Insurance: Lower non-linked surrender charges proposed

15 Dec 2023 , 10:33 AM

The IRDAI has released an exposure draft on Insurance products guidelines, which among other things, proposes a change in the method of calculating the surrender value for non-linked policies (both Par and Non-Par). This is by introducing a “threshold limit” with potentially an intention to reduce the surrender charges. As per the new methodology, threshold premium shall be defined for each product and surrender charges will be levied only up to the accumulated balance of premiums; based on that threshold limit and not on the overall accumulated premiums. Analysts of IIFL Capital Services believe that while the proposal can potentially improve the attractiveness of traditional products, it may likely have a negative impact on VNB margins because of higher payouts of surrender benefits. Analysts of IIFL Capital Services look at some scenarios where the income from surrender charges could reduce by up to 5%-75% for insurers. They await clarity on the draft to assess the final impact on margins for insurers and consequent changes in product strategy. 

Proposed regulations remove initial lock-in for surrender: 

As per the earlier regulations, a guaranteed surrender value was given only on payment of premium for at least two consecutive years, causing loss for the policyholder if the policy had to be discontinued due to exigencies. However, the draft proposes Guaranteed Surrender Value even if the policy is surrendered in the first year, with the payout being equal to balance premium over and above the threshold limit. 

Ambiguity around threshold premium: 

The exposure draft suggests the threshold limit should be fair and equitable but does not define a methodology to calculate the threshold premium, neither does it clarify as to who would be setting the limit between the insurers or the IRDAI. Analysts of IIFL Capital Services believe if the insurers were to set the threshold limit, it could give them the power to manage their loss of surrender charges due to the new guideline but at the same time, give them an opportunity to differentiate on their product strategy. 

Pros and cons of lower surrender charges: 

While the rate of surrender charges remains unchanged in the draft, introduction of threshold limit beyond which no surrender charges would be applicable reduces the financial impact on the policyholder, especially when the surrender is done in case of emergencies. A significantly reduced surrender charge would bring traditional products in line with other savings segments (like ULIPs), with improved liquidity and volumes in the long term, and force life insurers to focus a lot more on persistency. On the flip side, it could discourage long-term savings behaviour and make this product segment a target for higher competitive intensity and tactical investment opportunity. 

Potentially negative impact on margins: 

It is difficult to calculate the contribution of surrender charges to the overall VNB margins of the traditional products. For lack of disclosures, life insurers have also not disclosed the impact of reduced surrender charges on the business’s VNB. However, any threshold limit that is less than the actual premiums paid, will incrementally reduce the income from surrender charges for the insurer and consequently, their VNB margins from these products. Companies may try to reduce the impact of the same by introducing products with lower yields or focussing more on improving persistency in these products. 

Draft guidelines open for comments and discussions: 

The above-mentioned guidelines are draft in nature and open for comments and discussions, over the new few weeks. As per the companies, provision related to threshold limits have not been discussed with them in the recent past and would be open for debate in the coming days. Analysts of IIFL Capital Services will watch out any developments on this issue in the coming months. In the absence of adequate clarity, in their view, companies with the highest exposure to traditional products (LIC) would be impacted the most. Within analysts of IIFL Capital Services coverage group, SBI Life is the best-positioned given the lowest share of traditional products in their premium share, followed by IPRU Life and HDFC Life. Analysts of IIFL Capital Services maintain SBI Life as their preferred pick in the Life Insurance space.