Life insurers play tax-free interest arbitrage game to rev up business

November’s life insurance premium flow data came as a shocker after four consecutive months of promising growth. But here’s the interesting thing. While the overall private life insurers’ premium inflows contracted by 7 per cent year-on-year, those of HDFC Life rose by 20.4 per cent and ICICI Prudential Life (I-Pru Life) and SBI Life witnessed 30.8 per cent and 5.7 per cent year-on-year decline in November.

To understand the outperformance, one needs to deconstruct the composition of growth. After the initial months (April and May) of protection plans-led recovery, the trend has since steadily tapered and the focus has shifted to fixed return or assured sum yielding plans. These traditionally are non-participating products. While most insurance schemes aren’t tax-free anymore, assured return products are among the few exceptions. The bank fixed deposit (FD) rate plummeting to a new low has also helped the sales of fixed-return products. These are easy to sell for insurers and also attractive for investors - a win-win for both. Importantly, they have very little protection component vis-à-vis a term plan.

 

“Capturing on this tax-free low interest rate arbitrage, high net worth individuals are lapping up these products,” explains Sridhar Sivaram, investment director, Enam Holdings. Hence, he argues that the growth that life insurers are posting is highly skeptical. “A saving product is being disguised as protection”. Unlike other plans, profit streams of non-par products are slightly different – the spreads between the investments and pay-outs, mortality profit and lapsation gains. Mortality profit is the excess of the expected death strain over the actual death strain for a year. Lapsation means termination of a policy for a fault of the insured or customer, which absolves the insurer for any accruing liabilities.

Non-par savings products yield 30 – 40 per cent margin, covering for the upfront high agent commission.  But though very attractive, analysts at PhillipCapital note that these consume high initial reserves and result in higher capital strains. “Balance sheet risk tends to increase,” says Sivaram, because investing in risk-free government instruments won’t be adequate to deliver the assured returns. A likely reversal in interest rate cycle is also an inherent risk.

Among the top private life insurers, HDFC Life and Max Life had eight per cent contribution from non-par savings products in FY18 which climbed to 38 per cent and 18 per cent respectively in FY20 (see table).

In the context of life insurance stocks lately turning attractive within the financials space, and valuations having doubled in six months, it's perhaps time that the Street must evaluate growth qualitatively and not just quantitatively, before rushing in.