Increased Benefit for Lapsing Customers to Affect Returns for Persistent Life Insurance Policyholders

The proposed modification in the surrender value (or charges) of non-linked life insurance policies in the recently released the ‘Exposure Draft Product Regulations 2023’ by Insurance Regulator IRDAI has stirred up a hornet’s nest, Emkay Global Financial Services said in a report.

The idea behind this move seems to be bringing in additional control on expenses. The proposed changes in the surrender charges are looking to eliminate any surrender penalty above the “threshold premium”, which means a material and increasing change in the surrender value for higher-ticket policies with increased premium, the report said.

The proposal is still in the draft stage, to be applied prospectively, and there is no clarity on the “threshold premium”, making it extremely difficult to gauge the extent of impact on individual life insurers.

The accidental outcome of this proposal by the Regulator, to improve policyholders’ friendly aspect, is an indirect nudge or encouragement towards surrenders—and this goes against its philosophy of positioning life insurance as the long-term savings and protection product, the report said.

Nevertheless, the proposed increase in surrender value for the lapsing customers will lead to some reduced value for the other three stakeholders including reduced returns for the persistent policyholders, lower payouts to the distributors, especially reduction in the initial years and above the threshold premium and some impact on the life insurer’s VNB margin.

Typically, a non-par product with higher IRR to the policyholder and higher payout to the distributor supported by lapses will be hit by these proposed changes.

The intent of increasing the surrender value seems to be driven by the need of reducing the cost of distribution (and operation), especially not allowing it to grow proportionately to the premium.

Basically, the essence is the argument that the true efforts in selling one new policy with a 10x premium is much lower than selling 10 new policies with a 1x premium.

However, the dilemma here is the unintended or accidental outcome in the form of a nudge or encouragement towards surrenders by increasing the surrender value and of a reduced benefit for persistent policyholders, the report said.