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The lure of unit linked insurance

Though unit linked insurance has been in vogue in many countries for more than two decades, it was made available to the Indian public only after the insurance sector was thrown open to private players. Till then, this class of business could not be offered by the Life Insurance Corporation because of severe investment restrictions under the regulations. Unit linked insurance has come to dominate the life insurance market in the past three years to such an extent that the initial euphoria is slowly turning into concern. It is worth analysing the reasons behind the popularity of this product among the public, life insurance agents and private insurers.

The booming stock market has led the public to believe that this new class of policies provides a safe and easy way to make money. No one pauses to think whether the high rate of rise (about 30 per cent) in Sensex, witnessed in recent years, can be sustained. Take the Dow Jones index of the U.S. It rose at 20.5 per cent annually between 1997 and 1999. But, in the 10 year period 1997- 2007, the annual rate was only 5.4 per cent. While judging unit linked policies, one has to take a long term view and not be unduly influenced by the present or immediate past.

Insurance agents find it easy to push this product. All they have to do is assume that the recent high rate of increase will continue indefinitely.

It is difficult for a new life insurance company to match the bonus rates of a well established one. It will be at least ten years before it can offer any serious challenge. But, with unit linked policies, new and well established companies are on level ground as every thing depends only on the performance of the stock market. So, for quick results, the new companies are concentrating on unit linked products and turning to aggressive marketing. This, in turn, calls for hundreds of crores in additional capital. But they are confident that, thanks to a buoyant stock market, they can get more than double the amount invested by selling a part of their stake through initial public offers.

The solvency margin regulations of the Insurance Regulatory and Development Authority too acts as a catalyst for this tilt towards unit linked policies. In the case of traditional products, the regulation prescribes that a life insurance company should maintain, at all times, a solvency margin reserve equal to [6 per cent of the liability + 0.45 per cent of the sum at risk]. For unit linked policies, the reserve required is only [ 2 per cent of the liability + 0.3 per cent of the sum at risk]. Since solvency margin requirements directly impact capital sufficiency, this is an additional reason for preferring unit linked products.

As per the Insurance Act, 1938, shareholders were eligible for a maximum of 7.5 per cent of the surplus, namely, the difference between the value of assets and the actuarial valuation of liabilities. After the amendments to the Act made by the IRDA a few years ago, shareholders are eligible for 10 per cent of the surplus under participating and 100 per cent of the surplus arising under non-participating policies. Since unit linked policies come under non-participating category, the private sector’s preference for these products is obvious.

Till the assessment year 1977-78, the taxable income of LIC was being taken as the higher of net income and net valuation surplus. The net valuation surplus was taken as 20 per cent of the valuation surplus, on the assumption that 80 per cent of the surplus was being given back to holders of with-profit policies in the form of bonus. A single fund was being maintained for both with and without profit policies and 95 per cent of the total surplus was being distributed to with-profit policyholders. The rate of tax was 52.5 per cent (corporate tax rate). From 1977-78, in order to simplify the procedure, the taxable income was taken as the full valuation surplus and the rate of tax as 12.5 per cent (plus surcharge, if any). The amount of tax was the same under both systems at that time, but the second system was extremely simple. Both were based on the assumption that not less than 80 per cent of the surplus will be given back to policyholders in the form of bonus.

After the recent amendment to the Insurance Act, separate funds are being maintained for with and without profit policies. Though no part of the surplus under without profit fund goes to policyholders (not so, in the case of LIC), there is no change in the rate of tax. This gives an added advantage to the new companies, the major portion of whose funds pertains to unit linked policies.

Unit linked policies thus come under the without profit category for shareholders’ share of surplus, under the with profit category for taxation and get also preferential treatment for solvency margin requirement. Add to these the current boom in the stock market, the popularity of this product among all sections of the life insurance industry can be understood. Whether this trend is good for the industry, time alone can tell.

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