It is not often that India’s insurance regulator intervenes on behalf of consumers to change the ground rules for the industry. Therefore, a round of cheers went up in December 2023 when Insurance Regulatory and Development Authority (IRDA) floated a discussion paper to rein in the hefty surrender charges levied by insurers when policyholders prematurely opt out. As opposed to the industry practice of appropriating 30 to 90 per cent of premiums as surrender penalties, IRDA suggested a threshold level of surrender charges beyond which insurers must refund all premiums to the customer.

But a pushback by the insurance lobby seems to have prompted IRDA to issue revised regulations. The new norms will allow insurers to charge 100 per cent of premiums for customer exits in one year, 70 per cent in two years and 65 per cent in three. Dropping out between the fourth and seventh years will see the buyer forfeit 50 per cent of premiums paid. Given that insurers invest their funds in market instruments that allow premature exit, surrender charges of 50-100 per cent seem usurious. Besides, none of the arguments advanced by the insurance industry in favour of sky-high surrender charges holds much water. The main one was that trimming surrender charges would badly impact profitability. This is a sad commentary on the business model of Indian insurers because the world over, life insurers derive their profits from selling protection to customers against adverse events and underwriting and pricing these risks correctly. In India, the life insurance industry and its large agent force are overwhelmingly focused on insurance-cum-investment products that offer neither adequate life cover nor reasonable returns to the consumer.

The industry claimed that hefty penalties on surrender are necessary to discourage insurance buyers from reneging on their long-term contracts. But the reality is that most buyers of traditional insurance plans in India sign up without getting a true picture of either the tenor of the product or its benefits. Unit Linked Insurance Plans (ULIPs) are (mis)sold on the premise that the buyer needs to pay premiums only for five years. Marketing literature for insurance products is rife with jargon and this actively facilitates mis-selling.

IRDA’s grievance portal received over a lakh consumer complaints on mis-selling in FY23 alone. This leads to high dropout rates, with over 50 per cent of insurance buyers in India stopping premium payments by the fifth year. Higher surrender charges create perverse incentives for insurers and their intermediaries to encourage dropouts. Insurers pocket hefty customer penalties that aid their profitability, while agents benefit from front-loaded commissions that encourage constant churn. With such perverse incentives, the ball was really in IRDA’s court to streamline surrender charges. Ultimately, India’s insurance penetration cannot improve without their products delivering a better value proposition to the customer. The IRDA should revisit the surrender charges issue.