The Insurance Regulatory and Development Authority of India (IRDAI) is planning to increase the surrender charges of life insurance policies, according to a draft product regulation issued in December 2023. The proposal has sparked a debate among the industry players and policyholders, as it could affect the profitability of life insurers and the liquidity of policyholders.
What are surrender charges?
Surrender charges are the fees that life insurers deduct from the surrender value of a policy when a policyholder voluntarily terminates it before its maturity. Surrender value is the amount payable to the policyholder on withdrawal or termination of a policy during the term. Surrender charges are meant to discourage early exits and ensure that life insurers recover their expenses and earn a reasonable return.
What is the current scenario?
Currently, the surrender value and surrender charges vary depending on the type of product, duration of the policy, premium payment term, and other factors. For example, for non-linked savings and protection-oriented products, the minimum guaranteed surrender value is 30% of the total premiums paid if the policy is surrendered after paying at least two full years’ premiums. The surrender charges are calculated as a percentage of the premiums paid or the fund value, depending on the product.
What is the proposed change by IRDAI?
The IRDAI has proposed to create a premium threshold defined for each product, and no surrender charges will be imposed on the balance of the premiums beyond such threshold limits, irrespective of the time of surrender. The premium threshold will be determined by the IRDAI based on various parameters such as product features, risk profile, mortality rates, etc.
The IRDAI has also proposed to increase the minimum guaranteed surrender value for individual non-linked savings and protection-oriented products. The proposed slabs are as follows:
- 30% of the total premiums paid if the policy is surrendered during the second year
- 35% of the total premiums paid if the policy is surrendered during the third year
- 50% of the total premiums paid if the policy is surrendered during the fourth year
- 90% of the total premiums paid if the policy is surrendered during the seventh year and onwards
The surrender value beyond the seventh year will follow a smooth progression and converge to at least 90% of the total premiums paid less any survival benefits already paid, as the policy approaches maturity.
What is the rationale behind the change?
The IRDAI has stated that the objective of the proposed change is to ensure that policyholders get a fair and reasonable amount towards surrender value, especially towards the end of the term which is closer to the expected maturity value. The regulator has also said that it wants to align the surrender value with international best practices and make it more transparent and consistent across products.
What are the implications of the change?
The proposed change could have significant implications for both life insurers and policyholders. For life insurers, it could mean a higher payout on surrenders, which could affect their profitability and solvency margins. It could also increase their capital requirements and reduce their ability to invest in long-term assets. For policyholders, it could mean a higher liquidity option in case of emergencies or financial needs. However, it could also encourage more surrenders, which could defeat the purpose of long-term savings and protection offered by life insurance.
What are the views of stakeholders?
The proposal has received mixed reactions from different stakeholders. Some life insurers have expressed concerns over the impact of higher surrender values on their margins and business models. They have also suggested some alternatives to rationalise the proposal, such as lowering the premium threshold limits, creating different product constructs based on policyholder preferences, or introducing a five-year milestone beyond which policies could be considered long-term.
Some policyholders have welcomed the proposal as it would give them more flexibility and choice in managing their financial plans. They have also appreciated the transparency and consistency that would be brought by uniform surrender values across products.
The IRDAI is expected to consider all these views and finalise its decision in its March board meeting.
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