Multiple levers with insurers to mitigate higher surrender value: Experts

Insurance companies are likely to offset the impact of increased surrender value by changing commission structures and revising the Internal Rate of Returns (IRRs), according to analysts and experts.

According to a research note by Emkay Global Financial Services, “Undoubtedly, the impact of this enhanced surrender value, on ceteris paribus, is going to be material on non-par savings products. However, this also gives the life insurers the opportunity to moderate the impact of higher payouts to the surrendering policyholders or the other stakeholders.”

The Insurance Regulatory and Development Authority of India (Irdai) in its ‘Master Circular on Life Insurance Products’ issued on Wednesday prescribed enhanced Special Surrender Value (SSV).

As per the circular, life insurers will have to ensure that the SSV is at least equal to the expected present value of the paid-up sum assured, paid-up future benefits, and accrued or vested benefits, duly allowing for survival benefits already paid.

Surrender value will be applicable after the first year if the first-year annual premium has been paid. The guidelines provide for discounting of benefits at 10-year G-sec with a cushion of 50 basis points (bps) as compared to the draft, which proposed discounting at 10-year G-sec rates.

“Special Surrender Value (SSV) should be equivalent to at least the present value of the paid-up sum assured, paid-up future benefits, and accrued benefits, if any, and shall become payable on receipt of one full-year premium. With this, payouts on premature exits for policyholders making an early exit will go up,” said Satishwar B, managing director (MD) and chief executive officer (CEO), Bandhan Life.

The increased surrender value is likely to impact the Value of New Business (VNB) margin of the insurance companies. According to experts, even if these norms are applicable to both participating (par) and non-participating (non-par) products, the impact will be materially higher for non-par than for par.

Private insurer HDFC Life Insurance informed the exchanges that the company is expecting a gross impact of nearly 100 bps on its New Business Margin (NBM) due to higher surrender value, as a result of early exits.

According to industry sources, the VNB margin of the insurance companies for the entire financial year is likely to see a decline of 100-300 bps ceteris paribus. “As the surrender value comes into effect from the second half of FY25, the (half-year) impact is likely to be around 100-125 bps. It is also likely to result in a shift in product mix,” an industry insider who did not wish to be named said.

Meanwhile, speaking on the impact of the change on the VNB margins of the non-par segment, Deepak Jasani, head of retail research at HDFC Securities, said that the industry will see a one-time impact of about 20 to 30 per cent in the profitability of the segment.

Analysts at Kotak Securities estimate the surrender income of life insurance companies to decline by about 55-70 per cent as a result of the norms.

According to analysts, the insurance companies, however, have multiple options available to minimise the impact like reducing the guaranteed rates for the persistent policyholders, moving to trail-based commission payout, or introducing the claw-back provision on the first-year higher commission in case of early surrender.

The measures are likely to help the companies limit the net impact to 40-120 bps, from 6-8 percentage points (ppt) impact on gross margin due to the higher surrender value as per Jefferies’ estimates.