The changing face of insurance

Investment and insurance are usually considered to be inversely proportional. This is mainly because insurance is meant to cover your life. So even if insurance products may not offer higher returns, it always makes sense to have a cover.

On the other hand, investment is viewed as a vehicle that will help you multiply your money. Therefore, one always discusses investment in terms of returns offered.

However, a recent catalyst to this subject has been a judgement delivered by the Bombay high court, stating that trading in insurance policies is permissible.

As the episode goes, a petition was filed by an investor (who is one such "investor" company named Insurance Policy Plus Services, hereinafter referred to as IPPS) suddenly came across a situation when the Life Insurance Corporation of India refused to register the assignment for such policies, despite having earlier accorded permission to IPPS to conduct such transactions, on following grounds - IPPS had no insurable interest in the policies and was purchasing these policies merely with the aim of re-selling them onward.

Encouragement of such practices could result in unhealthy practices regarding trafficking in policies, which would be contrary to good public policy.

The Bombay high court, however, rejected LIC's contention broadly stating that, as the contractual terms of the policy did not prohibit assignment. As long as due process was followed, with both the parties being willing participants in the transaction, the LIC would merely be functioning in the capacity of a registering authority.

What happens in such situations is that by assigning one's policy to a third party, one loses all rights over it. This is a common practice in the UK and the US.

Typically, such policies are often lapsed policies, which are renewed and then assigned to an investor who pays the policyholder a sum, which is higher than the prevailing 'Surrender Value', which the insurance company would offer.

All further premiums on the policy are paid by the new investor. This practice enables the original policyholder to raise funds at a short notice, thereby, injecting liquidity into his defunct policy.

For instance, Person A has a life insurance policy of say Rs 50,000 that has acquired 'Surrender Value'. However, there may come a time when he is in need of excess cash to pay his medical bills.

In such a case, he can sell his policy to Person B who will pay him more than the surrender value of his present policy. The insurance company in this case will assign/change the name of the beneficiary to Person B.

So while the policy continues in the name of Person A, Person B is the one paying the premium.

On the maturity or unfortunate demise of Person A, Person B is entitled to receive all the benefits. From the perspective of the Person B, purchasing such a policy is similar to buying a bond with a negative coupon and an uncertain redemption date. The return depends on the seller's life expectancy and when he dies.

Implications of these judgement could be manifold. Increase in the number of investors/investor companies such as IPPS, as the ambiguity pertaining to the legality of such transactions has been dispelled. We may see a spate of renewal of lapsed policies. Many a time, policies lapse owing to the policyholder's inability to pay the premium.

Now we could see the investor company itself advancing sums of money to holders for the purpose of reinstating the policy. Once reinstated, the original holder can assign the policy onward.

We may also see an increase in the number of new insurance policies, as the holders can surrender their policies. However, this will not apply to term policies, as they have no surrender value).

The number of 'viatical' settlements will increase. Such settlements are common in the US and involve individuals with a short life expectancy (may be two years or even lower) selling their policies to investors in order to raise monies to meet medical expenses.

One negative implication, as perceived by some, is that such introduction of such practices create a situation wherein investors may try to "speed up" the process of claim generation by resorting to criminal means. While this cannot be totally ruled out, it should be viewed more as an exception than a rule.