Higher insurance agent commissions to continue, but IRDAI asks insurers to adhere to EoM caps

IRDAI's new rules are unlikely to bring down commissions.

From April 1, life, general and health insurance companies will have the flexibility to pay commissions to agents as per their board-approved policies.

However, they will have to ensure that they do not breach the overall expenses of management (EoM) ceiling that they have to adhere to. EoM, which is computed as a percentage of premiums collected, includes commissions and other expenses such as technology spends, employee costs, administrative expenses and so on.

Also read | How will IRDAI's latest proposal on agent commissions play out for policyholders?

As per an IRDAI notification issued on March 28, expenses of management of general insurers cannot exceed 30 percent of gross premium written in India in a financial year. In case of standalone health insurers, this ceiling is slightly higher at 35 percent.

This excludes expenses related to the rural sector, Pradhan Mantri Suraksha Bima Yojana, Pradhan Mantri Fasal Bima Yojana and costs incurred towards insurtech and insurance awareness initiatives.

In case of life insurance, EoM caps are linked to product categories. Under the pure risk product basket – for instance, regular premium term insurance policies with tenure of over ten years - the EoM ceiling will be 100 percent of first-year premium.

In the subsequent years, it will be 25 percent of renewal premiums. For other individual categories except pension products, the maximum limit is 80 percent of first-year regular premiums. The ceiling is 15 percent in the first year for deferred annuity products.

More flexibility to insurers

After proposing a 20 percent cap on first-year life insurance commissions in August last year, the Insurance Regulatory and Development Authority of India (IRDAI) relented and relaxed the draft rules in November to allow more flexibility to insurers. At present, the cap on first-year commissions is 35 percent of the premiums.

Greater flexibility to insurance companies could mean that commissions will not come down substantially, as was expected when IRDAI first framed draft rules on commission revisions. However, the mandate to stick to the overall EoM ceiling could still work in favour of policyholders, as the commissions—and rewards—will have to be subsumed into EoM.

According to the notification, insurers will have ensure that their payment of commissions policy is in the interest of policyholders and agents, and increases insurance penetration in the country and “brings cost efficiencies.”

Also read | Life insurers get wiggle room on spends, but don’t expect commissions to surge

High commissions’ role in mis-selling

Commission payouts in the insurance sector are high, especially when compared to other financial sector segments such as mutual funds where expense ratios have been trending downwards.

Higher commissions are seen as the key reason why the mis-selling menace in life insurance persists. Intermediaries often sell unsuitable life insurance products to gullible investors looking to make tax-saving investments at the last minute or senior citizens who may not be financially savvy. For instance, senior citizens end up buying unit-linked insurance policies (Ulips) and long-tenure traditional endowment policies without realising their advanced age could eat into potential returns.

Also, agents tend to get customers to churn policies in the initial years in order to earn higher first-year commissions. As a result, such policyholders end up shelling out steep surrender charges (penal charges for early exit, in simple terms) in the initial years.