I have never really admired IRDA as a regulator. They are always behind the curve. The insurers take very convenient view of the regulations much to the harassment of policyholders. Mis-selling is rampant. Still, IRDA is silent. It may be due to incompetence or indifference of those sitting at the helm or simply the result of powerful lobbying. Not my job to comment.
To the credit of IRDA, it has done some good work too. Revised ULIP regulations are a case in point. Moreover, the nature of insurance industry is such that your (or your family’s) gain is insurer’s loss and vice versa.
For instance, in case of term plans, you pay the premium and insurance company happily accepts it. In case of policy holder demise, the insurance company has to shell out a big sum (in comparison to premium received). The insurance company will leave no stone unturned to figure out a way to reject the claim. You are likely to have conflicts in such arrangements. And ultimately, the blame will be shifted to the insurance company and the regulator.
Contrast this with Mutual Fund industry. Distributors and AMCs make money when the investor makes money. Very little potential for conflict. Interests are likely to be perfectly aligned. There will be distortions though. By the way, this is not a post comparing MFs and insurance plans. Both MFs and insurance play an important plan in financial planning. My issue has been with insurance and investment products such as traditional plans and ULIPS.
Policy holder or the Agent/Intermediary?
There are two broad ways to get customers to purchase insurance.
- Make good products so that customers are themselves attracted.
- Strengthen the distribution chain. Incentive the distribution chain so that they are willing to reach out to potential customers and explain benefits.
In reality, it requires a mix of both the approaches. You need a good product that creates value in the long term. Over and above, you need to dedicated quality intermediaries to take the product to the public.
I have always felt IRDA is too keen on the incentivizing the value chain. Policyholder interest takes a backseat. This, in my opinion, is not the right approach.
Recently, IRDA came out with Payment of Commission or Remuneration or Reward to Insurance Agents and Intermediaries Regulations, 2016. The Regulations reiterated the guidelines for commissions paid to insurance agents for various types of policies. In this post, I will focus on guidelines for life insurance and health insurance plans.
What are the Commissions like?
Points to Note
- Individual Pure Risk refers to Term plans. Products except pure risk represent traditional life insurance plans and ULIPs.
- Do note this is the maximum that the insurance company can pay an intermediary. Actual commission can be much less depending upon the agreement and the intermediary clout.
- In some cases, the agents may share a portion of commission with policy holder. However, do note this practice is illegal.
- I have seen many from MF community comparing low commissions (~)1% in MF industry with high commissions (up to 35%) in insurance industry. Not the correct comparison. Do note insurance commission is typically on annual premium while MF commission is on the assets under management. So, you can expect MF commission to be low in the beginning but can expect to outgrow insurance commission when the MF assets grow.
Insurance Agents and Intermediaries do not earn just by way of commissions.
There is an additional concept of “Rewards” that is paid over and above the commission received for insurance sales. Rewards refers to incentives in the form of gratuity, term insurance cover, group insurance covers (for employees of agent/intermediary), telephone charges, office allowance, sales promotion gifts, competition prizes and such other items.
Reward for life insurance policies is capped at 20% of the first year premium. In case of Health Insurance policies, Rewards is capped at 30% of the commission.
Can you believe this?
As if 40% of the first year premium was not enough, there is provision for an additional 8% (20% of 40%) commission (albeit in a different name).
How should you interpret these numbers?
To be honest, I have nothing against insurance agents. They need to be compensated well for the efforts they put in to sell a policy. And a good agent can add a lot of value to your insurance portfolio.
Moreover, the agents can only sell what insurance companies offer them and what customers want to purchase. For instance, many do not want to purchase a term plan just because they do not get anything back. Such people have to be sold insurance-cum-investment products.
In any case, it is not right for me to comment upon the quantum of commission.
However, heavy upfront incentives can bring in conflict of interest i.e. the intermediary may be more willing to sell a policy that offers them greater incentives rather than the one that suits policyholder requirements better. In my opinion, higher upfront commission is the reason for such rampant mis-selling in the insurance sector.
If you are purchasing a traditional plan with an annual premium of Rs 1 lac (for 12 years), your agent may make up to Rs 42,000 on that sale in the first year and Rs 7,500 in the subsequent years. No wonder, the insurance agents sell these policies so hard. One of the reasons returns in traditional plans are so low.
As I understand, there is no claw back of premium if you surrender the policy next year or do not pay any further premiums. So, even if you stop paying the premium, the agent has already received first year commission of Rs 42,000.
The agent has no liability. Sale done, commission pocketed. You can very well go to hell.
Just like I advocate Direct plans of MF Schemes for Do-it-yourself schemes, you can also save on aforesaid commissions by going direct i.e. purchasing directly from the insurer or the insurer website.
The Regulations clearly mention “Where policies are procured directly by an insurer, no commission or remuneration shall be payable either to insurance agents or to the insurance intermediaries.”
How do you go direct?
You do not need to learn rocket science to purchase a term life insurance plan. So, pick up any. Do a bit of reading to figure out which riders to buy. Subsequently, you can purchase online from insurer website. And that’s where your life insurance purchase should end.
Avoid traditional life insurance plan. Even though the new age Unit Linked Insurance Plans (ULIPs) are a big improvement over their avatar of the last decade, ULIPs lack flexibility and portability. Hence, you can do without ULIPs too.
With health insurance, you may need some assistance (not necessary though). You can approach a good agent or advisor for assistance. In any case, commission is not so much of a problem with health insurance.
But yes, no matter how you purchase, fill up the proposal form yourself and make all medical disclosures.
Disclosure: I am a SEBI Registered Investment Adviser. I advise my clients to invest in mutual funds. Hence, I may have vested interest in showing insurance agents and investment and insurance combo products in poor light. My opinion may be biased.