The Indian life sector has been marred with tax-rate changes (on high-ticket non-par policies) in the budget last year (2023). Investments in smaller tickets, growth in interiors, higher payouts and the ULIP wave (over non-par) have kept margins muted. In this backdrop, it has been challenging to get visibility on near-term growth and margin trajectory of these companies, even as deep value makes the investment case
The Indian insurance regulator IRDAI has released the final master circular on life insurance products, significantly reducing surrender charges levied on traditional savings. This will have a definite negative impact on margins in the traditional segment.
The final guidelines are a tad better than the draft released last month. Based on our rough math, surrender income may decline by about 55-70% (lower than the 70-80% decline as per draft guidelines).
The impact on Value of new business (VNB) margins may be early to quantify, as insurance companies may offset the same through distributor clawbacks and/or changes in internal rate of return (IRRs).
Valuations of the Indian life insurance sector remain supportive, while investors await stability and visibility.
What has changed versus the draft?
The IRDA published master circular on life insurance products on June 12, 2024. Among other changes, the new guidelines, raise the special surrender value (SSV) for non-linked policyholders.
Insurers will have to ensure that the SSV is at least equal to the expected present value of paid-up sum assured, paid-up future benefits and accrued/vested benefits, duly allowing for survival benefits already paid, (whatsoever name called).
The final guidelines provide for discounting of benefits at 10-year G-sec + 50 bps as compared to the draft, which proposed discounting at 10-year G-sec rates. Most of the other clauses are unchanged. These guidelines will be effective as of October 1, 2024; the terms of current insurance contracts remain unchanged.
The math suggests that surrender income may decline significantly, i.e., 61% for HDFC Sanchay Life (71% as per draft guidelines), 57% for ICICI Prudential Gift and 73% for Max Life Smart Wealth Plus.
Sharing the burden with other stakeholders—distributors and policyholders
At this stage, it is challenging to calculate the impact of these guidelines. While the reduction in surrender income will definitely dent the margins of these products, life insurance companies have the leeway to reduce the impact of changing distributor payouts/structures and/or IRRs on products.
Competitive dynamics may change as well. Notably, the insurance business has three primary stakeholders, viz., companies (shareholders), distributors and policyholders. The impact of any business or regulatory change may be shared between the three in varying proportions.
In this case, while exiting policyholders’ benefit, the impact may be primarily borne by shareholders, but can be shared with distributors and continuing policyholders (in terms of lower IRRs). This may help offset some of the impact on companies’ margins.
Change in commission structure
Another option is to change commission structures, with higher trails or claw backs. It is unclear that if the industry is ready for any deferment, i.e., higher trail and lower upfronts.
However, linking payouts to persistency may be inevitable to avoid the risk of mis-selling. Any reduction in the commission structure may hit the fee income of private banks and Policybazaar; the latter claims of higher persistency and hence the impact of clawbacks may be low.
Notably, ICICI Prudential Life launched an annuity product, with deferred commission payouts last quarter.
Valuations remain undemanding; multiple moving parts have made the investment thesis challenging
Our near-term forecasts are modest, with 15% near-term APE estimates (18% for Max Life) with near-flat margins despite a contraction in FY2024. Private listed players have fared better in the last two months and may push non-par in the next few months, which may expand margins in the near term.
The IRDA released draft surrender penalty guidelines in December 2023, final guidelines in March 2024, revised draft in May 2024 (according to the media) and the master circular yesterday (June 12, 2024).
The sector has been marred with tax-rate changes (on high-ticket non-par policies) in the budget last year (2023). Investments in smaller tickets, growth in interiors, higher payouts and the ULIP wave (over non-par) have kept margins muted. In this backdrop, it has been challenging to get visibility on near-term growth and margin trajectory of these companies, even as deep value makes the investment case.
With surrender penalty guidelines out of the way, we expect some clarity to emerge over the next few months.
Source-Kotak Institutional Equities