Mumbai: The insurance regulator’s move to cap surrender charges on unit-linked insurance plans, or Ulips, will hurt life insurers where it hurts the most. Insurers’ income could drop by as much as half because of the move, which may require them to infuse more capital and delay their break-even, industry executives and experts say.
Among other changes in Ulip norms, the Insurance Regulatory and Development Authority (Irda) on Monday ordered insurers to deduct only a discontinuance charge from a customer and return the remaining amount of premiums paid in case a policy is surrendered before the end of its term.
So far, insurers have been levying a surrender charge of as much as 100% of the premium paid by customers in case of an early exit.
The regulator has ordered that for exits in the first year, insurers cannot charge more than Rs3,000 or 20% of the annual premium or fund value, whichever is lower, for discontinuance of policies carrying a premium payment of Rs25,000 a year.
For policies with annual premiums in excess of Rs25,000, an insurer cannot charge more than Rs6,000 or 6% of the annual premium.
These charges keep declining in subsequent years and insurers cannot deduct more than Rs2,000 for policies surrendered in the fourth year. For estimating the proceeds of the discontinued policies, the fund value has to be calculated after addition of interest computed at the minimum yearly rate of 3.5%.
“The cap on surrender charges will hit the profitability of insurers by at least 50%,” said Amitabh Chaudhry, managing director and chief executive officer of HDFC Standard Life Insurance Co. Ltd.
India has 23 life insurers with combined assets worth Rs11 trillion. According to data from the Life Insurance Council, a grouping of life insurers, total premium income went up by 18% during the last fiscal to Rs2.61 trillion. New business premium income rose by 25% to Rs1.09 trillion. Around 90% of the new business premium came from Ulips, according to industry estimates.
Persistency levels—which reflects the proportion of policies that continue to generate renewal premiums—tend to be very low in India, according to Rohan Sachdev, partner, business and risk advisory services, at consultant Ernst and Young.
“So, many life insurers have been making huge money from surrender charges. For some companies, 40% of their incomes come by means of surrender charges,” he said.
“With Irda’s cap on surrender charges, the balance sheet of these companies will become heavy, and more capital infusion programmes will be required to sustain their business models,” he added.
The break-even period of insurers could be delayed by at least two years and their valuations affected significantly.
Ulips are hybrid financial products in which a part of the premium paid goes towards insurance cover and a portion gets invested in equities. Agent commissions of up to 35% has been encouraging the sales of such products until now.
In an effort to curb mis-selling, abolish front-loading of charges, increase insurance cover and ensure that policy-holders receive most of their investments back in the case of early surrender of Ulips, Irda on Monday introduced several sweeping changes.
“Surrender charges contribute to over half of the profit margin of companies. The cap would therefore considerably impact the margin and cash flows,” said Rajagopalan Krishnamurthy, managing director, insurance and financial services, at consultant Towers Watson.
“... In actuarial parlance, the longer period also raises the probability of revival of lapsed policies, which would mean potentially lower benefits that can be appropriated to the bottomline of companies. It (Irda’s move) would force life companies to re-evaluate their product portfolio, distribution and cost management aspects. Importantly, the changes would have profound impact on future valuation of companies and the return expectations of shareholders,” added Krishnamurthy.
For the past few years, as life insurers shifted their focus from new business premium collections to renewal premium and profitability, they curbed their capital infusion programmes in an attempt to reach break-even earlier. Companies may now have to start pumping in more capital.
“We were already planning a capital infusion of Rs300 crore for this year, but now the infusion amount will depend on the changes we adopt after Irda’s move,” said Chaudhry of HDFC Standard Life.
The reduction in surrender charges will have a “significant impact”, said G.V. Nageswara Rao, managing director and chief executive officer of IDBI Fortis Life Insurance Co. Ltd.
“It might need a fresh infusion of capital. It is difficult to judge how much at this stage,” he said.
Insurers will have to ensure that discontinuance charges reflect the actual expenses incurred by them under the new norms. In the absence of such a requirement, most policy-holders have been made to forfeit their entire investments for exiting policies prematurely.
The new guidelines will benefit consumers by lowering their costs and improving returns, said Deepak Sood, managing director and chief executive officer of Future Generali India Life Insurance Co. Ltd.
“In the medium to long run, these changes could seriously impact choice of investment options to customers, restrict product design-innovation, increase new business strain and call for increased capital requirements for insurers—thus impacting the profitability of insurers,” he said.