Insurance: Largely unchanged surrender charges a big relief

26 Mar 2024 , 02:02 PM

At its 125th meeting, the IRDAI approved eight principle-based consolidated regulations; following the comprehensive review of the regulatory framework for the Insurance sector. These cover safeguarding of policyholders’ interests, rural and social sector responsibilities, electronic insurance marketplace, insurance products and operation of foreign reinsurance branches, as well as aspects of registration, actuarial, finance, investment and corporate governance. For the life insurance companies, the most important was the one regarding the proposed changes in the method of calculating surrender value for non-linked policies (both Par and Non-Par). Contrary to the draft where a “threshold limit” was proposed with potentially an intention to reduce the surrender charges, final guidelines have kept the surrender charges largely unchanged vs the current regulations. This removes a big overhang on life insurers, where the proposed reduction in surrender charges could have been up to 5%-75% in some scenarios; materially denting the VNB from non-linked businesses. Based on exposure to non-par segments, HDFCLI, MAXF, IPRU and SBILI would have been the most impacted in that order and hence, should be the beneficiaries of the overhang removal.

No introduction of threshold limit in final regulations:

The draft regulations released in Dec-23 introduced a threshold premium that was supposed to be defined for each product. Surrender charges were to be levied only up to the accumulated balance of premiums, based on that threshold limit and not on the overall accumulated premiums. It would have likely had a negative impact on VNB margins because of higher payouts of surrender benefits. In some scenarios, the income from surrender charges could have reduced by up to 5%-75% for insurers. Analysts of IIFL Capital Services believe post consultations with the insurers and industry participants, the regulator may have decided to go against the introduction of threshold limit and lower surrender charges.

Removal of initial lock-in also not implemented:

As per the current regulations, a guaranteed surrender value is given only on the payment of premium for at least two consecutive years. The draft proposed Guaranteed Surrender Value, even if the policy was surrendered in the first year, with the payout being equal to balance premium over and above the threshold limit. Final guidelines do not implement the removal of initial lock-in requirements and keep it in line with the current guidelines.

Removal of a material overhang:

Final guidelines remove a material overhang over life insurers, given that the surrender charges are largely unchanged vs a materially margin-dilutive proposal in draft guidelines. Companies with the highest exposure to traditional products would have been impacted the most, as per the draft and the stocks should witness a relief rally now. Within analysts of IIFL Capital Services coverage, HDFCLI has the highest exposure to the Non-linked segment, followed by IPRU. SBILI is the least exposed to these regulations. Analysts of IIFL Capital Services continue to prefer SBILI as their top pick, while HDFCLI should recover some of its recent underperformance post the removal of overhang.

Other regulatory revamp focussed on increasing Insurance penetration in the long term:

Apart from the regulations around insurance products, IRDA has also announced a host of other regulations with an intent to increase insurance penetration. For example, e-marketplace regulation aims to establish a digital public infrastructure named Bima Sugam; which will be a marketplace to serve as a one-stop solution for all insurance stakeholders, including customers, insurers, intermediaries, and agents. Corporate governance regulations aim to establish a robust governance framework for insurers, defining the roles and responsibilities of the Board and management. This is for the first time that governance aspects are notified in the form of regulations. Regulation on protection of policyholders’ interests is focusing on key objectives aimed at ensuring fair treatment of prospects during solicitation and sale of insurance policies and protecting the interests of policyholders throughout their engagement with insurers and distribution channels.