Among the raft of proposals put forth by the regulator on 12 December, the most significant one relates to surrender value in non-participating life insurance plans. Non-participating plans are those in which survival/maturity benefits are guaranteed and are not linked to the profits that insurers earn. If the proposal on surrender charges comes into effect, it will be a huge positive for policyholders looking to close the policy during the premium payment term. However, it will hit the business margins of insurers whose surrender income will reduce.

“The proposed draft will give policyholders more flexibility to choose appropriate saving-linked products in accordance with the changes in their financial plans as new rules will reduce the risk of substantial financial loss in case of early discontinuance. Although, it will compel insurers to reduce the underwriting and other costs,” says Sabyasachi Sarkar, appointed actuary, Go Digit Life Insurance.

The new proposal

The regulator has proposed a new framework to calculate surrender charges which is expected to increase the surrender value to 75-84% of the premium from the existing 0-50%. Essentially, a premium threshold will be fixed on which surrender charges will be levied. The balance premiums above this threshold will be returned to policyholders when they surrender the policy.

Irdai’s draft illustrates this with an example of a non-participating policy with an annual premium of 1 lakh and a 10-year policy term. It has considered the premium threshold at 25,000. As per existing regulations, if a policyholder is to surrender this policy in the third year, the insurer will return only 35% of the aggregate premium collected from the policyholder, which is 1.05 lakh (35% of 3 lakh). In the proposed draft, 35% of the threshold premium (0.35 * 25,000 *3) or 26,250 will be returned along with the 100% premium above the threshold (75,000*3 ) of 2.25 lakh. So guaranteed surrender value for three years will come in at 251,250 ( 26,250 + 225,000). This is an increase of a whopping 139% from the policyholder’s point of view. However, it will reduce insurance companies’ surrender income.

Estimates by Kotak Institutional Equities suggest that based on ratios used in Irdai’s illustration, the surrender income of insurers would decline by around 75% for a policy with 1 lakh annual premium. It can lead to a hit of 140-200 basis points in terms of VNB (value of new business) margins. “This is rough math and can vary significantly on a change in ratios and assumptions,” the report says.

It is important to note that insurers currently offer guaranteed surrender value (GSV) or special surrender value, whichever is higher. “Special surrender value tends to be higher in non-par products compared to the GSV. If it continues to be higher despite the changes in GSV computation, it won’t make any difference in insurers’ margins. Everything boils down to the threshold limit. We need to wait and watch as to how it will be fixed in coming days” says Akshay Dhand, appointed actuary of Canara HSBC Life Insurance.

Cheer for policyholders?

The proposed surrender rules may compel insurers to reprice the product or reduce the cost of acquisition and distribution. Sarkar of Go Digit Life says distributor commissions vary widely among risk and savings products. “It depends on new business and renewals and also on the premium payment term of such life policies. One will have to see the method stipulated by the regulator to calculate the threshold premium to assess the overall impact. But, prima facie, if the new regulations are adopted in its current form, one is likely to see some revision in the commission structure of partners.”

To be sure, Irdai has already removed the individual cap on commissions paid by life insurance companies to intermediaries or agents, while stipulating an expenses of management (EOM) structure. “This already gives flexibility to insurers to pay higher commission to those bringing in more business. Beyond this, I do not think there will be any impact on distribution commission. Insurers will try to reduce the cost of acquisition by tech or more customer-centric product lines that give scale,” says Mayank Gupta, co-founder & COO, Zopper, an insure-tech firm.

Kotak Institutional Equities highlights an interesting point. “Insurance commissions are currently front-loaded; the industry may not be ready for deferment and may take a while to make a transition. However, revising the compensation structure may be crucial to reduce mis-selling. This (revision of structure) may be the first step to the insurance industry’s eventual migration to a full trail model, on the line of the mutual fund industry,” it says.

The naysayers

A section of industry stakeholders, however, is of the view that if surrendering policies is made less punitive, it will have an impact on persistency. It means more people will surrender policies. “We believe the proposal is damaging to long-term policyholders’ interests and the industry at large–which is probably not the intent of the regulator. Accordingly, we argue there may be scope for a rethink for a benign final regulation release,” says Nuvama Institutional Equities in a report.

The report adds that insurance companies will have to rework products in the new regime which will negatively impact long-term policyholders, insurance companies, and intermediaries. “The extent of damage for the industry will depend on how “premium threshold” is determined. If thresholds are low, VNB margins may erode,” the report says.

An email sent to the insurance regulator on these concerns did not elicit any response.

Other significant proposals

Other proposals include a new index-linked insurance product. “It has only been launched for Ulip products. It means the fund value or net asset value (NAV) can be linked to an index such as Nifty50 or Nifty100. We hoped to have it for traditional policies also. To be sure, a lot of insurance companies had this product earlier on the traditional side also but Irdai had rolled it back in 2013. They have proposed to relaunch it in the limited capacity. It will be interesting to see if it gets lapped up,” says Dhand of Canara HSBC Life Insurance.

For 50 years and above, the minimum sum assured on death has been reduced to five times of the annual premium from seven times earlier. “Essentially they have reduced the mortality cost in the premium so that the savings element increases. It will improve the IRR of the product while the life cover will remain the same,” he says.

Ulip is short for unit-linked insurance plans, while IRR stands for internal rate of return.

In case of micro insurance, it has been proposed that the policy documents are provided in vernacular languages for ease of distribution. “The objective is to reduce the cost and to provide more information to the customers in a simplified manner that they can understand easily,” says Sarkar.

On the health insurance front, the regulator has proposed to reduce waiting periods for existing illnesses from four years to three. It also said that there will be no upper age limit in buying health insurance policies. “This is a great development. Health history, lifestyle, not age should be a bar for health insurance. If Irdai’s proposal is approved, people from any age group would be able to access these comprehensive products, provided, of course, they are healthy and fit in the eyes of the insurer,” says Mahavir Chopra, founder, Beshak.org, an insurance discovery platform.

The regulator also clarified that life insurers cannot sell indemnity- based health insurance plans. “With this draft, the Irdai has sent out a clear signal of keeping indemnity only with general insurance and health insurance companies. The customer would have been flooded with twice the number of products if life insurers are allowed to sell indemnity-based health insurance products,” says Chopra.

Irdai has sought comments on these proposals till 3 January.