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IRDAI proposes to reduce surrender charges

? In a surprise move, IRDAI has released an Exposure Draft that proposes to reduce surrender charges on life insurance products, especially non-par savings products.

? There will be a threshold level of premium beyond which an insurer will not be able to levy the surrender charge and the premium will have to be returned to the policyholder.

? Implications:

? If the measures in the draft are implemented as they are, margins could be hit.

? If the measures are implemented retrospectively, persistency assumptions in EVs will have to be modified, leading to cuts in EV estimates.

? Product construct will have to be modified to factor in the changes.

? To offset the impact, insurers could introduce a commission structure that rewards the distributors with better persistency.

? A lower surrender charge can influence customers to invest more comfortably in products. As a result, volumes could increase, but persistency could be under pressure.

? The draft does not mention any threshold levels, and hence estimation of the exact impact is not plausible.

? Insurance companies will give feedback on the draft to the regulator, after which final regulations could be announced.

Example of the proposed measure

? Product: Non-linked savings insurance policy

? Annualized premium: INR100,000

? Policy term: 20 years

? Threshold limit: INR25,000

? The adjusted guaranteed surrender value after payment of third annualized premium may be as follows:

i) Guaranteed surrender value for threshold premium: INR25,000 x 3 x 35% = INR26,250

ii) Premium refund beyond threshold premium: (INR100,000 – INR25,000) x 3 = INR225,000

iii) Adjusted guaranteed surrender value: (i) +(ii), i.e., INR251,250 i

v) Surrender value shall be higher of (adjusted guaranteed surrender value, special surrender value)

The adjusted guaranteed surrender value after payment of first annualized premium may be as follows:

i) Guaranteed surrender value for threshold premium: Zero

ii) Premium refund beyond threshold premium: (INR100,000 – INR25,000) x 1 = INR75,000

iii) Adjusted guaranteed surrender value: (i) +(ii), i.e., INR75,000 iv) Surrender value shall be higher of (adjusted guaranteed surrender value, special surrender value).

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