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Commentary

Insurance Profits from Surrenders, But Not *That* Much

LiveMint has an article by Monika Halan and Deepthi Bhaskaran talking about how investors lost Rs. 1.5 trillion (150,000 crore) rupees due to mis-selling.

I’m however not convinced by their number argument, that investors lost 1.5 trillion rupees. The way they arrive by the numbers is:

  1. Take all regular premium policy premium (first year, plus renewal premiums)
  2. Next year you should get at least that much (if it’s regular)
  3. Some of it will lapse due to death, maturity or economic stress, which they estimate to be 20% of premium.
  4. If what is collected next year is less than what you get at a) above, you have a “loss in premium”.

Insurance Profits from Surrenders, But Not *That* Much

(Above Figure from Livemint)

This figure, over years, adds up to 1.5 trillion rupees.

Not Exactly That Much

But this isn’t exactly true that investors lost this much (or more, as the article argues); the assumption is that if people don’t pay regular premium they lose all their money. While most ULIPs made you lose your money pre-2009, much of the money in 2010-11 and 2011-12 is safe in that regard (other than certain charges) due to IRDA’s changed regulations that if policyholders don’t pay premium, they still will get back their account balance at discontinuation five years after inception with 4% interest.

Therefore ULIPs (or “linked” policies) are ok for premium lost in 2010-11 and 11-12; the loss in premium using the same above formula is nearly 59,000 cr. (0.59 trillion). We need to reduce that much from this “loss” figure. 

For “traditional” policies, surrenders still carry a payout. According to the IRDA’s 2011-12 annual report, insurers paid out (for surrenders):

In 2011-12: Rs. 71,208 cr,

In 2010-11: Rs. 76,712 cr.

(Includes ULIP payouts)

Adds up to 145,000 cr. (1.45 trillion) in just two years of the total six. This is money returned to investors – money investors got back. They did lose some money – nearly all investors seem to do so in insurance – but not quite as much as 1.5 trillion.

The core assumption is that investors in ULIPs lost all their money if the surrendered in the first three years, for policies started before 2009 September. The above data and figures are of “all” policies (not just ULIPs), includes years post 2009, and doesn’t know about policies surrendered after three years, so the conclusion that Rs. 1.5 trillion has been lost might be a little exaggerated.

However, I must admit I need to do more research to come up with a counter-number of losses, which are likely to be available with more data crunching through the journal and reports of individual insurers.

Insurance is a Bad Investment

While we might debate whether investors lost X or “only” Y, we will all agree that investors lost money. Insurance is fine from the aspect of term policies, where if you live you lose that much premium. But the concept of insurance where you get your money back, has been a losing proposition.

We speak here of losing money that you invested. We don’t speak of the opportunity cost, or the fact that inflation would require your money to have grown by about 8% per year just to retain purchasing power.

Lowered Forward View of Insurance Companies

A larger problem in my view is that insurance company IPOs will be in serious trouble. According to an Oct 2012 Goldman Sachs report, insurers have a substantial amount of their profits coming from “lapsed profits”.

The pool of lapse profit represents amounts that are identified by the Appointed Actuary in
respect of lapsed policies that are entitled to be revived but not likely to be revived. Such
reserves are required to be held as an earmarked reserve until the expiry of the revival
period (two years), after which the same can be released in the P&L statement.

image(Courtesy Goldman Sachs report)

Such lapsed profits are declining due to the inability to pass such reserves into insurer profits (they will go back to the policy holder). If such profits are at stake due to changed regulation, the ability of these insurers to show great profits as they launch IPOs becomes suspect.

Furthermore, growth in new premium has stalled. The “NAV Guaranteed” products, which account for a good percentage of private insurance products sold, are stunted by the guarantee. The real scope for growth is pure term, and then non-life (like car, home and health).

Profit from lapsed policies is going to be a tough thing to maintain and the writing was on the wall in 2009 when the new ULIP regime came about. It would be more useful to think of insurance in the kind of timeframe that they want policy holders to think about: Sustainable profits in the very long term, and only if bad things don’t happen.

  • Murty says:

    Hi, Deepak,
    Like the Ad for the Sale of a Policy, the statistics on Mint are not that convincing:
    In particular to the Guranteed NAV policies, on offer, I requested the Agent few years back, how he can gurranty the Guarranty……
    It was a lengthy discussion , but finally, we arrived at a figure……………..
    It is less than Bank Interest, and the only plus point is it insures (HAHAHAHA) your future.
    I discouraged many of my coulleagues who were excited then.
    Thanks to the IRDA website, the salesman(Agent) was dumbfounded, to see how his company along with 10 others is performing, while the lone giant LIC, is flurishing!
    All these companies run on false promises….IT is my opinion!

  • Ranjan says:

    I agree that the Rs 1.5 trillion figure is exaggerated. But I am here to share my perspective on why completely writing off insurance as a bad investment can be misleading too.
    Let me begin by saying that I do not sell insurance/mutual funds and only recommend term insurance to those who care to ask me.
    Here’s an actual maturity payout where the premium was Rs 21127 for 5 years and a maturity value paid was Rs.117000/-. If you calculate the return, it is just 3.4%. However the policyholder took the 30% tax advantage and my calculations show that the return would be 15.7%. In addition, the policyholder also got a rebate from the agent. The above was a non-ULIP policy.
    I have a few examples of longer duration products that gave a return of around 10% after factoring in tax benefits.
    And I have also met a lot of people who dabbled in equity or tried their hands in market timing and ended ruing their decisions. We don’t have a Dalbar study in India but I reckon the difference between market returns and the individual investors’ return would be huge here too.
    So while I recommend term insurance and a select band of funds/stocks, I have nothing against the people who are comfortable buying insurance and investment together. I give myself no right to moral policing 🙂
    On another note, fighting mis-selling with exaggerated headlines (such as the 1.5 trillion loss) is like hate speeches, one by Owaisi and another by Togadia. Doesn’t help!
    Agree/Disagree?

    • Ranjan, while I respect that some people made some returns, they could have made much better returns by investing in an MF/ELSS policy combination, I’m reasonably sure. I don’t tell people to go do stock picking – just buy a regular diversified mutual fund instead, and your total returns will likely beat the heck out of the insurance policy. The tax benefits are incidental anyhow – for most people I know, tax benefits are wiped out by other things like kids education, EPF etc. – in fact for most people who get into the 30% bracket (>10 lakhs per year) most likely just PF/NPS payments make up their 80C completely.
      I think the 1.5 trillion figure is hugely overstated, but misselling does have a measurable cost. Agree that headlines like this are sensational and dilute the effort to cure the problem (by discrediting such sources).

  • Dheeraj says:

    Journalists will always exaggerate. Dull headlines don’t attract attention.
    I think we should also consider the culpability of the eventual customer / investor in all this.
    While mis-selling did happen, there was nobody holding a gun to their heads. Their own “greed” or “ignorance” led them to get into these difficult to understand products.
    I have little sympathy for them. Just as ignorance of the law is indefensible. So is ignorance of what you’re buying into – especially in matters of money. That hefty rebate or immediate passback was (and remains so even today) a big draw. I don’t know when we’ll understand – There is no free lunch. Period.
    Mis-selling isn’t exclusive to the insurance or financial services industry. It happens everywhere. That advert that promises fairness in 12 weeks. Isn’t that an example of blatant mis-selling? We don’t blame the FMCG companies or their selling agents for mis-selling? Why?
    As they say – “Caveat Emptor

  • prakash says:

    Hi Deepak,
    Can you please come out with your estimate?