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Ashish, a staff member, visited his bank a few months ago to rent a locker. He was asked to buy an insurance policy if he wanted the locker. He was informed he would need to pay a one-time premium of Rs 1 lakh and the returns would surpass those of bank fixed deposits (FDs). Since Ashish needed the locker, he broke his FD to pay the premium.
When he checked the policy, he discovered he had been sold a 30-year policy with a 10-year premium payment term. As he couldn’t afford the premiums, he enquired about surrendering the policy. He was told he wouldn’t get anything back unless he paid three premiums and only a fraction even then.
This incident encapsulates life insurance mis-selling. Like the chakravyuh in Mahabharata, one can get in, but the high surrender charges ensure one cannot exit.
Ashish had been told the policy, which required payment of Rs 10 lakh over 10 years, would pay Rs 35 lakh after 30 years. But hidden in the fine print was the fact that only Rs 15 lakh was guaranteed. Any sum above that depended on the insurer’s “investment performance”, with Rs 35 lakh being the best-case scenario. Even then the return would be 5 per cent per annum. He would be entitled to the maturity value only if he completed 30 years. If he surrendered even in the 29th year, he would get only Rs 9 lakh.
The numbers for the bank were compelling enough to justify cannibalising its deposits. In this example, the bank would earn 35 per cent commission on first-year premium (Rs 35,000). Even accounting for 50 per cent selling expense read high staff incentives that would add Rs 17,500 (17.5 per cent of the deposit) to its bottom line. If the bank had kept the deposit, it would have made maximum 2 per cent. Effectively a bank earns around nine times more by converting its deposit into insurance premium.
If the policyholder pays subsequent year’s premium, the bank will make a 5 per cent commission (Rs 5,000), which is pure profit as there are no significant costs from the second year onwards. And the bank does not have to set aside expensive share capital for selling policies.
Since insurers are allowed 80 per cent of first-year premium as expenditure, they need to invest only 20 per cent towards the maturity value. The insurer would distribute the first year’s premium as follows: Rs 35,000 commission (35 per cent); Rs 20,000 investment (20 per cent); Rs 15,000 first-year expenses (15 per cent assumed); and Rs 30,000 profit (30 per cent). If the policyholder does not continue, the Rs 20,000 invested gets added to the bottom line. If the policyholder continues, then also the insurer makes money each year on lower expenses.
Policyholders lose the entire premium if they surrender in the first year and get a fraction back if they surrender later. The bank and the insurer’s profits come at the cost of the policyholder.
Life insurance is the only investment product left in India that has such a high commission and cost structure. Both the banking and the insurance regulator have overlooked its mis-selling. The insurance regulator, in fact, recently rolled back the proposal for a modest drop in surrender charges.
Ashish publicised his plight on social media, forcing the insurer to refund a substantial portion of the premium paid. Truth be told, most policyholders lack his patience and persistence. Two out of three policyholders do not pay premiums beyond the fifth year. Policyholders are not the only sufferers. Taxpayers subsidise insurers’ and banks’ profits via unjustified tax concessions given to the maturity value of life policies. Citizens pay a price as life insurers focus on selling highly lucrative investment policies instead of their core product term policies. In the longer run, banks, too, suffer as depositors lose faith in them.
The finance minister has publicly promised to tackle the mis-selling menace. Let’s hope this happens sooner rather than later.
The writer heads Fee-Only Investment Advisors LLP, a Sebi-registered investment advisor; X (formerly Twitter): @harshroongta
Disclaimer: These are personal views of the writer. They do not necessarily reflect the opinion of www.business-standard.com or the Business Standard newspaper
(A slightly different version of this column first appeared in the Business Standard on April 08, 2024)