The Reserve Bank of India’s Financial Stability Report has flagged a sharp rise in surrenders and withdrawals of life insurance policies, indicating policyholder dissatisfaction. Saikat Neogi explains how early exits impact asset-liability management and the steps regulators are taking to curb mis-selling
Why is surrender of insurance policies on the rise?
For two years in a row, payouts on surrenders and early exits have overtaken maturity payouts in life insurance, signalling policyholder dissatisfaction and the risk of mis-selling. In FY26, surrenders and withdrawals accounted for 38.3% of total life insurance pay-outs, surpassing maturity benefits at 36.9%, data from RBI’s Financial Stability Report show.
In FY25, surrender and maturity payouts were 37% and 35.4% of the total life insurance payouts, respectively. Death claims remain unchanged at 8.1% of the total payouts. While the payouts by life insurers have risen sharply from Rs 4 lakh crore in FY21 to Rs 7.3 lakh crore in FY26, the composition of payouts is a structural concern as more of this money is being returned to customers who are surrendering their policies early. Mis-selling is a real driver, but it is not the whole story.
The RBI report points to three forces operating at once: dissatisfied customers, mis-selling, and competitive pressure from alternative financial instruments. Meanwhile, insurance penetration remained stagnant at 3.7% in FY25, roughly half the global average.
How do commission payouts influence mis-selling?
The commission numbers are telling. What private life insurers pay to sell a policy has doubled from FY22, and the rewards still sit at the point of sale, favouring the sale over the fit. In FY25, life insurers paid Rs 60,800 crore as commission, a year-on-year growth of 18%. In contrast, total premium collection grew only 6.7%.
The central bank points out that the escalation in distribution costs significantly outpaces private sector premium growth, compressing net margins and raising the risk of acquisition-cost-driven mis-selling. High first-year commissions in life insurance, which are front-loaded, create strong incentives for aggressive selling.
High commissions, coupled with intense sales targets, make bancassurance an aggressive sales channel leading to mis-selling. Meanwhile, the high distribution costs keep premiums unaffordable for large sections of the population, forcing people to surrender policies early or forego cover.
What’s the impact on asset-liability management?
The central bank has flagged that early exits impact asset-liability management (ALM) and force asset liquidation ahead of schedule. Insurers invest for the long term because they expect to pay out over the long term. Their money sits in long-dated bonds matched to policies meant to run for decades.
When more people cash out early , the unexpected spike in early surrenders causes massive liquidity drains. It forces life insurers to liquidate long-term investments sooner than planned, sometimes when markets are not in their favour. Moreover, they are forced to keep a higher proportion of their portfolio in low-yield, highly liquid assets.
This reduces overall profitability and creates a structural deficit in their long-term ALM framework. While this is not a solvency worry as they remain well-capitalised, it eats into profitability and the predictability the whole model rests on.
“In effect, how long customers stay has become an investment risk in its own right, which is why the central bank is flagging it,” says Aravind Venugopal, partner, Khaitan & Co.
Cost of early surrender to the policyholder
Half of retail life insurance policies do not survive beyond the fifth year, even though many of these policies are designed to last up to 20 years. As commissions are front-loaded, policyholders lose more when they make an exit in the initial years. The insurance regulator modified the rules of surrender value in late 2024 to make them customer-centric.
So, a policyholder who exits early no longer walks away with nothing, even after paying just one year’s premium. But leaving early still comes at a steep cost. If a policyholder surrenders in the first two or three years, she will recover only a fraction of the premium paid, with real value building only in the later years.
The penalty is lighter than it was, but early exit still means leaving money on the table. So, by making insurers bear more of the cost when a policy lapses early, the Irdai has effectively pinned the problem on how these products are sold, thus building pressure on insurers to curb mis-selling. Alongside, Irdai is working on distribution reforms to address product suitability.
RBI’s guidelines on mis-selling
The RBI has introduced new rules to combat mis-selling of financial products, effective from January 1, 2027. Banks have to obtain clear and informed consent from customers before selling any product and the consent must be recorded and cannot be assumed or pre-selected. Consent for multiple products cannot be clubbed.
The rules prohibit compulsory bundling of products linked to a loan such as purchase of insurance, which raises the cost of borrowing over 15-25 years. It has also tightened the oversight of third-party agents. In cases, where the mis-selling of a product is established, banks will have to refund the entire amount paid by the customer.
The lender will also compensate the customer for any loss arising due to mis-selling as per its approved policy.
