Life insurers headed for an initial public offering may have to lower their valuation expectations as investors could balk at their earnings that are accruing more from lapsed policies than from operational income.
According to a study by Goldman Sachs, insurance companies have either been reporting strong profit numbers or smaller losses due to increase in lapses.
Policies lapse when policyholders do not pay renewal premium. This has so far helped insurance companies post profits. The report said gains from lapsed policies, which is estimated at more than 30%, will disappear in the first half of the next financial year.
“Insurance companies have either been reporting strong profit numbers or smaller losses compared with those reported over the past one year. This is due to higher lapse profit, falling expense ratios and lower volume growth,” the report said.
High number of lapsed policies is helping life insurance companies post profit in the short term, but this may not generate long-term value. Private sector insurance companies such as ICICI Prudential have seen more than 90% profit coming from lapsed policies.
Out of Rs 807-crore profit posted in financial year 2010-11, Rs 730 crore came from lapsed policies. Similarly, HDFC Life has been able to lower its losses to Rs 99 crore, thanks to the lapsed profit of Rs 223 crore.
“Lapsation may result in higher profit booking for select companies based on the risk pool in the short term. However, it will negatively impact the long-term enterprise value. It takes more money to sell a new policy than to maintain an existing policy,” said Monish Shah, director, Deloitte Touche Tohmatsu India.
“Lapsation implies that there could have been some mis-selling. If you want to look at the health of a company, then you would like to see the persistency levels as well,” Shah said. After regulatory changes were brought in for unit-linked products, insurers are required to write off cost upfront, which adds to the pressure on profits.
Before September 2010, insurers were charging up to 100% as surrender charge, which is now capped at Rs 3,000 for a premium up to Rs 25,000. So, if a policy lapses after two years, then the premium is transferred to a discontinuance fund and the company recognises profit on this three years after deducting the acquisition cost.
“Strain on new business income is going up because of policy lapses,” said a senior executive of a large life insurance company. “Earlier all our acquisition cost was recovered through surrender charge, but now there is a cap and insurers do not make money on lapses.” The insurance industry has seen a significant shift in product mix with companies moving towards traditional products.
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