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Changing bonus concepts of Life Insurance Corporation

Savings under new strategy will benefit policyholders

INDIAN POLICYHOLDERS have long been accustomed to annual declaration of bonus under traditional life insurance policies other than pension policies. The concept of paying a lump sum bonus at the time of maturity, in addition to the regular bonuses declared, was introduced in 1979. This move was prompted by the need to give back to the policyholder, at the time of exit, his share of the implicit reserves built up over the years by the Life Insurance Corporation through margins in the actuarial valuation of the liability.

Two new plans

Recently, under two of LIC's new plans, Jeevan Saral and Bima Gold, a new concept of not declaring bonus every year and instead paying it only at the end, in one lump sum, was introduced.

When a person purchases a life policy, he wishes to have a rough estimate of the total amount of bonus he can expect at the time of maturity, on the basis of trends in bonuses declared.

Since the first set of policies under the new plans may not be due for maturity payment for more than a decade, one has to wait for many years to get an idea of the actual quantum of the lump sum payments. In the mean time, the agents may find it difficult to convince prospective clients who are not prepared to place full trust in the insurer. It is therefore necessary to examine the possible reasons behind the introduction of this new concept by LIC.

A life insurance company can declare bonus only out of the surplus (akin to profit) determined at the end of each year. The surplus is defined as the difference between the Value of Assets and the Value of Liabilities under all policies. The liability under a policy is defined as the discounted value, as on March 31, (of contractual benefits + discretionary benefits + expected expenses in future minus future premium income). The sum assured and bonuses already declared are known as contractual benefits. All types of bonuses expected to be declared in future are known as discretionary benefits. The bonus for the current year has to be declared out of the surplus that emerges.

However, the entire surplus cannot be distributed as current year's bonus. The company has to first pay tax (at about 14.1 per cent) on the surplus that emerges. From the balance surplus, five per cent has to be paid to the shareholder (that is, the Government) as its share of the surplus. The surplus thus gets depleted by more than 18 per cent, before it can be distributed to the policyholders.

Deferred payments

On the other hand, if the value of the bonus intended to be declared for the current year is added to the liability, the surplus gets reduced substantially. So also are the tax payable and shareholders' share of surplus. Though no bonus could be declared for the current year, a reserve would have been created for paying the same at the time of maturity. The regulations too ensure that such a reserve is created. The concept of declaring bonus only at the time of maturity is thus a simple strategy of deferring payment of tax and shareholder's share of surplus. The savings resulting from such deferment are passed on to the policyholders who are thus the only beneficiaries under this strategy.

If such a simple strategy is available, will not other insurance companies too adopt it? They cannot. This is because when payment of tax is deferred, payment to shareholders too gets automatically deferred.

Why has the LIC brought out a with-profit `Premium Back' plan like Bima Gold unlike other companies which have stuck to the without-profit route? The private companies prefer the without-profit route as 100 per cent of the surplus after tax goes to shareholders. Not only that. When interest rates start rising, the resultant increase in surplus (net of tax) goes fully to shareholders. In the case of with-profit policies, the benefit of any increase in interest rates goes to policyholders. The with-profit route is always preferable when the prospect of rising interest rates is quite high. Even if the yield on investments does not increase, the benefit to the policyholder will not be less than what it would be under the without - profit route.

The premium rates in the case of plans coming under `Only Loyalty Addition' class will be between those of the corresponding plans under without-profit and the traditional with-profit classes. While enjoying slightly lower premium rates, policies under such plans can enjoy the full benefit as under traditional with-profit plans in case interest rates rise.

R. RAMAKRISHNAN

Actuary

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