Lapsatio of A Life Isurace Policy LAPSATION OF A LIFE INSURANCE POLICY Jagedra Kumar, Corporate Head, (Trg), Shriram Group Compaies, Jaipur ABSTRACT Lapsatio is always the bug-bear of a life isurace compay. I Idia, the acceptace of a proposal for life isurace ecessitates admiistrative processes which, together with the aget s commissio ad medical charges, cost the Life isurer almost the whole of the first year s ad a major part of the secod year s premium. Early lapses, therefore, pose a major fiacial problem to the life isurer. It has bee realized that the pheomeo is ot ameable to ay simple statistical model due to a iheret stratificatio i the populatio of lapsed policies. Life isurers may have to adopt a uiform defiitio for lapsatio of isurace policies to give more leeway to policyholders o premium paymets. INTRODUCTION A life isurace policy lapses whe the subscriber does ot pay the premium withi the grace period. Whe a policy lapses, the holder forfeits the premium paid ad the isurace cover. The aget loses the reewal commissio. It also impacts the growth of the isurace busiess ad solvecy margis of the isurer. Lapsatio of a life isurace policy is discotiuatio of premium paymet by the policyholder durig the period of operatio of the policy, due to ay reaso other tha the death of the policyholder. The legth of life of a lapsed policy ca be defied as the period betwee the moth whe the last premium istallmet was paid ad the moth the policy was issued. WHAT IS LAPSATION? At preset, compaies have varyig defiitios o lapsatio of policies ad this creates a lot of cofusio. The suggestio for life isurers to adopt a uiform grace period ad lapse defiitio has bee made i IRDA s first occasioal paper o Lapsatio of isurace policies ad its impact o the domestic idustry. Lapsatio of isurace policies is a global cocer ad impacts all stakeholders. Fact reveals that the lapse rate i terms of the umber of policies icreased to 6.64% i 2006-07 from 5.62% i 2002-03. The lapse rate by premium rose to 6.95% from 4.4% i 2002-03. The lapse rate i ULIPs is 18% i terms of umber of 38 q Bimaquest - Vol. IX Issue II, July 2009
Lapsatio of A Life Isurace Policy policies ad 10% by premium. It is also higher as compared to most traditioal plas. Over 752,000 isurace policies of the Life Isurace Corporatio of Idia aloe have lapsed. The sum assured ivolved i lapsed policies is i excess of Rs 47,000 crore (Rs 470 billio). Isurace regulator IRDA has recommeded a uiform grace period of 30 days for policyholders payig their premium every quarter, half-year or every year. A 15-day grace period has bee suggested for policyholders payig mothly premium. WHEN DOES A POLICY LAPSE? For a uit-liked policy, which is less tha three years old, the chace of a lapse begis as soo as you skip a premium. Typically, the isurer seds a remider ad gives a grace period of a moth. Durig this time the life isurace cover would cotiue, so if the policyholder died durig the grace period, the omiee would still be able to get the beefit. However, oce the grace period is over, the isurer will sed a letter sayig the policy has lapsed. But this threat does ot hold water for a sigle-premium policy, sice the etire amout is, by defiitio, paid upfrot. For a policy, which is more tha three years old, the policy assumes a paid-up value. This would mea that eve as further premium flow stops, the policy would cotiue to be i force. Oce the policy becomes paid up, it will cotiue to be i force as log as the fud value is sufficiet to meet the expeses specified of the policy. Fud value is the total moey ivested mius charges, the isurer dips ito this corpus to meet its expeses if the policyholder does ot pay fresh premiums. However, if you have the moey, the a good idea would be to cotiue payig up premiums sice the charges would eat ito your fud value, pullig the returs dow. SURRENDER Vs. LAPSE Oe of the importat factors affectig the health of life isurace compaies is lapses. Lapse is the discotiuace of the policy by o-paymet of premiums due. It is importat to uderstad differece betwee surreder ad lapse, as surreder refers to a situatio where the policyholder surreders his policy ad takes the surreder proceeds as specified i the product - policy documet. Hece, there is a well-iformed separatio of policyholder from the compay. Whereas, i the case of lapses, withi some specified time, the policyholder may revive the lapsed policy by payig all the premiums, which are due o, that date ad provig cotiued isurability. But, the proportio of such revivals is less tha 3% ad hece majority of lapses are permaet i ature. DETERMINANTS OF LAPSE RATE To form the lapse rate for a specific life isurer, the value of lapsed policies for ordiary life products is divided by the average total life isurace i force durig the time period. This Bimaquest - Vol. IX Issue II, July 2009 q 39
Lapsatio of A Life Isurace Policy ratio is multiplied by a scalig factor of 100. Ordiary life policies iclude the followig types of isurace plas: level term life; decreasig term; reewable term; traditioal whole life; iterest sesitive whole or uiversal life; ad graded-premium whole life. Oe of the major causes for the growig lapsatio ratio is forced sellig by agets to achieve their targets. Agets also sell policies without takig customers eeds ito accout. Iterest i lapse rate determiats has become more promiet i recet years as some fiacial service firms have applied securitizatio techiques to life isurace policies held by idividuals. Uder securitizatio arragemets, the isured perso coveys the paymet rights of the policy to the firm structurig the securitizatio product. I retur, the isured perso receives a oetime cash paymet. The securitizig firm pools these policies, usig them as the basis for asset-backed securities. Isurace compaies, too, may egage i the securitizatio of their life isurace liabilities by trasferrig life policies ad the assets that back them. IMPACTS OF LAPSATION From the Isurers perspective, life isurace products, ad especially whole life products, typically etail large uderwritig ad upfrot origiatio costs, heavily drive by sales costs ad commissios. This cost structure provides isurers a strog motive toward lower lapse rates. Too high a lapse rate may impair the ability of the isurer to recoup these costs, give the projected beefits payouts required uder these lies of isurace. Compaies that are i a stroger market positio will be able to price more aggressively tha compaies i a weaker market positio. The lapse rate o life policies has traditioally bee oe of the cetral parameters i the maagerial framework for life isurers. Cosumer demad is widely recogized to be sesitive to pricig for both term ad whole life product lies. These ordiary life products are regarded as commodities. That is, these products are relatively homogeeous i ature, offered by a large umber of isurers, ad are competitively priced. From the cosumer s perspective, both term ad whole life policyholders with health or other isurability problems ted to lapse less frequetly, because their alteratives are limited ad ca be more expesive. The effect is to itroduce a tedecy toward adverse selectio. Healthy idividuals may lapse or fail to reew at the guarateed-reewal dates if they ca fid less expesive term isurace whe passig a medical exam. This adverse selectio effect causes the isurer to experiece a higher rate of claims o the remaiig policies tha would have bee expected from the etire pool of origial isured. Lapsatio ad policy termiatios may be iitiated by cosumers at ay time by failig to pay premium billigs o term ad whole life policies. The o-reewal of term ad whole life policies may also occur o reewal aiversaries for policies with guarateed reewable riders. REVIVAL OF LAPSED POLICIES For a lapsed policy, the isurer gives up to four years to revive the policy. However, revival becomes difficult because, for the isurer, the policyholder becomes a greater risk with the 40 q Bimaquest - Vol. IX Issue II, July 2009
Lapsatio of A Life Isurace Policy passage of years. The later you revive, the older you get, which aturally icreases the risk for the isurer. Also, you will have to udergo medical tests. The revival process is easy up to six moths from the date of lapsatio all you have to do is pay the premiums. But after six moths you will ot oly have to pay a specified amout as iterest, which may be 12-18 per cet of the premium or a charge of up to Rs 500, but may also have to udergo a medical check-up as per the isurer s specificatios. This is paid for by the policyholder. After the revival period is over, the cotract shall termiate ad the fud value, with the charges subtracted from it, would be paid at the ed of the third policy year, or at the expiry of the revival period, whichever is later. It is i your best iterests to pay your premiums regularly. I case you forgot to pay your premiums, pay them as soo as possible. Ad remember: the cover is o loger active whe the policy is lapsed. SPECIAL INCENTIVES Term assurace products showed the highest rate of lapse, while pesio policies had the lowest lapse rate. The lapse rate for o-medical policies was, however, higher tha that of medical covers. A part of the premium is ivested i equities or govermet bods, depedig o the choice of the policyholder. Solvecy margis refer to the excess of assets over liabilities that a isurer maitais as a prudetial measure i the iterest of policyholders. Revival campaigs have lowered the lapsatio rate. Low commissios i the first year ad special icetives to itermediaries helped check lapsatio. ULIPs are popular savigs istrumets that offer flexibility to policyholders i terms of ivestmet ad also a life cover. I a pure term product where there is either surreder beefit or maturity beefit the lapse will result i a loss to the compay if asset share uder the policy is egative at the time of lapse. Whereas i the case a edowmet product the asset share is built over the period of time ad if the lapse occurs i the iitial phase of the policy the this would result to a loss to the compay because compaies will ot be i a positio to recover the fixed cost icurred i writig the policy. Whereas, if the lapse occurs at a later period the the compay may be profited by forfeitig the mathematical reserves built uder that policy. Moreover, if the lapses are high i the iitial phase, compaies will ot be i a positio to recover the fixed cost ad hece, the deficit i fixed cost recovery is to be bore by the shareholder. TRADING OF LAPSE POLICIES With returs averagig ie to 12 per cet i these policies, large cash-rich corporates have started ivestig i tradeable isurace policies. Isure Policy Plus Service is amog the first market makers specializig i purchase of lapsed policies ad covertig them ito TIPs. It has tied up with a leadig credit ratig agecy to rate the fiacial istrumet. TIPs a ivestmet istrumet offerig assured, high returs agaist the maturity of a life policy, promises the purchaser the sum assured plus all the beefits that would accrue to the Bimaquest - Vol. IX Issue II, July 2009 q 41
Lapsatio of A Life Isurace Policy policyholder o maturity ad durig the life of the cotract. TIPs are bought ad sold i the market today after the origial LIC policyholder assigs all the rights ad beefits to the ivestors who offer a price higher tha the surreder value for the lapsed risk cover. As this istrumet helps revive a lapsed policy, Life isurer stads to beefit both i terms of past premiums paid plus iterest thereo at 12 per cet per aum. Credit ratig of TIPs will further drive sale of the product amog baks, mutual fuds, charitable trusts, providet fuds ad clubs with huge deposits lyig i bak accouts. The credit ratig will be take o LIC ad ot us. With its sovereig backig, this will help drive sales as we believe there is a huge market for the product, FINDINGS ON LAPSE POLICIES As per IRDA fidigs the lapse rates for the o-liked products ad liked products over the last three years were as follows: Lapse rate for seve compaies out of sixtee exceeded the idustry average (simple arithmetic mea) of 18% (lapse rate by umber) ad 11.9% (lapse rate by premium amout). However, majority of the compaies exceeded the idustry average rate (weighted average with weights beig premium exposed to risk) by a cosiderable margi. Age at etry, mode of premium paymet, duratio elapsed sice policy iceptio, policy type ad type of uderwritig are foud to be the most sigificat factors affectig the lapse rates. Lapse rate with respect to age at etry showed a decreasig tred from age group 18-22 to aroud 60 years ad lapse rate teded to icrease from the rage below 18 to age group 18-22. Lapse rate (by umber of policies) with respect to mode of premium paymet teded to be higher with the frequecy of premium paymet ad lower for mothly ad salary deductio modes. Lapse rates are observed to be decreasig with duratio elapsed sice iceptio. It was observed that the treds i lapse rate with respect to both umber ad premiums were almost similar to each other. With-profit policies showed higher rates of lapse whe compared to their o-profit couter parts for edowmet ad whole life policies. 42 q Bimaquest - Vol. IX Issue II, July 2009
Lapsatio of A Life Isurace Policy Term assurace products showed the highest rate of lapse with respect to both umber ad premium lapsed i.e. 28.27% by umber ad 18.95% by premium. Whole life products showed higher lapse rate tha edowmet products for with profit policies ad coverse is observed for o-profit policies. Pesio policies were observed to show the least lapse rates amog the all categories. Uit liked cotracts had lapse rate as 18.09% by umber ad 10.01% by premium. These were higher tha for traditioal plas. Lapse rate with respect to umber i traditioal products was observed to have decreased from 7.69% i 2004-05 to 6.59% 2006-07 ad premium lapse rate decreased from 6.45% to 5.63% i the same period. Lapse rates for o-medical policies are observed to be higher tha for medical policies. INDUSTRY TREND Life Isurace Corporatio s lapsatio ratio was aroud 25 per cet, while it was aroud 40 per cet for private isurers durig the last 3 years. Oe of the major causes for the growig lapsatio ratio is forced sellig by agets to achieve their targets. Agets also sell policies without takig customers eeds ito accout. After esurig that the customer paid premium for the first year, isurace agets would ot remid policyholders to pay their subsequet premiums as the commissio was ot attractive. The regulator had costituted a committee to brig certai amedmets to the agecy commissio structure. Curretly, the ceilig o the first year commissio is 40 per cet, followed by 7.5 per cet i the secod ad third years, ad is later capped at 5 per cet for the remaiig term of the policy. There is also the customer s casual attitude i sedig the premium cheque. This could be addressed with the help of techology. Customers, o the other had, isisted that isurace agets, while displayig tremedous eterprise i sellig policies, rarely cotacted them later o the status of policies or premium lapses. Costat remiders by isurers, though irritatig ad likely to attract harassmet charges from customers, are kow to work. For istace, private isurer ICICI Prudetial Life Isurace has maitaied its persistecy ratio at about 93 per cet i the first year ad 97 per cet i the secod year through the use of iformatio techology, Of special iterest i the area of lapse rate aalysis is the role of the fiacial stress positio of the isurer, ad whether ad i what ways stress cosideratios may ifluece policyholder lapsatio. Fiacial stress has ot made the ifluece o the lapse rates for ordiary life policies. The factors ifluecig the lapse rates o ordiary life isurace products ca be Bimaquest - Vol. IX Issue II, July 2009 q 43
Lapsatio of A Life Isurace Policy idetified ad their importace statistically be assessed. The lapse rate is a key operatig parameter that reflects both cosumer behavior ad isurer maagerial decisios ivolvig life policies. Projectios of the lapse rate are also critical i structurig securitizatio arragemets. Heterogeeity i the defiitio of lapse amog the compaies leads to may difficulties for lapses policies. Varied defiitio of lapse may lead to misiterpretatio of a compay s performace relative to others. To cosider a uiform lapse defiitio, the impact of legth of grace period eeds to be examied. The lapse may be either a pure lapse without acquirig ay paid-up/surreder value or otherwise. Life isurers should be vigilat ad seek ew ways ad meas of gettig across to its policyholders to impress o them, the eed to keep their policies alive. The lapsatio ratio has improved cosiderably ad it is hoped that i comig years it would be well below the expected idustry orms. Typically, a policy ca be revived withi six moths of lapsatio through a simple revival - paymet of outstadig premium, alog with reistatemet charges, if ay. If, the lapse has occurred more tha six moths ago, a persoal health declaratio eeds to be submitted. The policy is the revived subject to uderwritig decisios. Additioal medicals may be triggered depedig o uderwritig decisio. The policy ca be revived withi oe, two or five years of lapsatio depedig o the terms ad coditios of the policy, as specified i the policy documet. These terms ad coditios also vary alog with the size of the policy. While revivig a policy ad cotiuig with the protectio cover seems like a sesible idea, particularly i ucertai times like these whe life isurace seems idispesable, you eed to carry out a cost-beefit aalysis before goig ahead. You eed to ascertai whether the arrears payable by you outweigh the beefits offered by the policy. Revivig a lapsed policy will make sese oly if it is a ivestmet-orieted policy as it will help you reap the returs o ivestmets made. Also, you should cosider revivig a policy oly if it has acquired the surreder value. This apart, the time elapsed sice the lapse also eeds to be take ito accout. It is ot advisable to revive a policy, which is i lapsed coditio for more tha three years, as the policyholder will have to pay huge amout towards the arrears of premium ad iterest. This is despite the fact that the isurer was ot at risk durig the period the policy was i lapsed coditio. It is better to go i for a ew policy as per the fiacial eeds. However, if the policy guaratees far exceed the iterest compoet, the isured may opt for revival. qqq 44 q Bimaquest - Vol. IX Issue II, July 2009