Like in other parts of Asia, unit-linked insurance plans (Ulips) have grown in enormous popularity in the Indian life insurance segment during the recent years. The total new business premium generated from Ulip sales for the year ended March 2009 was Rs447 billion, or 55% of total new business, as per reports of the Insurance Regulatory and Development Authority (Irda). This has grown to about Rs60,000 crore in the latest year. Private life companies generate over 90% of their business from single and regular premium Ulips.
In a regulatory directive issued in June this year that took the insurance market by storm, Irda has brought vast changes concerning Ulips forcing life insurance companies to completely rework their Ulip strategies. From September 2010, companies have been required to relaunch their Ulips. While there have been regulatory interventions in several countries following market aberrations, India possibly presents a more dynamic picture in this regard.
Reasons for regulatory changes
The regulator has chosen to apply several restrictions on Ulips for three main reasons.
Firstly, the high level of churning in Ulips and their low persistency ratio. In India, a strong motive to buy insurance is the income-tax remission on insurance premiums in the annual tax statement and the exemption of maturity value of insurance policies from tax. As a result, customers have bought Ulips as short-term investment without serious intention to continue the policy until the final maturity date.
According to Irda, the lapse rate on Ulips was 26% in FY06 (according to Towers Watson estimates, this has climbed much higher since then), and the 13-month persistency level of Ulips has significantly trailed the traditional plans. The low level of life cover embedded in Ulips and the ease of exit had contributed to an unhealthy growth in lapsation.
Secondly, the regulator considered that the low persistency has been tacitly encouraged by the insurers as they stand to gain from surrender charges, which have been as high as 70-90%. Thus the “profits” earned by shareholders from the surrender charges have fuelled aggressive distribution of Ulips, forming a vicious circle.
Thirdly, Ulip distributors have tended to indulge in product push with little effort to develop a long-term relationship with customers or make a needs-based analysis of their insurance needs. Customers have failed to recognize that insurance policy is an instrument of long-term protection and growth.
The distribution commission came into sharp focus in August 2009 when the securities market regulator issued a directive requiring asset management companies not to deduct any distribution and other charges from the investment amount of customers on mutual fund schemes with a view to encouraging retail participation. This “no entry load structure” has led to a drastic reduction in the commission earning of mutual fund distributors, many of whom turned to sell Ulips that fetched attractive commission.
Key impact of regulations
The impact of the new regulations will be felt in life companies in several areas: product strategy, distribution strategy and profitability.
On products, companies will have to consider expanding their product suite to include traditional plans, term and health insurance covers, among others. The minimum guaranteed return stipulated on pension products may act as a constraint and it would lead to lowering the allocation made to equity investments. Several insurers are known to be considering the traditional products option, along with innovative pension products.
On distribution, the spreading of charges over a period of years along with the proposed cap has had the effect of lowering the first year commission to intermediaries to about half the current level, along with increases in premium thresholds. This may lead to companies sharply pruning agency size and associated management costs as Ulip volumes reduce in the short-term. Companies will need to pay attention to enhancing agency productivity and developing strategies to reward agent and bank intermediaries based on better policy persistency and other parameters. The changes may also have an impact on branch networks, which companies have built aggressively over the recent years.
On profitability, the severe curtailing of surrender charges will make a dent on profitability and prolong the break-even period for many insurers. Increased new business strain may also lead to fresh capital calls and impact business valuations.
On a positive note, the new rules are expected to breathe fresh life into Ulips with customers regarding this product as more friendly and transparent than in the past. As longer-term investments, Ulips may no longer need to compete with mutual funds. Interest in subscribing to Ulips is now likely to spread among smaller towns and the less affluent population, expanding the market opportunity considerably. New technological innovations are also likely to offer Ulips at competitive rates through online and lower-cost servicing options.
While there are likely to be immense short-term pain, the new regulatory measures would work for the benefit of the industry in the medium-term, making the market bigger and more attractive for existing operators and potential entrants. Towers Watson would estimate that the Indian life insurance industry would grow by 12-15% in the medium term and that companies would come up with better customer segmentation and innovative distribution approaches. Ulips would continue to command a bulk of the sales pie once the market digests the regulatory medicine and appetites return.
Edited excerpts from an article by Rajagopalan Krishnamurthy, managing director (products, distribution and markets, India), Towers Watson in a newsletter titled Asia Pacific Insurance Matters. We welcome your comments at firstname.lastname@example.org
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