New IRDAI rules: Insurance commissions to stay high, but backdoor incentives to agents could cease; insurance penetration to deepen

New commission and EoM rules will not lower commissions from policyholders' perspective, but on the upside, commissions are unlikely to rise either

The Indian insurance sector now has a new commission payout regime.

Effective April 1, life and general insurance companies will not have to adhere to any specific ceiling on commissions paid to agents, distributor banks and other intermediaries.

However, the payouts cannot exceed the overall expenses of management (EoM) limits specified by the Insurance Regulatory and Development Authority of India (IRDAI).

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

The new commission rules

Life insurance companies can now pay commissions as per their board-approved policies. This is in line with the regulator’s proposal in November, though a significant departure from the August 2022 draft, which had mooted a 20 percent cap on commissions, down from 35 percent until March 31, 2023.

Over and above the 35 percent cap, insurers also handed out rewards to distributors. Now, all the rewards and incentives that the insurance companies paid their distributors will have to be subsumed within commission payouts.

The industry has largely welcomed the regulator’s directives, though some smaller players could find the going tough in the days to come.

“The increased flexibility in commission limits will allow insurers to react to market forces in a quicker manner, thereby supporting the IRDAI’s vision of improving penetration of insurance in the country. The expenses of management have increased allowability in the later years of the policy while limiting expenses in the initial year,” says NS Kannan, MD and CEO, ICICI Prudential Life Insurance. He believes this will help boost long-term persistency (which translates into a lower lapsation rate).

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

Product innovation

Others feel it will pave the way for greater product innovation. “It will facilitate the development of new product distribution models and lead to more customer-centric operations. It will also increase insurance penetration and provide flexibility to insurers in managing their expenses. Overall, it will smoothen the adherence to compliance norms,” says Anil Kumar Aggarwal, MD and CEO, Shriram General insurance.

On the flip side, though, some smaller insurance companies feel they need to brace themselves for tougher times. “It is a negative for us. It will restrict our ability to pay commissions and offer other incentives. Only the bigger players will benefit from these moves,” says the CEO of a relatively smaller private life insurer who did not wish to be named.

Some analysts believe that the larger listed players will be under pressure to deliver as unlisted insurers now have the flexibility to be more aggressive. “This removal of explicit commission cap will bring in transparency and payouts to distributors will get reported under commissions. For listed larger players, despite commission limits being freed up, the struggle to deliver profitability to the shareholders while balancing policyholders and distributors' interests would mean the limited ability to materially tinker the payouts to their distributors,” notes broking firm Emkay Global’s report.

Unlisted players do not have to manage the pressure of delivering shareholders’ returns. “(they will) likely go aggressive and opportunistic, especially in larger institutional distribution (banks, NBFCs, brokers, etc) with their increased (commission) payouts,” the report states.

IRDAI’s new expense ceilings

The insurance regulator has issued a notification on the new EoM limits for life, general and health insurance companies.

EoM is expressed as a percentage of premiums collected and includes commissions, technology spends, employee costs, administrative expenses and so on.

In the case of general insurers, expenses of management cannot exceed 30 percent of the gross premium written in India in a financial year. The cap is 35 percent for standalone health insurers.

In the 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 a tenure of over ten years – the EoM ceiling will be 100 percent of the 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 (pension) products.

However, expenses that insurance companies incur towards conducting rural business, Pradhan Mantri Suraksha Bima Yojana, Pradhan Mantri Fasal Bima Yojana and insurtech and insurance awareness initiatives will be excluded from the cap.

So, while insurance companies can pay commissions as per their board-approved policies, they cannot exceed the overall expense proportion permitted. For example, the IRDAI has done away with segment-wise EoM caps for general and health insurance companies.

“The shift from product-level commissions to a company-wide limit of expenses…will ensure parity across varying business models while rendering greater flexibility in managing expenses for insurers. Moreover, with the majority of the insurers above the prescribed norms of expenses and with the industry reeling under a combined ratio of more than 118 percent, these EoM limits will help in bringing cost discipline,” says Tapan Singhel, MD and CEO, Bajaj Allianz General Insurance. He feels this will, ultimately, translate into better pricing and products for customers.

Also read | Mis-selling and claim rejections top complaints at insurance ombudsman

Moneycontrol’s take

The insurance regulator’s proposal in August 2022 had raised hopes of a pivot towards a lower commission structure, but the subsequent draft and the final notification have put paid to those hopes.

Insurance companies will continue to pay higher commissions – which in turn eat into policyholders’ returns – compared to other financial instruments such as mutual funds that come with much lower expense ratios. Higher commissions also mean a greater incentive for agents to mis-sell life insurance products to gullible individuals.

On the upside, commissions are unlikely to go up. “Theoretically, insurers have the flexibility to pay commissions. However, they are unlikely to go up as insurance companies will have to meet the expenses of management limits,” says Abhishek Bondia, Managing Direct0r and Principal Officer, SecureNow Insurance Brokers. The flexibility will ensure that they can pay higher commissions to distributors in areas with lower penetration, which is a positive, he adds.