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Ramesh Pathania/Mint
Ramesh Pathania/Mint

Irdai seeks to limit insurers’ expenses

Paying upfront commission and padding up costs in some policies come under focus in draft

The expenses that an insurer can deduct from your money, which include commissions and operational and administrative expenses, are limited in a unit-linked insurance plan (Ulip). That’s because the Insurance Regulatory and Development Authority of India (Irdai) has defined how much an insurer can take from you by imposing a limit on reduction in yield.

On 21 July, the insurance regulator issued draft regulations as an internal circular on expenses of management for life and non-life companies. The draft, a copy of which is with Mint, does not alter the limits on expenses of management for life insurance companies drastically but it plans to implement the rules strictly and prohibit the payment of upfront commissions.

“If insurers overspend, it will ultimately affect policyholder’s money. So, the regulator wants insurers to be prudent and cautious with their expenses," said Vighnesh Shahane, chief executive officer and whole time director, IDBI Federal Life Insurance Co. Ltd.

For Ulips, the current rules state that the net reduction in yield for Ulips should not be more than 4% in the fifth policy year, coming down to a difference of 2.25% by the 15th year and onwards. This means that if your fund value is growing at 10%, then all cost heads, except mortality charge, together should be such that the net return on your investments is not less than 6% by the fifth year and not less than 7.75% by the 15th year. So, the insurers can’t overcharge you to recover expenses.

But in opaque participating traditional products, owing to their structure, there is scope to overcharge.

This is not lost on the regulator, and in a discussion paper in October 2014, it had mentioned that expenses needed to be curtailed to ensure that returns to policyholders are not compressed on account of high expenses.

“Since opening of the insurance sector, the insurers are witnessing huge expense outgo on an ongoing basis. This is resulting into exceeding the limits prescribed in the Rule 17D.... The authority has been relaxing this in accordance with the provisions in Section 40B," noted the circular. According to the discussion paper, if excess expenses are loaded, the products will not be viable. The surplus under with-profit products will reduce, as will the bonuses. So, policyholders may not find the benefits or bonuses attractive, and the business as a whole will become loss making.

Rule 17D of the Insurance Rules, 1939, describes the expenses limit that life insurers may incur and for a particular class of insurance product. Section 40B of The Insurance Act, 1938, restricts the expenses of insurers according to the rules specified in 17D.

Proposed changes

At present, the limits under Rule 17D depend upon the age of the insurer, type of product, premium payment term and the business in force calculated in sum assured for companies that are more than 10 years old. Regular premium life policies with a premium payment term of less than 12 years have an expense limit equal to 7.5 times the premium payment term of the first-year premium.

The new rules are not very different; for companies that are more than 10 years old, the allowable limit on expenses is pegged on the premium payment term alone, with an additional allowance pegged to the renewal premium.

“The draft limits are not drastically different from the current norms and in some cases are more liberal, especially for lower premium payment term policies. But the draft has done away with the escalation process that the discussion paper had put in place," said an insurance company’s chief executive officer. “The discussion paper not only increased the solvency requirement on overstepping the expenses limit but also had a step by step process in place for the insurer to justify the overruns before a regulator action. The current draft has done away with that and the entire power is concentrated with Irdai," he added.

Penal action: According to the draft, Irdai may even direct the insurer to not underwrite new business if it persistently violates regulations. Irdai has, however, allowed some room for younger companies. “Authority based upon the representation received from a newly registered insurer, through Life Insurance Council or General Insurance Council (of India) as the case may be, exercise forbearance for a period not more than five years," the draft states. “Authority, giving due regard to the business model of an insurer, may direct an insurer to charge the expense above the allowable limit to the shareholders’ account," it added.

No upfront commission: The draft also prohibits upfront payment of commissions for current and future businesses to intermediaries and clearly specifies that no payment to insurance intermediaries can be made before the risk start date. “This helps in two ways. First, it will stop the practice of insurers paying upfront commission to corporate agencies. Second, upfront commission could lead to expense overruns, which may be passed on to customers through different charges," said Shahane.

Commissions are a part of expenses of management and are currently governed by linked and non-linked product regulations, which peg the limit of the commission to the premium payment term and the age of the insurance company.

Expenses of individual insurance plans: While the discussion paper focussed on parity between expenses of insurance plans, the draft has shifted rules on this to the compliance certificate, which needs to be certified by a statutory auditor.

The insurers need to ensure that the allocation of expenses to participating plans is not higher than that of non-participating plans. This is important as it prevent insurers from padding up costs in participating plans. Participating products are those in which the customer gets bonuses, over and above the guaranteed benefit (usually the sum assured).

Typically, these bonuses are a percentage of the sum assured and are declared at the end of every year. Once declared, these become guaranteed. The bonuses come from the surplus generated by the participating fund. The insurer is free to exercise its discretion while declaring the surplus, but once declared, the policyholder is entitled to get 90% of it, whereas shareholders can get up to 10%. In non-participating products or without-profits, the benefits are clearly defined right at the time of buying the policy. The insurer can’t alter these in any way. Since the returns are guaranteed upfront, the scope to load expenses is limited in such products. In participating products, the insurer can pad up costs even if they originate from other products.

Many in the industry, however, feel this needs to be addressed better; instead of simply prescribing rules for overall expenses. Insurers feel that just like in the case of Ulips, there should be norms on how much an insurer can charge from the policyholder in the participating fund; the rest can be met using shareholder money.

“In the case of Ulips, the regulations have described the maximum that insurers can charge the customer by way of maximum reduction in yield allowed. In the case of term plans and other non-participating funds that guarantee return, market competition through premium rates will keep expenses under control," said K.S. Gopalakrishnan, managing director and chief executive officer, Aegon Religare Life Insurance Co. Ltd. “Therefore, we should focus on participating funds and have a limit that can be charged from the customers. Anything over that can be paid for by the shareholder. UK’s Principles and Practise of Financial Management already follows this model and prescribes the maximum that an insurer can charge the customer from the traditional life fund," he added.

If this happens it will lead to transparency as even you, the policyholder, will be aware of the charges in a traditional plan. Irdai has asked insurers to send their comments by 30 July.

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