Tackling customer protection issues in life insurance for low-income households

Insurance-cum-investment life policies offer little protection to the insured

Priyadarshini Ganesan and Sowmini G Prasad 

A couple lives in Kumbakonam village in Tamil Nadu with their two children. They earn Rs 3 lakh annually from running an auto and a door-front petty shop.

A relative, an insurance agent, comes to them with an endowment plan where they would have to pay a monthly premium of Rs 738 over 20 years. In return, the plan promises an assured sum of Rs 1 lakh and a bonus of up to Rs 32,400 at the end of the policy term.

It also provides a life insurance cover of Rs 1 lakh. The couple is persuaded to buy the plan, partly because it seems to offer a pathway for long-term savings and partly because the relative is urging them to do so.

After paying a total premium of about Rs 45,000 over five years, a health shock in the family puts the household’s finances under severe strain. With no other financial recourse, the couple decides to surrender the plan to pay for hospital expenses.

But they realise that surrendering the plan after five years would fetch them only about Rs 24,000, and the insurance company would retain the rest as a penalty for pre-closure. This was not disclosed to them at the time of purchase. They are disappointed and frustrated about losing their hard-earned savings but are unable to continue paying for the policy.

Also read: Why traditional life insurance policies aren't great long-term investments

Unsuitable plan

This case (a fictional account) illustrates the journey of many low-income households (LIHs) with traditional life insurance products. It also underscores the low persistency rates for life insurance policies in India.

The 13th-month persistency of the Life Insurance Corporation of India (LIC), for instance, was about 63 percent in 2022 – meaning 37 in 100 policies lapsed within the first 13 months. Globally, the persistency ratio for the 13th month is almost 90 percent.

The low persistency points to not just Indian households losing life cover but also the thousands of rupees lost as penalty for pre-closure. This is particularly worrisome for LIHs that can scarcely afford to lose their life cover or meagre savings from unsuitable products.

Traditional life insurance products such as endowment plans (bundle of investment and insurance) offer low life cover per rupee of premium compared to term life plans, low returns on their savings component, and high penalties for pre-closure. These features make them ill-suited for LIHs, given their income levels, instability in income flows, and the persistent need for liquidity.

However, endowment plans are a common feature of Indian household portfolios, which is true of LIHs as well. As per the All-India Debt and Investment Survey 2019 (National Sample Survey, 70th Round), the take-up of endowment plans among LIHs stands at over 20 percent.

While typical behavioural biases such as loss aversion (the tendency to view losses more severely than equivalent gains) and optimism bias (the tendency to overestimate the likelihood of experiencing positive events and underestimate the likelihood of experiencing adverse events) contribute to the preference for such bundled products, misaligned agent incentives also have a role to play.

The possibility of earning high commissions overshadows the need for product suitability assessments, resulting in agents mis-selling endowment plans. Consumers are also often shortchanged because essential information on pre-closure charges and alternative product options is unavailable.

While the Insurance Regulatory and Development Authority of India (IRDAI) has directed insurance companies to conduct product suitability assessments at the time of sale, the instructions fall short of meeting their objective because they have been watered down to a mere box-ticking exercise.

Protection gap

While ensuring the suitability of products at the point of sale is necessary, the availability of products designed to meet the specific needs of LIHs is equally important. The Pradhan Mantri Jeevan Jyoti Bima Yojana (PMJJBY) is one such product launched by the government as a subsidised term life plan.

It calls for a pocket-friendly yearly premium of Rs 436 for a life cover of Rs 2 lakh. With the right thrust, it can potentially bridge the mortality protection gap faced by LIHs in India.

However, the distribution and servicing of the product are riddled with multiple challenges, stifling its potential to provide valuable social protection to a large section of the Indian population. Further, apart from PMJJBY, there is a glaring life insurance product gap in the market for LIHs.

Packaging insurance with savings is, therefore, one way to address insurance take-up among LIHs. Dvara Research conducted a study to understand the drivers and barriers of life insurance purchase among low-income households, which also indicated that there is a case for providing tailor-made insurance-cum-savings bundles to this segment.

Beyond such bundling, life insurance companies should critically evaluate the products sold to LIHs against their financial realities by ensuring affordable premiums, safety of capital, and low penalties for premature exit. They should align their sales practices to generate the best outcomes for LIHs by ensuring easy access to a variety of products with disclosures that provide accurate information and aid product comparison.

Further, they should ensure optimal post-sale service that engenders trust by setting up transparent grievance redress channels and claim settlement procedures. There is an immediate need for the insurance sector in India to consider these recommendations seriously so that life insurance may be made to work for this crucial yet underserved population.

(The authors are researchers at Dvara Research)