The report appeared recently in the media that the Life Insurance Corporation (LIC) suffered a notional loss of Rs.14,000 crore in three of its schemes has been cited as one of the reasons for the stock market fall on November 16. What are the real facts?
Till March 1987, the pension portfolio was just a spec in the corporation's total portfolio. In the context of rising yields on bank deposits and corporate bonds, the pension rates were unattractive. Realising the need for developing the pension business, so essential for ensuring social stability, the government requested LIC to introduce a pension plan with attractive returns. Permission was given to the corporation to invest the pension fund equally in government securities and corporate bonds.
LIC introduced two plans ? Jeevan Akshay (immediate pension) and Jeevan Dhara (deferred pension). Under Jeevan Akshay, for a single premium of, say, Rs.1 lakh, a life pension Rs.1,000 a month was guaranteed, with provision for return of the single premium on death of the policyholder. Equally attractive returns were provided under Jeevan Dhara. In 1997, LIC was directed to introduce a more comprehensive pension plan, Jeevan Suraksha.
The two plans
In the late 1980s and in the good part of 1990s, it was possible to obtain an yield of 16.5 per cent under the investment pattern permitted by the government ? much more than the minimum yield of 13.5 per cent required to meet the obligations and expenses under these plans. When the yield on investments began falling, LIC was not able to revise immediately the premium rates under these plans. However, once the Centre opened up the insurance sector, the premium and pension structures under these plans were revised and aligned with the then market conditions.
In 1987, compared to the total life fund of Rs.12,000 crore, the Pension and Annuity Fund of LIC was just Rs.350 crore. While the total Life Fund is about 100 times its value in 1987, the Pension and Annuity Fund (under linked and non-linked business) has now grown by about 300 times. It will continue to grow rapidly in the coming years and, within a decade, the fund will match the Assurance Fund in terms of size and profitability and emerge as the second arm of the corporation.
Invisible capital
Where did the capital come from for financing the development of pension fund? The with-profit (participating) policyholder contributes some additional amount, known as bonus loading, with every instalment of premium. This bonus loading is actually a contribution towards capital. This invisible capital of a life insurance company goes on increasing with continuous flow of new business. This is how LIC has been functioning with virtually no visible capital, but generating huge profits. The profits generated from deployment of capital are given back in the form of bonus along with capital at the time of exit of a policy. The assistance being extended at present from assurance business to pension business is not a subsidy. Subsidy means a non-repayable loan. On the contrary, what has been done is similar to creating a venture fund out of the capital contributed by the policyholders and using the same to finance the emerging pension business. This has not in any way harmed the interests of the past or present policyholders, but will only give high return to them in the coming years.
The pension business will start yielding rich dividends in the near future. Not only the present and future policyholders, but the entire nation will benefit from this pension fund launched two decades ago.
Equitable premiums
The profits generated, when the yield on pension funds was more than the minimum required, were not kept in a separate reserve, but merged with the total profits, a part of which was utilised to finance the rapid growth of the assurance business. Now the flow is in the opposite direction.
In life insurance, while determining the premium rates, long-term assumptions have to be made regarding various parameters. The Actuary has to ensure that the premiums charged under each plan/scheme are fair and equitable. Over the years, there will always be variations, favourable and unfavourable, between these assumptions and actual experience. While the experience under one group of policies is favourable, that under another group may be unfavourable and vice-versa. The profit or loss emerging due to such variations has to be shared by all policyholders.
Insurance companies had been functioning on this principle for more than a century. The perceived loss in the pension fund of LIC is only due to lack of understanding of this guiding principle and artificial segmentation of policies into multiple water tight compartments.
One has to understand and stick to the basic principles of insurance and desist from blindly copying whatever is happening in other countries.
