How to grab 70% of a premium
At a time when reducing costs and giving the Indian investor a fair deal is at the centre stage of policy and regulation, the insurance regulator, in a move that is stunning on many counts, has proposed to hike commissions and payouts to sellers of insurance, legitimise illegal payments and bring back hereditary commissions. In the draft rules (read here: http://bit.ly/1RlmiJ9) on commissions released last week, the Insurance Regulatory and Development Authority of India (Irdai) has raised total sales-linked compensation across the board.
Here’s the draft in short: Irdai classifies two categories of sellers of insurance products—agents are individuals and intermediaries can be corporate agents like banks, insurance brokers, web aggregators, insurance marketing firms and anybody else that the regulator may recognise. The draft defines three categories of payments to agents and intermediaries. Agents get paid a ‘commission’. Intermediaries get a ‘remuneration’. And, here is the stun factor, there is a third category introduced by Irdai that formalises what have been illegal payments paid by insurance companies to large agents, banks and brokers, called ‘rewards’. A ‘reward’ is a direct or indirect incentive payment to an agent or an intermediary and includes gratuity, term insurance cover, group life insurance cover, group personal accident cover, group health insurance cover, telephone charges, office allowances, sales and promotion gift items and so on. These heads have been used by the industry to hide commissions and one has to only look at strictures passed by Irdai in the past to see how pervasive these illegal payments have been. India now has a regulator that is making illegal payments legal. Way to go!
The draft defines commission and remuneration rates according to policy type, and rates vary according to tenure of the policy. Pure insurance, or term plans, gets a higher commission rate than bundled products (traditional and unit-linked plans). Now, stun factor two. ‘Rewards’ for agents are capped at 20% of the first-year commission and at 40% for intermediaries. The final impact of adding commissions and ‘rewards’ in the first year are given in the graphics. The peak cost of sales in the first year is 70%. If your premium is Rs.1 lakh, see up to Rs.70,000 disappear into the pocket of the agent or the bank. Of course, more can be eaten up by the insurance company since we have only discussed sales cost. There are others—mortality, administration and fund management costs—that can soak up all of your premium.
Why are high first-year commissions and payouts a problem? Because they encourage churn. The evidence of the damage caused by such commissions comes from looking at persistency data of life insurance companies. The 13th month persistency numbers tell you how many policies out of 100 are still alive one year after the policy was sold. For India’s largest life insurance company, Life Insurance Corp. of India (LIC), this number is 59 as on 31 March 2014. The lowest 13th month persistency is seen at DHFL Pramerica Life Insurance Co. Ltd—40.62. This number rapidly falls and by the time the mandatory lock-in is over after five years, the 61st month persistency drops to a low of 3.98 at Bajaj Allianz Life Insurance Co. Ltd, and an average-setting 44 for LIC, according to the Irdai Handbook on Indian Insurance Statistics 2013-14.
Clearly, investors are trapped by sharp sales practices aimed at harvesting the high upfront commissions into paying the first premium. By the time they realise that they have bought a dud, it is too late. Hiking commissions on a product that already has exorbitant commissions is unpardonable.
Stun factor three: hereditary commissions are back on the table. These are commissions paid to families of insurance agents when they die. Ironically, life insurance agents forget to buy a cover to look after their families in case of their own untimely death—why else would they lobby for hereditary commissions so that their hard work’s reward looks after their families? Despite protests by agent lobbies, the Insurance Laws (Amendment) Act, 2015 had ended hereditary commissions, but Irdai, in stun factor three, has opened the door to bring them back. A company now needs a board-level policy on these commissions before they are brought back. I wonder if the independent directors on the boards of life insurance companies will do their job and stop this incumbent entitlement.
Two government committees have recommended scaling down front commissions in insurance over the past five years—Swarup committee in 2009 and Bose committee in 2015. (Disclosure: I have served as a consultant to the first, and a member of the second). Ignoring the recommendations, Irdai is doing all it can to push more sales incentives towards a distribution force fattened on unreasonable extortion from household savers. The government needs to step in to stop this destruction of household savings at the altar of toxic products.
Monika Halan works in the area of financial literacy and financial intermediation policy and is a certified financial planner. She is editor , Mint Money, Yale World Fellow 2011 and on the board of FPSB India. She can be reached at firstname.lastname@example.org