment and switch from fund to fund. In case of public provident fund, you can borrow against your investment. You cannot borrow against Ulips.

The attraction of Ulips was always superficial, no matter what insurance companies said. Insurance and investments are two very different financial products and the new IRDA rule makes no difference. In trying to add an insurance-like feature, the new rules adds a new drawback - the three-year lock-in clause.

So What Should You Do?

Under the new rules, it is mandatory for all insurance agents and intermediaries to be retrained before they are authorised to sell ULIPs, to ensure appropriate market conduct. When they come, ask your agent all these above questions and finally ask him to do some simple math. What would your protection and return be if instead of buying Ulip, you were to take a pure risk insurance policy and invest the excess premium of Ulip in a diversified equity fund. He is unlikely to come back with a winning answer. Decide on an amount that you would like to insure yourself for and choose a term insurance policy of a long period. As for investments, choose from the mutual funds that pop up on our fund screens.

The New Rules

• IRDA has set a formula linking annual premium to the minimum sum assured in ULIPs. This used to be left to insurance players and policy holders. The sum assured for single premium products would be 125% of a single premium paid. For other products, it should be five times the annualised premium or half of a policy term multiplied by annualised premium, whichever is higher.
  
  
• IRDA says ULIPs must have a guaranteed sum assured, payable on death, and may have a guaranteed maturity value. It also says no loans should be granted under ULIPs.
  
  
• The regulator has specified that the minimum policy term will be five years. It has also banned withdrawals within three years of commencement of a policy. Partial withdrawal will be allowed only after the third anniversary of a policy for all regular premium contracts and single-premium contracts.
  
  
• The insurers will have to clearly mention and display on the policy prospectus/brochure all the expenses in their Ulips.
  
  
• The insurers will also have to publish the portfolio of investments under their various Ulips so that a buyer can make an informed decision.
  
  
• IRDA has also made training mandatory for all insurance agents and intermediaries before they are authorised to sell ULIPs, to ensure appropriate market conduct by industry participants.
  
  
• The new norms take effect immediately. IRDA has said that existing ULIP products must be modified by June 30th.
  
  
• IRDA has suggested that life insurers go in for voluntary rating of ULIP funds in order to have an independent evaluation of their performance.