Need to replace ‘sum assured’ with ‘sum at risk’

On June 28, 2010, the Insurance Regulatory & Development Authority (Irda) issued a circular mandating certain elements to be incorporated in all Ulips starting September 1.

One of these elements is a ‘minimum sum assured” for all Ulips (other than pension and annuity products) not less than 10 times the annualised premium. This was done to ensure that Ulips are not turned into pure investment products.

Irda expected the Direct Taxes Code, 2010 Bill to follow this norm while extending tax incentives on insurance premia. However, the Bill went one step further to raise the multiple to 20 times the annualised premium (Section 70(2)).

The logic was obviously the same, doubly reinforced. The government wanted that the tax incentive be availed of for genuine insurance only.

But what I wish to contest today is the term “sum assured” used by the Irda circular and the term “capital sum assured” used by Section 70 of DTC; both terms refer to “sum assured” as defined under Annexure I(1) of guidelines for unit linked life insurance products, 2005. In this discussion, we shall refer to it simply as SA.

The spirit of both the statutes, the Irda circular and Section 70(2) of the DTC, is to ensure purity of insurance. That raises a fundamental question: What constitutes insurance? It is a device where two entities, the policyholder and the insurer, enter into a contract to transfer risk from the former to the latter. Prior to the contract, the policyholder carries a risk: that he/ she may die causing financial distress to dependants.

Through an insurance contract, she transfers this risk to the insurer or, more correctly, to a pool of similarly-placed policyholders.

Now the question that is: does SA constitute the entire risk cover that the policyholder seeks? My submission is that it is not; there could be another component in the risk cover (in addition to SA) that the Irda circular and DTC need to accommodate while specifying the multiple of premium.

Both statutes deviate from the standard procedure followed by insurers to calculate risk premium or mortality charge. Because the risk they assume on behalf of the pool of policyholders may be more than the SA, insurers calculate the risk premium on the actual sum they are liable to pay on death of the life assured — they call it the “sum at risk”.

What is sum at risk?
In case of a pure term policy, the sum at risk is equal to SA. But in case of an endowment plan with a waiver of a premium rider, the sum at risk is SA plus the present value of the future premia payable by the policyholder. Sum at risk, therefore, is the correct measure of the risk cover sought by a policyholder.

Therefore, both the Irda circular and Section 70(2) of the DTC the term “sum assured” should be replaced by term “sum at risk”.

This is not just a play on words. Waiver of premium rider is a sine qua non of an endowment policy; without it an endowment plan is merely investment and insurance packed together. One who buys an endowment plan with a waiver of premium rider, buys pure insurance, not a package of investment and insurance.

Rather, she buys a protection against two types of financial distress that may be caused to her dependents as a result of her death: (i) loss of a source of livelihood for the dependents, and (ii) ceasing of an investment plan for the future of the dependents.

Statutes that discriminate between a pure term policy and an endowment plan with a waiver of premium rider discriminate between the two types of financial distress. Such discrimination is unjustified.

Replacing the term "sum assured" by "sum at risk"  shall serve two purposes -- one, it shall remove statutory discrimination against policyholders who choose an endowment plan with a waiver of premium rider in place of a pure term policy to meet a specific need for a risk cover, and, two, it shall promote pure insurance as against investment-oriented endowment policies, which is the very raison-d'etre of both statutes.

The writer has been working in the retail financial products space for 15 years, both in the industry
as well as a visiting faculty in the subject at Goa University. He can be reached at tenala@gmail.com