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Shyamal Banerjee/Mint
Shyamal Banerjee/Mint

How a persistency rate of 81% dropped to just 7% in FY15

You need to worry because insurance policies are front-loaded and when they lapse, you lose money

For the life insurance industry in India, getting customers to hold onto their policy remains an uphill task. A large part of the problem has to do with the fact that these policies are sold and bought for all the wrong reasons. And the impact so far has been disastrous. According to the financial year (FY) 2014-15 numbers reported in the handbook of statistics by Insurance Regulatory and Development Authority of India (Irdai), other than one (IDBI Federal Life Insurance Co. Ltd), the remaining 22 insurers were unable to retain even half the policies they sold five years back, and one ‘young’ insurer didn’t have five-year-old policies. Some companies lost as many as 93 of 100 policies sold (http://bit.ly/1SA4TZo ). This leakage should worry both you and the policymakers.

You need to worry because insurance policies are front-loaded and when they lapse, you lose money. If it’s a traditional plan (and not a unit-linked plan), you can lose all your money in the first two years. Policymakers must worry because an industry that’s worth about 3 trillion (in premiums) and which manages retail money is destroying value for customers by selling products in a way that most investors stop paying premium within five years.

For an industry in the business of selling long-term products, it’s important that customers continue to pay premiums and stay in the policy for the full term. This is key to sustainability and growth of the industry in the long haul, and good investor experience.

How long customers stay with their policies is measured by persistency ratio. This measures the number of policies that continue in the books of the insurer by the end of the first year (13th month persistency), second year (25th month persistency), third year (37th month persistency), fourth year (49th month persistency) and fifth year (61st month persistency).

Even as efforts are being made to improve persistency numbers, they continue to remain abysmal. For some, the 61st month persistency ratio is much worse compared to the last year. Shriram Life Insurance Co. Ltd, for instance, stood out when its FY14 and FY15 numbers were compared. Its 61st month persistency number was a decent 81% in FY14 but dropped like a large lemon to 7% in FY15. Canara HSBC Oriental Bank of Commerce Life Insurance Co. Ltd also saw a drop of 61st persistency from 81% in FY14 to 37% in FY15.

We faced some flak on Twitter for ‘misreporting’ data: how can an insurer that was able to retain 80% of its policies hold on to just 7% the next year, we were asked. Here’s what happened.

In 2014, Irdai standardised the method of reporting persistency. Those who continued to report using the lax method for FY14 but moved to the more transparent method in FY15, showed the drop.

Let’s understand this better. There are two methods to calculate persistency. The first method (the not so good one), called the reducing balance method, calculates the leakage from the preceding year and not from the year of sale. The second method (the prescribed one) calculates persistency on a cumulative balance basis. It calculates leakages from the year in which the policies were sold. Since the first method uses the preceding year as the base, persistency numbers can look good. For example, if a company sells 100 policies and only 70 get renewed after the first year, the first-year persistency ratio would be 70% under both the methods. At the end of the second year, if only 60 policies get renewed, then the 25th month persistency would be 86% under the first method (60 out of 70 policies) but 60% under the second method (60 out of 100 policies). If in the third year, 50 policies get renewed, the first method will show a persistency of 83% (50 out of 60) and the second method will show a persistency of 50% (50 out of 100). Just using a smaller denominator gives a higher persistency.

Why did the regulator allow two standards of reporting in the first place? Mint first asked this question in 2012 when we analysed persistency ratios (read more here: http://bit.ly/1SrARue and http://bit.ly/1rhju59 ). Our analysis was followed by an interview with the former insurance regulator, J. Hari Narayan, who made it clear that insurers need to follow the second method (read the interview here: http://bit.ly/1SOPAS8 ). This was nearly four years ago, but until FY15, some insurers continued to report numbers based on a reducing balance basis.

In fact, the persistency number can be a little worse than what we see because, according to insurers, they also include single-premium policies in the calculation. This may dilute the numbers in favour of an insurer with a large portfolio of single-premium policies. Such policies are one-shot investments and you can’t lapse them since no renewal premium is due. You can surrender them and if you do, it lowers the persistency. Insurers say that Irdai wants one number that tracks persistency and also factors in surrenders. So, if a policy, including a single-premium policy, is surrendered, the persistency will drop. But if one were to look at persistency and surrender numbers separately, the analysis will be more transparent. Persistency ratios should be further sliced, and if that is already done internally, the data should be made public, to look at persistency of specific products and distribution channels. The industry should actively adopt this metric in compensating distributors. It should be an ongoing work for the regulator.

Tracking persistency of life insurance policies is important because poor numbers point to shoddy sales practices of the industry, which should ring alarm bells.

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