Life insurance stocks steady as brokerages see manageable impact of new SV norms on insurers

Shares of life insurance companies remained steady on Thursday as brokerages foresee initial margin reductions for insurers due to a new regulation by insurance regulator Insurance Regulatory and Development Authority of India (IRDAI), but expect the industry to adapt and adjust over time.

On June 12, IRDAI dismissed life insurers' concerns regarding higher premature exit payouts, retaining most provisions related to increased special surrender value (SSV) for endowment policies proposed last month. It mandated life insurance companies to offer surrender value (SV) from the first year, a change from previous norms that allowed it from the second or third year.

Among stocks, HDFC Life rose 4.4 percent to ₹597.95 followed by Max Financial Services, which increased 3 percent to ₹994.50. Meanwhile, ICICI Prudential gained 1.7 percent to ₹589.85, LIC advanced 1.5 percent to ₹1,013.00 and SBI Life added 1.2 percent to ₹1,478.25.

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In essence, compared to the current scenario, surrender values—or payouts on premature exits—will increase for policyholders who exit early due to mis-selling or an inability to pay premiums. Unlike the present situation where policyholders lose the entire premium if they exit after the first year, they will now receive a portion of their premiums back.

IRDAI has mandated that the Special Surrender Value (SSV) should be at least equivalent to the present value of the paid-up sum assured and any paid-up future benefits, such as regular income payouts. The paid-up value is calculated using the formula: (number of premiums paid) x (sum assured) / (total number of premiums payable).

"The IRDAI has issued the final master circular on life insurance products, significantly reducing surrender charges on traditional savings plans. We note that the final guidelines are somewhat more favorable than the earlier draft. Based on our preliminary calculations, surrender income could decrease by approximately 55-70%. It's too early to quantify the impact on the Value of New Business (VNB) margin, as insurance companies might offset this by adjusting distributor terms or making changes to internal rate of return (IRR) calculations. While the valuation of the insurance sector remains supportive, investors are looking for stability and clearer visibility," said Shrikant Chouhan, Head Equity Research, Kotak Securities.

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Furthermore, to address complaints about insurers not complying with insurance ombudsman orders promptly, the IRDAI has introduced additional penalties. Insurers will now face a penalty of ₹5,000 per day if they fail to honor the ombudsman order within 30 days.

What has changed versus the draft?

The IRDAI published a master circular on life insurance products on June 12, 2024. Among other changes, the new guidelines, raise the special surrender value for non-linked policyholders. Insurers will have to ensure that the SSV is at least equal to the expected present value of the 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.

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Brokerage views

Jefferies expects Max Life and HDFC Life to face a greater impact from the new regulations, whereas ICICI Prudential Life and SBI Life may experience milder repercussions. The regulations mandate higher payouts for policyholders opting for premature exits, potentially squeezing insurers' margins. Analysts acknowledge the negative impact but believe insurers can manage it through strategic adjustments.

The new SSV norms, effective from October 2024, align with draft regulations. Jefferies highlights that insurers offering participating (par) savings products and those with lower policy persistency rates will feel the brunt more significantly. They estimate that the increased SVs could reduce the gross margins of affected products by 6-8 percentage points.

Despite this, Jefferies suggests insurers could mitigate the net impact by 40-120 basis points through actions such as commission deferral, clawbacks, and reducing commission rates. They believe this manageable impact could alleviate concerns and potentially improve the sector's valuation.

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Morgan Stanley's analysis echoes Jefferies in recognising the adverse impact of the revised Special Surrender Value (SV) norms on insurers' margins. The firm underscores the necessity for insurers to implement strategies to mitigate potential margin pressures.

Under the new regulations, insurers are mandated to raise the special surrender value to at least match the present value of the paid-up sum assured and paid-up future benefits. This adjustment aims to provide more equitable compensation to policyholders who choose to exit prematurely, often due to financial constraints or issues like mis-selling awareness.

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Meanwhile, Kotak Securities also noted that the change is expected to impact margins in the traditional segment negatively. However, the final guidelines are slightly more favorable than the draft released last month. Preliminary estimates suggest that surrender income may decline by 55-70 percent, which is less severe than the initially projected 70-80 percent decline. The impact on the Value of New Business (VNB) margins is still uncertain, as insurers might mitigate it through distributor clawbacks or adjustments in internal rates of return (IRRs). Valuations remain supportive, while investors look for stability and clarity.

Disclaimer: The views and recommendations made above are those of individual analysts or broking companies, and not of Mint. We advise investors to check with certified experts before taking any investment decisions.