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You can fool all the people all the time - or at least try to.Insurers are giving a new spin to the Abraham Lincoln caveat. Of late, insurance companies have been claiming that they have reduced the upfront charges on the unit linked insurance plans (Ulips).

Ulips are essentially investment plans which come with a mild dash of insurance.

Now this contention is somewhat true: Several Ulips in the market today do not have any premium allocation charges in the first year of the policy.

Earlier, insurers used to deduct a substantial portion of the premium being paid in the first year as premium allocation charge. If a policyholder was paying a premium of Rs 1 lakh per annum, the premium allocation charge in the first year could be 40%, so Rs 40,000 would be deducted. The money would be used to pay high commissions to agents.

Only the remaining Rs 60,000 (Rs 1 lakh-Rs 40,000) would getinvested and against this investment units would be given to the policyholder depending on the prevailing net asset value. This charge has now come down. But what insurers lost have been more than made up through a much higher "policy administration charge".

This charge includes the cost of administering the policy, sending regular statements to the policyholder, etc. Typically, it is Rs 40-60 per month or around Rs 500-Rs 700 per year. But that's not how things work. In many cases, the policy administration charge is now a certain proportion of the premium paid in the first year of the policy.In others it is a portion of the sum assured or the insurance cover on the policy.

DNA studied 30 policies across seven private sector players that were following this structure. In the most extreme case (See table) a policy administration charge of 48% of the premium paid is being collected in the first year. Meaning, if you pay a premium of Rs 1 lakh, Rs 48,000 will go towards policy administration charge.

The average policy administration charge of the 30 policies studied was 12.5%.Or Rs 12,500 of your first premium money is used as policy administration charge. Of course over and above this, you also need to pay a premium allocation charge in most cases. The average premium allocation charge across 30 policies came to 10%.So for every Rs 1 lakh of premium paid, Rs 22,500 (or 22.5%) is still being deducted by insurance companies to pay fancy commissions to agents on Ulips in the first year, on the 30 policies studied. This raises a few fundamental questions. Do insurance companies spend so much money on administering a policy? How can the cost of administering the policy depend on the amount of premium paid or the sum assured, given that it is a fixed cost and not a variable one?

The funny thing is most companies continue to charge a policy administration charge of Rs 40-60 per month for some of their policies. So how can the policy administration charge in one case be Rs 40-60 per month and in another case be Rs 30,000-48,000 per year?These are answers that insurance companies and the Insurance Regulatory and Development Authority of India (Irda), the insurance regulator, need to give.

Also, more than anything this is a clear mis-selling trick. With such widespread mis-selling, the policyholders had figured out that the huge premium allocation charges ensured that a large portion of the premium in the first year was not being invested. And that clearly was not helping the sales pitch.

So these charges were cut, and in some cases even reduced to 0%. But the trouble was that the insurance agent still needed his commission. To ensure that insurance companies have resorted to these fancy ways of bloating the policy administration charge and passing it on to agents as commission.

Also, unlike the premium allocation charge which is deducted upfront, the policy administration charge is deducted every month through the cancellation of accumulated units. So most policyholders either do not realise that this charge exists or do not realise how humongous this charge can be, in the first year of the policy. An insurance company recovers this charge every month by cancelling units that have accumulated in the Ulip. So if the policy administration charge is Rs 3,000 per month and the prevailing net asset value of a single unit of the Ulip stands at Rs 50, then the company will cancel 60 units from the accumulated units to recover this charge.

One explanation given by insurance companies is that the overall charges over the period of the policy meet the current regulatory norms of expenses being capped at 3% for policies of up to 10 years and 2.25% of policies of greater than 10 years. Fair point.But by loading the charges upfront, they continue to pay high commissions to agents during the first few years of the policy. This of course leads the insurance agents to churn the money. With higher upfront commissions there is incentive for insurance agents in getting a policyholder to close a policy after the lock-in period and enter a new one using the money received from the old one. In this way, the agent continues to earn high commissions at the cost of the investor. (DNA had proved this through data in the story Guess what's got Sebi's goat? on April 13, 2010).

The insurance companies obviously will continue to do what they do, until they are reined in. As the Russian author Leo Tolstoy once famously said, "The most difficult subjects can be explained to the most slow-witted man if he has not formed any idea of them already; but the simplest thing cannot be made clear to the most intelligent man if he is firmly persuaded that he knows already, without a shadow of doubt, what is laid before him."

Source : http://www.dnaindia.com/