Indian private life insurers want a part of their additional capital to be treated as a notional loan. This raises major legal, accounting and ethical issues, says Venkatachari Jagannathan.

Chennai: The promoters of Indian private life insurers now want a money-back policy for themselves. They say that a part of the additional capital infused by them should be treated as a notional loan, with a first charge on the future surplus. They want Section 49 of the Insurance Act 1938 to be amended accordingly.

Section 49 lays down that bonus to policyholders can be declared only out of the surplus shown in the life fund / valuation balance sheet. The ratio in which the surplus is to be shared between the policyholders and shareholders is also prescribed in the law. In the case of participating / with profit policies, it is 90:10 in favour of policyholders, while in the case of non-participating / without profit policies, the shareholders get the entire surplus.

At a time when private life insurers are selling unit-linked policies that are not participating, the sudden need for amending the law is what piques many. Further, the first charge on any surplus is tax. Can a provision be made to the contrary? This is another question that lingers.

Be that as it may, the fact is that though they commenced operations with a minimum capital of Rs100 crore, most private life insurers have infused substantial sums as additional capital. While part of it is towards the solvency norms, the major portion is towards meeting start-up expenses and for declaration of bonus to policyholders.

It is a fact that during the first couple of years, any life fund will be negative. Recognising this, the Insurance Act does not stipulate that a life fund should always be in positive figures. All that a life insurer has to ensure is that the life fund and the shareholders' fund are together in excess of the valuation liability.

"It is to gain a competitive edge in the market vis-a-vis the Life Insurance Corporation of India (LIC) that private insurance companies started generating artificial surpluses by transferring significant sums of money from the shareholders' fund to the life fund," says R Ramakrishnan, a consulting actuary.

It was HDFC Standard Life Insurance Company that first started this practice (See ). Others quickly followed suit. According to industry experts, private life insurers will not be able to see significant returns for at least the next 10 years.

Why should capital be termed a notional loan?
Normally, a charge is created only if there is a loan. Currently, life insurers are not allowed to raise any loans. Even if they are allowed, it would put the insurers in a bind as the loan amount would have to be brought under the head of 'creditors' and dealt with appropriately. In these circumstances, the life fund would continue to show a negative balance.

"To circumvent this problem, private life insurers want the transferred amount to be treated as a notional loan. In the life insurer's revenue account, the amount would feature as 'miscellaneous income' and the auditors would be satisfied recording a footnote in the balance sheet," explains Ramakrishnan.

ICICI Prudential Life Insurance CFO Sandeep Batra counters: "It would help in reducing the onerous responsibility of the shareholders to a certain extent." He admits, though, that such a practice "might also result in a delay in the turnaround of policyholders' funds".

It is debatable whether such a move could be termed as transparent in the eyes of policyholders, as they do not have any chance of seeing a life insurer's balance sheet. According to Ramakrishnan, the proposed move is akin to financial re-insurance, which is banned in India.

"Under financial re-insurance, the re-insurer provides the money required by a life insurance company to clear deficits, if any, in the life fund and to satisfy solvency margin requirements. In return, the re-insurer is given the right of a share in the valuation surplus. Since such an arrangement facilitates an indirect take-over of life insurance companies, it has been specifically disallowed under the re-insurance regulations framed by the Insurance Regulatory and Development Authority (IRDA)," he says.

Another question is whether the notional loan and the first charge on the surplus could be handled under existing accounting standards. The proposal would also put the appointed actuary in a spot, as (s)he has to put a value on the additional liability; repayment of the notional loan out of the surplus.

A way out
Ramakrishnan suggests a way out without amending the law. According to him, Section 49 will apply only if the bonus is to be declared by the appointed actuary, and not if the bonus is declared and financed by the shareholders.

"The shareholders can inform the policyholders that as soon as the initial years' strain is overcome, the bonus will be declared by the company / appointed actuary at not less than the rates of interim bonus, in respect of each year a policy had been in force. Till the bonus is declared, the shareholders will guarantee the payment of this minimum bonus," he suggests.

A reserve equal to the actuarial value of the bonus payable on maturity can be set up. Every year, the actuary can certify the reserve required to be set up by the shareholders' fund in respect of each year's bonus, for which a guarantee has been given.

"During the initial years, since the value of the new bonus will also be quite small, setting up such reserves will not cause much strain to the shareholders' fund. As soon as the company declares the bonus in respect of one of the past years, the shareholders can withdraw the reserve set up in respect of that year's bonus," explains Ramakrishnan.

By the end of the fourth or fifth year, a surplus will start emerging and the company will be in a position to declare bonus not only for the current year but also in respect of one of the past years for which no bonus was declared earlier.

True, but that doesn't address the main issue of scrapping the 90:10 surplus-sharing ratio, says an appointed actuary of a life insurance company. "It is the competition that should decide the appropriate bonus to the policyholders," he contends.

He agrees that such a move would be radical, and suggests an alternative: "In the case of new companies, the expense overrun could be identified for the first seven years. Any transfers from shareholders' to the policyholders' fund, subject to a maximum of the total of expense overrun, could be treated as a loan." Until this interest-free loan is repaid to the shareholders, the 90:10 ratio could be waived, he feels. Any other suggestions, anyone?