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

The Insurance Regulatory and Development Authority of India (IRDAI) has revised its proposal to cut agent commissions.

In a new proposal on November 24, IRDAI plans to allow insurers to pay commissions as per their board-approved policies. However, there is a rider: Insurers have this flexibility as long as the commissions paid do not breach the overall expenses of management (EoM) ceilings they have to adhere to.

“This is a big step forward in the insurance industry as it puts all costs under one head and gives freedom to the industry to allocate according to their own priorities,” says Monika Halan, author and adjunct professor, National Institute of Securities Markets (NISM).

It could also eliminate the dubious practice of giving incentives and rewards over and above regulatory limits. “This is the first serious step that the IRDAI has taken in its history as a regulator towards reducing commissions in products that are at ridiculously high levels today,” she adds.

Also read: Policyholders to gain as IRDAI backs 20 percent cap on first-year commission, sops to boost persistency

EoM includes commissions and other expenses such as technology spends, employee costs, administration expenses and so on. The August draft, too, had given the flexibility of determining commission payouts to companies that did not breach the EoM limits. Once finalised, these regulations will come into force from April 1, 2023.

“The industry has come of age and it’s time to give independence and flexibility to find the right balance between customer, distributor and shareholder. The revised draft gives insurers flexibility on commission payouts and also more responsibility, instead of being hand-held at every stage. This is also how banking regulations were gradually relaxed, empowering the banks over a period of time,” says RM Vishakha, MD and CEO, IndiaFirst Life Insurance.

The scourge of high commissions

Steep commission rates, particularly in life insurance policies, have often acted against the interests of policyholders.

The sector has had a long history of complaints about agents and bank relationship managers pushing unsuitable life insurance products to individuals.

For example, unit-linked insurance policies (Ulips) and long-tenure traditional endowment policies are sold to senior citizens. This is despite the fact that those in the older age groups attract higher mortality charges, which eat into potential returns, denting the final corpus.

This is why a cap of 20 percent (down from 35 percent at present) on first-year commissions proposed in August for life insurers was welcomed by independent financial experts (see graphic for current and proposed first-year commission structures). Going forward, it remains to be seen whether insurance companies rein in commissions and reward payouts over the long term.

Also read: ULIP woes: How a senior citizen lost 90% of his premiums after staying invested for 14 years

Disadvantage policyholders?

For now, insurers need not reduce their commission payouts as long as they are within the EoM limits. These are steep, especially when compared to other financial sector segments such as mutual funds where expense ratios have been trending downwards.

“Both the regulator and the industry need to overcome the ostrich syndrome and reconcile with the fact that, progressively, the overall expense ratios will decrease with an increase in the industry size. It is not prudent for the insurance industry to stay inward-looking,” Avinash Singh, Senior Research Analyst, Emkay Global, says in his report on the proposed commission structure.

He points to the contrast that mutual funds, banking and other financial services have to offer in this context. The costs have come down substantially as the size of the industry has increased.

While policyholders now can do little about hefty commission payouts to agents, they can make purchases from insurers directly to save on premiums, say experts. “The new draft says policyholders – life as well as non-life – can go to insurers directly and get discounts on premiums. At present, approaching the insurer is of no use as the premiums are fixed, irrespective of whether you buy directly or through an intermediary," says Hari Radhakrishnan, Regional Director, First Global Insurance Brokers.

Commissions will not rise despite the flexibility

For insurance companies, this flexibility comes as a relief. “Net net, the revised draft on EoM and commissions allows flexibility to insurers and provides some immediate relief to a number of life insurers (including LIC), which would otherwise have needed to bring down their commission payouts, had the August draft regulations been enacted just as they are,” the Emkay report notes.

On the upside, Singh does not foresee commissions going up if the draft is implemented as insurance companies will have to be mindful of the EoM cap and maintain a balance between commission and non-commission expenses (employees, technology, marketing, etc), which are also key to boosting growth.

Moneycontrol’s take

While insurers have welcomed IRDAI’s move to provide more flexibility to insurance companies for fixing commissions, from life insurance policyholders’ perspective, in particular, this is a step back.

The August proposal had raised hopes of high commission payouts being reduced significantly, but the IRDAI has done away with specific caps in the latest proposal.

The silver lining: the insurance companies still have to adhere to the EoM caps, which could keep commissions under check.

However, they continue to remain relatively higher at a time when expense ratios of other competing financial products such as mutual funds are tightly controlled and trending lower.

The regulator and the industry ought to move in the direction of a drastic reduction in commissions and charges. They need to take these steps to be able to compete with mutual funds and National Pension System, which offer lower charges and greater transparency, features that appeal to a growing tribe of financially-savvy Indian investors.