Concept Of Unit Linked Products

Concept of Unit Linked Products

May 2005

Concept of UL

Background to Unit Linked Policies U.K. had the most successful development of unit linked business worldwide

First UL policies were launched in the sixties There was a rapid increase in new regular premium business Even more rapid increase in Single Premium (grew to over 3x level of regular premiums in by 1990s)

May 2005

Concept of UL

Successful Markets Co untry UK

USA

C an ad a

May 2005

So ld fro m

Un it-lin ked plans In m arket sh are year (%)

E arly 1960 s

Life 26% 46% 40% 43% 40% 43% 40%

Co m m ents / (sou rces)

Pension n/a 44% 55% 59% 51% 52% 53%

1975 1985 1995 1996 1997 1998 1999

M arket share is % of all new individual business (using AP plus 10% SP )

c1970 Univ ersal V ariable but in 38% 4% effect 24% 15% from 22% 20% late 21% 29% 1970 s 20% 34% 19% 40%

1985 1995 1996 1997 1998 1999

M arket share is as UK F igures exclude extra “dum p-ins”

1986 1995 1996 1997 1998 1999

M arket share is as UK F igures exclude extra “dum p-ins”

Pension 33% 1996 37% 1997

M arket share is as UK (S ource : S wedish Insurance F ederation)

Late 1970 s

Sw eden

c1990

Irelan d/ Australia

E arly 1960 s

Neth erland s

E arly 1980 s

8% 34% 38% 44% 52% 54% Life 61% 82%

(S ource : AB I)

(Source : LIM RA )

(Source : LIM RA )

th

Ov er 70%

1995

21% 35% 43%

1996 1997 1998

M arket share is % of all indiv idual life new AP

48%

1999

(A ssurantie M agazine)

Concept of UL

9 C olloquium , G roupeConsultatif

Why has unit linked been successful?

Historically shares offer a satisfactorily real investment return (Average 10 year return around 12-14%) Public awareness of investing, directly or indirectly in the share market Pressure to design products directly linked to shares A more modern approach to risk management, transparency and bonus distribution.

May 2005

Concept of UL

Why link to Units?  Direct access to investment gains  Open ended investment funds  Spread of investment  Different risk profiles  Accessible to small savers as well  Published prices in local daily newspapers  Strategic In-House Funds or managed by reputed fund managers.

May 2005

Concept of UL

What is Unit-Linking ? Unit-linked policies are said to be unbundled Explicit charges are assessed against the policy - the premiums paid belong to the policy-owner (like a bank deposit)

May 2005

Concept of UL

What is Unit-Linking ? Unit-linked policies make use of unit-linked funds 

A unit-linked policy is one whose underlying investments are identifiable and determine its cash values.

Unit linked policies should be matched  The

unit-linked policy liability should be matched by holding the appropriate asset or assets to which it is linked.

Some life insurance element is added to the coverage

May 2005

Concept of UL

Benefits to The Customer Transparency of charges Flexibility Control of investment risk Prospect of better returns

May 2005

Concept of UL

Benefits to the Intermediary Ability to meet client’s needs The concept is easy to explain Help get the client’s investment rupee Help retain clients (by advisory role, quality sale, regular meetings)

May 2005

Concept of UL

Benefits to The Company Lower reserves and capital requirements: 

Unit linked products are less capital hungry compared to traditional products. The weighting of mathematical reserves in the computation of the regulatory solvency margin is lesser for unit-linked policies than traditional contracts.

Reduce investment risk to the company  Guarantees

in traditional products are costly

More profitable business versus with-profits  Shareholders

can take profits upfront

Happy clients and agents Build-up investment expertise

May 2005

Concept of UL

Uses of Unit-Linked The key advantage of a fully flexible Unit Linked product (Universal life) is that it can be positioned as: Endowments/Anticipated Endowments Open-ended whole of life Deferred pensions Tax free annuity 

May 2005

Concept of UL

Traditional product Cannot Change

Premiu m

Acquisition and maintenance expenses

Death Cash & benefit value amoun t

Savings

Insurance cost

May 2005

Black box Concept of UL

Cannot Change Cannot Change

UL product Can Change

Premium

Can Change

Distribution cost Investme nt returns

Customer account value (like a

Expenses and mortality charges

bank a/c)

Death Benefit

Partial withdrawal or surrender May 2005

Can Change Concept of UL

Advantages of Unit Linking Choice of investments several fund managers several fund choice under each fund manager different risk profiles switching between funds 

Flexibility Sum

Assured Premium Payment Withdrawals

May 2005

Concept of UL

Advantages of Unit Linking The roll-up advantage of Insurance – No tax on maturity benefits helps unit linked products to be positioned as – Savings plan  Attractive Investment  Annuities that are tax advantaged 

Policyholder participates fully in the rewards and risks - which is favorable for the company in a declining interest rate scenario. Rupee Cost Averaging – takes out the risk in investments significantly.

May 2005

Concept of UL

Advantages of Unit Linking In a traditional product, once you fix the Sum assured and the term, the premium is fixed (age and gender are also fixed) In a unit linked product, you can provide different levels of cover for the same level of premium. So, the customer has flexibility to balance savings and protection needs.

May 2005

Concept of UL

Disadvantages Usually there is no guaranteed maturity value. Unpredictable performance: unit values may go down as well as up. Requires risk taking ability by customer. Surrender penalties on cashing out early.

May 2005

Concept of UL

Key Issues in an UL Product  Death Benefit  Increase/Decrease in DB  Riders  Premiums – RP/SP/Top Ups  Fund Options  Switching  Bid-Offer Spread  Paid Up, Premium Holiday

May 2005

 Charges      

Admin Investment management Top-Up Policy fee Alteration Mortality/Riders

 Allocation of Premium  Surrenders, Withdrawals

Concept of UL

Death Benefit Option to pay: Sum Assured or Fund Value, whichever is higher.  Sum Assured + Fund Value 

The first one has the advantage of competitive quotation, while the second has the advantage of better protection. Flexibility to choose from a range of Sum Assured for a given premium. Have a Min. and Max. SA linked to premium.

May 2005

Concept of UL

Death Benefit Structures Face 2,000 amou nt 1,500

Death benefit

10million

Net amount of risk

500

Account value

0 35

40

45

50

Age May 2005

Concept of UL

55

60

65

Death Benefit Structures Face amou nt 2,000

Type 2

Face amou nt 2,000

Death benefit 1,500

1,500

10 million

10million

Type 3 Death benefit Account value

Face amou nt

Net amount of risk 500

500

Net amount of risk

Account value 0 35

0

40

45

50

55

60

65

35

age May 2005

40

45

50

age Concept of UL

55

60

65

Increase/Decrease Death Benefit  Increase DB by

Indexing to inflation (Escalation, with option for Policyholder to decline)  At pre-specified Periods  within pre-specified limits  With or w/o UW  Increasing regular premium/top-ups 

Decrease DB by choice or at pre-specified intervals.

May 2005

Concept of UL

Riders Large rider choice increases complexity Flexibility in riders also increases admin costs and easy management of policy benefits Common riders offered: 

Accidental Death benefit, Accidental Disability, Critical Illness, HC/Surgical Benefit, Waiver of Premium/Payor benefit.

These benefits may be charged by:  Explicit

additional premium  Deduction from the fund through unit cancellation

May 2005

Concept of UL

Premiums Premiums can be: Regular Premium Single Premium Top Ups (can be paid anytime) 

Regular premiums can be payable on due dates or anytime (in universal life products)

May 2005

Concept of UL

Fund Options Funds Managed In-House

Investment Management/AMC

Funds Choice Asset

Class Funds (Pure Equity, Pure Debt, Pure Cash, Gold, Real Estate etc.) Mixed Funds (Usually have a portion of debt and equity in the fund)

Customer usually has the choice of allocating money between funds

May 2005

Concept of UL

Fund Options The greater the number of funds, the greater the need for sales agents to act as investment advisors. It is likely to generate more switching, increasing the administrative burden. A large number of funds will decrease the projected balances to be held in individual funds, which hinders the company’s ability to negotiate favourable wholesale terms.

May 2005

Concept of UL

Switching Number of free switches per year – market practice is to allow 3 free switches. Amount charged after free switches can be – fixed

amount a % of the switched amount.

May 2005

Concept of UL

Allocation of premium Various allocation structures available – Choice is fundamentally between transparent (Bajaj Allianz, ICICI) and nontransparent (AVIVA) for the customer. Most companies prefer a transparent structure. The market has gradually moved from low allocation, high commission to low commission high allocation products.

May 2005

Concept of UL

Bid-Offer Spread Bid-offer spreads are effectively a form of non-allocation of premium. They can facilitate a higher headline allocation rate, sometimes in excess of 100%.

May 2005

Concept of UL

Withdrawals Full/Partial Withdrawals allow liquidity, a key differentiator from traditional products. Partial Withdrawal can have limits: Min. balance  Max. withdrawal amount 

Time to allow partial/full withdrawals – 2 to 3 years, depends on product profitability. Surrender Penalties also may be there for early withdrawals to protect company profits.

May 2005

Concept of UL

Premium Holiday Another key advantage of UL policies. During premium holiday, the benefit of protection continues, even if premiums are not paid, so long as there are units available. Huge customer benefit, because the customer is not obligated to continuation of premium payments for life insurance protection to continue. Easy to explain and sell to the customer.

May 2005

Concept of UL

Charges The charges in UL policies can be: Non-Allocated portion (Used for commission payment, sales team salaries and overrides, infrastructure, etc.)  Mortality (Charged usually on a one year basis)  Rider Charges  Investment Management Charges – usually as a % of the funds)  Admin Charges – Flat fee/% of fund  Policy Fee  Other Charges (to recover initial costs like medical, stamp duty, etc.) 

May 2005

Concept of UL

The Power of Systematic Investment

Regular premium Unit Linked Plans are like Systematic Investment Plans – They reduce the risk of investing in equities significantly. You do not need to time the market. You get the benefit of Rupee Cost Averaging

May 2005

Concept of UL

The Power of Systematic Investment

Let us look at 3 funds, with an investment of Rs. 1000 per annum. 13.00

12.00

Months Amount Invested Fund A Fund B Fund C 1 2 3 4 5 6 7 8 9 10 11 12

1000 1000 1000 1000 1000 1000 1000 1000 1000 1000 1000 1000

10.00 10.20 10.40 10.60 10.80 11.00 11.20 11.40 11.60 11.80 12.00 12.00

10.00 9.18 8.60 8.92 10.20 11.80 12.37 12.60 12.58 12.37 11.72 12.00

10.00 10.97 10.80 10.22 10.00 11.43 11.85 11.58 11.04 11.05 11.50 12.00

11.00

10.00

9.00

8.00

7.00 1

May 2005

2

3

Concept of UL

4

5

6

7

Fund A

F und B

8 Fund C

9

10

11

12

The Power of Systematic Investment

Months Amount Invested Fund A Fund B Fund C 1 2 3 4 5 6 7 8 9 10 11 12

1000 1000 1000 1000 1000 1000 1000 1000 1000 1000 1000 1000

10.00 10.20 10.40 10.60 10.80 11.00 11.20 11.40 11.60 11.80 12.00 12.00

Fund A

10.00 10.00 9.18 10.97 8.60 10.80 8.92 10.22 10.20 10.00 11.80 11.43 12.37 11.85 12.60 11.58 12.58 11.04 12.37 11.05 11.72 11.50 12.00 12.00 Total Units

100.00 98.04 96.15 94.34 92.59 90.91 89.29 87.72 86.21 84.75 83.33 83.33 1086.66

Fund B

100.00 108.93 116.28 112.11 98.04 84.75 80.84 79.37 79.49 80.84 85.32 83.33 1109.30

Fund C

100.00 91.16 92.59 97.85 100.00 87.49 84.39 86.36 90.58 90.50 86.96 83.33 1091.20

Total Investment Value 13039.90 13311.59 13094.38

Higher amounts because of rupee cost averaging despite volatility May 2005

Concept of UL

A real life example…NSE NIFTY Close Date Price Investment 3-Jul-90 279.02 100000 2-Jan-91 318.95 100000 1-Jan-92 572.82 100000 4-Jan-93 744.92 100000 3-Jan-94 1083.74 100000 2-Jan-95 1182.14 100000 1-Jan-96 908.01 100000 1-Jan-97 939.55 100000 1-Jan-98 1081.2 100000 1-Jan-99 890.8 100000 3-Jan-00 1592.2 100000 1-Jan-01 1254.3 100000 1-Jan-02 1055.3 100000 1-Jan-03 1100.15 100000 1-Jan-04 1912.25

May 2005

Units Allocated at Closing Cumulative Cumulative Price Investment Units 358.40 100000 358.40 313.53 200000 681.33 174.57 300000 861.89 134.24 400000 1011.85 92.27 500000 1121.90 84.59 600000 1234.32 110.13 700000 1388.27 106.43 800000 1530.49 92.49 900000 1659.17 112.26 1000000 1827.16 62.81 1100000 1917.81 79.73 1200000 2067.12 94.76 1300000 2230.26 90.90 1400000 2380.65

Concept of UL

Value of Units (Endof year) 114311 390281 642042 1096586 1326243 1120776 1304349 1654766 1477991 2909203 2405514 2181433 2453625 4552391

Average Annual Return, with a 3% dividend 14% 48% 38% 44% 33% 14% 12% 13% 7% 19% 11% 7% 7% 16%

Thank You

May 2005

Concept of UL