Misplaced Concern

Some people take out life insurance policies. They may want to leave their wives and children with some money in case they die. The simplest way to do so is to save the money and put it in some investment — a bank account, a mutual fund, a house or whatever. But if the money is put in a policy, it gives the investor a chance to multiply his money if he dies. The premium is no more than one or two per cent of the sum insured; if the investor manages to die, his money is multiplied fifty or a hundred times.

Insurance companies are there to make a profit; they try to maximize the premia they earn and pay out as little as possible. So before an insurance company insures someone’s life, it tries to find out what is the chance of him costing it money; the less the risk, the better the terms it offers him. As people get old, the chances of their dying increase. So young people are better customers; insurance companies try to attract them by offering to charge them lower premia. When they insure someone, they also try to find out how risky it is to insure him; they ask him what diseases he has, what accidents he has had, and just in case he is lying, they also get him medically examined. So insurance companies also have knowledge about their own customers which they do not have about others. They avoid the cost and hassle of acquiring the knowledge if they reinsure people they have insured before. So they offer their own customers a discount on subsequent premiums — a loyalty discount. From an insurance company’s point of view, renewal of an insurance policy is better — more profitable, less troublesome — than insuring someone new. If a life insurance policy is not renewed, they call it a lapse — like a lapse from virtue. (They also try to sell policies that cannot lapse, by charging the entire premium right at the start; those are called single-premium policies. But they do not sell many of those; people do not like to pay a hefty premium today if they expect to die and get the money after forty years.)

As I said, insurance companies like to renew the life insurance of someone who is insured with them already, because it costs them less and they know the risk he entails. So they keep measuring what they call retention ratio — premia paid on old policies divided by the sum of premia paid on last year’s new policies and on old policies. It tells them what proportion of those who could have renewed their policies actually renewed them. One minus the retention ratio is the lapse ratio — the proportion of premia lost because some people did not renew their policies.

Why were people so stupid? Why did they buy policies and then stop paying premia on them? Because they did not want those insurance policies in the first place. The policies came bundled with mutual fund units they bought. Sometimes when the value of the shares underlying the units rose, the investors made a profit, and cashed it. Sometimes they lost money, got disgusted, and cashed out. Either way they got their money, or some of it, and threw away their insurance policy.

In doing so, they were not being stupid. If they had been given the chance of selling the units and retaining the insurance policy, some of them might have. They were not given the chance, so they dumped the policies together with the units.

This lapse ratio for India was 5 per cent in 2002-03. It has gone up; last year, it was 17 per cent. People insure themselves, pay premia, and then stop paying — and naturally lose insurance cover. More and more people have been doing that. That has got Insurance Regulation and Development Authority (IRDA) worried. It is saddened by the fact that so many people spend money on insurance and then forgo the chance of earning loyalty discounts. It blames agents who sell unit-linked insurance policies; it accuses them of mis-selling.

It is mistaken. Bundling of investments and insurance policies is done, not by agents, but by or on the instigation of life insurance companies. Premia on lapsed policies are pure profit for insurance companies; they love ULIPs because they entail higher lapse ratios. If anyone is mis-selling, it is insurance companies, not agents. IRDA does not see it because it has been indoctrinated by insurance companies.

It should unbundle ULIPs — in other words, ban them. There should be no joint selling of insurance and units. At best, insurance companies may be allowed to send publicity literature to the buyers of the units they sell; they should by no means be allowed to offer insurance free to any investor in the units they sell.

The author is Consultant Editor of Businessworld.
ashok.desai@gmail.com