Policyholders have become cautious and want to ensure that their capital is secured, even though the returns may be low.
As equity markets stay volatile, customer preference has moved towards guaranteed products from plain vanilla unit linked insurance plans (Ulips). During the financial year 2009-10, though the equity market bounced back from its lows, insurers saw an increase in income from traditional plans. Insurance companies launched equity-linked products but with an element of guarantee. Most insurers launched Ulips that guaranteed the highest net asset value (NAV) for a particular year.
Insurers say that equity markets are unpredictable and there is always a possibility of a downside loss even when the market is generally going up. After having seen the market’s decline by more than 50 per cent, policyholders have become more cautious and want to ensure that their capital is secured even though the return is low.
“Market fluctuation or volatility leads to a sense of insecurity. Downside protection adds value to investors, as they look to optimise risk and reward. For them it is a win-win situation, as the downside is taken by the company but the upside is still available to them,” said Sanjiv Pujari, Appointed Actuary, SBI Life.
Over the last few years, the insurance industry has gone through a transformation in terms of investment. Ulips started generating 90 per cent of total business for insurance companies. When the markets witnessed a northward trend, over the last few years, consumers invested in Ulips without realising the risk associated with investing in equity.
The premium earned under traditional policies is regulated. Current regulations require that 50 per cent of the premium earned under traditional policies must be invested in government securities, 35 per cent in equities and other approved securities, and 15 per cent in infrastructure. However, in the case of Ulips, the investment allocation depends on policyholders’ risk appetite and they can opt for 100 per cent investment in equities. Last year’s fluctuation in the markets forced investors to ensure protection against market swings.
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“Even though the stock market has recovered, there are consumers who are averse to exposing their capital to stock market volatility, and hence opting for guaranteed products,” said Sunil Kakar, Chief Actuary, Max New York Life.
The cost of offering guarantees depends on the extent of the guarantee and the risk management practices put in place by the companies that are offering the products. It depends primarily on the asset allocation between equities and fixed-interest securities.
Similarly, the highest NAV guarantee products are assured through a dynamic asset allocation but on a daily re-allocation, depending on the market situation and market interest rates.
“The algorithm for these have been back-tested and forward-tested through models to withstand fairly extensive market fluctuations,” added Pujari.
A guarantee comes with a cost and, therefore, guarantee products are costlier compared to plain Ulips. For simple capital guarantees, the cost is low; this includes the cost of holding debt, which would generally provide lower returns. For products assuring the highest NAV, customers pay an explicit guarantee cost which can range from 25 to 60 basis points of the fund.
However, schemes that guarantee the highest NAV do not assure the highest returns. Unlike regular Ulips, these schemes do not provide a wide range of fund options, such as equity-oriented growth funds, balanced funds and debt funds. Also, policyholders do not have the option to switch between funds in these policies. The investment under these schemes is entirely based on the fund manager’s discretion. Under these schemes, premiums can be invested in equities, debt instruments or money-market instruments, in proportions varying from zero to 100 per cent.
Traditional products have also increased their share in the overall portfolio. Market leader Life Insurance Corporation of India (LIC) saw the share of traditional products going up to 32 per cent in the first nine months of the financial year (April-December 2009), against 25 per cent in the corresponding period of last year.
Private sector firms such as Max New York Life and Bajaj Allianz Life have adopted a similar strategy. Max New York Life increased its traditional products’ share from 25 per cent in April-December 2008 to 30 per cent in April-December 2009. Likewise, Bajaj Allianz Life’s share of traditional products increased from 4 per cent of total sales in April-December 2008 to 19 per cent in April-December 2009.
“Traditional products are the bloodline of any insurance company. Insurance means that we are trying to de-risk the customers. It is not as lucrative as Ulips, but meets the real need of insurance,” said LIC Managing Director D K Mehrotra.
The cap on Ulip charges has also affected Ulip sales. Irda chairman J Hari Narayan had said that the regulator may consider a similar cap on traditional plans also.
Another life insurer, Aviva, saw a marginal shift towards Ulips from traditional products in the first nine months of the financial year. Strong sales of policies have helped the industry post around 30 per cent growth in new business income.
Insurers are trying to increase their exposure to traditional plans in order to beef up their valuations before listing. Higher exposure to traditional plans will result in higher valuations for companies. Insurers are also moving towards listing. Meanwhile, Irda and Sebi are working on the IPO norms.
“There was a major transfer towards traditional plans when the market collapsed. But a delay in insurers’ listing would have had the opposite impact on sales of traditional products. Insurers who were eyeing a listing had emphasised more on traditional plans to get a higher valuation,” said Ernst & Young Partner Ashwin Parekh.
“We would like our share of traditionals to grow in the pie. Overall volume was negative last year. The sales will be driven by the consumers’ view on the market, but we see the need for protection rising,” said T R Ramachandran, CEO Aviva Life Insurance.
Traditional products need more capital than Ulips. It makes sense for new players to offer more Ulips, as it is cheap to underwrite.
So, are these products here to stay or are they the flavour of the season? HDFC Standard Life CEO Amitabh Chaudhry says they are the flavour of the season. He believes that as risk aversion abates and people gain confidence, products offering higher returns will make a comeback.