Opinion | Making sense of the business of life insurance

The Life Insurance Corp. of India (LIC) has been a partner of middle-class India for decades in building an annual saving habit towards a future corpus. Its army of agents provided doorstep service to millions of Indian investors at a time when there were few long-term corpus-building financial products in the country. But the feature of a monopoly, and that too owned by the government, is that it is slow to take note of change and upgrade processes and practices. The post-2010 Indian financial sector is very different from the 1980s and even 1990s with modern financial products and mark-to-market practices on equity, bond and loan valuations to ensure transparency and fairness. As of 31 March 2019, LIC managed almost 80% or ₹27.61 trillion of Indian household money in the life insurance sector, and had an annual premium book of just over ₹3 trillion in 2018-19, that’s about 66% of the total market. As this behemoth, also used by the government of the day to bail out its stock and bond paper, which carries a sovereign guarantee gets ready to list on the stock market, it is important that the business of life insurance is better understood by policyholders, investors and commentators.

In its simplest form, a life insurance policy is called a pure term plan that just insures the life and pays on death over the life of the policy. So ₹8,000-10,000 for a 30-year-old gets about ₹1 crore of cover. But this is a tiny part of the life insurance market in India since the agency network does not find it profitable to sell. About 15% of the Indian market is in the more transparent unit-linked insurance plans (Ulips) that have the structure of a mutual fund with a wrap of a life cover, the rest being in traditional plans. Ulips were introduced in India soon after the market opened to private entities in 2000 and brought better transparency to what goes on inside the product.

Ulips have a clear segregation since the premium is split into investible and non-investible parts. The non-investible part goes to the “non unit fund” that is used for the mortality costs, other expenses and profits on good actuarial pricing of lives. The investment part of the premium goes to the “unit fund”. The “non unit reserves” are used to pay death claims. If the insurance company gets its estimates wrong and faces a higher number of death claims, it needs to pay out of own reserves—it cannot dip into the investment pool. Also, the policyholder has a fairly clear idea of what costs and returns are since the product discloses the net asset value of the investment pool every day.

The story is much more muddled in traditional plans and LIC has 99.76% of its business in these more opaque products. There are two kinds of traditional products. Those that do not share in the profits of the company are called “non-participating” (non-par) and those that get a share of profit are “participating” (par). The non-par is the most basic product with the entire premium going into one pool called the non-par pool—there is no segregation of the mortality cost and investment. Investors are disclosed a guaranteed return (this is usually an annual 2% to 4% return) and insurers have to manage costs and death claim payouts from the fund.

It is in the par product that the entire story of the insurance industry plays out. Par products give the policyholder a base level guaranteed return and then offer a “bonus” every year as a share of profits earned by his money. Of course, the nomenclature is designed to mislead because the return is not a “bonus” but earned profit. The premium comes into a “par fund” where there is a notional division between mortality, costs and investment but this stops short of unitization and a hard break between the insurance part and the investment part. A basic finance 101 problem with this pool is that it is a common pool across generations of policyholders, making it difficult to apportion gains and losses according to the investment decisions. A 10% interest bond bought 10 years ago will still fund the returns of investors who buy into the pool in the years to come. Apart from being inherently unfair in a quasi-market linked product, this leaves enough elbow room for the firms to “manage” returns on some products at the expense of others.

Par products are supposed to share 90% of the profits earned with policyholders. This sounds very good till you ask the question: but what about the costs? High costs will cause profits to fall and even a 90% sharing of profits may not mean high returns to the policyholder. Life insurance companies remain reluctant to answer this question of what have past cohorts of policyholders in par products earned in hand. Our analysis of past products across the industry tells us that these returns are in the range of 4%.

The listing of LIC will bring many of these issues into focus. Both shareholders and policyholders need to know what the real insurance deal is. Many times the interest of the shareholder and the policyholder will be in conflict. But the listing will at least open the door to more questions and better understanding of where a large chunk of the Indian household savings go.

Monika Halan is consulting editor at Mint and writes on household finance, policy and regulation