After the shock on 16th November, LIC received good news on 20th. The Chairman, IRDA, clarified that LIC did not break any Rules. He also added that “certainly LIC would not transfer money from one account to another in violation of existing guidelines”. While this declaration brought cheers to millions, it left them also wondering “What is meant by transfer of money from one account to another, Why is it not permitted and, does this restriction apply to LIC? To answer these questions, one has to understand the structural difference between LIC and private insurance companies.
In the case of private insurers, Insurance Act has been amended, giving the shareholders 10% of the profits emerging under participating (with profit) and 100% of profits emerging under non-participating (without profit, including unit linked) policies.
This difference in share of surpluses emerging from participating and non-participating policies means that the two surpluses have to be estimated separately. This, in turn, necessitates insulation of funds pertaining to participating policies from funds pertaining to other policies, so that, no part of the surplus emerging under participating policies gets transferred to non-participating policies and, from there, to shareholders. So, the new insurance companies have to maintain a minimum of two funds and, naturally, Inter Fund transfers are not permitted.
What about LIC? Sec.24 of LIC Act states, “The Corporation shall have its own fund and all receipts of the Corporation shall be credited thereto and all payments of the Corporation shall be made therefrom”. What this apparently innocuous looking Section implies is very important. The LIC can have only one Fund (known as Life Fund). When there is only one fund, there cannot be any inter-fund transfer. What about intra fund transfers?
The “Valuation Surplus” at the end of each year is to be determined as difference between value of assets and the total liability under all policies, as determined by the Actuary. The total liability is determined by estimating the liability under each policy and adding up all these liabilities. As per Sec.28, not less than 95% of this surplus shall be allocated to or reserved for Participating policyholders.
Surplus will be emerging under some policies (majority of non-linked assurance policies, linked policies, … etc.) and Deficit under some (small sum assured, like Rs.25000, assurance policies, some pension policies, … etc.). Wherever there is surplus it increases and, wherever there is deficit it decreases, the Total Surplus. It is the Final Net Surplus that matters.
Though LIC can have only One Fund, this Fund is notionally divided into a number of sub-funds, corresponding to each class of policies. Like, Non-Linked, Participating, Assurance Fund ; Non-Linked, Non-Participating, Assurance Fund; … etc. The assets pertaining to each of these funds are also kept in separate baskets. This is mainly to assess which class of policies is making adequate profits, under which class the profits are inadequate and which class is making loss, study the reasons for the same and take appropriate corrective measures.
At the end of each year, the value of assets in the baskets corresponding to each class of policies are to be made equal to the total liability under that class, by appropriate shifting of assets from surplus baskets to deficit ones. Since the maintenance of different baskets of assets corresponding to each class of policies and shifting of assets from one basket to another, are purely notional, no accounting entries need be passed. So, intra fund (or inter account) transfers too are not necessary.
Why does 95% of all the profits go to Participating policyholders? The premium paid by a policyholder is made up of many components. In the case of Participating policies there is an additional component, known as bonus loading. The premium amount corresponding to this additional component is returned later, with interest, in the form of bonus, final additional bonus and loyalty addition. During the tenure of a policy, it is possible to use a part of this additional amount, temporarily, to create an implicit reserve, which is effectively equivalent to capital. The entire capital of the Corporation is thus indirectly and implicitly coming from Participating policyholders, who are its real shareholders. So, not less than 95% of the net profits, including those emerging under unit linked and other non-participating policies gets allotted to participating policies.
Effectively, the participating policies get a major share of profits earned and losses suffered by a life insurance company. Their position is similar to that of equity shareholders of a limited company.
The model adopted by LIC is based on the needs and expectations of policyholders and general public. It looks at life insurance business in its entirety and keeps clear of the segmented approach. Profit is not its sole driving force. This objective was summarised by Pandit Jawaharlal Nehru on the eve of formation of LIC. “Life Insurance becomes one of the major State Undertakings of India. Its objectives will be to serve the individual as well as the State. The profit motive goes out of it and the service motive becomes much more dominant”.
R.RAMAKRISHNAN
(Actuary)
