Capital Markets: Challenges and Developments

What are Participatory and Non-Participatory Funds?

Note4Students

From UPSC perspective, the following things are important :

Prelims level : Participatory and Non-Participatory Funds

Mains level : NA

The amendment to Section 24 of the LIC Act, brought prior to commencing the IPO, segregated the previously single ‘Life Fund’ into the participatory and non-participatory fund.

What are Participatory and Non-Participatory Funds?

  • Under a participatory policy, a policyholder can get a share of the profits of the company.
  • This is received as a bonus. Examples of such products offered by LIC include  Jeevan Labh and  Bachat Plus.
  • No such sharing of profits happens under non-participatory products, which under the LIC fold includes policies such as  Saral Pensionand  Nivesh Plus.
  • As all insurance companies do, LIC also reinvests premium monies that policyholders pay.
  • The profits or surplus that comes about, as a result, was till September last year held in one single fund. This was the Life Fund.
  • The surplus was divided in the 95:5 ratio between policyholders (in the form of bonuses) and shareholders (in the form of dividends).

What has the Amendment changed?

  • But the amendment to Section 24 of the LIC Act has necessitated the segregation of the Life Fund into participatory and non-participatory funds, depending on the nature of the policies they support.
  • The amendment stipulates terms on how surplus is to be shared with respect to participatory and non-participatory funds.
  • As for non-participating funds, surplus from the non-participating business would be transferred to shareholders.
  • Surplus from participatory business, however, would be shared between policyholders and shareholders.

How does this change impact the shareholder?

  • The change, especially the one that has enabled 100% of the surplus in non-participatory funds to flow to the shareholder, has led to a massive jump in the Indian Embedded Value, or IEV.
  • IEV is a measure of future cash flows in life insurance companies and the key financial gauge for insurers.
  • The embedded value will help establish the market valuation of LIC and determine how much money the government raises in the flotation.
  • That will be crucial for the government to help meet its divestment targets and keep its fiscal deficit in check.

Why is it a risk, then?

  • LIC has stated in the document that a significant portion of its business premiums come from participating and single premium products.
  • It added, should the participating products generate lower than expected returns for policyholders, it could lead to increased surrenders.
  • This could also potentially bother their financial condition, operations, and cash flows.

 

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