IRDAI hikes surrender values for non-linked products; here’s how insurance stocks react

Shares of insurance companies remained in focus today after the Insurance Regulatory and Development Authority of India (IRDAI) raised surrender values for non-linked products. The regulator has issued a master circular on insurance products, significantly increasing surrender values for non-linked productsin the initial periods, a move that could impact their margins.

Despite this development, shares of most life insurance companies were trading higher, in sync with the broader market. Index heavyweights LIC of India, SBI Life Insurance Company, HDFC Life Insurance, and Max Financial Services gained up to 2% in early trade today. The equity benchmark Sensex and Nifty50 also traded higher by 0.35%, tracking firm cues from global peers.  

Domestic brokerage Nuvama Institutional Equities in a report says HDFC Life and Max Life each derived 52% of FY24 total annualised premium equivalent (APE), a common sales measure used in the life insurance industry, from this segment and “shall be hurt most”. Meanwhile, non-linked savings products contributed 70% of APE to LIC of India in FY24.

“We expect companies to defer commission payouts to manage this change with margin moderation by up to 200bp. The impact of this change on distributor behaviour and sales growth is more difficult to assess,” the report notes.   

The brokerage, however, believes that the impact on growth is more difficult to assess as lower/deferred commission payouts and higher surrender values may lower mis-selling and reduce growth, to that extent. However, despite lower commission, insurance is still the highest commission paying product. Hence, the distributor has no choice but to sell the product, it adds.

“We are awaiting more clarity from companies after which we shall revisit estimates. This marks the end to a large regulatory uncertainty, and we believe the current market prices largely factor in the change,” it highlights.

Meanwhile, Nuvama continues to prefer HDFC Life with a target price of ₹750 apiece, and SBI Life at ₹1,780 per share.  

As per the IRDAI circular, the new product guidelines propose payment of surrender value on a present value on sum of paid-up sum assured; paid-up future benefits; and accrued benefits, reduced by any payouts. Moreover, surrender values become payable even if only one premium is received (earlier at least two premiums should have been received). Present values shall be calculated using the 10Y G-Sec rate and up to 50bp allowance, the report notes.

Nuvama estimates that surrender values contribute 40–60% to margins of companies; hence, companies will have to significantly re-design their businesses.

On sectoral implications, the brokerage said that after removing commission caps, some companies had been paying very high commissions to distributors. “We believe IRDAI – to control mis-selling, protect policyholder interest – has raised surrender values as this shall indirectly need insurance companies to rein in/defer commission payouts and/or work at lower margins (up to 200bp lower).”

The agency believes that lower commission payouts/deferred commission payouts will aid larger firms with superior distribution as they enjoy better scale. They will also benefit from lower competitive intensity from companies building in higher surrender charges in their return/margin calculation.