A new committee for simplifying insurance

A new committee for simplifying insurance It has been more than 6 years since the life insurance industry embarked upon product regulations to address the problems of high costs, heavy exit penalties and poor insurance cover. The new product regulations—‘linked insurance product regulations’ and ‘non-linked insurance product regulation’—which looked at most of these issues came into effect in

2014. And now, 3 years later, the Insurance Regulatory and Development Authority of India (Irdai) has constituted a committee to review the provisions of these regulations.

The eight member committee will be chaired by Amitabh Chaudhry, chief executive officer and managing director, HDFC Standard Life Insurance Co. Ltd. The committee would review product regulations in light of current market environment, policyholders’ interests and distribution incentives. It will also review the recommendations of the Sumit Bose Committee, which had some big bang suggestions.

Given the agenda, what all can the committee discuss? We pick three crucial reforms that will go a long way in making life insurance products more customer friendly.

Exit penalty

Exit penalties in traditional insurance-plus-investment policies are one of the steepest in the financial industry and even after product reforms they continue to be high. To illustrate, if you buy a policy with a premium payment term of at least 10 years, you get a surrender value, or any money back, only after three premium instalments have been paid. But what you get is just 30% of all the premiums paid. Although the surrender charge goes down in subsequent years, it continues to remain high.

But the industry is concerned about lowering surrender penalty as this would ease the exit barrier and encourage policyholders to surrender. For the insurers, this means that they can’t invest in long-term assets as they will need to hold more liquid assets, which in turn impacts the returns of a persistent policyholder. This, according to some, is not the right way to approach exit penalties. “Insurance as an investment product is slowly becoming obsolete, which is one of the reasons why growth is not coming back to the industry. A main reason why customers are shying away from insurance is heavy exit penalties,” said P. Nandagopal, founder and chief executive officer, OpenWorld Money Insurance Broking Ltd. “The industry needs to adopt best practices of other financial products, which come with low surrender penalties,” he added.

In fact, the industry has an example in the form of unit-linked insurance plans (Ulips). From surrender penalties that could consume the entire premium in the initial years, the new rules cut the penalty to a maximum of Rs6,000 in the first year, tapering to Rs2,000 in the fourth year and nil thereafter. “It’s very important that traditional plans are not lapse supported. This means that the exit penalties are so high that insurers actually make a profit from lapsed policies. In the industry...about 60% of the traditional products are lapse-supported products. It’s important to give better exit options to the customers,” said Kapil Mehta, executive director, SecureNow Insurance Broker Pvt. Ltd.

Disclosures

It is crucial to improve disclosures. Traditional plans are opaque products that do not disclose costs or investment portfolios. In terms of investment, you are either guaranteed all the benefits upfront or a minimum amount with additional benefits pegged to performance of the underlying participating fund. Even as the product-benefit illustration walks you through the amount of money you get across various scenarios, it needs to make the connection between what you pay and what you get by disclosing the net return. This again is mandatory in the case of Ulips. However, even in Ulips, factors like mortality costs and service tax are excluded from the calculation of net returns.

Bose committee proposals

Disclosures and reducing exit loads are part of the Sumit Bose Committee’s recommendations, but the big bang proposal is to unbundle life insurance plans into insurance and investment components, and levy charges and pay incentives as per separate functions. “The basic issue before the committee was misselling of financial products. So the focus was simplifying product structure and improving transparency. Insurance has ordinarily been sold as a composite product with the investment component bundled in. Our recommendation was to promote the product such that insurance and investment are seen as separate elements and each can be explained clearly in terms of cost and benefits and be benchmarked against the relevant products in the market. This was the overarching theme and to this end the committee made several recommendations,” said S Vishvanathan, retired managing director, SBI and SBI capital markets.

The committee suggested splitting the premium into mortality and investment components. It recommended that investment costs be benchmarked against products in the same category, so that similar functions across various products have similar costs. Further, these costs need to sit in one place and be capped.

Even commissions need to be redesigned according to functions. The committee recommended levelling commissions on the investment component, whereas upfront commissions for pure mortality can continue. The current commission structure is front loaded. Although the incentives are slightly higher for term plans, it doesn’t segregate premiums in the case of bundled products.

You can read the full text of the committee report at: http://bit.ly/1LZo9B1. The product committee constituted by Irdai is expected to submit its report in 2 months and is likely to meet on 20 January to set the agenda. The committee would do well to focus on standardising costs, removing exit barriers and simplifying the investment benefits through proper disclosures.