Ch. 7: Charges in ULIP

If you’ve ever purchased something online, you’ll probably be aware of how online sellers levy delivery/shipping charges, convenience fees, etc. Or, if you go to a restaurant or a cafe, you would have noticed how the owners apply service fees, GST, etc. on the bill amount. Now, similar to this, insurance companies, too, levy several charges when you purchase a Unit Linked Insurance Plan.

Unit Linked Insurance Plans, or ULIPs, offer dual benefits of insurance and investment. So, a part of the premium you pay is used to provide an insurance cover, and the remaining is invested in various funds. However, before investing your money in funds, insurers deduct certain charges or fees for the services they provide. They will then invest the remaining premium amount in various fund options depending on your preference.

In this article, we take a look at the various charges levied by insurance companies on Unit Linked Insurance Plans.

So, let’s begin!

Premium Allocation Charge

Before allocating the ULIP coverage, insurers charge a percentage of the instalment premium they receive. This is known as the Premium Allocation Charge. In some products, this charge may only be levied on the premiums for the initial years.

Basically, when an insurer issues the ULIP, there are several initial expenses incurred by them. Expenses such as the cost of underwriting the policy, medical tests, agent’s commission charges, etc. The insurer will recoup these expenses from the premium you pay through the Premium Allocation Charge. And then, the remaining amount will be invested in the fund chosen by you.

Example:
Raj buys a ULIP where the Premium Allocation Charge is 5%. And, he is required to pay an annual premium of Rs. 1,00,000. In this case, the insurance company will deduct Rs 5,000 and invest the remaining Rs. 95,000.

There are two important things you must note about this type of charge -

• At the time of maturity, some products may return the Premium Allocation Charge that was levied to boost the fund value.
• The Premium Allocation Charge imposed by the insurer every year can be the same or different, depending on the product.

As the name implies, Policy Administration Charge is deducted by the insurer at the start of every month for administering or maintaining your policy. This charge is deducted by cancelling the units proportionately from each of the funds selected by you.

The Policy Administration Charge will either be the same throughout the policy tenure or may vary at a predefined rate.

Please note that this may or may not be charged, depending on the product you buy.

Example:
Shivya buys a ULIP where she is supposed to pay a premium of Rs. 1,00,000 every year. Let’s assume the Premium Allocation Charge is 5%. So, the insurer will deduct 5%, i.e., Rs 5,000 from the premium and invest the remaining Rs. 95,000. Shivya

decides to invest in Fund A, where the price of each unit is Rs. 100. So, she receives 950 units (95,000/ 100).

Let’s assume the Policy Administration Charge under her ULIP is 0.6% of the basic annual premium, subject to a maximum of Rs. 6,000. Let’s see how the Policy Administration Charge will be deducted under Shivya’s policy -

Annual Policy Administration Charge = 0.6% of the Basic Annual Premium
= Rs. 600

Policy Administration Charges are deducted on a monthly basis, and so the monthly charge = 600/12 months = Rs 50

So, Rs. 50 will be deducted on a monthly basis by cancelling the units proportionately from each of the funds selected by Shivya.

NAV, i.e., the price of each unit held by Shivya = Rs. 100

So, 50 / 100 = 0.5

So, the insurer will cancel 0.5 units monthly from Shivya’s total investment.

ULIPs come with a lock-in period of five years. This means you cannot withdraw any funds during the lock-in period. Now, suppose you decide to stop paying the premiums and discontinue the policy within the lock-in period. In this case, upon a discontinuance of premium payments, your money will be transferred from your current fund to a Discontinuance Policy Fund.

Before transferring, however, the insurer will deduct a discontinuance charge as a percentage of the fund value or as a percentage of the premium. And then, the balance fund value will be moved to the Discontinued Policy (DP) Fund. In case you stop paying the premiums after the lock-in period is completed, you don't need to pay this charge.

Example:
Sumedh buys a ULIP where he pays a premium of Rs. 40,000 annually. He invests Rs. 40,000 in Fund A, where the Net Asset Value for Fund A on that day is Rs. 1000. For the sake of simplicity, let’s assume that the entire amount is getting invested. So, he receives 40 units of Fund A. Now, he decides to stop paying the premiums in Year 2, i.e., within the lock-in period of 5 years. In this case, let’s see how the insurer will deduct the Surrender or Discontinuance Charge under Sumedh’s policy.

As per Sumedh’s policy conditions, the Surrender or Discontinuance Charge will be the lower of -

• 10% of the Annual Premium
• 10% of the Fund Value
• 3000 (Amount specified by the insurer)

Let’s assume that the NAV of the fund on the day he stops paying the premium is Rs. 800. He has 40 units of Fund A. So, the fund value will be calculated as -
Fund Value = NAV X No. of Units = 800 X 40 = Rs. 32,000
Let’s see how much Surrender/ Discontinuance Charge will the insurer levy under Sumedh’s policy -

The insurer will levy a charge that is the lowest of the above-mentioned amounts. So, in Sumedh’s case, the Surrender/ Discontinuance Charge will be Rs. 3000.

The Surrender/ Discontinuance Charge will get deducted from the current Fund Value. So the remaining Fund Value, i.e., Rs 29,000 (Rs 32,000 - Rs 3000) will be transferred to the Discontinued Policy Fund.

Let’s assume that the NAV of the DP Fund is Rs 50 on the date of discontinuance.

So, the number of units = 29,000/50
= 580.

The DP Fund Value will be paid to Sumedh after the lock-in period of 5 years. The number of units will remain the same till the lock-in period ends, since he has stopped paying the premiums.

Let’s assume the NAV after lock-in period = Rs 20.

So, DP Fund Value = 20 x 580 = 11,600

Hence, Sumedh will receive Rs 11,600 (Discontinued Policy Fund Value) as payout.

This type of charge is levied by the insurer for providing an insurance cover to you. The Mortality Charge will vary across individuals because they depend on a variety of factors, like your age, gender, etc. In addition to these factors, Mortality Charge also depends on the ‘sum at risk’.

‘Sum at risk’ is the amount the insurer will have to pay out of their pocket in case you pass away during the policy term. It ideally reduces as and when the fund value increases. The formula for calculating 'sum at risk' is Sum Assured - Fund Value.

The Mortality Charge is deducted on a monthly basis. It is generally calculated per 1000 of the ‘sum at risk’ - and is deducted proportionately from your chosen fund by redemption of units. At the time of maturity, some products may return the Mortality Charge to boost the fund value. This is known as the Return of Mortality Charge.

So, basically, the formula to calculate Mortality Charge is -

Please note, the Mortality Rate is defined on an annual basis. It is sourced from the revised Indian Assured Life Mortality Table that is published by the Institute of Actuaries of India. Since the mortality charge gets deducted on a monthly basis, we multiply the formula by '1/12' to get the monthly mortality charge.

Let’s understand how the insurers deduct the Mortality Charge with the help of Mayur’s example.

Example:
Mayur, 25, buys a ULIP where he is required to pay an annual premium of Rs. 1 Lakh - and, he invests in Fund A. The sum assured under his policy is Rs. 10 Lakhs (10X of the annual premium). He holds 5,000 units of Fund A with NAV of Rs. 20 on that day. Let’s assume no other charges are deducted from his policy for the sake of simplicity. Hence, on the day of purchase, his fund value will be Rs. 1 Lakh. The ‘sum at risk’ under his policy will be Rs. 9 Lakhs (10 Lakhs - 1 Lakh).

Let’s assume the Mortality Rate specified under Mayur’s policy is 0.75%. So, the Mortality Charge under Mayur’s plan will be calculated as -

Mortality Charge = [(Mortality Rate X Sum at Risk) ÷ 1000] X 1/12
= [(0.75 X 9,00,000) ÷ 1000] X 1/12
= (6,75,000 ÷ 1000) X 1/12
= 675/12
= 56.25

So, the Mortality Charge of Rs. 56.25 will be deducted by cancelling the units proportionately from each of the funds Mayur chose.

Price of each unit held by Mayur = Rs. 20

So, 56.25 / 20 = 2.81

So, the insurer will cancel 2.81 units on a monthly basis from the total number of units he holds.

Note: The Mortality Charge will vary on a yearly basis, as his age increases.

This charge is imposed by the insurance company for managing your funds. It is charged as a percentage of the fund’s value and is deducted before computing the NAV (Net Asset Value) of the fund. The Fund Management Charge (FMC) is adjusted from NAV on a day-to-day basis.

Basically, every insurance company has professionals known as fund managers, who manage every fund. They ensure that the funds they are managing give the maximum returns at the end of the day. To achieve this, they use their expertise in asset allocation. The FMC is the fee for these fund managers that insurers deduct on a daily basis.

According to IRDAI norms, the Fund Management Charge should not be more than 1.35%. Generally, insurers levy the maximum charges in equity funds, while the charges on non-equity funds are lower.

Example:
Kavish invests in a ULIP where he invests a total of Rs. 50,000 in Fund ABC where the NAV of each unit on that day is Rs. 100. So, he is allotted 500 units of Fund ABC.

Now, let’s assume two of Kavish’s friends, Rinkal and Pinkesh, have also invested in Fund ABC on the same day. Rinkal invests Rs. 30,000 - so, he receives 300 units of Fund ABC. And, Pinkesh invests Rs. 20,000 - so, he gets 200 units of Fund ABC.

So, the total fund value of Fund ABC is Rs. 1 Lakh (50,000 + 30,000 + 20,000), and the total number of units in Fund ABC is 1000 units.

For the sake of simplicity, we’re assuming -

• No other charges are deducted from the invested amount.
• The Fund Management Charges are not deducted on Day 1.
• The total fund value remains the same on Day 2
• The total number of units, too, remains the same on Day 2.

Now, let’s assume that the Fund Management Charges that will be levied on Fund ABC is 1% . So, the insurer will deduct 1% from the total fund value, i.e., Rs. 1 Lakh - which will now be reduced to Rs. 99,000.

NAV on Day 2 = Total Fund Value / No. of units
= 99,000 / 1000
= Rs. 99

This is how the fund value of Kavish, Rinkal, and Pinkesh will change -

At the time of buying the ULIP, insurers allow you to choose a fund as per your financial goals and risk appetite. If the fund you selected is not performing up to your expectations, you can move your money to a fund that may fetch you better returns. This is called fund switching. The charge that is levied on fund switches is known as Fund Switching Charge.

Generally, insurers may allow a limited number of fund switches without levying any charge. And then, beyond a number of free switches, they may impose a certain fee on every fund switch.

The Fund Switching Charge is very nominal - and may range anywhere from Rs. 50 to Rs. 500. This charge can be deducted from the fund value of your existing fund before investing the remaining amount in the new fund. It may also be deducted by cancelling units proportionately from each fund selected by you. Also, if the fund switching is done online, some insurers may charge lower switching fees.

Example:
At the time of buying the ULIP, Arya tells the insurer that she wants to invest in Fund A. After a few years, she finds out that another fund, say, Fund B is offering higher returns. So, she decides to switch from Fund A to Fund B.

The insurer has mentioned under Arya’s policy that they will allow 3 free switches, after which they will charge a fee of Rs. 300 for every switch.

Now, let’s assume Arya has switched from one fund to the other 3 times. A few months later, she wants to switch to another fund. In this case, the insurance company will charge a fee of Rs. 300 for the switch. And, they will keep on charging a fee of Rs. 300 every time Arya decides to switch from one fund to another.

Under Unit Linked Insurance Plans, you can withdraw funds. In return, however, you may have to pay certain fees. This fee is called the Partial Withdrawal Charge. The fee levied by the insurer is usually a specific percentage of the amount you withdraw.

Now, usually, the insurer allows a certain number of free withdrawals, say 2 times or 4 times. And, then they levy the Withdrawal Charges. There are some ULIPs that allow free unlimited withdrawals. Meaning, the insurer does not levy any withdrawal charge at all.

Let’s understand how this charge is levied with the help of Kinshuk’s example.

Example:
Kinshuk invests in a Unit Linked Insurance Plan where he pays a premium of Rs. 50,000 every year. He decides to invest in Fund XYZ where the NAV of each unit is Rs. 500. So, he receives 100 units of Fund XYZ. (50,000 / 500). Let’s assume that his entire amount is getting invested and no other charges are getting levied.

After 6 years, Kinshuk wants to withdraw some money from his fund value. Let’s assume he holds 600 units of Fund XYZ. On the day he decides to withdraw the funds, the price of each unit is again Rs. 700. So, on the day Kinshuk wants to make the partial withdrawal, Kinshuk holds funds worth Rs. 4,20,000 (600 units X NAV of Rs. 700).

As per Kinshuk’s policy conditions, the insurer will charge 1% of the amount withdrawn. Kinshuk decides to withdraw Rs. 1,00,000 from his fund value of Rs. 4,20,000. So, in this case, he’ll have to pay a Partial Withdrawal Charge of Rs. 1000 (1% of 1,00,000).

Please note, depending on the insurance company, the charges we’ve mentioned above may vary slightly. And, some insurance companies may not levy certain charges as well.

Let’s understand in a better way, how the charges are levied, and how frequently they are levied - with the help of the below table.

These are the charges insurance companies levy under Unit Linked Insurance Policies. While some charges, like the Fund Management Charges are deducted on a day-to-day basis, charges like the Mortality Charges are deducted on a monthly basis. Further, some charges, like the Fund Switching Charge, Withdrawal Charge are deducted when the fund switch or the withdrawal is made. And, there can be ULIPs where some of these charges may not be levied at all.

So, ensure you’re aware of all the charges levied under ULIPs, and how often they are levied - so that there are no hassles later on.