SEBI’s Order on ULIPs: A Misfired Shot? – Part II

(This is in continuation of Abhishek Tripathi’s previous post, and it examines the regulation of ULIPs in the backdrop of the reasoning adopted by courts in the Commonwealth)

Insurance Act regulates companies engaged in any class of insurance business, and requires such companies to register themselves with the IRDA prior to commencing any insurance business. ‘Life insurance business’ has been defined under the Insurance Act to mean ‘the business of effecting the contracts of insurance upon human life, including any contracts whereby the payment of money is assured on death (except death by accident only), or the happening of any contingency depending on human life, and any contract which is subject to payment of premium for a term dependent on human life…..’.

While the term ‘contract of insurance upon human life’ is not defined as such, the above definition does indicate certain instances, which ipso facto qualify as the contracts of insurance on human life, namely:

(a) contracts whereby payment of money is assured on death (except death by accident only), or the happening of any contingency depending on human life, and

(b) any contract which is subject to payment of premium dependent on human life.

The above are two distinct categories. For the purposes of the definition of ‘life insurance business’, it is not important whether an amount is payable otherwise than on death (such as on surrender). The only requirement that needs to be fulfilled is whether an amount is payable on death or the happening of a contingency dependent on life. Payments due on maturity is widely recognized contingencies depending on human life. In addition, acquisition of a surrender value in all insurance policies in which payments are guaranteed on maturity or on occurrence of a contingency is recognized in Section 113 of the Insurance Act itself.

Whether or not the premium is dependent on human life is immaterial in determining the nature of a contract as a contract of life insurance, if the benefits are otherwise payable on death or contingency depending on human life. The method of computation of benefits in a manner such that it appears to be an investment product will also not change the nature of the contract as one of life insurance.

While similar disputes have not arisen before Indian courts, several other decisions in the Commonwealth clearly set out that investment element does not change the nature of a life insurance contract as an insurance contract, as long as insurance is also one of the components of the contract. In Fuji Finance Inc. v. Aetna Life Insurance Co Ltd ([1996] 3 WLR 871), the Court of Appeal in UK held ‘capital investment bonds’ (having features identical to ULIPs), to be contracts of insurance. Rejecting the argument that a policy is not a contract of insurance unless quantum of the payment made unless triggered by death or a contingency on life (and not same as what insured would get on surrender of the policy) and instead offered a new line of reasoning. It held that since the policy came to an end on the death of the insured and the right to surrender was related to the continuance of life for it could not be exercised after the death of the insured, there was an uncertainty involved. While it accepted that a contract offering merely a surrender value would not have been an insurance policy, it held that there should be no reason why a contract that offers both death benefits and surrender benefits should not be considered as a contract of insurance.

In the case of NM Superannuation Pty. Ltd. v. Young (113 A.L.R. 39), the Federal Court of Australia had to determine whether a policy under employee superannuation scheme constituted contract of ‘life insurance’ or ‘endowment assurance’. The events on which benefits were payable under the policy were (a) retirement on or after the retirement date defined in the policy, (b) death in employment before the age of 70, and (c) leaving of the employment of the employer before the retirement date. The benefits payable were uniformly calculated, i.e. the accumulated contributions made by the employer along with the accrued interest from date of payment of the contribution to the date of the event in question. The Federal Court held the policy to one of life insurance and observed as follows:

The retirement benefit, payable under clause 11, is uncertain because the member may die before reaching the retirement date and thus receive no benefit under that clause. The death benefit, payable under clause 13, is equally uncertain, not in the sense that death is uncertain, but because the time of death is uncertain and that benefit will not be payable if the member retires before the event of death occurs. Equally, the benefit payable under clause 17 is uncertain because it will only be payable if death has not intervened. The fact that the quantum of the benefits is the same does not affect, in my view, the outcome.

In another judgment, in the case of Marac Life Assurance Ltd. v. Commissioner of Inland Revenue [1986] 1 N.Z.L.R. 694 the Court of Appeal in New Zealand upheld the nature of certain bonds that offered fixed percentage of return on the anniversary of the policy, falling after the death of the insured. Recognising investment to be an integral characterstic of insurance policies, Cooke J., observed that:

In the general sense all life insurance is investment. What distinguishes it from other kinds of investment is that the gain or yield, if there is one, depends on the contingencies of human life. That is the case as regards all these bonds. Under each a fixed sum, being more than the premium, becomes payable to the policyholder or his personal representative (the 10-year bond carrying as well participation in surplus), but the date on which that fixed sum becomes payable depends on whether or not the life assured is continuing.

The court also rejected the test of primary or dominant purpose on the ground that any such determination will depend on the emphasis that parties to the contract placed on the policy, i.e. the insurer and the insured. It is possible that both may be entering into the contract under the same belief, i.e. the contract is one of investment.

The judgments reflect the realities of the insurance industry. Pure life insurance products, such as term life insurance, have very low marketability and acceptance amongst consumers. Investment benefits make the product saleable and have come to form an essential feature of life insurance. SEBI’s claim that investment products should be registered with SEBI will take away the whole logic behind having a distinct regulator for the insurance industry, and any such attempt is definitely not conducive to proper regulation.

In my view, requiring ULIPs to be regulated by SEBI is neither legally teneable, nor commercially feasible. Any such move will merely stigmatize the growth of the industry, and cause instability and anxiety in the securities market. It is equally important to address SEBI’s concerns around mis-selling of ULIPs by insurance agents, however, such steps should originate from the IRDA. It is time that IRDA regulates the selling of ULIPs by insurance companies and bring them in line with the regulatory regime surrounding the mutual funds. Else, the court may be convinced to pass orders directing the IRDA to fix the malaise in selling of ULIPs. That may be SEBI’s best shot and that may exactly be what SEBI is aiming to achieve out of this controversy.

– Abhishek Tripathi