So it seems the private life insurance companies
(PLIs) have finally realized the importance of renewal premia (ref. Economic
Times Delhi 9-Mar-09 ‘Ulips add premium to life insurance renewals’). The other
day at the Economic Times insurance conclave, the head of one of the PLIs
indicated that the industry perhaps had a misplaced emphasis on new business,
and new measures of performance need to be evolved. In another context,
critical today in view of current liquidity problems in which almost all
enterprises find themselves in the current economic environment, a host of
mavens and industry experts have emphasized the need to conserve cash and in
fact wring the last drop of cash out of operations (ET Delhi 6-Mar-08 Corporate
Dossier ‘Liquidity crisis bites amid global meltdown’).
I remember a post-railway budget public session on TV taken by the Union
Railway Minister Mr. Laloo Prasad a few years back. To widespread mirth, he
shared the homegrown wisdom that ‘you need to milk your cows to the fullest
extent possible’, in the context of the phenomenal rise in the profitability of
the Railways. Laloo did become the toast of the management community, with
appearances before IIM and Harvard students, though the source of his
management insights remains a mystery (does he have a speech writer par
excellence?!). However, many did not catch on to a specific aspect of the
wisdom above, perhaps due to the then relaxed liquidity environment, viz. the
need to get out in the open the liquidity hidden in many stages of the process.
Sounds familiar? (see above).
Back to the insurance industry. How much emphasis do PLIs put on the
realization of the second (and subsequent) premium? Perhaps much less than that
on the first year premium. To be fair, at the corporate level, there are
measures to track something called ‘persistency’ and ‘conservation ratio’,
which most PLIs track religiously. And the ratios are quite encouraging for
many PLIs, mayby 75% or more. But what about the balance 25%? Is there a source
of hidden cash there. And do these measures translate to concrete action at the
ground level to improve, the same way a fall (or ‘de-growth’) of a few basis
points in new business does? Perhaps not.
Any why such disproportionate emphasis on first year premium as compared to
subsequent year premiums? There are two ways of looking at it: from the PLIs
perspective and from the ground level agent’s perspective. Yes, much as they
may insist on complete synchronization between the aims of the company and the
individual aims of the agents, the reality may point otherwise.
At the corporate level, most PLIs are running like mad trying to improve their
rankings within the industry. And what are the rankings based on? Mostly on
measures related to first year premium i.e. new business.
To the agent, and the other sales staff. How much commission does an agent get
on first year premium: upto 35% depending on the type of polilcy! Times are
good. It may be interesting to look at the trends in insurance commission over the years in more mature markets (India is one of the markets with perhaps the
lowest penetration levels of insurance, both in terms of percentage coverage of
total population and insurance premium as a percentage of GDP, which hover in
the low single digits). But, coming back to the issue, how much is the renewal
commission for the agent? Perhaps a low 5-7%. So where would the agent invest
his time and energy – in getting new business or in following up with the old
customers? Get the point!
So what does this lopsided commission structure encourage the agent to do.
Obviously, like any rational human being, the agent would like to rake in the
moolah while the going is good. And in this, s/he is ably supported by the
entire sales infrastructure of the PLIs which, as we’ve seen, is attuned
to maximization of new business.
So the main target of the agent while trying to ‘close a sale’ is somehow to
get the customer to agree to go in for the policy and put the money down for
the first year premium. Once that is done (and of course the policy is enforced
after underwriting), the agent is assured of his commission. In fact, some may
be on the way to unforeseen heights like the famed Million Dollar Round Table
(MDRT)!
And do the agents tend to take a few short cuts in this pursuit? You bet. Let’s
consider the selling process of a typical unit linked insurance plan (ULIP),
since an overwhelming majority of the business of PLIs currently consists of ULIPs (the
tide is turning the other way towards traditional or endowment plans lately,
but only very slowly). Wider issues of the suitability of a specific insurance
plan to fulfill the financial goals of the customer are conveniently given the
go by most of the time anyways. But the agents are also not beyond selling a
regular (i.e. other than single year) policy to the client as virtually a
single premium policy. The logic they give the customer is: pay the first year
premium, and then sit tight. Even if you don’t pay the premia for the
subsequent years, you’ll get a good return on the first year premium at the end
of three years (the minimum period for which a policy must be continued, as per
regulations).
What they conveniently omit to tell the customer is that the corpus represented
by his first year premium may have depleted significantly during this time due
to the charges which are front-loaded to the policy. And that the expected
returns on this (already depleted) corpus would most probably not be enough to
cover the depletion, leave alone come out with a profit above the premium paid.
The customers, at least the more intelligent ones who take an active interest
during the selling process and don’t go purely on personal equations with the
agent (more on that later), could probably make this out if given complete
information. But how many customers are aware of an animal called ‘allocation
ratio’? Not too many one would guess. Because they were shown rosy pictures of
sky-high returns in the booming market, sometimes projected on growth rates
even exceeding the max. rates mandated for illustration purposes by IRDA.
IRDA recently seems to have caught on to this kind of mis-selling. It came out
with the directive that in case the second-year premium on a policy is less
than the first year premium (may perhaps also cover cases in which the
second-year premium is not at all paid by the customer), the difference between
the two premiums should be considered as single premium (on which the agent
commission is capped at 2%) and the excess commission paid on it (over the
mandated 2%) should be clawed back from the agent and credited to the account of
the customer.
Now, some PLI representatives have come out with the apprehension that this may
incentivise the customer to ‘blackmail’ the agents, by threatening not to pay
the second year premium. One is tempted to say that such agents (who lure the
customers into taking a policy by, uh, let’s say, not being completely
transparent) deserve to be blackmailed. But this needs a reality check.
How many agents keep in touch with their customers after the first year premium
is paid. There is a lot of sales talk of the PLI being a trusted financial
partner of the customer. However, the only interface most customers have with
the PLI is the agent, who is most probably acquainted, or even related, to
the customer in some way beforehand. But once the first year premium is paid (and
the policy enfoced), the agent most probably well nigh disappears (some
customers could say, like horns from the head of a donkey ‘gadhey ke sir sey
seeng’ – any allusion to the customer being treated like a donkey being strictly
unintended!).
We’ve seen that the agent does not really have a pecuniary interest in getting
the customers to continue the policy by paying premia regularly. In fact, some
of the less than scrupulous ones (is that a euphemism for the majority of agents these days?) may even want
the policy to lapse, as that may absolve them of the trouble of explaining the
less-than-promised returns to the policyholders (if at all the customer manages
to get hold of them).
I have a few policies of different PLIs. Regardless of which channel was used
during issue of the policy, it is doubtless assigned to some agent. But do the
agents follow up with me when I fail to pay a premium (I’m sure most PLIs share
the defaulting companies data with the agents, or do they not?). Except for
one, no. Most of the time, it’s the PLI’s call center agents who come back to
me. And, most of the time, their talk is so similar to the pesky executives
trying to sell me everything from personal loans, credit cards to travel
options, that I switch off the moment the person begins to speak. Bottomline,
this method of follow up would hardly persuade me to change my view (if I’ve
not yet decided whether or not to pay the second- or subsequent-year premium
that is) and pay the premium.
Transported to another context, this scenario looks alarmingly (you could even
say scaringly) similar to the analysis of reasons of the origins of the current
US (and World) banking and economic crisis. There were companies whose only job
was to sell mortgages, often to sub-prime customers. The mortgages, once sold,
were bundled and sold off to (perhaps bigger) financial institutions. Then the
i-bankers came in and, using esoteric financial jugglery involving SPVs and
what not, transformed the mortgages (including a lot of toxic sub-primes) into
securitized debts. These securities were then sold by the investment banks to a
wide range of investors, inland and abroad. And, oh, the rating agencies played
their role too, giving guilt-edged ratings to such mortgage backed securities
(MBSs).
The interesting thing to note above is: probably none of the players in the
whole chain had an integrated view of the whole process. The only aim of the
front-end companies was to sell the mortgages; once that was done, they had
made their money and exited the chain, for a particular customer that is
(sounds familiar to insurance agents? you bet!). The others up the chain were
just pass-through players who made money from individual steps of the process.
And the end-investor, probably in some far away land, who was left holding the
paper (later proved almost worthless) eventually, didn’t in most cases realize
what was the worth of the paper, having relied totally on the integrity of the
intervening players in the chain (who conveniently disappeared when the time
came).
In this scenario, do you think the front-enders who created the mortgage would
follow up with the customers if the payments (EMIs) stopped coming? Why should
they? They had already sold off their interest in the mortgage and made their
money.
Back to the humble (!) insurance agent. S/he has probably used her contacts to
the hilt while selling the policies in the first place. So many of the
customers would perhaps treat him as representative of the PLI when they have
to take a decision regarding the policy, right. But is the insurance agent willing to provide such financial advice when the need comes. In the light of
factors outlined above, perhaps not. In fact, s/he would perhaps tacitly
encourage a trend where the policies lapse (especially where it was a case of
mis-selling in the first instance anyway), vicariously so that s/he is able to
sell newer products to the same customer, and make money by way of first year
commission on such new policies. So the whole concept of the agent being a trusted
advisor to the customer (perhaps the reason why many PLIs loftily designate
their agents as Agent Advisor) goes out the window.
One point though. Since many such agents have not invested the time and energy
to become the trusted financial advisors of the customers, they would find it
increasingly difficult to sell further policies. Much of their selling may have
been based on showing dreams (some would say ‘sabz baagh’) of unheard of
returns to the customers for ULIPs, based on the booming stock market. Now,
with the market on a downward spiral, even the gullible customers would not
fall for such dreams (the reason why many customers are now choosing traditional
or endowment products, and why PLIs are coming up with more such policies). The
new plans with ‘guaranteed returns’ could stem the tide some, but not always,
and there is a whole lot of mis-selling going on in such plans as well so the
customer is wary this time.
To the other end of the spectrum now. The PLIs probably have all these trends
and data already with them. So why are they not putting more emphasis on
realizing the second (and subsequent) year premia? One reason of course is that
all industry performance measures and rankings are based on new business, as
we’ve seen above. However, there is one more, more technical, reason.
By law (read: IRDA regulations), based in large part on industry prudential
practices, PLIs (for that matter, all insurance companies) are required to
invest most of the money received as premium into prescribed forms of
investment. Which is logical, since this is policyholders’ money and should be
used to earn returns for them. On top of that, PLIs are required to create
‘reserves’ in their books, at a certain proportion to the premia received
depending on the type of policy. So PLIs actually “earn” very little out of the
premia after the first year, only the prescribed administrative costs. No
wonder they try to get the maximum first year premium and front-load all
possible charges on that.
Most PLIs have a phenomenal ‘burn rate’ when compared to other industries in
their initial stages. Most PLIs have to invest their own (or their principal
investors’) money in establishing their business and taking it to a certain
critical mass. In things like setting up new offices, building their sales
channels by way of new staff, et al. In fact, most PLIs could be ‘losing’ money
on each new policy issued, counterintuitive as it may seem. Insurance is
typically a long-gestation business, with break-even periods typically ten years
or longer.
This does not, however, discount in any way the importance of getting the
liquidity concealed in the system out in the open. Insurance companies may not
treat their unrealized premia as ‘receivables’ in the conventional sense of the
terms as used by other businesses. If they did, they would realise that
enormous amounts of money are held up in such ‘receivables’, and could reorient
their thinking to increased efforts on realizing such ‘receivables’. Even the
minor proportion of such premium realised (after investment & reserving)
could enhance their liquidity significantly. And this, for many PLIs, could
mean the difference between being quasi-self sufficient as far as their
expansion plans are concerned, and running to their investors or principals
frequently for more money.
And for the customer, an increased emphasis on subsequent-year business by the
PLI should mean more hand-holding by their agent. The agent would, in such a
scenario, perforce have to act more responsibly towards the agent, minimizing
instances of mis-selling and ‘slam bang thank you ma'am’ kind of blitzkrieg
tactics. This would, then, truly transform the insurance company from a
distant, impersonal behemoth to a ‘trusted financial advisor’, in the form of
an agent.
But all this requires concerted action on the part of the industry as a whole
(a relook at commission structures?), the individual PLIs (looking at their
performance measures) and the regulators (reserving structures?). Are we all
upto the challenge?
