IRDA has moved swiftly to make ULIPs less attractive for agents and insurance companies. While this is laudable, there is an unintended impact. Policyholders will be persuaded to buy the more opaque traditional plans now

Unit-linked Insurance Plans (ULIPs) were the main source of revenues for insurance companies all these years. The new framework of ULIPs substantially reduces the profitability of companies and agents. As a result, agents will be less motivated to sell ULIPs and they may shift to selling traditional plans like endowment plans and money-back plans. For the insurance companies too, selling traditional plans means more profits now. A lot of them were making money from high surrender charges so far on ULIPs. The Insurance Regulatory and Development Authority (IRDA) has capped surrender charges drastically.

But both commissions and surrender charges for traditional plans remain as high as before. The commissions for selling traditional plans are still 30% to 35% in the first year; in the second and third years the commission is 7.5%; from the fourth year onwards, the commission is 5% for a 15-year policy. Clearly, traditional plans would be an important focus now.

This is where the customer loses out. "When you compare ULIPs to traditional plans, in a traditional plan there is a lack of clarity, no choice in the allocation of funds and surrender charges are unclear. However with a ULIP plan, the customers can easily understand the commitment he has made," GN Agarwal, chief actuary and chief risk officer, Future Generali, told Moneylife.

In a traditional plan, nearly 85% of that money will go into bonds and the remainder will go into the equity market. But there is no way of knowing how much is invested when and how they are performing. In other words, traditional plans are opaque.

In ULIPs you know how much money is going into stock markets. ULIPs allow you to invest in a 60:40 portfolio (60% in equity and 40% in bonds). For that matter you can also put your money in a 70:30 portfolio or 50:50 portfolio and know how you are faring.

"We explain to our clients that in traditional plans the risk is low, so your benefits are also low, whereas in ULIPs more often, the money invested enters stock markets, which gives them a higher yield," explains an agent of Max New York Life Insurance.

"A traditional plan is a rigid plan and the insurance cover in it has a pre-determined premium rate depending on the term of the insurance. It's a good preservation asset but not a good accumulation asset," said an agent of HDFC Life Insurance.

Another drawback of traditional plans is that they are not flexible. The money put in traditional plans remains locked. You cannot shift your investments to any other pool. However, ULIPs gives you the luxury of being flexible. You can shift your invested amount from the equity markets to bonds, if you fear that the markets would go down, allowing you to change fund allocation and giving ULIP customers a better chance of controlling what they get out of these instruments.

"ULIPs are more transparent, which gives the consumer the opportunity to view the product. Traditional plans on the other hand, only give you the sum assured payable on death or maturity, along with the bonus amount declared by the insurer from time to time. Also, a majority of investments are put in bonds and you cannot shift your funds as per investment guidelines of IRDA," an official from Bajaj Allianz said.

Therefore, what is the upshot of all this? In a supreme irony, in trying to help customers, the insurance regulator has now pushed them into a product that makes them worse off.

It may be recalled that the regulator has ordered that commission charges in ULIPs be distributed evenly over the entire lock-in period, which has been extended to five years from three years. IRDA has capped the charges at 4% annually for 5 years, and 3% for 5-10 years and 2.25% for products above 10-year terms.

Of course, choosing between ULIPs and traditional plans still means sailing between the devil and the deep blue sea. Even with ULIPs having become cheaper and traditional plans being costly and opaque, it is still advisable to go for term plans as they are more beneficial for the consumer. If IRDA has to be really customer-friendly it has to ensure that term plans become ubiquitous. Insurance companies have a nasty habit of denying you term plans.