Insurers Told To Check Assured Return Pitfalls

Indian life insurance companies do not have any access to hedging their portfolio even as they offer guaranteed returns.

The Indian insurance market is yet to introduce derivatives for hedging against an adverse investment climate, or else charge a fee to clients for providing guarantees. International experience of insurers show that lack of proper risk management in investment have led to companies going under.

In India, there has been a spurt of life insurers such as the Life Insurance Corporation of India (LIC), SBI Life, ICICI Prudential Life, OM Kotak Mahindra Life scaling down the assured rate of returns on guaranteed risk products in wake of the adverse investment climate.

With interest rates move south, the Insurance Regulatory and Development Authority itself is not comfortable with the ability of insurers to sustain the promised rate of returns, and has asked them to scale down the rate of interest on guaranteed products.

Many insurance firms in the US, UK and Japan have gone into liquidation or have undergone financial difficulties, where the common thread has been their inability to anticipate a alteration in the environment in terms of changes in the inflation rate, as well as rate of returns earned on government bonds, equity markets and the property markets.

Insurance companies need to design products that are robust and meet the changing investment environment, according to Gary Palser, chief actuary, Old Mutual (South Africa).

Cautioning companies against making decisions based on the current investment climate, Palser said companies should "allow for conditions to change (lower inflation/interest, market decline). There were many examples of guarantees being provided or investments being made on the implicit assumption that the current investment environment would continue".

Insurance companies are greatly dependent upon a good investment performance for their success. According to a global study, a number of companies showed consistent under-performance that adversely affected the competitiveness of their products, reduced their new business volumes and contributed to the ultimate demise of the company.

Many Indian life insurance companies have introduced guaranteed return schemes in view of customer expectations. Globally, however, based on past experience, the trend is to move away from offering guaranteed products without taking adequate measures to hedge against these risks. "We need to be particularly vigilant in these areas, and not allow conventional thinking to blinker us," Palser said.

Global insurers deduct capital charges from the capital returns for offering guarantees. Palser said, "This could work out to 1 per cent per annum, which then goes to the shareholder account to back the guarantees". Several global companies that provided guarantees under-estimated the cost of these guarantees, and therefore did not charge or reserve adequately for the same, he added.

Guaranteed risk products in India have been selling such as hot cakes as evident from LIC's sale of its single premium product -- Bima Nivesh.

Citing the international scenario, Palser said: "One of the reasons why these (guaranteed) products were so popular was that were under-priced. It is important that policies offering guarantees are properly matched as far as possible".

Senior officials at ICICI Prudential Life Insurance pointed out that there is a tremendous re-investment risk even if one were to match long-term liabilities (risk covers) with long-term assets (25-30 year government papers). "Even though the yield to maturity for 30-year paper stands at 7.95 per cent, as the RBI is paying semi-annual coupons over 30 years, we cannot be sure that we can invest the sum (interest) at 7.95 per cent," officials said.