Life Insurance: An endangered species called Traditional Product

In many life insurance markets across the world, the traditional product has lost its relevance. Either it has already disappeared from the market or it is in the process of disappearance. And one of the main reasons for this is, lack of transparency. There is Sum Assured and there is some policyholder bonus declared by company. Since this is reversionary bonus that is paid at the end of the term of the policy, policyholder doesn’t know what is its value today. There is no way he/she can know how his/her money is performing from time to time.

What does ‘bonus’ indicate?

While bonus gives some indication of the performance of money, it doesn’t exactly reflect the performance of the money due to various cross subsidies. There are cross subsidies between big premium and small premium, long term and short term, old age and young age etc.

Usually, one bonus rate is declared across the product. This is for ease of administration. However, the underlying bonus under each policy will not be exactly same. The rate will differ from one policy to another. Since you are trying to fit it into one rate or few rates, some policies gain and some policies lose. The extent of gain or loss can be very small and sometimes very big also. Wherever it is big, it is not fair to some policyholders.

Because of these cross subsidy issues, and the way the bonus is declared, it is not very transparent to policyholder. Hence policyholder doesn’t get enough confidence that his / her policy got a fair share of surplus in the form of bonus. This is leading to mis-trust. And this is the reason why the traditional products are becoming less and less popular in other markets.

Why traditional products still exist in India?

In India, traditional products are still doing well. One of the main reasons for this is LIC has always been selling predominantly traditional products. The other reason is, there is a commission arbitrage between Traditional and UL products. Traditional gives more commission hence intermediaries are still pushing traditional products. However, this may not continue very long. The traditional product may come under threat for the same reason as other markets.

But the big question is ‘do we need traditional products in the market’? Especially when it is disappearing in other markets. My answer is ‘yes’. It may not be required for advanced markets where people go for separate options for insurance and savings. But in India, we still have significant people who want some decent stable returns along with insurance cover.

More transparency needed

What’s the solution? Address the problem of transparency. Convert them into variable insurance type products. These products are traditional in nature but transparent in terms performance. However, this has regulatory hurdle. As per the current rules, all variable products need to follow unit linked rules. This means the commission advantage is not available. So, this should be changed by regulator. Otherwise, its only a matter of time that the traditional products will disappear from the market due to lack of trust from the customers.