As the entire financial sector moves towards lower fees, payments and charges, there is one outlier—the Indian insurance industry. The industry is not at fault; for that we must look towards what the regulator is doing. Almost a year after it floated a draft on rethinking commission rates, on 14 December 2016, the insurance regulator—Insurance Regulatory and Development Authority of India (Irdai)—hiked the total payout to the distribution arms. You can read the document here: http://bit.ly/2jjM69X.
The good news first. Total payouts have gone up but are lower than what were proposed in the draft, which had suggested a peak rate of 70% as payout. You can read what the draft proposed here: http://bit.ly/2i7I17I. The new rules have raised overall payments in the life insurance business to agents and intermediaries. The new rules break up the market into three categories of distributors of life insurance products: agents, intermediaries with more than half their income coming from insurance, and intermediaries with less than half their income coming from insurance (see table below). Agents represent one company and are individuals. Intermediaries include corporate agents, insurance brokers, Web aggregators and insurance marketing firms. Agents are paid a commission on the sale of insurance policies. Intermediaries’ sales commissions are called ‘remuneration’. A third payment category has been introduced. This is called ‘rewards’. A reward is an amount paid, directly or indirectly, as an incentive by the insurer to agents and intermediaries. The rewards look like a formalisation of the payments being made earlier by insurance companies to intermediaries, which were over and above the commission limits.
The notification has made some changes to the existing commission structure for selling policies. First, it has hiked commissions for pure risk policies as compared to policies that bundle investment and insurance. Two, it has raised renewal commissions on regular premium policies and made them level through the life of the policy. Earlier, the renewal commissions would reduce over the years. The direction is right but the rates are too high. Term policies are only pure risk products and the cheapest way to buy life cover. To reward intermediaries more for selling a term product over a product that bundles investment and insurance is good but the rates look far too high, at 40% of the first year premium for a term plan and 35% of the first year premium in a bundled policy. Remember that upfront commissions are zero in mutual funds. To make trail commissions, or commissions on regular premiums higher is a good direction to follow since it makes the agent service the policy and prevents churn. But with upfront payments as high as they are, the role of trail gets muddied. Policyholders will continue to get churned as long as upfront remain this high, specially as agents are not forced to return the commissions if the policyholder stops funding the policy midway.
But the payouts do not stop here. Irdai is giving away more to the intermediary in the form of ‘rewards’. What are these rewards? Irdai believes that agents need to be rewarded to account for benefits such as gratuity, term insurance cover, various group insurance covers, telephone charges, office allowance, sales promotion gift items, competition prizes and such other items. Intermediaries need rewards to compensate for services such a risk analysis, gap analysis, plan design, predictive modelling, data management, infrastructure, advertisements and such other items, including any additional incentives by whatever name they are called. How much are these rewards? All agents are eligible for rewards that are fixed at a maximum of 20% of the first year commission that they collect. Not all intermediaries are eligible for rewards. Only those who earn more than half their income from the insurance business are eligible for rewards. Others are not. The definition used by Irdai for rewards begs the question: if intermediaries need to be compensated under the various heads listed, what was the commission for? Irdai will go down in history as perhaps the first regulator to formalise what were informal payments.
After these changes, from 1 April 2017, the peak rates of payouts to intermediaries go up to as high as 48% in the first year. The hikes by Irdai must be seen in context of an overall reduction in cost in the financial sector due to the use of technology, the new payment systems and rising levels of entrepreneurship. Finally, we all need to ask this question: what is it that they sell that needs such high commissions? Why does selling largely government securities with a warp of a life cover cost so much?
Monika Halan works in the area of consumer protection in finance. She is consulting editor Mint, consultant NIPFP, and on the board of FPSB India. She can be reached at firstname.lastname@example.org