Mumbai: India’s insurance regulator will, in the next two-three weeks, effect a complete makeover of traditional life insurance products to make them more attractive, improve transparency and curb rampant mis-selling, in a move akin to what it did in 2010 for unit-linked insurance plans (Ulips).

The new rules will limit upfront commission for agents, expenses charged by insurers and surrender charges while enhancing the prospect of returns on investment for policyholders, said a person with direct knowledge of the new rules who asked not to be identified.

The rules being considered will also specify minimum death benefits, the minimum life protection component and a minimum guaranteed amount to be paid when a policy is surrendered.

J. Harinarayan, chairman of the Insurance Regulatory and Development Authority (Irda), confirmed that the regulator was working on new regulations and would announce them in the next “two-three weeks".

“Irda is working with experts to make broad changes in the design of traditional life insurance products. The new rules will cover all aspects of life insurance like charges and expenses, commission, surrender and yields," he added.

The insurance regulator does not have direct powers to change commission norms, but it can tweak rules on expenses to influence insurers’ ability to pay agent commission. Agents are currently attracted to selling traditional life insurance due to high agent commissions and surrender charges.

“Irda wants the industry to sell longer-term products. The changes will certainly impact the businesses and squeeze smaller players. What the regulator is doing is driven by an effort to curb mis-selling, but they are imposing too much too fast," said Amitabh Chaudhry, managing director and chief executive officer of HDFC Life Insurance Co. Ltd.

Irda has been working on the new rules for some time, and several drafts of the changes have done the rounds.

The most significant change will be on the expenses and commissions insurers can charge from policyholders on the money invested by them in traditional life insurance products such as endowment, money back plans, term assurance and non-linked pension plans.

In the three months ended 30 June, policyholders paid nearly 10,000 crore as expenses to their life insurers in the form of agent commissions and operating expenses that include policy administration charges and fund management charges.

There are around 2.3 million individual life insurance agents in India and under existing rules, life insurers less than 10 years old can charge up to 40% of the first year’s premium as agent commission and the older ones can charge up to 35%. The norms allow companies to deduct a further 7.5% (of the annual premium) as agent commission each in the second and the third year, and 5% every year thereafter. At such rates, a policyholder currently pays 20-25% of his premium money as commission over a five-year period. This rate goes up further in term assurance plans. The average agent’s commission in the first year of a policy is around 17-18%.

There are 24 life insurers in India with total assets of at least 16.6 trillion. In the current fiscal year, the industry collected a total first-year premium of 53,814.09 crore. There are around 350 million life insurance policies in force currently.

The new rules will also require an insurer to manage expenses and surrender charges in such a way that the maximum difference in the gross and net return at maturity in a traditional life product does not exceed four percentage points. There is no such limit currently and the change will compel insurers to significantly reduce agent commission and operating expenses.

“Maintaining such reduction in the difference between the gross and the net return in traditional life policies will force the agents to sell longer-term policies to earn adequate commissions. So, an agent who gets around 36-40% in 10 years in a traditional policy, will now get it in 15 years," said Chaudhry of HDFC Life.

Another significant change is in terms of surrender charge, or what it costs a shareholder to terminate a policy. Currently, such charges could even be around 100%, which means the policyholder hardly gets any money in most cases if he stops paying premium before the end of the policy term.

The new rules reduce the charge.

“There could be a minimum surrender value for traditional life products under the new guidelines. There will be different slabs of surrender charges for different years of policy completion. The charges will reduce progressively every year and will decrease to almost nil during the final years of the policy term," said the person cited in the first instance.

Insurers fear that they will lose money if the surrender charge is reduced because they spend a lot of money on customer acquisition and product development.

Irda may also cap the proportion of money that can be deducted from the annual premium as so-called amortization cost when a policy is surrendered.

Amortization is an accounting practice of spreading the cost of selling and managing a policy over its lifespan.

“These artificial limits will put the industry’s viability in question. If surrender charges are capped in line with the norms for Ulips, agent commission will fall dramatically, may be by half. Any kind of price control is against a free-market regime. We have to realize that any regulation which benefits only one stakeholder is eventually going to harm the policyholders only," said G.V. Nageswara Rao, managing director and chief executive officer of IDBI Federal Life Insurance Co. Ltd.

Some of the changes are similar to those effected in Ulips in 2010, when Irda had asked insurers to ensure that the difference between the amount paid to policyholders and the fund value should not be more than three percentage points for policies up to 10 years and 2.25 percentage points for policies above 10 years’ term. The rules reduced agent commissions on Ulips drastically and made these instruments more investor friendly. The regulator also capped the first-year surrender charges at 12.5% for Ulips with a term of less than 10 years and 15% for those above 10 years.

Like in the case of Ulips, the changes will likely curb mis-selling of policies with an eye on commissions.

They could also increase returns on investments in traditional life policies.

The regulator has been concerned over rampant mis-selling in life insurance products. In its latest annual report, Irda said, “An analysis of the data in IGMS (Integrated Grievance Management System) for the year 2011-12 shows that in the life insurance area, complaints relating to mis-selling or ‘Unfair Business Practices’ as the category is called in the system is predominant... A drill down into the category of Unfair Business Practices for the year 2011-12, shows that mis-selling is predominant in the conventional policies category as against Ulips, which was the case earlier."

Irda recently issued stringent guidelines on distance marketing modes such as through the phone and the Internet. In February 2011, the regulator had framed guidelines on persistency, which were relaxed a bit in September 2011.

The persistency rate is the percentage of policy contracts still in force in the specified time interval after they have been issued and is calculated on the basis of premium earned or the number of policies sold.