The insurance industry is likely to get a facelift in days to come. If the recommendations of the Finance Ministry committee are implemented, it can entirely change the way insurance policies are bought and sold in India.
Earlier in November 2014, the Finance Ministry had constituted a nine-member committee to review distribution incentives across financial products, rationalize commission structure and recommend measures to curb mis-selling. The committee, headed by Sumit Bose, former Union Finance Secretary, had submitted the report in August which was made public on September 3.
Here are the seven key recommendations that can change the face of the insurance industry:
Transparency in premium disclosure: The committee has proposed that insurance companies should explicitly give breakup of premium amount – expense ratio, mortality charges and investment.
IRDAI norms allow insurance companies with over 10 years of operation to deduct up to 90% of first year premium and 15% of renewal premium towards expenses. Such deductions can go even higher for the companies which have not completed 10 years.
This would help policyholders understand the cost of policies and make informed decisions.
Stringent performance metric: Hitherto, only experts could gauge the performance of insurance policies. However, if the recommendation of the committee goes through, even a lay person will be able to assess the performance.
The committee has recommended using relevant benchmark (created by an independent agency) to measure the performance. Apart from this, the committee has recommended benchmarking of mortality costs against the mortality tables created by independent actuarial firms.
Meanwhile, the current practice of disclosing returns in which insurers use sum assured and maturity benefit to depict inflated returns may end. Insurance companies are advised to indicate returns based on actual performance of the policy. “The current practice of showing future returns benchmarked to 4% and 8% should be discontinued since forecasting of returns is misleading,” states the committee report.
Insurers may be required to disclosure internal rate of return (IRR) on guaranteed return policies (non-participating policies). On ULIPs, the committee has recommended disclosing NAV after deducting expenses.
Meanwhile, the committee has advised insurance companies not to use the word ‘bonus’ while calculating returns. “The current practice of using the word ‘bonus’ to indicate return is misleading. Disclosures should use the word ‘net return’ instead. Changing the way we call something has an impact on the way we think about it,” recommended the committee.
Reasonable refund value: Another key recommendation is on surrender value. The committee has recommended that insurance companies should pay reasonable amount to policyholders after deducting costs and charges on surrendering of a policy. Currently, surrender value is calculated by discounting a certain percentage on paid up value which is generally much lower than the premium paid.
Single expense ratio: The committee has recommended that all charges like distribution cost, management fee and R&T charges should be clubbed under one head. No charges would be deducted towards premium allocation charge. In addition to management fee, insurance companies currently deduct charges for allotting fund towards mortality and investment.
Lapsation benefit to all: Insurers may not be able to utilize the corpus of lapsed policy. Instead, the committee has suggested that insurance companies should pass on this benefit to the policyholders of ULIPs.
Stringent disclosure: The committee has recommended that insurance companies should periodically disclose asset allocation and portfolios on their websites. Also, insurance companies were advised to provide an online calculator to help people calculate paid up value and surrender value so that customers can better understand the consequence of exits across each year.
Commission: The committee has recommended continuation of upfront commission in traditional policies and ULIPs. However, such commissions would be paid on mortality charges or the part of premium paid towards availing life cover.
The committee has recommended that insurance companies should pay a fixed percentage of premium till the tenure of non-participating policies as renewal commission or trial commission. Participating policies which distribute realized gains among policyholders, should pay trail commission based on assets under management.
Among other key recommendations are putting an end to the practice of paying advance commissions to distributors, passing back of commission to policyholders and using riskometer to depict risk level in ULIPs.
Though these recommendations may help policyholders make informed decisions, it may transform the insurance industry as it exists today. Generally, policyholders have no idea where their premium goes. Traditional life insurance policies typically deliver 4-6% return. Such a return may not attract anyone to invest. If these recommendations go through, insurance companies would have to rethink their strategy.
In a column published in ‘The Economic Times’, Dhirendra Kumar, CEO, ValueResearch wrote, “A customer with even minimal financial literacy would instantly be able to see that going for a separate life cover (term insurance) and any other investment — even a recurring deposit in the post office or a bank — would be a better option than endowment plans and other such horrors that our insurance industry runs.”
