India Proposes Scrapping Commission Loads on Insurance Products

An Indian government panel is proposing eliminating commission loads on all insurance products by 2011 in a bid to lift the standards of insurance sales by shifting the focus from price to quality services.

The Pension Fund Regulatory and Development Authority suggests consumers should not bear incentive costs for insurance agents because the system encourages agents to promote the interests of the life insurance industry rather than insurance buyer.

"India is ready for a statutory body to bring all financial advisers under a common minimum standard of regulation," said the regulator in a report. A Financial Well-Being Board of India is recommended to establish common minimum standards for financial advisers and to increase financial literacy.</p>

This new policy "would bring much needed order in the hitherto Wild West of insurance product sales in the country, besides education and empowering end consumers," said Ravi Nawal, an analyst with Celent India, an international management and consultancy firm.

"The market will see a resurgence of core insurance product sales, away from linked products. Sales arms are likely to move from a push to pull approach," said Nawal. Consumers will be benefited most with increased transparency leading to enhanced accountability."

"The commission and reward system today makes the adviser the agent of the financial products manufacturers, but this compensation comes from the customer," said the regulator. "This must change for the adviser to look after the consumer of financial products. The consumer, too, will have to learn to pay directly."

In India, the overall industry's commission expense ratio, as a percentage of total premium, is 16.25%. Commissions vary by product type and the maximum cap set by Insurance Regulatory and Development Authority is 40% of premium for a first-year policy, 7.5% for second and third years and 5% for following years.

Total commissions amounted 147 billion rupees (US$3 billion) for the financial year between 2007 and 2008. "The reasons for sharp selling is obvious," said the pension authority.

India has high lapse rates for insurance policies, ranging between 4% to 80%. The lapse rates for half of the 16 insurers was more than 20%. About 8.6 million life insurance policies lapsed in the financial year between 2006 and 2007, according to IRDA.

The distributor has "a huge role" to play in high lapse rates, which are mostly caused by mis-selling. "The chief cause of mis-selling is the incentive structure that induces agents to look after their own interest rather than that of the customer," said the pension authority.

Pension products and mutual funds are already "no-load" on commissions. Insurance policies need to remove the bias toward selling the policy with highest commission, said the pension authority. There are almost 3 million agents serving about 188 customers in India.

The authority suggested the up-front commissions embedded in the premium be cut down to no more than 15% immediately and then 7% in 2010 and none in April 2011.

The new policy will have "a dramatic impact" on the sales and distribution of insurance products for both life and nonlife sectors but the impact will be stronger on the life segment. "Advisory-based models of selling would gain over the current agent-based model focused on pushing products," said Nawal.

Eventually, Nawal said insurance industry "would evolve to a fee-based model over a commission-based model, resulting in third-party open architecture distributors gaining more traction over the company-owned agency force." Insurers will also have better control on sales costs in terms agent and brokerage commissions.

In the short term, Nawal noted insurers "are likely to witness increasing churns as renewals would get impacted" as policyholders find more ease to move by reducing front-loading of costs and consequently reducing exit barriers.

As a result, it will bring more focus back on customer service. There is also a "likelihood of increased litigation costs around contested advice quality," noted Nawal.

The biggest gainers from this new proposal would be insurance brokerages adopting an advisor-centric open architecture model. "They would gain only if they are able to play the volumes game effectively in a zero commission environment," said Nawal.

Bancassurance would continue to gain owing to the reach and sophisticated targets. However, agency sales "would likely face the heat," said Nawal.

Over time, Nawal said this policy will ensure that all insurance companies will have a "level playing field" with insurance brokerages, the merit being the products, not the incentives they offer. This will bring to a re-thinking on products, sales, distribution, incentive and payment models.

The proposal to raise professional standards of insurance agents is to ensure quality financial advice for consumers. "Compliance and governance on sales and distribution standards would add to overall advice quality at the same time increasing spends on these counts for the industry," said Nawal.

(By Iris Lai, Hong Kong bureau manager: [email protected])