To be sure, while the GSV has been left unchanged, the insurance regulator has modified the way the special surrender value (SSV) is calculated. Insurance companies either pay GSV or SSV, whichever is higher, when a customer surrenders the policy.
What is SSV?
“Typically, SSV is what is paid to subscribers on surrendering their policers. GSV is only a minimum benchmark,” says Sanket Kawatkar, fellow, Institute of Actuaries of India, and director at Wisdom2Wealth, a firm focused on spreading financial awareness.
In non-participating plans, insurers calculate the SSV in terms of the present value of the maturity benefit against the number of premiums paid for an individual policyholder. With effect from 1 April, according to Irdai, the SSV will reflect the notional asset share of the policy. This concept already exists in participatory plans.
What is a notional asset share, you would wonder! “Consider it as a bank account where all inflows and outflows linked to a policy are managed. The value of this bank account is the asset share,” explains Kawatkar. As per new regulations, the SSV will “reflect the notional asset share, guaranteed maturity or survival benefits under the policy”.
Does it mean the surrender value for policyholders will be better? Not necessarily! “It will not be as low as GSV but will not be significantly better either. It is a better approach than what the industry practises today. It will fine-tune the process of calculating SSV,” says Kawatkar.
Why the rollback happened
Insurance experts said there was stiff opposition to the proposals, which most insurers claimed would hurt their profitability unless they reduce the guaranteed returns that non-participatory policies offer. They also point out that life insurance is a long-term contract and policyholders incur penalty charges for breaching the contract midway. Insurers say they incur sizable acquisition costs which is partially recouped through investment income only during the term of the policy. Early surrender disrupts this process and forces untimely liquidation of assets to cover surrender benefits, resulting in additional costs.
“When policyholders surrender the policy midway, insurers apply a surrender charge to compensate for costs towards acquisition costs and asset-liability mismatch. Decreasing these charges and offering higher surrender benefits would mean reduced returns for policyholders at maturity, unfairly penalizing those who fulfill the entire contract,” says Sumit Ramani, actuary and co-founder, ProtectMeWell.com.
Krish Prabhakar, general manager at Kuwait-based Zain Insurtech, differs. “All these arguments justifying status quo are based on the assumption that the lapse ratios of such policies will continue to remain the same. If efforts are taken to improve the persistency, the resultant internal rate of return will in fact improve. Amortizing the commission structure over the long term can improve fund value from day one. What if scenarios’ based on simulations will establish this,” he says.
Insurers, on the other hand, claim that surrenders or the lapse ratio will increase if the surrender value goes up. This too is a “specious argument” according to Prabhakar. “Surrenders are force majeure and not voluntary. If a policyholder loses 70% of his capital today and 30% tomorrow, why would he want to lose even that 30%?” says Prabhakar.
Amortizing commissions
Insurance is a push product, and so the distribution cost for selling a policy is significantly high for insurers. “Insurance companies pay upfront commission and recoup the cost from policyholders at the front-end which is not proportionate to the benefit they receive. Most individual agents walk away with upfront commission and clients bear the brunt with poor engagement. There needs to be clawback of commissions on early surrenders also,” says Prabhakar, who has a four-decade experience of working in the global insurance industry.
Data shows 5-year persistency ratio for private insurance companies, usually calculated for 61 months, has been in the range of 35-43% in the last five years. It means a significant number of people discontinue their policy after 5 years. They either surrender the policy or the premiums are fully paid-up. To be sure, the paid-up value is higher than the surrender value but can be withdrawn only after the policy matures.
Why do many subscribers discontinue their policies? Non-participatory products come at a high premium. If an individual faces liquidity issues, they would rather want to stop paying premiums. However, the low surrender value is a shocker. “The trouble is many agents selling these policies may not be genuinely aware of all the features associated with a product. It is a structural issue where distributors are not trained well. Part of the blame lies with buyers also who do not ask or read about exit clauses,” says Kawatkar.
A better approach could be introducing the trail commission— agents get rewarded when their clients renew the policies. “The problem is not with the product but the way it is being sold. Instead of wasting energy in finding the optimal surrender factor, insurance companies should be made accountable to improve their lapse ratios. If they do not do it, they should pay a hefty penalty and should not be allowed to underwrite the new business. If they do it, there won’t be any need for micro regulations in the first place,” says Kawatkar.
Moreover, a trail commission would attract those serious about long-term distribution careers.
Secondary market in insurance
Can you sell your insurance policy to someone else for a better surrender value? Yes, you can assign your policy to someone else. Two-year-old start-up ValuEnable has created a marketplace where policyholders can assign their policies to interested investors who could be institutions or individuals. “Policyholders in need of emergency liquidity can get a better deal than surrendering the policy as they get an amount at least equal to the surrender value while part of the life cover continues. The maturity benefit will obviously go to the investor, while the death benefit is split between the nominee of the original policyholder and the investor, as per a predefined formula protecting financial interest of both parties,” say Mithil Sejpal and Satprem Mohanty, co-founders of ValuEnable.
Kawatkar suggests having a well-regulated secondary market where life insurance policies can be traded. “This will give it a better scale and the presence of multiple market-makers will ensure competitive surrender value. It is a win-win situation for all because the insurance company will continue receiving premiums, hence better persistency, while the acquirer will get better IRR and the seller a better surrender value,” says Kawatkar.
To be sure, a divisional bench of the Bombay High Court had ruled in 2007 that life insurance policies can be traded. “LIC appealed against this verdict in the Supreme Court. In 2015, SC dismissed its appeal and upheld the Bombay High Court ruling. The same year, Parliament amended section 38 of the Insurance Act, 1938, which deals with assignment of policies. Life insurers can now reject the assignment request if they do not find insurable interest,” says Kawatkar.