Published in IRDA Journal in August 2011,Written by Kapil Mehta
High lapse of life insurance policies is one of the most serious issues in the Indian market place. On average about 20 per cent of policies lapse in the first year. At some companies and in some product lines lapses are much higher. When applied to the large base of policyholders this is a big number. It implies a high degree of financial losses for policyholders and general dissatisfaction with the products they had purchased.
The view on the impact of lapses is not uniform. Surprisingly, different stakeholders see the issue very differently.
Stakeholder’s varied perspective on lapses
Customers are the worst affected by lapses. In general they have a significant financial loss in the form of a surrender charge. Also, there is an opportunity cost as the premium amount may have been deployed productively elsewhere and the cost of purchasing insurance increases with age.
In general intermediaries such as individual agents, corporate agents and brokers are focussed on the first year compensation from an insurance sale. Renewal commissions are small (typically 5 per cent of premium in traditional policies) and it may not be profitable for the intermediary if there is considerable follow-up work required for renewal.
The situation is aggravated because many agents have low productivities and invariably become inactive over time. For all practical purposes they lose interest in soliciting or renewing insurance. In banks and other corporate agents, the issue is different. High attrition levels, frequent transfers and lack of training of the sales staff are an important reason for poor persistency.
The impact of lapses on insurers is more complicated. Good, long-term oriented insurers understand that a lapse results in loss of a long term cash flow and the resultant profits. There is also loss of reputation each time a company’s insurance policy lapses.
However, sometimes, lapses may actually increase an insurer’s profits in the short term. Several products are lapse-supported. This means that, because of the high surrender charges, lapses may actually increase short-term profits. This creates a tension as, often enough, meeting short term objectives is important for the insurers.
Further, in some markets, even the long term impact of lapses can be positive for the insurer. Taiwan is one such example. Policies that were sold there a decade ago were embedded with high guarantees as interest rates were at a peak at that time. Over the years interest rates in Taiwan have reduced considerably and to such an extent that many of the policies are unprofitable for the insurer. In such a situation, insurers can actually create significant long term value by lapsing policies. Customers have realized this and therefore persistency in these markets is high. Several insurers have now exit this market because of the unfavourable insurance economics. There is a lesson here about the risks of offering high guarantees but that is the subject of another article.
In summary, the impact of lapses on insurers is not always clear and there can be several conflicting outcomes. This makes it critical for regulators to take the right steps and for consumers to be more aware about insurance.
We must understand why policyholders lapse their policies. Do they understand the costs involved and the options available?
Why do customers lapse policies?
Understanding the root causes of lapses is the first step to addressing the issue. There are several reasons why policyholders lapse policies:
a) A surprisingly large number of people do not even realize that the policy has lapsed. This is because most individuals are notoriously poor in systematically keeping track of their finances. It is common to have individuals pay their premiums for years and then suddenly slip up on payment in a particular year.
b) Many a time, the reminder notices or calls by an insurer are the call for action for a consumer to renew their policies. If for some reason the company fails to remind customers of their obligations then the policy is very likely to lapse. Failure on the part of the insurance company is not deliberate. Often enough policyholders change homes or phones and do not provide updated information to the insurance companies.
c) In many instances, policyholders terminate a policy deliberately. Here too, quite often, termination is instigated by the advisor and driven by his desire to earn first year commissions once again. This is called replacement of policies and is illegal in many countries including India. The main challenge in curbing replacement is to systemically track it. If a company has thousands of agents it is hard to determine when replacement has occurred.
d) Then there are cases where the customer was mis-sold a policy. On becoming aware of this, he decides to terminate the policy. This is a serious breakdown of the solicitation process. It is not enough to say that all policy details were provided in the terms and conditions of the policy. Insurers and intermediaries have a responsibility to make sure that customers understand all conditions clearly.
e) Finally, customers may lapse a product if their needs change or new, much improved products enter the market. Both these situations are market realities in India. The lapses on term products tend to be the highest and one of the reasons is that policyholders feel that they no longer need death protection. An improvement in prosperity; changed financial circumstances can lead to this. Many a time customers realize that significantly cheaper term products have become available.
A structural change in ULIPs driven by the regulatory changes last year could also result in higher than normal lapses. The new ULIP products are much more attractive for customers as there are restrictions on how much insurers can charge customers. Many policyholders may be tempted to replace their products with the new ULIPs – particularly if their old policies have been active for a long time and surrender charges are minimal.
f) Lapses due to financial shocks or a liquidity cash crunch.
During a liquidity crunch some policyholders seek to cash out their policies. The immediate cash requirement in their mind supersedes the long term benefits of keeping the policy active.
What can stakeholders do to reduce lapses?
To address the issue insurers must:
- Design products that minimize the risk of inadvertent lapses. Single premium products are one such example. These are once-and-done products and can often be very cost effective for customers. Another product feature that is common in the US and Japan is the no-lapse guarantee. The product feature ensures that even in traditional products, once a minimum premium has been paid the death benefits on the products are guaranteed not to lapse even if the remaining premiums are not paid in a timely manner
- Automate premium collection. Cash collection in the country is complex. There are several areas where bank penetration is low. Even if a customer wants to make a payment it may be administratively difficult. Insurers can address this issue by increasing ECS mandates or, in the urban areas, ensuring automated credit card payments. These are not fool proof methodologies but do go a long way in improving persistency because people tend to keep their bank accounts and credit cards unchanged over the years.
- Build an effective technology system to identify replacements. Replacement is when an agent encourages a customer to lapse an existing policy of theirs and replace with a new policy. This seldom benefits the customer but helps the agent earn a higher commission through the new sale. This process is not allowed by the regulator. However, effectively monitoring replacement in the market place is difficult and requires effective technology. Insurers must also actively discourage replacements by taking strict action on defaulting agents, even if they are high performers.
- Finally, insurers have to keep strengthening their ability to deliver renewal notices or reminder calls to customers. Contactability of customers is another big issue in the industry and can only be addressed by ensuring that the information collected while selling the product is accurate and reliable.
For intermediaries the priority is to develop a long term orientation on the business. Key initiatives would be to:
- Build a stronger community to share best practices. There is a small but growing segment of agents who embody the best practices of life insurance solicitation. Their renewal performance would be second to none in the world. These high performing agents need to be showcased within the agent community.
- Build stronger cross-selling capabilities. Intermediaries may find that cross-selling can get them very good results, perhaps more attractive than searching for new clients. Cross selling results in an individual customer becoming more valuable for the intermediary. This forces the intermediary to move towards a more comprehensive key account management and relationship based approach. Such approaches do tend to increase customer’s satisfaction levels and enhance renewals
In order to reduce lapses, regulators must:
- Discourage lapse-supported products. Insurers need to have their products approved by the regulator prior to launch. The Authority must take a hard look at products where profitability increases with an increase in lapses.
- Publish a consolidated list of renewal persistency each quarter – similar to the new business sales that are published. This will help bring about customer (and media) focus on the issue. The Authority’s initiative to link the renewal of an agent’s license to persistency is an excellent move. This must be defined in a manner that is practical to implement.
- Encourage a compensation system for agents that rewards renewals. Insurers need more flexibility in renewal commissions. Currently, the absolute amount of renewal compensation is low and many agents or intermediaries do not focus on this aspect.
Finally, a last word on term insurance. This is the purest and cheapest form of insurance. Typically, the proportion of term insurance steadily increases as a market matures. Therefore it is disturbing that term insurance has the highest lapse rates in the country. This clearly points to the need for educating customers about protection oriented insurance and ensuring that they have done a proper comparison of products and prices before making a purchase.
In the years ahead, I expect the spotlight to shine brightly on lapses and, as a result, lapses should reduce considerably.