INTRODUCTION

The Government of India (GoI) opened the insurance sector to private players on October 24.
2000, thus unraveling a new chapter in this field. This new policy of GOI is an outcome of
India’s policy of liberlisation and also the result of its obligation as a signatory to the WTO to
conform to its principles and guidelines relating to the reduction of barriers to trade in services.
This epoch-making decision has ushered in a new era that has transgressed four decades of
complete control by the public sector over the insurance sector (life insurance was nationalized
in 1956 by merging 245 private insurance companies to form the life Insurance Corporation Of
India (LIC), while general insurance was nationalized with the formation of general Insurance
Corporation (GIC) in 1972).

This decision of the GOI has been accompanied by a set of laws and regulations governing this
domain. Accordingly the Insurance Regulatory and Development Authority Act 1999 (The
IRDA Act) was enacted with the predominant aim of setting up an autonomous body known as
the Insurance Regulatory and Development Authority (the IRDA) to regulate, promote and
ensure orderly growth of the insurance industry.

The influx of new players in both life and non-life sectors has made the insurance market a
consumers paradise. All new players are striving to introduce innovative products. Where the
old players (LIC and GIC) have a first mover advantage and have a wide spread network, the
new players are banking on their innovative products and superior services to surge them ahead.

It is too soon to say which of the new players will succeed and which of them will perish. But
the opening up of the sector is a step that will be beneficial both to the insured as well as the
insurer.

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 THE CONCEPT OF INSURANCE

"Insurance is a contract between two parties whereby one party called insurer undertakes in
exchange for a fixed sum called premiums, to pay the other party called insured a fixed amount
of money on the happening of a certain event."

Insurance is a protection against financial loss arising on the happening of an unexpected event.
Insurance companies collect premiums to provide for this protection. A loss is paid out of the
premiums collected from the insuring public and the Insurance Companies act as trustees to the
amount collected.

For Example, in a Life Policy, by paying a premium to the Insurer, the family of the insured
person receives a fixed compensation on the death of the insured. Similarly, in a car insurance,
in the event of the car meeting with an accident, the insured receives the compensation to the
extent of damage.

It is a system by which the losses suffered by a few are spread over many, exposed to similar
risks. Insurance is a mechanism for transferring risk and reducing risk by having a large number
of individuals who share in the financial losses of the group. Risk inhibits action and is highly
subjective on an individual basis. Insurance objectifies risk. People trade the possibility of
financial loss for the relative certainty of the premium paid and reimbursement for loss.
Insurance frees people to take action even in the face of possible financial loss. Thus, insurance
provides utility even if no loss ever occurs.

Some people believe insurance is similar to gambling or opening a savings account. Neither is
true. When you place a bet, you create a risk and you have the chance of losing all or making
more than your wager. Insurance companies write policies for pure not speculative risks and
indemnify you when you have a covered loss. In the insurance industry, the word "indemnify"
means you cannot be put in a better position than you were before the loss.

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BASIC INSURANCE TERMINOLOGIES

• Insured
The person known as the policyholder, a person with insurance coverage.

• Insurer
A company licensed to transact the business of insurance and issue insurance policies.

• Policy
It's the written contract between an insurance company and its insured. It defines what
the company agrees to cover for what period of time and describes the obligations and
responsibilities of the insured.

• Premium
It's the amount of money a policyholder pays for insurance protection.

• Claim
It's the notice to the insurance company that under the terms of a policy, a loss maybe
covered.

• Indemnity
Legal principle that specifies an insured should not collect more than the actual cash
value of a loss but should be restored to approximately the same financial position as
existed before the loss.

• Agent
A licensed person or organization who sells insurance and represents the insurance
company to the policyholder.

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 • Broker
An organization or person paid by the policy holder to look for insurance on their behalf.

• Deductible
It's the amount of the loss which the insured is responsible to pay before the insurance
company pays the benefits.

• Expiration Date
This is the date on which the policy ends.

• Grace Period
A period (usually 30 or 31 days) following each insurance premium due date, other than
the first due date, during which an overdue premium may be paid. All provisions of the
policy remain in force throughout this period.

• Limit
It's the maximum amount paid by the insurance company under the terms of a policy.

• Underwriting
The process of classifying applicants for insurance by identifying characteristics such as
age, gender, health, occupation and hobbies. People with similar characteristics are
grouped together and are charged a premium based on the group's level of risk.

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REQUIREMENTS OF AN INSURABLE RISK

1. From the perspective of the insured:

 The risk must be high. Losses with extremely high odds and extremely low odds might best
be handled in other ways.

 The loss must be unaffordable.

 The premium must be affordable or, at least, low in comparison with the possible loss.

2. From the perspective of the insurer:

 The loss must be fortuitous (unexpected in terms of timing and magnitude).

 The loss must non-catastrophic with neither the possibility of many losses at one time or any
one loss of overwhelming magnitude.

 The losses must be personal because only people can suffer losses.

 The loss must be definite in time, place and amount. This allows for a reasonably accurate
prediction of loss and thus calculation of premium.

CONCEPT OF INSURABLE INTEREST

 The insured party must have an insurable interest in the person or property covered. This
means that he or she must stand to suffer a loss should the peril occur.

 Generally, insurable interest must exist at the time that the loss occurs.

 Requiring insurance supports the principle of indemnity, which states that an insured should
collect no more than the actual loss.

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CONCEPT OF INSURANCE INDUSTRY

The important feature of insurance industry is the fact that not much
capital is required to start and develop the business the equity base is
always much smaller than the liabilities undertaken and the resources
generated. The resources accumulation in the form of reserves investment
and other assets are much more enormous than the equity base. The need for
additional capital infusion in response to inflation and consequent
increase in management expenses and other input is very little and
non-existence. The premium income generated and proper husbanding of the
resources take care of this aspect.

WHY DO PEOPLE IN INDIA TAKE INSURANCE

People in India have been viewing Insurance, especially life insurance as a form of Investment .
These are the common reasons why people in India take up insurance:

1 Insurance safeguards a person /his family /his business against possible losses on account of
risks and perils. It provides financial compensation for the losses suffered due to the
happening of any unforeseen events.
2 Tax Relief:
a. Under Section 88 of Income Tax Act , a portion of premiums paid for life
insurance policies (LIC) are deducted from tax liability. Similarly, exemption is
available for Health Insurance Policy premiums.
b. Money paid as claim including Bonus under a life policy is exempted from
payment of Income Tax.

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1 Encourages Savings : An insurance scheme encourages thrift among individuals. It
inculcates the habit of saving compulsorily, unlike other saving instruments, wherein the
saved money can be easily withdrawn.
2 The beneficiaries to an insurance claim amount are protected from the claims of creditors by
affecting a valid assignment.
3 Life Policies are accepted as a security for a loan. They can also be surrendered for meeting
unexpected emergencies.
4 Based on the concept of sharing of losses, the society will benefit as catastrophic losses are
spread globally.

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TYPES OF INSURANCE

Insurance has been classified into:

• Life Insurance
• General Insurance or Non-Life insurance

LIFE INSURANCE

Life insurance is a written contract between the insured and the insurer, that provides for the
payment of the insured sum on the date of the maturity of the contract or on the unfortunate
death of the insured, whichever occurs earlier.

The different types of life insurance are:

• Whole Life Assurance Plans

• Term Assurance Plans

• Annuities

NON LIFE INSURANCE

There are various broad categories of non-life or general Insurance as follows:

Health Insurance:

Just like one looks to safeguard ones wealth, these policies ensure guarding the insurer's health
against any calamities that may cause long term harm to ones life and even hamper ones earning
ability for a lifetime. Some examples of this type of policy are mediclaim policy, personal
accident, group accident, traffic accident, etc.

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Business Insurance:

Risks of loss of profits/business, goods, plant and machinery are most profound in case of
business. Under this head they cover the most widely used policies that cover a business from
any loss of the above kind. Some of these policies are burglary insurance, shopkeepers
insurance, key-man insurance, marine insurance, public liability insurance, workmen
compensation insurance, air transit insurance, fidelity guarantee insurance etc.

Automobile Insurance:

Auto Policy is required to be taken to cover the risks that arise to the owner, vehicle and third
party. This includes the Compulsory Vehicle Policy (In India, by the Motor Vehicles Act, every
car owner is required to covered against Act risks) and the Comprehensive Vehicle Policy.

Fire Insurance:

This policy is required to be taken to prevent any loss of profits / property from incidental fire.
Eg: fire insurance and fire consequential loss policy.

Travel Insurance

Every year number of tourists die while travelling. They lose their baggages, passports etc are
left stranded in unfamiliar environments. Medical attention in a foreign land while very
expensive is also very difficult to find in foreign land. Travel policies are designed to take care
of all the problems that generally occur while travelling, whether domestic or foreign.

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 BRIEF HISTORY OF THE INSURANCE SECTOR IN INDIA

The insurance sector in India has come a full circle from being an open competitive market to
nationalisation and back to a liberalised market again. Tracing the developments in the Indian
insurance sector reveals the 360 degree turn witnessed over a period of almost two centuries.
Till the end of 1999-2000, two government insurance companies, namely, Life Insurance
Corporation (LIC) and General Insurance Corporation (GIC) were the monopoly insurance
(both life and non-life) providers in India.

In the year 2000-01, the Indian Government lifted all entry restrictions for private sector
investors. Foreign investment insurance market was also allowed in the Indian market and the
face of the Indian Insurance sector changed dramatically.

We will first take a brief look at the old players in the market and understand the position they
were in before the opening up of the Insurance Sector.

LIFE INSURANCE CORPORATION OF INDIA (LIC)

In 1956, 245 Indian and foreign insurers and provident societies that were prevalent in India
were taken over by the central government and nationalised to form the Life Insurance
Corporation of India (LIC) with a contribution of Rs. 5 crore from the Government of India. LIC
was formed to spread the message of life insurance in the country and mobilise people's savings
for nation-building activities. A monolith then, the corporation, enjoyed a monopoly status and
became synonymous with life insurance.

Today LIC has its central office in Mumbai and seven zonal offices at Mumbai, Calcutta, Delhi,
Chennai, Hyderabad, Kanpur and Bhopal and operates through 100 divisional offices in

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important cities and 2,048 branch offices. LIC has 5.59 lakh active agents spread over the
country. The Corporation also transacts business abroad and has offices in Fiji, Mauritius and
United Kingdom. LIC is associated with joint ventures abroad in the field of insurance, namely,
Ken-India Assurance Company Limited, Nairobi; United Oriental Assurance Company Limited,
Kuala Lumpur; and Life Insurance Corporation (International), E.C. Bahrain. It has also entered
into an agreement with the Sun Life (UK) for marketing unit linked life insurance and pension
policies in U.K

LIC sold 2,32,50,078 individual policies and earned a first premium income of Rs.14,844.05
crore during the financial year 2001-02.

Post liberalisation, the company is bound to face stiff competition from the newer players in the
market. However, LIC has the first mover advantage and today the common man relates life
insurance with LIC and this will be the companies biggest advantage.

GENERAL INSURANCE CORPORATION OF INDIA (GIC)

The General Insurance business in India was nationalized with effect from 1.1.1973 by the
General Insurance Business (Nationalization) Act, 1972 and a Government company known as
General Insurance Corporation of India was formed. 107 Indian and foreign insurers which were
operating in the country prior to nationalisation, were grouped into four operating companies
namely

1. National Insurance Company Ltd.

2. Oriental Insurance Company Ltd.

3. New India Assurance Company Ltd.

4. United India Insurance Company Ltd.

The Government of India subscribed to the capital of GIC. GIC, in turn, subscribed to the capital
of the above four companies. All the four companies are government companies registered
under the Companies Act.

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All the above four subsidiaries of GIC operate all over the country competing with one another
and underwriting various classes of general insurance business except for aviation insurance of
national airlines and crop insurance which is handled by the GIC

GIC and its subsidiaries have representation either directly or through branches in 18 countries
and through associate/ locally incorporated subsidiaries in 14 other countries. A subsidiary
company of GIC India International Pvt. Ltd. is operating in Singapore and their joint venture
company, Kenindia Assurance Company Ltd. in Kenya. On the whole, the foreign operations of
the general insurance industry have been profitable.

GIC was converted into India's national reinsurer from December, 2000 and all the subsidiaries
working under the GIC umbrella were restructured as independent insurance companies.

Indian Parliament has cleared a Bill on July 30,2002 delinking the four subsidiaries from GIC.
A separate Bill has been approved by Parliament to allow brokers, cooperatives and
intermediaries in the sector.

Currently insurance companies- both private and public-- has to cede 20 percent of its
reinsurance with GIC. GIC is planning to increase re-insurance premium by 20 percent which
works out at Rs. 3000 cr. GIC is actively considering entry into overseas markets including West
Asia, South-east Asia and SAARC region.

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 REASONS FOR OPENING UP OF THE SECTOR

INDUCE COMPETITION

It was seen that though the waves of competition were sweeping across the economy, LIC and
GIC remain overstaffed, hierarchial monolithic monopolies with little competition even between
the subsidiaries. As a result, the consumers are deprived of benefits such as wider range of
products, efficient service and lower price of insurance covers.

LIBERALISATION EFFORT

The opening up of Insurance sector was a part of the on going liberalization in the financial
sector of India. The changing face of the financial sector and the entry of several companies in
the field of life and non life Insurance segment are one of the key results of these liberalization
efforts. Insurance business by way of generating premium income adds significantly to the GDP.

HIGH PREMIUM AND LOW RETURNS

Pointing out that the insurance industry's funds are preempted through government-mandated
investments with low yield, the report said this affects the financial results of the insurance
companies. This is why rates of insurance premia are so high and returns on savings invested in
life insurance are so low. In the absence of competition, LIC's vast marketing and services
network was inadequately responsive to customer needs and there was excessive lapsation of
policies.

INSURANCE MOBILISATION

The entry of several private insurance companies, particularly international insurance

companies, through joint ventures, will speed up the process of insurance mobilisation. The

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competition will unleash new schemes and benefits, which will give consumers a better chance
to save as well as insure. The penetration of Insurance in India is extremely low and the opening
up of the sector was seen as a way increasing penetration.

FLOW OF FDI

The policy of the government to open up the financial sector and the Insurance sector is
expected to bring greater FDI inflow in to the country.

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 POTENTIAL OF THE INSURANCE SECTOR IN INDIA
LIFE INSURANCE STATISTICS
Indian Population 1 bn
GDP as on 2000 (Rs billion) 20000
Gross Domestic Savings as a % of GDP 23%
Estimated Market by 2005 650 million
Source: Indiainfoline.com and NCAER

India has an enormous middle-class that can afford to buy life, health, and disability and pension
plan products. The low level of penetration of life insurance in India compared to other
developed nations can be judged by a comparison of per capita life premium. Despite the fact
that the market is vast in India for the Insurance business, the coverage is far less compared with
the international standards. Estimates show that a meagre 35-40 million, out of a population of
950 million, have come so far under the umbrella of the insurance industry.

India has traditionally been a high savings oriented. Insurance sector in the Unites States is as
big in size as the banking industry there. This gives us an idea of how important the sector is.
Insurance sector channelises the savings of the people to long term investments. In India where
infrastructure is said to be of critical importance, this sector will bring the nations own money
for the nation.

Life Insurance sector is one of the key areas where enormous business potential exists. In India
currently the life insurance premium as a percentage of GDP is 1.3 percentage against 5.2 per
cent in the US. But in the liberalized scenario, the life insurance premiums were projected to
grow at around 18% to 20% from Rs. 215 billion in 1998-99 to Rs.592 billion in 2004-05 and to
Rs.1450 billion by 2009-10. Corporate non-life premium was projected to grow from Rs.84
billion in 1998-99 to Rs.386 billion in 2009-10 and personal line non-life from Rs.4 billion to
Rs.51 billion.

The potential market is so huge that it can grow by 15 to 17 per cent per annum. Now with the
entry of private insurance companies, the Indian Insurance Market may finally be able to make
deeper penetration into newer segments and expand the market size manifold.
REFORMS IN THE SECTOR
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The eagerly awaited Insurance Regulatory and Development Authority (IRDA) Bill to open the
insurance sector in India to private and foreign players, was passed by the Lok Sabha on
December 2, 1999 and by the Rajya Sabha on December 7, 1999.

The Bill seeks to grant statutory status to the interim Insurance Regulatory Authority and amend
the 1938 Insurance Act, the 1956 Life Insurance Corporation Act and the 1972 General
Insurance Business (Nationalization) Act to end the public sector monopoly. The IRDA Bill
incorporates the recommendations made by the parliamentary Standing Committee on Finance.

Salient Features of Insurance Sector Reform Bill:

 The bill seeks to regulate, promote and ensure orderly growth of the insurance industry and
provides for solvency norms and specifies that the funds of policyholders would be retained
within the country.

 The minimum capital requirement for life and general insurance has been retained at Rs 100
crore ($23.02 million) and for reinsurance firms at Rs 200 crore ($46.04 million) as provided
in the earlier IRA Bill.

 It has been stipulated that the aggregate foreign holding in an Indian insurance company
shall not exceed 26 per cent of the paid-up equity. Moreover, to provide a level playing field,
It has been proposed that the Indian promoters would also be required to bring down their
equity holding to 26 percent after a period of 10 years from the commencement of business.

 The Bill has proposed solvency margins of Rs. 50 crores (US $ 11.51 million) for life and
general Insurance and Rs. 100 crores (US $ 23.02 million) for reinsurance companies.

 IRDA, in addition to other functions, would supervise the functioning of the Tariff Advisory
Committee (TAC) and specify the percentage of premium income of the insurers to be set
aside to finance schemes for promoting and regulating professional organizations in the
insurance sectors.

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 REGULATORY AUTHORITY

INSURANCE REGULATORY AND DEVELOPMENT AUTHORITY

IRDA is formed as an authority to protect the interests of holders of insurance policies, to

regulate, promote and ensure orderly growth of the insurance industry.

With the Insurance Regulatory and Development Act, the focus shifted to the following:

• The Insurance Regulatory and Development Authority (IRDA) should give priority to
health insurance while issuing certificates of registration

• Policyholders' funds will be invested in the social sector and infrastructure. The
percentage may be specified by the IRDA and such regulations will apply to all insurers
operating in the country;

• Insurers will be expected to undertake a certain percentage of business in the rural or

social sector and provide policies to persons residing in rural areas, workers in the
unorganised and informal economically back;

• In case the insurers fail to meet the social sector obligation a fine of Rs.2.5 mn would be
imposed the first time. Subsequent failures would result in cancellation of licenses.

DUTIES, POWERS AND FUNCTIONS OF IRDA

The following are the powers and the functions of the IRDA are as follows:

(a) The IRDA issues, modifies, renews, suspends, withdraws and cancels all
certificate of registration for all parties that apply.

(b) They are also responsible for the protection of the interests of the policy holders
in matters concerning assigning of policy, nomination by policy holders,
insurable interest, settlement of insurance claim, surrender value of policy and
other terms and conditions of contracts of insurance.

(c) The IRDA specifies requisite qualifications, code of conduct and practical
training for intermediary or insurance intermediaries and agents.

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(d) It also specifies the code of conduct for surveyors and loss assessors.

(e) The IRDA has been given the responsibility of promoting efficiency in the
conduct of insurance business.

(f) It is in charge of promoting and regulating professional organisations connected

with the insurance and re-insurance business;

(g) It has been entrusted with the control of the Insurance sector by calling for
information from, undertaking inspection of, conducting inquires and
investigations including audit of the insurers, intermediaries, insurance
intermediaries and other organisations connected with the insurance business;

(h) It will also be responsible for the control and regulation of the rates, advantages,
terms and conditions that may be offered by insurers.

(i) The IRDA will specify the form and manner in which books of account shall be
maintained and statement of accounts shall be rendered by insurers and other
insurance intermediaries.

(j) One of the most important functions is that of regulating investment of funds by
insurance companies and the maintenance of margin of solvency.

(k) The other function is that of adjudication of disputes between insurers and
intermediaries or insurance intermediaries.

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 INVESTMENT REGULATIONS
Source : IRDA (Investment) Regultions,2000
All insurance companies in India have to follow certain norms and limitations with regards
to the investments they make. We studied the regulations laid down by the IRDA and given
below are the various sectors or types of investments and their minimum requirements that
the companies are supposed to follow.

(1) Life Business: Every insurer carrying on the business of life-insurance has to invest in the
following manner:

S.No Type of Investment Percentage

i) Government Securities 25%
ii) Government Securities or other approved Not less than 50%
securities (including (i) above)
iii) Approved Investments as specified in Schedule I
*
a) Infrastructure and Social Sector Not less than 15%
b) Others to be governed by Exposure/ Prudential Not exceeding 20%
Norms specified in Regulation 5 #
iv) Other than in Approved Investments to be Not exceeding 15%
governed by Exposure/ Prudential Norms
specified in Regulation 5#

* Schedule I is a part of the Notification issued by the IRDA for all Insurance companies in
India. This Schedule lists the approved investments for all businesses providing life
insurance in India.

# Regulation 5 is a section in the Notification issued by the IRDA for all Insurance
companies in India. The section lays down exposure and prudential norms with respect to
investments in shares, bonds, debentures, long term and short term loans.

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(2) Pension and General Annuity Business: Every insurer shall maintain invested assets of
Pension Business, General Annuity Business and Group Business in the following manner:

S.No Type of Investment Percentage

i) Government securities, being not less than 20%
ii) Government Securities or other approved securities 40%
inclusive of (i) above, being not less than
iii) Balance to be invested in Approved Investments as Not exceeding 60%
specified in Schedule I* and to be governed by Exposure/
Prudential Norms specified in Regulation 5#

(3) General Business: Every insurer carrying on the business of general insurance has to invest
and maintain investments in the manner given below:

S.No Type of Investment Percentage

i) Central Government Securities, being not less than 20%
ii) State Government securities and other Guaranteed securities 30%
including (i) above, being not less than
iii) Housing and Loans to State Government for Housing and 5%
Fire Fighting equipment, being not less than
iv) Investments in Approved Investments as specified in Schedule II **
a) Infrastructure and Social Sector Not less than
10%
b) Others to be governed by Exposure/ Prudential Norms Not exceeding
specified in Regulation 5 30%
v) Other than in Approved Investments to be governed by Not exceeding
Exposure/ Prudential Norms specified in Regulation 5 25%
** Schedule II lists the approved investments for companies providing general Insurance
in India.

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 CURRENT PLAYERS

In the first year of insurance market liberalisation (April 2-December 31, 2001) as much as 16
private sector companies including joint ventures with leading foreign insurance companies
have entered the Indian insurance sector. Of this, 10 were under the life insurance category and
six under general insurance. Since then, till June, 2002 two more joined the life insurance sector.
Thus in all there are 18 players (12 life insurance and 6 general insurance) in the Indian
insurance industry till date.

Life Insurance Companies:

• Life Insurance Corporation of India

• ICICI Prudential
• HDFC Standard Life Insurance
• Max New York Life
• Birla Sun Life Insurance
• SBI Life
• Tata AIG Insurance
• ING Vysya Life Insurance
• Allianz Bajaj
• Amp Sanmar
• Old Kotak Mahindra Life
• MetLife India Insurance

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General Insurance Companies:
• Bajaj Allianz General Insurance Co. Ltd
• ICICI Limited
• IFFCO-TOKIO General Insurance
• National Insurance
• New India Insurance
• United Insurance
• Oriental Insurance
• Royal Sundaram
• TATA AIG Insurance

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 DISTRIBUTION CHANNELS

In the liberalized insurance market, there will be multiple distribution channels, which will
include agents, brokers, corporate intermediaries, bank branches, affinity groups and direct
marketing through telesales and Internet. Some channels will be cheaper than others. Hence
there will be competition among the channels. The new insurers will operate with the help of
multiple distribution channels but the existing insurers may be forced to operate only with the
help of agents. Hence, intense competition will grow among the old and new insurers in the
market to win the consumers. Firms will need to forge relationships with the partners for
strategic advantage. They need to have strong partner relationship management. For example,
local partners may have strong distribution channel in their line of business. That can be used to
sell insurance also in a cost-effective manner.

All these will pose a great challenge to the insurers in the liberalized insurance market.

DISTRIBUTION THROUGH BANKS

Distribution of insurance products through banks are considered to be the most popular banks
are considered to be the most popular medium as the private players prefer to utilise the wide
network of banks for the distribution of insurance policies in India.

Like in the European market, bancassurance can be an effective channel. In countries like Italy,
France and Spain, insurance companies have taken advantage of customers' typical loyalty to
single banks and pattern of long-term banking relationships by successfully selling their
products through these banks. Here banks can leverage their existing resources and earn
supplementary fees while widening their range of available services. In the face of strong
profitability pressures in their traditional banking services, banks will likely seize upon
opportunities to expand their offerings by including insurance products.

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DISTRIBUTION THROUGH INSURANCE AGENTS

Insurance agents and development officers provide another vital link in insurance selling and
various surveys have proven this aspect. These intermediaries help the insurance companies to
keep in touch with policyholders, assist claimants, and act as advisors to those who invest their
claim proceeds.

NEW CHANNELS

Other approaches, like call-center, direct marketing, and the Internet will grow dramatically in
importance over the next several years. These ensure direct contact with the customers. It will
enable firms to acquire, retain and build loyalty among customers while lowering transaction
costs. To make multiple channel delivery work, all channels must be integrated tightly to deliver
on the promise of service anytime, anywhere. Information gathered by each channel must be
combined to provide a consolidated view of the customer relationship and identify likely
financial needs. The online media is definitely considered to be one of the most effective modes
of distribution as a number of websites have already started offering policies online. At present,
12 per cent of the world's insurance products are sold through the Internet, a figure likely to
grow exponentially with a likely increase in customer usage of the Internet for their own
research and product comparisons.

Extensive use of information technology can make the role of these intermediaries more
effective and buyer-friendly.

OTHER MODES OF DISTRIBUTION

Marketing alliances with people/companies having a strong physical presence is gaining

popularity and is considered to be a good distribution strategy as well.

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CHALLENGES BEFORE THE INDUSTRY

The new as well as the old insurers will have to face a number of challenges in the liberalized
market.

New Insurers
The new insurers will have to invest a minimum capital of Rs. 100 crores. The normal gestation
period is of five years. The generation of profit normally starts in the sixth year. Hence the new
insurers will have to be ready for locking up their capital for at least 5 years before earning any
profits. Besides they will face problems of shortage of trained manpower for the insurance
industry. The setting up of various offices and distribution network is a time consuming process.
Further the new insurers will have to compete with the established insurance companies like LIC
and GIC which have a corporate image and market presence for several years.

Expectation of the consumers

Today LIC has more than 60 products and GIC has more than 180 products to offer in the
market. But most of them are outdated, as they are not suitable to the needs of the consumers.
Hence old as well as new insurers will have to offer innovative products to the consumers. The
consumers are particularly expecting good pension plans, health insurance, term insurance and
investment products like unit-linked insurance, from the life insurers. Similarly the consumers
expect innovative products from the general insurers for managing healthcare, property
insurance, accident insurance and other products related to the personal line of insurance.

The consumers also expect reduction in the premium of the insurance products as the mortality
rate in India has come down by three times in the last 50 years.

Distribution Channel
In the liberalized insurance market, there will be multiple distribution channels, which will
include agents, brokers, corporate intermediaries, bank branches, affinity groups and direct

25
marketing through telesales and Internet. Some channels will be cheaper than others. Hence
there will be competition among the channels. The new insurers will operate with the help of
multiple distribution channels but the existing insurers may be forced to operate only with the
help of agents. Hence, intense competition will grow among the old and new insurers in the
market to win the consumers. This will pose a great challenge to the insurers in the liberalized
insurance market.

Consumer Education
Very soon the market will be flooded by a large number of products by a fairly large number of
insurers operating in the Indian market. Even with limited range of products offered by LIC and
GIC, the consumers are confused in the market. Their confusion will further increase in the face
of a large number of products in the market. The existing level of awareness of the consumers
for insurance products is very low, it is so because only 62% of the population of India is
literate and less than 10% well educated. Even the educated consumers are ignorant about the
various products of insurance. Hence it is necessary that all the insurers should undertake the
extensive plan for education of consumers. The consumer organizations and the media also can
play very important role in education of the consumers. This will result in expansion of the
insurance market and will also enable the needy consumer to purchase appropriate products.

Consumer Grievance Redressal

The insurers will have to face an acute problem of the redressal of the consumers, grievances for
deficiency in products and services. The Insurance Regulatory Development Authority (IRDA),
the regulatory body has already appointed Ombudsman for looking into the grievances of the
policyholders, his judgement will be binding on insurers. Further, under Consumer Protection
Act 1986, the consumer courts are operating at district, state and the national level. In the
competitive market, awareness level of the consumers will increase and it will help consumers to
fight for their legal right for deficiency in services. Hence the number of legal cases filed by the
consumers against insurers is likely to increase substantially in future. This will be a challenge
to the insurers.

26
27
 FUTURE SCENARIO OF INSURANCE INDUSTRY

The size of the existing insurance market is very large and is growing at the rate of 10% per
year. The estimated potential of the Indian insurance market in terms of premium was around
Rs. 3,44,000 crores in the year 1999. Only 10% of the market share has been tapped by LIC and
GIC and the balance 90% of the market still remains untapped.

This vast potential can be tapped only by a large number of insurers. To serve 100 crores of
population, Indian insurance market offers tremendous opportunities to prospective insurers.
Hence, the regulator should issue licenses to a large number of insurers if the insurance market
has to grow at a fast rate.

With the increase in the life span of individuals and disintegration of the joint family system,
each Individual now has arranged insurance cover for himself and for his family. Hence,
coverage of insurers, which was around 7% of the population in 1999, has to grow very fast. In
fact all the citizens in the middle class, estimated around 314 million can afford insurance from
their own financial resources. The remaining population has to be given subsidized insurance
with the help of the government as well as the insurers.

The huge fund from insurance investments can be utilized for financing the infrastructure
industry as well as a support to other industries in the country. Hence insurance industry is likely
to play a key role in changing the economic landscape of the country. However the success of
the insurance industry will primarily depend upon meeting the rising expectations of the
consumers who will be the real king in the liberalized insurance market in future.

28
Mutual Funds

29
All About Mutual Funds

Before we understand what is mutual fund, it’s very important to know the area in which
mutual funds works, the basic understanding of stocks and bonds.

Stocks: Stocks represent shares of ownership in a public company. Examples of public

companies include Reliance, ONGC and Infosys. Stocks are considered to be the most common
owned investment traded on the market.

Bonds: Bonds are basically the money which you lend to the government or a company, and in
return you can receive interest on your invested amount, which is back over predetermined
amounts of time. Bonds are considered to be the most common lending investment traded on the
market. There are many other types of investments other than stocks and bonds (including
annuities, real estate, and precious metals), but the majority of mutual funds invest in stocks
and/or bonds.

What Is Mutual Fund

A mutual fund is just the connecting bridge or a financial intermediary that allows a
group of investors to pool their money together with a predetermined investment objective. The
mutual fund will have a fund manager who is responsible for investing the gathered money into
specific securities (stocks or bonds). When you invest in a mutual fund, you are buying units or
portions of the mutual fund and thus on investing becomes a shareholder or unit holder of the
fund.

Mutual funds are considered as one of the best available investments as compare to
others they are very cost efficient and also easy to invest in, thus by pooling money together in a
mutual fund, investors can purchase stocks or bonds with much lower trading costs than if they
tried to do it on their own. But the biggest advantage to mutual funds is diversification, by
minimizing risk & maximizing returns.

30
 Thus a Mutual Fund is the most suitable investment for the common man as it offers an
opportunity to invest in a diversified, professionally managed basket of securities at a relatively
low cost. The flow chart below describes broadly the working of a mutual fund

Unit Trust of India is the first Mutual Fund set up under a separate act, UTI Act in 1963,
and started its operations in 1964 with the issue of units under the scheme US-64.
Overview of existing schemes existed in mutual fund category

Wide variety of Mutual Fund Schemes exists to cater to the needs such as financial
position, risk tolerance and return expectations etc. The table below gives an overview into the
existing types of schemes in the Industry.

Type of Mutual Fund Schemes

BY STRUCTURE

Open Ended Schemes

An open-end fund is one that is available for subscription all through the year. These do
not have a fixed maturity. Investors can conveniently buy and sell units at Net Asset Value
("NAV") related prices. The key feature of open-end schemes is liquidity.

Close Ended Schemes

A closed-end fund has a stipulated maturity period which generally ranging from 3 to 15
years. The fund is open for subscription only during a specified period. Investors can invest in
the scheme at the time of the initial public issue and thereafter they can buy or sell the units of
the scheme on the stock exchanges where they are listed. In order to provide an exit route to the
investors, some close-ended funds give an option of selling back the units to the Mutual Fund
through periodic repurchase at NAV related prices. SEBI Regulations stipulate that at least one
of the two exit routes is provided to the investor.

Interval Schemes
Interval Schemes are that scheme, which combines the features of open-ended and close-
ended schemes. The units may be traded on the stock exchange or may be open for sale or
redemption during pre-determined intervals at NAV related prices

31
BY NATURE

1. Equity fund:

These funds invest a maximum part of their corpus into equities holdings. The structure of
the fund may vary different for different schemes and the fund manager’s outlook on different
stocks. The Equity Funds are sub-classified depending upon their investment objective, as
follows:

• Diversified Equity Funds

• Mid-Cap Funds
• Sector Specific Funds
• Tax Savings Funds (ELSS)
Equity investments are meant for a longer time horizon, thus Equity funds rank high on the
risk-return matrix.

2. Debt funds:
The objective of these Funds is to invest in debt papers. Government authorities, private
companies, banks and financial institutions are some of the major issuers of debt papers. By
investing in debt instruments, these funds ensure low risk and provide stable income to the
investors. Debt funds are further classified as:

• Gilt Funds: Invest their corpus in securities issued by Government, popularly known as
Government of India debt papers. These Funds carry zero Default risk but are associated
with Interest Rate risk. These schemes are safer as they invest in papers backed by
Government.

• Income Funds: Invest a major portion into various debt instruments such as bonds,
corporate debentures and Government securities.

• MIPs: Invests maximum of their total corpus in debt instruments while they take
minimum exposure in equities. It gets benefit of both equity and debt market. These
scheme ranks slightly high on the risk-return matrix when compared with other debt
schemes.

• Short Term Plans (STPs): Meant for investment horizon for three to six months. These
funds primarily invest in short term papers like Certificate of Deposits (CDs) and
32
 Commercial Papers (CPs). Some portion of the corpus is also invested in corporate
debentures.

• Liquid Funds: Also known as Money Market Schemes, These funds provides easy
liquidity and preservation of capital. These schemes invest in short-term instruments like
Treasury Bills, inter-bank call money market, CPs and CDs. These funds are meant for
short-term cash management of corporate houses and are meant for an investment
horizon of 1day to 3 months. These schemes rank low on risk-return matrix and are
considered to be the safest amongst all categories of mutual funds.

3. Balanced funds: As the name suggest they, are a mix of both equity and debt funds. They
invest in both equities and fixed income securities, which are in line with pre-defined investment
objective of the scheme. These schemes aim to provide investors with the best of both the
worlds. Equity part provide growth and the debt part provides stability in returns.

Further the mutual funds can be broadly classified on the basis of investment parameter viz,
Each category of funds is backed by an investment philosophy, which is pre-defined in the
objectives of the fund. The investor can align his own investment needs with the funds objective
and invest accordingly.

BY INVESTMENT OBJECTIVE
• Growth Schemes: Growth Schemes are also known as equity schemes. The aim of these
schemes is to provide capital appreciation over medium to long term. These schemes
normally invest a major part of their fund in equities and are willing to bear short-term
decline in value for possible future appreciation.

• Income Schemes: Income Schemes are also known as debt schemes. The aim of these
schemes is to provide regular and steady income to investors. These schemes generally
invest in fixed income securities such as bonds and corporate debentures. Capital
appreciation in such schemes may be limited.

• Balanced Schemes: Balanced Schemes aim to provide both growth and income by
periodically distributing a part of the income and capital gains they earn. These schemes

33
 invest in both shares and fixed income securities, in the proportion indicated in their
offer documents (normally 50:50).

• Money Market Schemes: Money Market Schemes aim to provide easy liquidity,
preservation of capital and moderate income. These schemes generally invest in safer,
short-term instruments, such as treasury bills, certificates of deposit, commercial paper
and inter-bank call money.

OTHER SCHEMES

• Tax Saving Schemes: Tax-saving schemes offer tax rebates to the investors under tax
laws prescribed from time to time. Under Sec.88 of the Income Tax Act, contributions
made to any Equity Linked Savings Scheme (ELSS) are eligible for rebate.
• Index Schemes: Index schemes attempt to replicate the performance of a particular
index such as the BSE Sensex or the NSE 50. The portfolio of these schemes will consist
of only those stocks that constitute the index. The percentage of each stock to the total
holding will be identical to the stocks index weightage. And hence, the returns from such
schemes would be more or less equivalent to those of the Index.
• Sector Specific Schemes: These are the funds/schemes which invest in the securities of
only those sectors or industries as specified in the offer documents. e.g. Pharmaceuticals,
Software, Fast Moving Consumer Goods (FMCG), Petroleum stocks, etc. The returns in
these funds are dependent on the performance of the respective sectors/industries. While
these funds may give higher returns, they are more risky compared to diversified funds.
Investors need to keep a watch on the performance of those sectors/industries and must
exit at an appropriate time.

Types of returns

34
There are three ways, where the total returns provided by mutual funds can be enjoyed by
investors:

• Income is earned from dividends on stocks and interest on bonds. A fund pays out nearly
all income it receives over the year to fund owners in the form of a distribution.
• If the fund sells securities that have increased in price, the fund has a capital gain. Most
funds also pass on these gains to investors in a distribution.
• If fund holdings increase in price but are not sold by the fund manager, the fund's shares
increase in price. You can then sell your mutual fund shares for a profit. Funds will also
usually give you a choice either to receive a check for distributions or to reinvest the
earnings and get more shares.

Pros & cons of investing in mutual funds:

For investments in mutual fund, one must keep in mind about the Pros and cons of
investments in mutual fund.

Advantages of Investing Mutual Funds:

1. Professional Management - The basic advantage of funds is that, they are professional
managed, by well qualified professional. Investors purchase funds because they do not have the
time or the expertise to manage their own portfolio. A mutual fund is considered to be relatively
less expensive way to make and monitor their investments.

2. Diversification - Purchasing units in a mutual fund instead of buying individual stocks or

bonds, the investors risk is spread out and minimized up to certain extent. The idea behind
diversification is to invest in a large number of assets so that a loss in any particular investment
is minimized by gains in others.

3. Economies of Scale - Mutual fund buy and sell large amounts of securities at a time, thus
help to reducing transaction costs, and help to bring down the average cost of the unit for their
investors.

35
4. Liquidity - Just like an individual stock, mutual fund also allows investors to liquidate their
holdings as and when they want.

5. Simplicity - Investments in mutual fund is considered to be easy, compare to other available

instruments in the market, and the minimum investment is small. Most AMC also have
automatic purchase plans whereby as little as Rs. 2000, where SIP start with just Rs.50 per
month basis.

36
Disadvantages of Investing Mutual Funds:

1. Professional Management- Some funds doesn’t perform in neither the market, as their
management is not dynamic enough to explore the available opportunity in the market, thus
many investors debate over whether or not the so-called professionals are any better than mutual
fund or investor himself, for picking up stocks.

2. Costs – The biggest source of AMC income, is generally from the entry & exit load which
they charge from an investors, at the time of purchase. The mutual fund industries are thus
charging extra cost under layers of jargon.

3. Dilution - Because funds have small holdings across different companies, high returns from a
few investments often don't make much difference on the overall return. Dilution is also the
result of a successful fund getting too big. When money pours into funds that have had strong
success, the manager often has trouble finding a good investment for all the new money.

4. Taxes - when making decisions about your money, fund managers don't consider your
personal tax situation. For example, when a fund manager sells a security, a capital-gain tax is
triggered, which affects how profitable the individual is from the sale. It might have been more
advantageous for the individual to defer the capital gains liability.

37
Mutual Funds Industry in India

The origin of mutual fund industry in India is with the introduction of the concept of mutual
fund by UTI in the year 1963. Though the growth was slow, but it accelerated from the year
1987 when non-UTI players entered the industry.

In the past decade, Indian mutual fund industry had seen a dramatic improvements, both quality
wise as well as quantity wise. Before, the monopoly of the market had seen an ending phase, the
Assets Under Management (AUM) was Rs. 67bn. The private sector entry to the fund family
rose the AUM to Rs. 470 in in March 1993 and till April 2004, it reached the height of 1,540 bn.

Putting the AUM of the Indian Mutual Funds Industry into comparison, the total of it is less than
the deposits of SBI alone, constitute less than 11% of the total deposits held by the Indian
banking industry.

The main reason of its poor growth is that the mutual fund industry in India is new in the
country. Large sections of Indian investors are yet to be intellectuated with the concept. Hence,
it is the prime responsibility of all mutual fund companies, to market the product correctly
abreast of selling.

The mutual fund industry can be broadly put into four phases according to the development of
the sector. Each phase is briefly described as under.

38
The major players in the Indian Mutual Fund Industry are:

Major Players of Mutual Funds In India

Period (Last&nbsp1 Week)

Ran Scheme Name Date NAV Last Since

k (Rs.) 1 Inceptio
Week n
1 JM Core 11 Fund - Series 1 - Mar 8.45 5.12 -94.64
Growth 26 ,
2008

2 Tata Indo-Global Mar 8.26 5.05 -40.42

Infrastructure Fund - 26 ,
Growth 2008

3 Tata Capital Builder Fund - Mar 12.44 5.03 15.35

Growth 26 ,
2008

4 Standard Chartered Mar 14.07 5 20.92

Enterprise Equity Fund - 26 ,
Growth 2008

5 DBS Chola Infrastructure Mar 9.01 4.65 -17.17

Fund - Growth 26 ,
2008

6 ICICI Prudential Fusion Mar 10.2 4.62 23.69

Fund - Series III - 26 ,
Institutional - Growth 2008

7 DSP Merrill Lynch Micro Mar 9.93 4.56 -0.85

Cap Fund - Regular - 26 ,
Growth 2008

8 ICICI Prudential Fusion Mar 10.19 4.51 22.39

Fund - Series III - Retail - 26 ,
Growth 2008

39
 9 DBS Chola Small Cap Fund Mar 6.36 3.75 -81.78
- Growth 26 ,
2008

10 Principal Personal Taxsaver Mar 124.6 3.44 29.97

25 , 6
2008

11 Benchmark Split Capital Mar 141.5 3.14 13.71

Fund - Plan A - Preferred 26 , 1
Units 2008

12 ICICI Prudential FMP - Mar 9.89 2.91 -7.88

Series 33 - Plan A - Growth 26 ,
2008

13 Tata SIP Fund - Series I - Mar 10.25 2.38 2.39

Growth 26 ,
2008

14 Sahara R.E.A.L Fund - Mar 7.64 1.86 -49.52

Growth 25 ,
2008

15 Tata SIP Fund - Series II - Mar 9.93 1.58 -0.94

Growth 26 ,
2008

A mutual fund is a professionally-managed firm of collective investments that pools money

from many investors and invests it in stocks, bonds, short-term money market instruments,
and/or other securities.in other words we can say that A Mutual Fund is a trust registered with
the Securities and Exchange Board of India (SEBI), which pools up the money from individual /
corporate investors and invests the same on behalf of the investors /unit holders, in equity
shares, Government securities, Bonds, Call money markets etc., and distributes the profits.
The value of each unit of the mutual fund, known as the net asset value (NAV), is mostly
calculated daily based on the total value of the fund divided by the number of shares currently
issued and outstanding. The value of all the securities in the portfolio in calculated daily. From
this, all expenses are deducted and the resultant value divided by the number of units in the fund
is the fund’s NAV.
40
 NAV = Total value of the fund……………….
No. of shares currently issued and outstanding

Advantages of a MF
– Mutual Funds provide the benefit of cheap access to expensive stocks

– Mutual funds diversify the risk of the investor by investing in a basket of assets

– A team of professional fund managers manages them with in-depth research

inputs from investment analysts.

– Being institutions with good bargaining power in markets, mutual funds have
access to crucial corporate information, which individual investors cannot access.

History of the Indian mutual fund industry:

The mutual fund industry in India started in 1963 with the formation of Unit Trust of India, at
the initiative of the Government of India and Reserve Bank. The history of mutual funds in India
can be broadly divided into four distinct phases.

First Phase – 1964-87

Unit Trust of India (UTI) was established on 1963 by an Act of Parliament by the Reserve Bank
of India and functioned under the Regulatory and administrative control of the Reserve Bank of
India. In 1978 UTI was de-linked from the RBI and the Industrial Development Bank of India
(IDBI) took over the regulatory and administrative control in place of RBI. The first scheme
launched by UTI was Unit Scheme 1964. At the end of 1988 UTI had Rs.6,700 crores of assets
under management.

Second Phase – 1987-1993 (Entry of Public Sector Funds)

1987 marked the entry of non- UTI, public sector mutual funds set up by public sector banks and
Life Insurance Corporation of India (LIC) and General Insurance Corporation of India (GIC).
SBI Mutual Fund was the first non- UTI Mutual Fund established in June 1987 followed by
41
Canbank Mutual Fund (Dec 87), Punjab National Bank Mutual Fund (Aug 89), Indian Bank
Mutual Fund (Nov 89), Bank of India (Jun 90), Bank of Baroda Mutual Fund (Oct 92). LIC
established its mutual fund in June 1989 while GIC had set up its mutual fund in December
1990.At the end of 1993, the mutual fund industry had assets under management of Rs.47,004
crores.

Third Phase – 1993-2003 (Entry of Private Sector Funds)

1993 was the year in which the first Mutual Fund Regulations came into being, under which all
mutual funds, except UTI were to be registered and governed. The erstwhile Kothari Pioneer
(now merged with Franklin Templeton) was the first private sector mutual fund registered in
July 1993.
The 1993 SEBI (Mutual Fund) Regulations were substituted by a more comprehensive and
revised Mutual Fund Regulations in 1996. The industry now functions under the SEBI (Mutual
Fund) Regulations 1996. As at the end of January 2003, there were 33 mutual funds with total
assets of Rs. 1,21,805 crores.

Fourth Phase – since February 2003

In February 2003, following the repeal of the Unit Trust of India Act 1963 UTI was bifurcated
into two separate entities. One is the Specified Undertaking of the Unit Trust of India with assets
under management of Rs.29,835 crores as at the end of January 2003, representing broadly, the
assets of US 64 scheme, assured return and certain other schemes
The second is the UTI Mutual Fund Ltd, sponsored by SBI, PNB, BOB and LIC. It is registered
with SEBI and functions under the Mutual Fund Regulations. consolidation and growth. As at
the end of September, 2004, there were 29 funds, which manage assets of Rs.153108 crores
under 421 schemes.

42
Categories of mutual funds:

Mutual funds can be classified as follow:

 Based on their structure:

• Open-ended funds: Investors can buy and sell the units from the fund, at any point of
time.

• Close-ended funds: These funds raise money from investors only once. Therefore, after
the offer period, fresh investments can not be made into the fund. If the fund is listed on

43
 a stocks exchange the units can be traded like stocks (E.g., Morgan Stanley Growth
Fund). Recently, most of the New Fund Offers of close-ended funds provided liquidity
window on a periodic basis such as monthly or weekly. Redemption of units can be
made during specified intervals. Therefore, such funds have relatively low liquidity.

 Based on their investment objective:

Equity funds: These funds invest in equities and equity related instruments. With
fluctuating share prices, such funds show volatile performance, even losses. However,
short term fluctuations in the market, generally smoothens out in the long term, thereby
offering higher returns at relatively lower volatility. At the same time, such funds can
yield great capital appreciation as, historically, equities have outperformed all asset
classes in the long term. Hence, investment in equity funds should be considered for a
period of at least 3-5 years. It can be further classified as:
i) Index funds- In this case a key stock market index, like BSE Sensex or Nifty is tracked.
Their portfolio mirrors the benchmark index both in terms of composition and individual stock
weightages.

ii) Equity diversified funds- 100% of the capital is invested in equities spreading across different
sectors and stocks.

iii) Dividend yield funds- it is similar to the equity diversified funds except that they invest in
companies offering high dividend yields.

iv) Thematic funds- Invest 100% of the assets in sectors which are related through some theme.
e.g. -An infrastructure fund invests in power, construction, cements sectors etc.

v) Sector funds- Invest 100% of the capital in a specific sector. e.g. - A banking sector fund will
invest in banking stocks.

vi) ELSS- Equity Linked Saving Scheme provides tax benefit to the investors.

Balanced fund: Their investment portfolio includes both debt and equity. As a result, on the
risk-return ladder, they fall between equity and debt funds. Balanced funds are the ideal mutual
funds vehicle for investors who prefer spreading their risk across various instruments. Following
are balanced funds classes:

i) Debt-oriented funds -Investment below 65% in equities.

ii) Equity-oriented funds -Invest at least 65% in equities, remaining in debt.

44
Debt fund: They invest only in debt instruments, and are a good option for investors averse to
idea of taking risk associated with equities. Therefore, they invest exclusively in fixed-income
instruments like bonds, debentures, Government of India securities; and money market
instruments such as certificates of deposit (CD), commercial paper (CP) and call money. Put
your money into any of these debt funds depending on your investment horizon and needs.

i) Liquid funds- These funds invest 100% in money market instruments, a large portion being
invested in call money market.

ii)Gilt funds ST- They invest 100% of their portfolio in government securities of and T-bills.

iii)Floating rate funds - Invest in short-term debt papers. Floaters invest in debt instruments
which have variable coupon rate.

iv)Arbitrage fund- They generate income through arbitrage opportunities due to mis-pricing
between cash market and derivatives market. Funds are allocated to equities, derivatives and
money markets. Higher proportion (around 75%) is put in money markets, in the absence of
arbitrage opportunities.

v)Gilt funds LT- They invest 100% of their portfolio in long-term government securities.

vi) Income funds LT- Typically, such funds invest a major portion of the portfolio in long-term
debt papers.

vii) MIPs- Monthly Income Plans have an exposure of 70%-90% to debt and an exposure of
10%-30% to equities.

viii)FMPs- fixed monthly plans invest in debt papers whose maturity is in line with that of the
fund.

45
Investment strategies:

1. Systematic Investment Plan: under this a fixed sum is invested each month on a fixed date
of a month. Payment is made through post dated cheques or direct debit facilities. The investor
gets fewer units when the NAV is high and more units when the NAV is low. This is called as
the benefit of Rupee Cost Averaging (RCA)

2. Systematic Transfer Plan: under this an investor invest in debt oriented fund and give
instructions to transfer a fixed sum, at a fixed interval, to an equity scheme of the same mutual
fund.

3. Systematic Withdrawal Plan: if someone wishes to withdraw from a mutual fund then he
can withdraw a fixed amount each month.

46
Risk v/s. return:

47
Working of a Mutual fund:

The entire mutual fund industry operates in a very organized way. The investors, known as unit
holders,handover their savings to the AMCs under various schemes. The objective of the
investment should match with the objective of the fund to best suit the investors’ needs. The

48
AMCs further invest the funds into various securities according to the investment objective.
The return generated from the investments is passed on to the investors or reinvested as
mentioned in the offer document.

Working Of Mutual Fund

Mutual Funds

Before we understand what is mutual fund, it’s very important to know the area in which
mutual funds works, the basic understanding of stocks and bonds.

Stocks : Stocks represent shares of ownership in a public company. Examples of public

companies include Reliance, ONGC and Infosys. Stocks are considered to be the most common
owned investment traded on the market.

Bonds : Bonds are basically the money which you lend to the government or a company, and in
return you can receive interest on your invested amount, which is back over predetermined
amounts of time. Bonds are considered to be the most common lending investment traded on the
market. There are many other types of investments other than stocks and bonds (including
annuities, real estate, and precious metals), but the majority of mutual funds invest in stocks
and/or bonds.

What Is Mutual Fund

A mutual fund is just the connecting bridge or a financial intermediary that allows a
group of investors to pool their money together with a predetermined investment objective. The
mutual fund will have a fund manager who is responsible for investing the gathered money into

49
specific securities (stocks or bonds). When you invest in a mutual fund, you are buying units or
portions of the mutual fund and thus on investing becomes a shareholder or unit holder of the
fund.

Mutual funds are considered as one of the best available investments as compare to
others they are very cost efficient and also easy to invest in, thus by pooling money together in a
mutual fund, investors can purchase stocks or bonds with much lower trading costs than if they
tried to do it on their own. But the biggest advantage to mutual funds is diversification, by
minimizing risk & maximizing returns.

Thus a Mutual Fund is the most suitable investment for the common man as it offers an
opportunity to invest in a diversified, professionally managed basket of securities at a relatively
low cost. The flow chart below describes broadly the working of a mutual fund

50
51
Overview of existing schemes existed in mutual fund category

Wide variety of Mutual Fund Schemes exists to cater to the needs such as financial
position, risk tolerance and return expectations etc. The table below gives an overview into the
existing types of schemes in the Industry.

52
Type of Mutual Fund Schemes

BY STRUCTURE

Open Ended Schemes

An open-end fund is one that is available for subscription all through the year. These do not
have a fixed maturity. Investors can conveniently buy and sell units at Net Asset Value ("NAV")
related prices. The key feature of open-end schemes is liquidity.

Close Ended Schemes

A closed-end fund has a stipulated maturity period which generally ranging from 3 to 15
years. The fund is open for subscription only during a specified period. Investors can invest in
the scheme at the time of the initial public issue and thereafter they can buy or sell the units of
the scheme on the stock exchanges where they are listed. In order to provide an exit route to the
investors, some close-ended funds give an option of selling back the units to the Mutual Fund
through periodic repurchase at NAV related prices. SEBI Regulations stipulate that at least one
of the two exit routes is provided to the investor.

Interval Schemes

Interval Schemes are that scheme, which combines the features of open-ended and close-
ended schemes. The units may be traded on the stock exchange or may be open for sale or
redemption during pre-determined intervals at NAV related prices.

53
BY NATURE

Under this the mutual fund is categorized on the basis of Investment Objective. By nature the
mutual fund is categorized as follow:

54
1. Equity fund:

55
 These funds invest a maximum part of their corpus into equities holdings. The structure of
the fund may vary different for different schemes and the fund manager’s outlook on different
stocks. The Equity Funds are sub-classified depending upon their investment objective, as
follows:

• Diversified Equity Funds

• Mid-Cap Funds
• Sector Specific Funds
• Tax Savings Funds (ELSS)
Equity investments are meant for a longer time horizon, thus Equity funds rank high on the
risk-return matrix.

2. Debt funds:
The objective of these Funds is to invest in debt papers. Government authorities, private
companies, banks and financial institutions are some of the major issuers of debt papers. By
investing in debt instruments, these funds ensure low risk and provide stable income to the
investors. Debt funds are further classified as:

• Gilt Funds: Invest their corpus in securities issued by Government, popularly known as
Government of India debt papers. These Funds carry zero Default risk but are associated
with Interest Rate risk. These schemes are safer as they invest in papers backed by
Government.

• Income Funds: Invest a major portion into various debt instruments such as bonds,
corporate debentures and Government securities.

• MIPs: Invests maximum of their total corpus in debt instruments while they take
minimum exposure in equities. It gets benefit of both equity and debt market. These
scheme ranks slightly high on the risk-return matrix when compared with other debt
schemes.

• Short Term Plans (STPs): Meant for investment horizon for three to six months. These
funds primarily invest in short term papers like Certificate of Deposits (CDs) and
Commercial Papers (CPs). Some portion of the corpus is also invested in corporate
debentures.

56
 • Liquid Funds: Also known as Money Market Schemes, These funds provides easy
liquidity and preservation of capital. These schemes invest in short-term instruments like
Treasury Bills, inter-bank call money market, CPs and CDs. These funds are meant for
short-term cash management of corporate houses and are meant for an investment
horizon of 1day to 3 months. These schemes rank low on risk-return matrix and are
considered to be the safest amongst all categories of mutual funds.

3. Balanced funds: As the name suggest they, are a mix of both equity and debt funds. They
invest in both equities and fixed income securities, which are in line with pre-defined investment
objective of the scheme. These schemes aim to provide investors with the best of both the
worlds. Equity part provides growth and the debt part provides stability in returns.

Further the mutual funds can be broadly classified on the basis of investment parameter viz,
Each category of funds is backed by an investment philosophy, which is pre-defined in the
objectives of the fund. The investor can align his own investment needs with the funds objective
and invest accordingly.

BY INVESTMENT OBJECTIVE

• Growth Schemes: Growth Schemes are also known as equity schemes. The aim of these
schemes is to provide capital appreciation over medium to long term. These schemes
normally invest a major part of their fund in equities and are willing to bear short-term
decline in value for possible future appreciation.

• Income Schemes: Income Schemes are also known as debt schemes. The aim of these
schemes is to provide regular and steady income to investors. These schemes generally
invest in fixed income securities such as bonds and corporate debentures. Capital
appreciation in such schemes may be limited.

• Balanced Schemes: Balanced Schemes aim to provide both growth and income by
periodically distributing a part of the income and capital gains they earn. These schemes

57
 invest in both shares and fixed income securities, in the proportion indicated in their
offer documents (normally 50:50).

• Money Market Schemes: Money Market Schemes aim to provide easy liquidity,
preservation of capital and moderate income. These schemes generally invest in safer,
short-term instruments, such as treasury bills, certificates of deposit, commercial paper
and inter-bank call money.

OTHER SCHEMES

• Tax Saving Schemes: Tax-saving schemes offer tax rebates to the investors under tax
laws prescribed from time to time. Under Sec.88 of the Income Tax Act, contributions
made to any Equity Linked Savings Scheme (ELSS) are eligible for rebate.
• Index Schemes: Index schemes attempt to replicate the performance of a particular
index such as the BSE Sensex or the NSE 50. The portfolio of these schemes will consist
of only those stocks that constitute the index. The percentage of each stock to the total
holding will be identical to the stocks index weightage. And hence, the returns from such
schemes would be more or less equivalent to those of the Index.
• Sector Specific Schemes: These are the funds/schemes which invest in the securities of
only those sectors or industries as specified in the offer documents. e.g. Pharmaceuticals,
Software, Fast Moving Consumer Goods (FMCG), Petroleum stocks, etc. The returns in
these funds are dependent on the performance of the respective sectors/industries. While
these funds may give higher returns, they are more risky compared to diversified funds.
Investors need to keep a watch on the performance of those sectors/industries and must
exit at an appropriate time.

Types of returns:

There are three ways, where the total returns provided by mutual funds can be enjoyed by
investors:

58
 • Income is earned from dividends on stocks and interest on bonds. A fund pays out nearly
all income it receives over the year to fund owners in the form of a distribution.
• If the fund sells securities that have increased in price, the fund has a capital gain. Most
funds also pass on these gains to investors in a distribution.
• If fund holdings increase in price but are not sold by the fund manager, the fund's shares
increase in price. You can then sell your mutual fund shares for a profit. Funds will also
usually give you a choice either to receive a check for distributions or to reinvest the
earnings and get more shares.

Pros & cons of investing in mutual funds:

For investments in mutual fund, one must keep in mind about the Pros and cons of
investments in mutual fund.

Advantages of Investing Mutual Funds:

1. Professional Management - The basic advantage of funds is that, they are professional
managed, by well qualified professional. Investors purchase funds because they do not have the
time or the expertise to manage their own portfolio. A mutual fund is considered to be relatively
less expensive way to make and monitor their investments.

2. Diversification - Purchasing units in a mutual fund instead of buying individual stocks or

bonds, the investors risk is spread out and minimized up to certain extent. The idea behind
diversification is to invest in a large number of assets so that a loss in any particular investment
is minimized by gains in others.

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3. Economies of Scale - Mutual fund buy and sell large amounts of securities at a time, thus
help to reducing transaction costs, and help to bring down the average cost of the unit for their
investors.

4. Liquidity - Just like an individual stock, mutual fund also allows investors to liquidate their
holdings as and when they want.

5. Simplicity - Investments in mutual fund is considered to be easy, compare to other available

instruments in the market, and the minimum investment is small. Most AMC also have
automatic purchase plans whereby as little as Rs. 2000, where SIP start with just Rs.50 per
month basis.

Disadvantages of Investing Mutual Funds:

1. Professional Management- Some funds doesn’t perform in neither the market, as their
management is not dynamic enough to explore the available opportunity in the market, thus
many investors debate over whether or not the so-called professionals are any better than mutual
fund or investor himself, for picking up stocks.

2. Costs – The biggest source of AMC income, is generally from the entry & exit load which
they charge from an investors, at the time of purchase. The mutual fund industries are thus
charging extra cost under layers of jargon.

3. Dilution - Because funds have small holdings across different companies, high returns from a
few investments often don't make much difference on the overall return. Dilution is also the
result of a successful fund getting too big. When money pours into funds that have had strong
success, the manager often has trouble finding a good investment for all the new money.

4. Taxes - when making decisions about your money, fund managers don't consider your
personal tax situation. For example, when a fund manager sells a security, a capital-gain tax is

60
triggered, which affects how profitable the individual is from the sale. It might have been more
advantageous for the individual to defer the capital gains liability.

Guidelines of the SEBI for Mutual Fund Companies :

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To protect the interest of the investors, SEBI formulates policies and regulates the mutual
funds. It notified regulations in 1993 (fully revised in 1996) and issues guidelines from time to
time.

SEBI approved Asset Management Company (AMC) manages the funds by making
investments in various types of securities. Custodian, registered with SEBI, holds the securities
of various schemes of the fund in its custody.
According to SEBI Regulations, two thirds of the directors of Trustee Company or board of
trustees must be independent.
The Association of Mutual Funds in India (AMFI) reassures the investors in units of mutual
funds that the mutual funds function within the strict regulatory framework. Its objective is to
increase public awareness of the mutual fund industry. AMFI also is engaged in upgrading
professional standards and in promoting best industry practices in diverse areas such as
valuation, disclosure, transparency etc.

Documents required (PAN mandatory):

Proof of identity :

1. Photo PAN card

2. In case of non-photo PAN card in addition to copy of PAN card any one of the following:
driving license/passport copy/ voter id/ bank photo pass book.
Proof of address (any of the following ) :latest telephone bill, latest electricity bill, Passport,
latest bank passbook/bank account statement, latest Demat account statement, voter id, driving
license, ration card, rent agreement.

Offer document: An offer document is issued when the AMCs make New Fund Offer(NFO).
Its advisable to every investor to ask for the offer document and read it before investing. An
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63
ULIPS

64
PLATFORMS OF LIFE INSURANCE- UNIT LINKED INSURANCE PLANS

World over , insurance come in different forms and shapes . although the generic names may
find similar , the difference in product features makes one wonder about the basis on which
these products are designed .With insurance market opened up , Indian customer has suddenly
found himself in a market place where he is bombarded with a lot of jargon as well as marketing
gimmicks with a very little knowledge of what is happening . This module is aimed at clarifying
these underlying concepts and simplifying the different products available in the market.

We have many products like Endowment , Whole life , Money back etc. All these products are
based on following basic platforms or structures viz.
➢ Traditional Life
➢ Universal Life or Unit Linked Policies

TRADITIONAL LIFE – AN OVERVIEW

The basic and widely used form of design is known as Traditional Life Platform. It is based on
the concept of sharing . Each of the policy holder contributes his contribution (premium) into the
common large fund is managed by the company on behalf of the policy holders.

Administration of that common fund in the interest of everybody was entrusted to the insurance
company .It was the responsibility of the company to administer schemes for benefit of the
policyholders. Policyholders played a very passive roll . In the course of time , the same concept
of sharing and a common fund was extended to different areas like saving , investment etc.

65
FEATURES OF TL :

 This is the simplest way of designing product as far as concerned. He has no other
responsibility but to pay the premium regularly.
 Company is responsible for the protection as well as maximization of the policyholder’s
funds.
 There is a common fund where in all the premiums paid are accumulated. Expenses
incurred as well as claims paid are then taken out of this fund.
 Companies carry out the valuation of the fund periodically to ascertain the position. It is
also a practice to increase the minimum possible guarantee under a policy every year in
the form of declaring and attaching bonuses to the sum assured on the basis of this
valuation. Declaration of bonuses is not mandatory .
 Based on the end objective , companies may offer different plans like saving plans,
investment plans etc.(e.g. Endowment , SPWLIP)
It helps to maintain a smooth growth and protects against the vagaries of the market. In other
words it minimizes the risk of investments for an average individual. He shares his risk with a
group of like-minded individuals.

ULIP is the Product Innovation of the conventional Insurance product. With the decline in
the popularity of traditional Insurance products & changing Investor needs in terms of life
protection, periodicity, returns & liquidity, it was need of the hour to have an Instrument
that offers all these features bundled into one.

A Unit Link Insurance Policy (ULIP) is one in which the customer is provided with a life
insurance cover and the premium paid is invested in either debt or equity products or a
combination of the two. In other words, it enables the buyer to secure some protection for his
family in the event of his untimely death and at the same time provides him an opportunity to
earn a return on his premium paid. In the event of the insured person's untimely death, his
nominees would normally receive an amount that is the higher of the sum assured or the value of
the units (investments).

66
 To put it simply, ULIP attempts to fulfill investment needs of an investor with
protection/insurance needs of an insurance seeker. It saves the investor/insurance-seeker the
hassles of managing and tracking a portfolio or products. More importantly ULIPs offer
investors the opportunity to select a product which matches their risk profile.

Unit Linked Insurance Plans came into play in the 1960s and became very popular in Western
Europe and Americas. In India The first unit linked Insurance Plan , popularly known as ULIP –
Unit Linked Insurance Plan in India was brought out by Unit Trust Of India in the year 1971 by
entering into a group insurance arrangement with LIC o provide for life cover to the investors ,
while UTI , as a mutual was taking care of investing the unit holders money in the capital market
and giving them a fair return .

Subsequently in the year 1989 , another Unit Linked Product was launched by the LIC Mutual
Fund called by the name of “DHANARAKSHA” which was more or less on the line of ULIP of
UTI . Thereafter LIC itself came out with a Unit Linked Insurance Product known by name
“BIMA PLUS “ in the year 2001-02 .

Presently a number of private life insurance companies have launched Unit Linked Insurance
Products with a variety of new features.

TYPES OF ULIP

There are various unit linked insurance plans available in the market. However, the key ones are
pension, children, group and capital guarantee plans.

The pension plans come with two variations — with and without life cover — and are meant for
people who want to generate returns for their sunset years.

67
The children plans, on the other hand, are aimed at taking care of their educational and other
needs..
Apart from unit-linked plans for individuals, group unit linked plans are also available in the
market. The Group linked plans are basically designed for employers who want to offer certain
benefits for their employees such as gratuity, superannuation and leave encashment.

The other important category of ULIPs is capital guarantee plans. The plan promises the
policyholder that at least the premium paid will be returned at maturity. But the guaranteed
amount is payable only when the policy's maturity value is below the total premium paid by the
individual till maturity. However, the guarantee is not provided on the actual premium paid but
only on that portion of the premium that is net of expenses (mortality, sales and marketing,
administration).

How ULIPs work

ULIPs work on the lines of mutual funds. The premium paid by the client (less any charge) is
used to buy units in various funds (aggressive, balanced or conservative) floated by the
insurance companies. Units are bought according to the plan chosen by the policyholder. On
every additional premium, more units are allotted to his fund. The policyholder can also switch
among the funds as and when he desires. While some companies allow any number of free
switches to the policyholder, some restrict the number to just three or four. If the number is
exceeded, a certain charge is levied.
Individuals can also make additional investments (besides premium) from time to time to
increase the savings component in their plan. This facility is termed "top-up". The money parked
in a ULIP plan is returned either on the insured's death or in the event of maturity of the policy.
In case of the insured person's untimely death, the amount that the beneficiary is paid is the
higher of the sum assured (insurance cover) or the value of the units (investments). However,
some schemes pay the sum assured plus the prevailing value of the investments.

68
ULIP - KEY FEATURES

• Premiums paid can be single, regular or variable. The payment period too can be regular
or variable. The risk cover can be increased or decreased.

• As in all insurance policies, the risk charge (mortality rate) varies with age.

• The maturity benefit is not typically a fixed amount and the maturity period can be
advanced or extended.

• Investments can be made in gilt funds, balanced funds, money market funds, growth
funds or bonds.

• The policyholder can switch between schemes, for instance, balanced to debt or gilt to
equity, etc.

• The maturity benefit is the net asset value of the units.

• The costs in ULIP are higher because there is a life insurance component in it as well, in
addition to the investment component.

• Insurance companies have the discretion to decide on their investment portfolios.

• Being transparent the policyholder gets the entire episode on the performance of his
fund.

• ULIP products are exempted from tax and they provide life insurance.

• Provides capital appreciation.

69
 • Investor gets an option to choose among debt, balanced and equity funds.

USP of ULIPS

Insurance cover plus savings

ULIPs serve the purpose of providing life insurance combined with savings at market-linked
returns. To that extent, ULIPS can be termed as a two-in-one plan in terms of giving an
individual the twin benefits of life insurance plus savings.

Multiple investment options

ULIPS offer a lot more variety than traditional life insurance plans. So there are multiple options
at the individual’s disposal. ULIPS generally come in three broad variants:

 Aggressive ULIPS (which can typically invest 80%-100% in equities, balance in debt)

 Balanced ULIPS (can typically invest around 40%-60% in equities)

 Conservative ULIPS (can typically invest upto 20% in equities)

Although this is how the ULIP options are generally designed, the exact debt/equity allocations
may vary across insurance companies. Individuals can opt for a variant based on their risk
profile.

Flexibility

The flexibility with which individuals can switch between the ULIP variants to capitalise on
investment opportunities across the equity and debt markets is what distinguishes it from other
instruments. Some insurance companies allow a certain number of ‘free’ switches. Switching
also helps individuals on another front. They can shift from an Aggressive to a Balanced or a
Conservative ULIP as they approach retirement. This is a reflection of the change in their risk
appetite as they grow older.

Works like an SIP

Rupee cost-averaging is another important benefit associated with ULIPS. With an SIP,
individuals invest their monies regularly over time intervals of a month/quarter and don’t have
to worry about ‘timing’ the stock markets.
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HURDLES OF ULIP

NO STANDARDIZATION

All the costs are levied in ways that do not lend to standardisation. If one company calculates
administration cost by a formula, another levies a flat rate. If one company allows a range of the
sum assured (SA), another allows only a multiple of the premium. There was also the problem
of a varying cost structure with age

LACK OF FLEXIBILITY IN LIFE COVER

ULIP is known to be more flexible in nature than the traditional plans and, on most counts, they
are. However, some insurance companies do not allow the individual to fix the life cover that he
needs. These rely on a multiplier that is fixed by the insurer

OVERSTATING THE YIELD

Insurance companies work on illustrations. They are allowed to show you how much your
annual premium will be worth if it grew at 10 per cent per annum. But there are costs, so each
company also gives a post-cost return at the 10 per cent illustration, calling it the yield. some
companies were not including the mortality cost while calculating the yield. This amounts to
overstating the yield.

INTERNALLY MADE SALES ILLUSTRATION

During the process of collecting information, it was found that the sales benefit illustration
shown was not conforming to the Insurance Regulatory and Development Authority (Irda)
format. in many locations30 per cent return illustrations are still rampant

NOT ALL SHOW THE BENCHMARK RETURN

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To talk about returns without pegging them to a benchmark is misleading the customer. Though
most companies use Sensex, BSE 100 or the Nifty as the benchmark, or the measuring rod of
performance, some companies are not using any benchmark at all.

EARLY EXIT OPTIONS

The Ulip product works over the long term. The earlier the exit, the worse off is the investor
since he ends up redeeming a high-front-load product and is then encouraged to move into
another higher cost product at that stage. An early exit also takes away the benefit of
compounding from insured.

CREEPING COSTS

Since the investors are now more aware than before and have begun to ask for costs, some
companies have found a way to answer that without disclosing too much. People are now asking
how much of the premium will go to work. There are plans that are able to say 92 per cent will
be invested, that is, will have a front load of just 8 per cent. What they do not say is the much
higher policy administration cost that is tucked away inside (adjusted from the fund value).

While most insurance companies charge an annual fee of about Rs 600 as administration costs,
that stay fixed over time, there are plans that charge this amount, but it grows by as much as 5
per cent a year over time. There are others that charge a multiple of this amount and that too
grows

72
COMPARISON
BETWEEN ULIPS
AND MUTUAL
FUNDS

73
COMPARISON BETWEEN ULIPS AND MUTUAL FUNDS:

Unit Linked Insurance Policies (ULIPs) as an investment avenue are closest to mutual funds in
terms of their structure and functioning. As is the case with mutual funds, investors in ULIPs are
allotted units by the insurance company and a net asset value (NAV) is declared for the same on
a daily basis.

Similarly ULIP investors have the option of investing across various schemes similar to the ones
found in the mutual funds domain, i.e. diversified equity funds, balanced funds and debt funds to
name a few. Generally speaking, ULIPs can be termed as mutual fund schemes with an
insurance component.

However it should not be construed that barring the insurance element there is nothing
differentiating mutual funds from ULIPs.

Points of difference between the two:

1. Mode of investment/ investment amounts

Mutual fund investors have the option of either making lump sum investments or investing using
the systematic investment plan (SIP) route which entails commitments over longer time
horizons. The minimum investment amounts are laid out by the fund house.

ULIP investors also have the choice of investing in a lump sum (single premium) or using the
conventional route, i.e. making premium payments on an annual, half-yearly, quarterly or
monthly basis. In ULIPs, determining the premium paid is often the starting point for the
investment activity.

This is in stark contrast to conventional insurance plans where the sum assured is the starting
point and premiums to be paid are determined thereafter.

74
ULIP investors also have the flexibility to alter the premium amounts during the policy's tenure.
For example an individual with access to surplus funds can enhance the contribution thereby
ensuring that his surplus funds are gainfully invested; conversely an individual faced with a
liquidity crunch has the option of paying a lower amount (the difference being adjusted in the
accumulated value of his ULIP). The freedom to modify premium payments at one's
convenience clearly gives ULIP investors an edge over their mutual fund counterparts.

2. Expenses

In mutual fund investments, expenses charged for various activities like fund management, sales
and marketing, administration among others are subject to pre-determined upper limits as
prescribed by the Securities and Exchange Board of India.

For example equity-oriented funds can charge their investors a maximum of 2.5% per annum on
a recurring basis for all their expenses; any expense above the prescribed limit is borne by the
fund house and not the investors.

Similarly funds also charge their investors entry and exit loads (in most cases, either is
applicable). Entry loads are charged at the timing of making an investment while the exit load is
charged at the time of sale.

Insurance companies have a free hand in levying expenses on their ULIP products with no upper
limits being prescribed by the regulator, i.e. the Insurance Regulatory and Development
Authority. This explains the complex and at times 'unwieldy' expense structures on ULIP
offerings. The only restraint placed is that insurers are required to notify the regulator of all the
expenses that will be charged on their ULIP offerings.

Expenses can have far-reaching consequences on investors since higher expenses translate into
lower amounts being invested and a smaller corpus being accumulated. ULIP-related expenses
have been dealt with in detail in the article "Understanding ULIP expenses".

75
3. Portfolio disclosure

Mutual fund houses are required to statutorily declare their portfolios on a quarterly basis, albeit
most fund houses do so on a monthly basis. Investors get the opportunity to see where their
monies are being invested and how they have been managed by studying the portfolio.

There is lack of consensus on whether ULIPs are required to disclose their portfolios. During
our interactions with leading insurers we came across divergent views on this issue.

While one school of thought believes that disclosing portfolios on a quarterly basis is
mandatory, the other believes that there is no legal obligation to do so and that insurers are
required to disclose their portfolios only on demand.

Some insurance companies do declare their portfolios on a monthly/quarterly basis. However the
lack of transparency in ULIP investments could be a cause for concern considering that the
amount invested in insurance policies is essentially meant to provide for contingencies and for
long-term needs like retirement; regular portfolio disclosures on the other hand can enable
investors to make timely investment decisions.

4. Flexibility in altering the asset allocation

As was stated earlier, offerings in both the mutual funds segment and ULIPs segment are largely
comparable. For example plans that invest their entire corpus in equities (diversified equity
funds), a 60:40 allotment in equity and debt instruments (balanced funds) and those investing
only in debt instruments (debt funds) can be found in both ULIPs and mutual funds.

If a mutual fund investor in a diversified equity fund wishes to shift his corpus into a debt from
the same fund house, he could have to bear an exit load and/or entry load.

76
On the other hand most insurance companies permit their ULIP inventors to shift investments
across various plans/asset classes either at a nominal or no cost (usually, a couple of switches are
allowed free of charge every year and a cost has to be borne for additional switches).

Effectively the ULIP investor is given the option to invest across asset classes as per his
convenience in a cost-effective manner.

This can prove to be very useful for investors, for example in a bull market when the ULIP
investor's equity component has appreciated, he can book profits by simply transferring the
requisite amount to a debt-oriented plan.

5. Tax benefits

ULIP investments qualify for deductions under Section 80C of the Income Tax Act. This holds
good, irrespective of the nature of the plan chosen by the investor. On the other hand in the
mutual funds domain, only investments in tax-saving funds (also referred to as equity-linked
savings schemes) are eligible for Section 80C benefits.

Maturity proceeds from ULIPs are tax free. In case of equity-oriented funds (for example
diversified equity funds, balanced funds), if the investments are held for a period over 12
months, the gains are tax free; conversely investments sold within a 12-month period attract
short-term capital gains tax @ 10%.

Similarly, debt-oriented funds attract a long-term capital gains tax @ 10%, while a short-term
capital gain is taxed at the investor's marginal tax rate.

Despite the seemingly similar structures evidently both mutual funds and ULIPs have their
unique set of advantages to offer. As always, it is vital for investors to be aware of the nuances
in both offerings and make informed decisions.

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Investing in ulips? Remember …………

The high returns (above 20 per cent) are definitely not sustainable over a long term, as they
have been generated during the biggest bull run in recent stock market history.

The free hand given to ULIPs might prove risky if the timing of exit happens to coincide with a
bearish market phase, because of the inherently high equity component of these schemes.

While a debt-oriented ULIP scheme might be superior to a debt option in a conventional mutual
fund due to tax concessions that insurance companies enjoy, such tax incentives may not last.

Look beyond NAVs

The appreciation in the net asset value (NAV) of ULIPs barely indicate the actual returns earned
on your investment. The various charges on your policy are deducted either directly from
premiums before investing in units or collected on a monthly basis by knocking off units.

Either way, the charges do not affect the NAV; but the number of units in your account suffers.
You might have access to daily NAVs but your real returns may be substantially lower.

A rough calculation shows that if our investments earn a 12 per cent annualised return over a 20-
year period in a growth fund, when measured by the change in NAV, the real pre- tax returns
might be only 9 per cent. The shorter the term, the lower the real returns.

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How charges dent returns

An initial allocation charge is deducted from our premiums for selling, marketing and broker
commissions. These charges could be as high as 65 per cent of the first year premiums. Premium
allocation charges are usually very high (5-65 per cent) in the first couple of years, but taper off
later. The high initial charges mainly go towards funding agent commissions, which could be as
high as 40 per cent of the initial premium as per IRDA (Insurance Regulatory and Development
Authority) regulations.

The charges are higher for a linked plan than a non-linked plan, as the former require lot more
servicing than the latter, such as regular disclosure of investments, switches, re-direction of
premiums, withdrawals, and so on. Insurance companies have the discretion to structure their
expenses structure whereas a mutual fund does not have that luxury. The expense ratios in their
case cannot exceed 2.5 per cent for an equity plan and 2.25 per cent for a debt plan respectively.
The lack of regulation on the expense front works to the detriment of investors in ULIPs.

The front-loading of charges does have an impact on overall returns as we lose out on the
compounding benefit. Insurance companies explain that charges get evened out over a long
term. Thus we are forced to stay with the plan for a longer tenure to even out the effect of initial
charges as the shorter the tenure, the lower our real returns.

If we want to withdraw from the plan, you lose out, as you will have to pay withdrawal charges
up to a certain number of years.

In effect, when we lock in our money in a ULIP, despite the promise of flexibility and liquidity,
we are stuck with one fund management style. This is all the more reason to look for an
established track record before committing our hard-earned money.

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Evaluate alternative options

As an investor we have to evaluate alternative options that give superior returns before
considering ULIPs.

Insurance companies argue that comparing ULIPs with mutual funds is like comparing oranges
with apples, as the objectives are different for both the products.

Most ULIPs give us the choice of a minimum investment cover so that we can direct maximum
premiums towards investments.

Thus, both ULIPs and mutual funds target the same customers. If risk cover is your primary
objective, pure insurance plans are less expensive.

When we choose a mutual fund, we look for an established track record of three to five years of
consistent returns across various market cycles to judge a fund's performance.

It is early days for insurance companies on this score; investing substantially in linked plans
might not be advisable at this juncture.

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Try top-ups

Insurance companies allow us to make lump-sum investments in excess of the regular

premiums. These top-ups are charged at a much lower rate — usually one to two per cent. The
expenses incurred on a top-up including agent commissions are much lower than regular
premiums.

Some companies also give a credit on top-ups. For instance, if you pay in Rs 100 as a top up, the
actual allocation to units will be Rs 101. If you keep the regular premiums to the minimum and
increase your top ups, you can save up on charges, enhancing returns in the long run.

Reduce life cover

The price of the life cover attached to a ULIP is higher than a normal term plan. Risk charges
are charged on a daily or monthly basis depending on the daily amount at risk. Rates are not
locked and are charged on a one-year renewal basis.

Our life cover charges would depend on the accumulation in your investment account. As
accumulation increases, the amount at risk for the insurance company decreases. However, with
increasing age, the cost per Rs 1,000 sum assured increases, effectively increasing your overall
insurance costs. A lower life cover could yield better returns.

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Stay away from riders

Any riders, such as accident rider or critical illness rider, are also charged on a one-year renewal
basis. Opting for these riders with a plain insurance cover could provide better value for money.

ULIP's as an investment is a very good vehicle for wealth creation ,but way Unit Linked
Insurance schemes are sold by insurance company representative's and insurance advisors is not
correct.

ULIP's usually have following charges built into it :

a) Up-front Charges
b) Mortality Charges ( Charges for providing the risk cover for life)
c) Administrative Charges
d) Fund Management Charges

Mutual Fund's have the following charges :

a) Up-front charges ( Marketing, Advertising, distributors fee etc.)

b) Fund Management Charges ( expenses for managing your fund)

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A few aspects of investing in ULIPs versus mutual funds.

Liquidity

ULIPs score low on liquidity. According to guidelines of the Insurance Regulatory and
Development Authority (IRDA), ULIPs have a minimum term of five years and a minimum
lockin of three years. You can make partial withdrawals after three years. The surrender value of
a ULIP is low in the initial years, since the insurer deducts a large part of your premium as
marketing and distribution costs. ULIPs are essentially long-term products that make sense only
if your time horizon is 10 to 20 years.

Mutual fund investments, on the other hand, can be redeemed at any time, barring ELSS (equity-
linked savings schemes). Exit loads, if applicable , are generally for six months to a year in
equity funds. So mutual funds score substantially higher on liquidity.

Tax efficiency

ULIPs are often pitched as tax-efficient , because your investment is eligible for exemption
under Section 80C of the Income Tax Act (subject to a limit of Rs 1 lakh). But investments in
ELSS schemes of mutual funds are also eligible for exemption under the same section .Besides
the premium, the maturity amount in ULIPs is also tax-free , irrespective of whether the
investment was in a balanced or debt plan. So they do have an edge on mutual funds, as debt
funds are taxed at 10% without indexation benefits, and 20% with indexation benefits. The
point, though, is that if you invest in a debt plan through a ULIP, despite its tax-efficiency your
post-tax returns will be low, because of high front-end costs. Debt mutual funds don’t charge
such costs.

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Expenses

Insurance agents get high commissions for ULIPs, and they get them in the initial years, not
staggered over the term. So the insurer recovers most charges from you in the initial years, as it
risks a loss if the policy lapses. Typically , insurers levy enormous selling charges, averaging
more than 20% of the first year’s premium, and dropping to 10% and 7.5% in subsequent years.
(And this is after investors balked when charges were as high as 65%!) Compare this with
mutual funds’ fees of 2.25% on entry, uniform for all schemes. Different ULIPs have varying
charges, often not made clear to investors.

For instance, an agent who sells you a ULIP may get 25% of your first year’s premium, 10% in
the second year, 7.5% in the third and fourth year and 5% thereafter. If your annual premium is
Rs 10,000 and the agent’s commission in the first year is 25%, it means only Rs 7,500 of your
money is invested in the first year. So even if the NAV of the fund rises, say 20%, that year,
your portfolio would be worth only Rs 9,000—much lower than the Rs 10,000 you paid. On the
other hand, if you invest Rs 10,000 in an equity scheme with a 2.25% entry load, Rs 225 is
deducted , and the rest is invested. If the scheme’s NAV rises 20%, your portfolio is worth Rs
11,730. This shows how ULIPs work out expensive for investors. Deduct the cost of a term
policy from the mutual fund returns, and you’re still left with a sizeable difference.

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 CONCLUSION

The exhaustive research in the field of Life Insurance threw up some interesting trends which

can be seen in the above analysis. A general impression that I gathered during Data collection

was the immense awareness and knowledge among people about various companies and their

insurance products. People are beginning to look beyond LIC for their insurance needs and are

willing to trust private players with their hard earned money.

People in general have been impressed by the marketing and advertising campaigns of insurance

companies. A high penetration of print, radio and Television Ad campaigns over the years is

beginning to have it’s impact now.

Another heartening trend was in terms of people viewing insurance as a tax saving and

investment instrument as much as a protective one. A very high number of respondents have

opted for insurance for such purposes and it shows how insurance companies have been

successful to attract public money in recent times.

The general satisfaction levels among public with regards to policy and agents still requires

improvement. But therein lies the opportunity for a relative player like MetLife India

Insurance Co. Ltd. LIC has never been known for prompt service or customer oriented

methods and MetLife India Insurance Co. can build on these factors.

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Questionnaire

Personal Details :
Name : __________________________________________________
Address : __________________________________________________
Age : __________________________________________________
Contact No. : __________________________________________________
Profile of respondent:

Student Business

Housewife Self-Employed

Working Professional Government Service Employee

Date:_______________

Do you have a life insurance policy/investment plan in your name?

o Yes o No

If yes which company’s insurance policies do you hold?

o HDFC Standard Life Insurance o Birla Sun Life Insurance

o Aviva Life Insurance o Bajaj Allianz Life Insurance

o LIC o Tata AIG Life Insurance

o ICICI Prudential Life Insurance o ING Vysya Life Insurance

o Bharti Axa Life Insurance o Others (specify name)

______________________________

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What is the approximate premium paid by you annually (in Rupees)?

o Rs. 5,000 – Rs. 10,000 o Rs. 10,001 – Rs. 15,000

o Rs. 15,001 – Rs. 25,000 o Rs. 25,001 – Rs. 50,000

o Rs. 50,001 – Rs. 60,000 o Rs. 60,001 – Rs. 80,000

o Rs. 80,001 – Rs. 1,00,000

o More than Rs. 1,00,000 (specify premium) ____________________________

What kind of insurance policy would suit you best in your current stage of life?

o Life Insurance o Life Insurance and Investment Plans

o Pension Plans o Child Plans
o Tax saving plans
Are you aware of the new unit linked insurance plans in the market?

o Yes o No

How much would you be willing to spend per annum if you were to go for an

investment/insurance plan?

o Less than Rs. 6,000 o Rs. 6,001 – Rs. 10,000

o Rs. 10,001 – Rs. 25,000 o Rs. 25,001 – Rs. 50,000
o Rs. 50,000 – Rs. 1,00,000 o More than Rs. 1,00,000
Which according to you is an ideal policy term? (Number of years you would be willing to

pay premium)

o 3 to 5 years o 6 to 9 years
o 10 to 15 years o 16 to 20 years

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o 21 to 25 years o 26 to 30 years
o More than 30 years o Whole life policy

What motivates you to purchase insurance/investment plans?

o Advertisements o High Returns

o Advice from friends o Family responsibilities

o Others (specify)

In which kind of company would you prefer to make a purchase of insurance?

o Government owned company o Public Limited Company

o Private Company o Foreign based company

Typically what kind of returns would you look at from your investments? (Please note:

Higher returns involve greater risk)

o Less than 5% o 6% - 10 %

o 11% - 15 % o 16% - 20 %

o 21% - 25% o 26% - 30%

o 31% - 40% o 41% - 50%

o More than 50%

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Bibliography

 www.metlife.co.in
 www.irdaindia.org
 www.thehindubusinessline.com
 www.scribd.com

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