IRDAI signs off on investor gouging
Early exits from life insurance will continue to haemorrhage savings
How would you react if your bank kept half your money when you withdrew a fixed deposit before the maturity date? There would be huge depositor angst and the regulator, the Reserve Bank of India, would step in to stop this money gouging. However, in another part of the financial sector, the insurance regulator has just signed off on rules that allow life insurance companies to continue to gouge investor money for an early exit. In a gazette notification on March 22, the Insurance Regulatory and Development Authority of India (IRDAI) released an updated list of product regulations that continue with the old structure of surrender values. In December 2023, IRDAI proposed a re-haul of the surrender value regulations in an effort to make the product a bit more investor-friendly. In a shocking move, IRDAI has abandoned this draft and seems to have given in to lobbyists from the insurance industry to continue with the high-cost-to-investor route. For a government that is focused on the average citizen, this is a very regressive step — to allow a regulated product to loot trusting investors just because they want to exit a policy earlier than they signed up for.
Investment-bearing life insurance products that are called “traditional” or “non-linked” include policies such as endowment, money back and whole-life policies. Think of them as a very long-term fixed deposit with a crust of a life cover along with the deposit. These policies mainly invest in government bonds and seek to give a predictable return to the investor. Unfortunately, they have very hard rules that are harmful to investors who want to exit the policy earlier than the maturity date. A surrender value is the minimum money that the investor who exits the policy before the maturity date will get. These values have been very low and IRDAI’s attempt to reduce investor loss has failed. The new rules perpetuate the old system of very low surrender values.
How high are the losses to investors? The rules say that policies will gather a surrender value after two premiums. This means that after one premium if the policy is discontinued, no money comes back to the investor. The surrender value rises over the life of the policy but not by much. After two premiums, if a third is not paid, an investor gets back just 30% of the total premiums paid. After three premiums, if the fourth is not paid, 35% of the first three premiums is returned. For policies between years four and seven, the investor gets back half the total money invested. After the seventh year, insurance companies can use a self-determined sliding scale such that 90% of the total premiums paid are returned if the policy is discontinued during the last two years of the policy. This means that should the investor exit even till one year before the end of the policy, she does not even get back the full principal invested — even if she has been in the policy for 20 years. She gets only 90% of the money invested returned.
But do many people surrender early? In other words, how big is this practice of early surrender? IRDAI data shows that the surrenders are huge and less than half the policyholders continue with their policies after paying five premiums. This data for some insurance firms is abysmal, showing a surrender rate of over 70% after five years of the policy. This means that insurance companies pocket more than half of the total premium paid and investors take home capital losses!
News reports say that IRDAI gave into the insurance industry which cited an asset-liability mismatch as the reason they needed the current surrender value system to continue. If true, this is a very sad reflection on a regulator that is allowing the gouging of investors so that insurance companies can profit from early surrenders. Insurance industry insiders point to early surrender-linked profits being a part of the future profitability calculations of insurance companies. This means that business plans build in profits made from early exits of policies. This is absurd. How can a regulator allow companies to profit from the decision of investors to change their minds? How can the penalty gouge away so much of investors’ savings towards costs?
Investors need to only compare their investment experience with another long-term safe product such as the Public Provident Fund (PPF) to see the sheer toxicity of a bundled life insurance product where they can lose capital. PPF is a 15-year fixed-interest saving product that has a penalty of the loss of one percentage point of interest for an early closure. PPF will turn ₹1 lakh a year invested for 20 years into ₹41.45 lakh at the current 7.1% interest. In the insurance product, a 21-year policy that an investor exits in the 20th year, the ₹20 lakh invested becomes ₹18 lakh. Or compare it with an early exit from a fixed deposit. Investors lose half a percentage point in interest — that’s it. The principal is safe and most of the promised interest is given back. It is only in the case of traditional life insurance policies that there is such a heavy price on investors for an early exit.
A regulator’s first job is to protect the interest of the investor — the weakest link in the chain, but on whose money the whole industry lives off and profits. For a regulator to allow such investor gouging is a shocking statement of irresponsibility and looks like a textbook case of regulatory capture. That the regulator is appointed by the government of India, makes it the final responsibility of the government to prevent such a capture. For a government that is focused on the benefit of the average citizen, this regulator-allowed loot is inexplicable.
Monika Halan is the author of the best-selling book Let’s Talk Money. The views expressed are personal
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