No bonus marks for this policy

Chennai: The one-time founders bonus announced by HDFC Standard Life Insurance Company, Mumbai, has evoked mixed response from industry experts. Some of them believe the company has contravened the Insurance Act, 1938, and is practicing misleading and unethical methods.

Its nothing but unethical trade practice and indicates a lack of self confidence on the part of the company, says R Ramakrishnan, member of the Malhotra Committee on Insurance Reforms and chairman of RBIs advisory group on insurance.

Such a move is akin to giving back to the policyholders a part of the premium collected, which contravenes Section 41 of the Insurance Act. The said section bars all persons from offering or allowing either directly or indirectly an inducement to any person to take or renew or continue an insurance. Clearly, the founders bonus is an inducement by the company by undercutting other players, he says.

But Nick Taket, general manager (finance) and appointed actuary, HDFC Standard Life, doesnt subscribe to the theory. The addition of bonuses to policies has no connection whatsoever with rebating. The distribution of valuation surplus through the addition of bonuses to policies is a perfectly legal and common practice in India as well as in the rest of the world. HDFC Standard Lifes bonus declaration is fully compliant with all the requirements of the Insurance Act.

Taket says the founders bonus is a non-recurring bonus and the full cost of this bonus is to be funded by shareholders. Sufficient money from the companys shareholders fund will be transferred to its policyholders fund so as to create a large-enough valuation surplus, from which the bonus will be declared.

But opinions too are divided on the issue of specifying the cut-off date for being eligible for the bonus. While a chief actuary of a private life insurer finds no fault with the company, there are others who hold contrary views. Says Liyaquat Khan, past president, Actuarial Society of India: A statement by an insurer that policyholders will be eligible for bonus if they take out a policy on or before a specified date is not only misleading but also unethical.

A par policy in force on valuation date is entitled for the bonus declared on that valuation date. During times when actuarial valuation was not on an annual basis, this rule made such policies ineligible for a bonus, which commenced and ended between any two consecutive valuation dates. In those times some of the insurers did try to sell more just before a valuation date, propagating that such a policy would be entitled to the bonus declared on the immediately following valuation date.

Even then it was not entirely right, as a bonus might or might not have been declared on the valuation date and a policy was entitled to bonus if it were in force on any future valuation date, says Khan. While some experts are miffed with the companys founders bonus, they are appreciative of another aspect: declaring reversionary bonus out of shareholders funds.

HDFC Standard Life has transferred Rs 2 crore of the shareholders money to policyholders account through the revenue account mode. As on 31 December 2000, the policyholders fund stood at Rs 1,47,13,118 and liabilities in respect of life insurance policies at Rs 98,77,982, thereby showing a valuation surplus of Rs 48,35,136. And the reversionary bonus is entirely compliant with Section 49 of the Insurance Act, says Taket.

As long as an actuarial surplus is established a bonus can be declared. A life insurer can transfer his money from anywhere (including the shareholders fund) through his revenue account to produce a surplus, says an actuary with a private life insurer.

Says Ramakrishnan: For a life insurer bonus declaration is possible at the end of three years if the products are carefully designed and good coordination between actuarial and marketing wings are brought about. But normally it takes five years for a new life insurer to declare bonus.

Declaring bonus out of the shareholders fund is a matter of management philosophy. It is undesirable from the point of view of policyholders, shareholders and the Insurance Regulatory and Development Authority (IRDA) if the bonus is declared in the form of cash or dividend to policyholders, says Khan.

On the other hand if the bonus is in the nature of reversionary bonus that would enhance the sum assured to be paid on the happening of insured event, then it is not only good management practice but desirable from IRDAs perspective. Higher the growth and volume of business, the longer will be the period when valuation surplus will first emerge. A prudent new insurer would plan for a valuation surplus in not less than five years time since, in my view, it is technically not feasible otherwise, he says.

Incidentally, even HDFC Standard Life MD Deepak M Satwalekar, at the time of launching the company, had said that bonuses would be declared only at the end of the third year. But the bonus declaration without genuine valuation surplus means enhancing the amount of liabilities that implies requirement of more capital than what would otherwise be the case. And if promoters risk more of their capital they would be wise to mange the affairs more prudently so as to secure adequate returns on capital at one end and minimise the risk of losing the capital at the other end, says Khan.

Curiously, one of the demands of life insurers is to tax-exempt the money transferred from the shareholders fund to the surplus account for the purpose of bonus declaration.

IRDAs move comes under glare

While the above issue will take some time to settle down, what the experts are viewing with deep concern is the IRDAs move to amend Section 49 to permit bonus/dividend declaration even in the absence of a surplus in the valuation account. Currently, this section expressly states that bonus to policyholders and dividends to shareholders are to be declared only out of valuation surplus - the difference between assets and liabilities excluding shareholders funds.

Says L P Venkataraman, a Mumbai-based actuary and a member with RBIs advisory group on insurance: This section was introduced in 1941. This has stood the test of time before LICs nationalisation in 1956 for 15 years. A need was felt for the introduction of this section because the then insurers were finding ways of declaring bonus to the policyholders and dividend to the shareholders from other than the valuation surplus.

As per the provision, the valuation account or valuation balance sheet in form I as set forth in the fourth schedule of the Act is to be prepared to decide on bonus/dividend declaration. However, the Preparation of Financial Statements and Auditors Report of Insurance Companies Regulations, 2000, formulated by the IRDA, has simply substituted the fourth schedule provision without first amending the Act.

According to Khan, these changes have blurred the situation a bit and the fate of valuation balance-sheet in form I is difficult to comprehend. The proposed insurance, Amendment Bill 2001, vide section 18 states: The First Schedule, the Second Schedule, the Third Schedule and the Fourth Schedule to the principal Act shall be omitted. Further, vide para 12, section 49 is proposed to be amended so as to replace the balance-sheet in form I as set forth in the fourth schedule by the words: [The] balance sheet in such form as may be specified by regulations made by the authorities.

In my view, the abolition of valuation balance-sheet in the present format takes away the spirit of the original section 49 that explicitly mandates declaration of a dividend/bonus only out of valuation surplus, says Khan.

Opposing the removal of the restriction of declaring of bonus/dividend only out of valuation surplus Ramakrishnan warns: At present the first charge on the valuation surplus is tax. The shareholders share of surplus comes only next. If a bonus is allowed to be declared irrespective of the fact whether there is a valuation surplus or not, it might lead to tax evasion. This possibility has to be fully examined before any such step is taken.