Irda norms fan insurers' thirst for funds

17-Jul-2010

They need to maintain capital adequacy and also cover losses on Ulip portfolios

The capital needs of life insurance companies has grown this year, thanks to new guidelines from the industry regulator on its hottest selling product -- unit linked insurance plans (Ulips). Life insurance companies chalking out capital infusion plans now have two clear agendas - meeting capital adequacy requirement and covering the perceived losses they will incur on their Ulip portfolios. As per the new norms laid down by the Insurance Regulatory and Development Authority of India (Irda) on Ulips, the difference between the actual returns made on investments in Ulips and the amount the investor finally gets in hand after subtracting various charges and commissions etc cannot be more than 4% at the end of 5th policy year and more than 3% at the end of 10 years.

This means companies would not be able to deduct the plethora of charges that they so far have, which will help shore up the customer's returns. Also, the charges deducted have to be evened out in the first five years as opposed to the earlier model where the expenses of running the life insurance business were recovered from a customer in the initial three years. However, if these norms are to be followed, higher expenses will either have to be eliminated or incurred from the insurers' own pockets.

Gaurang Shah, director of Kotak Mahindra Old Mutual Life Insurance says, "Apart from meeting capital adequacy, capital will be needed for funding losses if any. Companies have to reduce costs in order to not incur losses. But they might incur losses as productivity will take time to improve." For instance, the promoters of HDFC Standard Life will be infusing Rs 300-350 crore in the company this year as against Rs 172 crore infused last year.

This indicates the company is looking to grow at a higher pace and will need higher capital since Irda mandates that insurers maintain 1.5% as capital adequacy. All insurers now have to set aside this amount as a security for those who get insured with them. As you write more and more premium, you have to set aside a higher amount of money as security.

"Now, the DNA of the products will be such that we will have more and more back-ended charges since you can recover lesser upfront. If you are able to manage the cost, then you need lesser capital from the promoters. It is a reflection of the expense overrun. We are expecting it to go down. Last year, the expense overrun was at Rs 251 crore. This year, we are at Rs 171 crore," said Vibha Padalkar, chief financial officer of HDFC Standard Life. HDFC Standard Life aims to eliminate the acquisition expense overrun by 2012-2013."If the costs are not recovered in the first year then it will be recovered in the next year. As a result, there will be strain on the business," said V Srinivasan, chief financial officer at Bharti AXA Life Insurance.

According to him, capital will have to be introduced to meet the strain, in case the costs are not recovered from customers. Higher capital needs will also be as a result of guarantees that are to be offered on pension plans. "The 4.5% guaranteed returns on pension plans too will give rise to risk capital. But it will be lower as the guarantee is not for the entire portfolio. The rates will be prescribed each year," says P Nandagopal, managing director & CEO of IndiaFirst Life Insurance.

Companies that can contain costs will not need higher capital infusion from the promoters. Nandagopal says, "It depends on the business model. If the company is able to reduce its operations costs, then there is no need to get more capital. It is going to have an impact on the capital. But we will be happy to manage with the existing capital. IndiaFirst Life Insurance, a venture of Bank of Baroda, Legal & General and Andhra Bank, is planning a regular infusion. "We have our normal capital infusion in the second quarter. Last year it was Rs 330 crore," Nandagopal said. To be able to manage with the same level of capital, a company would have to streamline operations and cut costs. Experts say that if the costs are cut by 15-20%, the business can be managed more efficiently.

"You need to manage the costs much more efficiently because the revenue margins are low," said Nandagopal. Also, now a customer can stop paying premiums after as little as one year. Hence, insurers will find it tricky to decide on how to recover costs from investors. "Another worry is we cannot take too much strain as customers may exit for an exemplary reason you won't know. Then you won't be able to recover the losses as the customer may or may not be with you in the second policy year," said Srinivasan.

Source : www.insuremagic.com