(Photo: istock)
(Photo: istock)

Opinion | After all the noise, traditional insurance still isn’t customer-friendly

The cost of early surrender needs to be felt by insurers, intermediaries, not customers

Other than reasons of lack of transparency and complicated structures, a high exit load—charge levied for early exit—is what makes traditional bundled life insurance plans the least favourite among financial planners and Mint’s personal finance team. In fact, from data on persistency—which is the number that shows how many policies are renewed year after year—it appears that even customers have a change of heart and end up surrendering these plans despite the painfully high exit barriers.

As per the latest data on persistency for FY18, on an average, around 30% policyholders decided to move out of their policies after the first year; by the end of the fifth year, this number increased to around 65%. Given that the industry is dominated by traditional plans, it’s not hard to guess the products customers are choosing to surrender. 

Surrender costs in traditional plans have been an issue with the product right from the start but since the industry focused on unit-linked insurance plans (Ulips), the more transparent brethren of traditional plans, the issue got swept under the rug. Ulips too came with high surrender costs but a product clean-up initiated by J. Harinarayan, head of Insurance Regulatory and Development Authority of India (Irdai) in 2010, reduced these costs to a bare minimum: up to 6,000 if surrender occurred in the first year and zero in the fifth year.

The surrender costs could be brought down because overall expenses in the policy were capped. This, among other things, also meant spending less on customer acquisition and, therefore, less recovery in case of early exit. The industry obviously turned to traditional plans where the problem of surrender charges was graver. Until the rules changed in 2013, the typical cost of surrendering a traditional policy in the first three years was the entire premium. This meant the policy acquired a surrender value only after three annual premiums were paid. So if you paid an annual premium of, say, 1 lakh for two years and decided to quit after the second premium, you went home 2 lakh poorer. But if you quit after paying three premiums—that is if you paid 3 lakh—the minimum guaranteed surrender value was 30% of your premiums minus the first-year premium, netting 60,000. In other words, you paid 2.4 lakh as surrender costs.

Clearly the rules had to be changed, but this time the regulatory teeth didn’t bite much. Deliberated under Harinarayan but implemented under T.S. Vijayan, former head of Life Insurance Corp. of India who succeeded Harinarayan in early 2013, the new rules decreased the surrender costs but only slightly. The policy continued to acquire a surrender value after paying three premiums for policy term of at least 10 years, but what you got back was 30% of the premiums paid. High surrender costs have not pushed policyholders to stay put but has caused loss of reputation to the industry. This was admitted by the products committee report constituted by Vijayan towards the fag end of his tenor and this generated a new ray of hope.

But the new product guidelines issued on 15 July for non-linked plans by Irdai—now under Subhash C. Khuntia—continues to be more sympathetic towards the industry. Surrender costs have come down further, but even after the revision they continue to hurt. Now, as per the new rules, a policy acquires a surrender value after two annual premiums are paid, but the surrender charge is 70%. Subsequently, this cost comes down, but doesn’t drop to zero. Read more about it here

Of course, in case of a Ulip, it’s easier to dictate lower surrender costs because costs are spelt out and deducted from the fund value, and it’s the net asset value that is available for surrender. In fact, the new rules have also capped individual charges like the policy allocation charge (capped at 12.5% of the annual premium), policy administration charge (not more than 500 per month) and the cost of guarantee (not more than 0.5% of the fund value). In case of traditional plans, costs are not transparent but if one were to map the costs to Ulips, costs in traditional plans that gets reflected in surrender costs are huge. Irdai has so far shied away from wielding a heavy hand, but it’s about time to tip the scale in favour of a “sellers beware" market from a “buyers beware" market. In other words, the cost of early surrender needs to be felt by the insurer and the intermediary and not by the customer. Irdai can start with the nudge of a lock-in to dissuade early surrenders and subsequently reduce the surrender costs substantially to only recover insurance and other administrative costs.

And no, this will not encourage policy lapsation. Despite lower exit barriers in Ulips, some companies, which primarily sell Ulips, have reported above average persistency. 

Clearly, with costs contained and surrenders brought down, the focus is squarely on the renewal book of the business which is what a long-term vehicle such as life insurance is all about.

Deepti Bhaskaran is editor, personal finance at Mint

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