Cashing Out on Life Insurance:?The Controversial Practice of Policy Trading and F&O Market Parallels
In a prudent move, the Insurance Regulatory and Development Authority of India (IRDAI) has introduced new rules to increase the surrender values of life insurance policies. This decision, while beneficial for policyholders, has left insurance companies apprehensive about potential impacts on their profitability. The new regulations mandate a higher Special Surrender Value (SSV) for traditional endowment policies, ensuring policyholders receive a portion of their premium even if they exit after just one year.
Interestingly, some of these schemes operate covertly under the radar, paying cash upfront to policyholders in exchange for future transfers from their insurance policies.
The prevalence of low surrender values has given rise to numerous policy-trading schemes, both with and without the knowledge of the insurers. Companies that engage in policy-trading offer to purchase policies from dissatisfied policyholders at rates higher than the surrender values offered by insurers. Interestingly, some of these schemes operate covertly under the radar, paying cash upfront to policyholders in exchange for future transfers from their insurance policies. These transfers are secured through separate agreements, which can be formal or informal in nature.
Ethical Concerns and Global Perspective
While this practice provides immediate liquidity to policyholders, it raises ethical and legal concerns about the original intent of insurance contracts, potentially diluting the ethical responsibility of insurance companies. Such schemes aren't unique to India. In the United States, similar practices known as viatical or life settlements exist but are heavily regulated to protect vulnerable individuals and maintain the integrity of insurance as a means of providing for dependents.
Higher surrender values would likely diminish the allure of secondary market schemes. If policyholders receive fairer exit options directly from insurers, the incentive to sell policies at a discount to third parties diminishes.
Root Cause: Low Surrender Values
The emergence of policy-trading businesses underscores the issue of low surrender values in life insurance policies. In India, where policies often have long tenures and relatively low returns, these schemes capitalize on policyholder dissatisfaction.
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While the new IRDAI rules may raise concerns for insurers regarding increased liabilities and reduced profitability, they are a positive step towards consumer protection. Higher surrender values would likely diminish the allure of secondary market schemes. If policyholders receive fairer exit options directly from insurers, the incentive to sell policies at a discount to third parties diminishes. This approach not only safeguards policyholder interests but also bolsters the insurance sector's credibility.
Parallels with Retail F&O Trading
Interestingly, parallels can be drawn between policy trading schemes and the prevalence of retail F&O trading in India. Both scenarios involve less-informed participants being lured into seemingly lucrative opportunities, often resulting in significant risks and potential losses. In FY24, 92.5 lakh retail traders and proprietorship firms incurred a staggering trading loss of over Rs 51,000 crore. In F&O trading, retail investors frequently engage in high-risk trades based on supposed expert advice, such as call or put writing close to expiry dates. However, if these strategies were truly profitable with minimal risk, sophisticated trading firms would have already exploited these opportunities, leaving little arbitrage for retail investors.
The need to eliminate unfair arbitrage opportunities in financial markets is paramount. When entities can benefit from arbitrage without adding real value to other players in the ecosystem, it creates an imbalance that can harm consumers and undermine market integrity.