How are variable insurance products structured?
Last month, the Insurance Regulatory and Development Authority of India (Irdai) came out with a draft proposal recommending changes to life insurance products. One of the changes it proposed was simplifying variable insurance products (VIPs). While most of you would know term insurance, traditional and unit-linked insurance plans (Ulips), a VIP maybe unheard of. That’s because the insurance industry has largely stayed away from the category.
Structure of VIPs
VIPs take their structure from Ulips whereas their investment pattern mirrors traditional plans. So, just like Ulips, in VIPs the costs are laid out and clearly defined, and are also capped. That means the reduction in yield—or the difference between the gross and net yields—can’t be more than 4 percentage points in the fifth year, coming down to a difference of 2.25% in the 15th year and thereafter. However, the draft proposal gives more elbowroom to VIPs.
In terms of product construct, the premiums you pay, net of expenses, get credited into a policy account. The money then gets invested and you earn interest on it depending on the type of VIP you have bought. In case of a participating product, every year the bonus declared by the insurer gets credited to the policy account. In case of a non-participating product, the investment benefit needs to be guaranteed upfront. Typically, under both the products, the policy needs to declare a minimum floor rate of return. In case of non-par products, any additional returns need to be declared every year in advance as well.
VIPs are not popular
VIPs have not been very popular because of a few reasons. First, they were unpopular because like Ulips they have to lay out the costs and conform to a cost cap. Second, a minimum floor rate had to be declared upfront and third insurers were asked to maintain shadow accounts (notional accounts that kept track of income like premium, investment income-and costs). According to actuaries we spoke to, all this was very cumbersome. Insurers, therefore, largely stuck to traditional plans after the last round of product regulations that took place in 2013.
The draft now proposes to make VIPs more flexible. Insurers no longer have to guarantee a minimum floor rate. The need for a shadow account has been done away with, and interest credit in non-par products needn’t be declared in advance. The cost caps too are more relaxed—net reduction in yield by the 4th year is up to 4.5% instead of 4% that Ulips have to conform to, this cap gradually narrows down to 2.25% by the 15th year and is comparable to Ulips.
Experts feel if the draft proposals come into effect, the industry may dabble in VIPs once again. From an investment standpoint, VIPs are better than traditional plans as they are more transparent.