The Committee on Investor Awareness and Protection, constituted by Government of India, released a Consultation Paper on Minimum Common Standards for Financial Advisers and Financial Education. The six-member committee headed by D. Swarup, who incidentally is also the Chairman of the Pension Fund Regulatory and Development Authority (PFRDA), has put forward some groundbreaking proposals which have caused turmoil of sorts in the life insurance industry. The committee has proposed the phased elimination of commissions paid to insurance agents by April 2011. The committee’s recommendations are designed to reform the industry but they miss the peculiarities of the life insurance business in India. By doing away with insurance agents’ commission, they will be throwing the baby out with the bath water!
The Insurance Act, 1938, currently allows insurance companies to pay a maximum commission of 40 per cent of the first year’s premium, 7.5 per cent of the second year’s premium and 5 per cent from there on. The committee recommends a move from a commission-based system to a fee-based system. The report proposes that the upfront commission embedded in the premium paid (to agents of insurance companies) should come down to 15 per cent immediately. It should fall to 7 per cent in 2010 and there should be a zero-commission structure in place by 2011. The objective is to remove the bias towards selling policies with higher commissions and to ensure that the entire premium paid by an investor is put to work, increasing returns on investments.
The committee’s recommendations have triggered opposition from the industry regulator, the Insurance Regulatory and Development Authority (IRDA). The IRDA has written to the finance ministry opposing the removal of commission from the premium and contesting the observations of the committee regarding the working of the commission system.
The committee report draws attention to the huge sum of Rs.14,704 crore paid by the industry as commission in 2007-08,but ignores the fact that the industry earned a premium of over Rs.220,000 crore and that the commission-to-premium ratio actually fell from 12.2 per cent at the time of liberalising the sector to 6.6 per cent.
The report also expresses its concern over the possibility of high upfront commissions (40 per cent of premium) leading to mis-selling by insurance agents. It points out that agents hard-sell high commission products that require premium higher than what customers can afford. The IRDA data however reveals that 42 per cent of new premia came from the plans where the upfront commission ranged from 1.75 to 2 per cent (with no trail commission to follow). For a few products, the maximum commission can be 40 per cent whereas there are several products where the maximum commission is 2 per cent. Also, the average earnings of an agent range from Rs.8,000 to Rs.10,000 per month, which contradicts the general perception that agent commissions in India are high.
The committee feels that since insurance commissions are the highest in the first two years, agents have a vested interest in letting policies lapse and getting clients to subscribe to new ones instead, so that they continue earning high commissions. The report, therefore, highlights the high lapsation* rate of insurance policies but fails to mention the rise in renewal premium income from Rs.26,250 crore at the time of opening up of the sector to Rs.156,000 crore in 2007-08. However, the report rightly emphasises on the need for investor education which can also address issues in sales processes and spare the investors the burden and cost of multiple regulatory regimes.
IRDA’s primary objection to the committee’s report is that its implementation would affect financial inclusion adversely. IRDA fears that millions of rural agents, who rely on commissions from the sale of small-ticket insurance policies, stand to lose if there is a switch to a fee-based regime and would, therefore, be reluctant to sell insurance. Therefore, reach is bound to be affected and financial inclusion would suffer a big blow.
Excluding agent commissions from premia and adopting a fee-based model will work only when insurers match the commissions earned by agents with an equally lucrative incentive structure. But such a move will increase the expenses of the insurer and adversely affect their profitability. A well-defined process to affix responsibility for a bad financial outcome and the consequent loss suffered by the consumer; along with punitive action including fines will ensure that incentives alone are not the driving force in marketing. This will also ensure that agents adopt a more professional sales approach.