Do insurance agents deserve those commissions?

“The agent will go where the money is.”

The committee on investor awareness and protection, headed by D Swarup, chairman of the Pension Fund and Regulatory Development Authority (PFRDA), has put out some groundbreaking proposals as far as insurance commissions are concerned.

The committee has suggested that upfront commissions embedded in the premium paid be “immediately” cut to no more than 15 per cent of the premium. This should fall to 7 per cent in 2010 and become nil by April 2011, states the committee report.

The Insurance Act, 1938, 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 commission paid is limited to 2 per cent in case of single premium policies. In case of pension plans, the commission is limited to 7.5 per cent of the first year’s premium and 2 per cent there on.

Of course, this has led to a situation wherein the commission paid to insurance agents as a percentage of premium paid is extremely high. As the report points out, for the year from April 1, 2007 to March 31, 2008, the insurance companies paid out a whopping Rs14,704crore as commission.

This, as a percentage of premium collected, works out to 16.25 per cent. This means that for every Rs100 of premium paid by the average policyholder, Rs16.25 goes to the insurance agent as commission. Now you, dear reader, decide if that is high or not.
Such a high rate of commission has led to a situation wherein the average sum assured of the insured Indian is around Rs90,000, which is very low. What this means is, insurance agents are really not interested in selling pure insurance policies (or term insurance, as they are known) simply because the commission earned from selling such policies is very low. They are more interested in selling Unit-linked insurance plans (Ulips), where they make more money.

Also, with insurance commissions being lopsided — they are the highest in the first two years of the policy — agents have an incentive in letting those policies lapse and getting policyholders to subscribe to new policies instead, so that they can continue earning high commissions.

As the report points out: “Data for 2007-08 shows that lapsation rates range between 4 per cent and a shocking 80 per cent. The lapsation rate for half of the 16 companies was more than 20 per cent. Only three insurers had a rate of less than 10 per cent.”

Ulips have a cover continuance option, which the individual can opt for at the time of taking the policy. This option ensures that if the policyholder is unable to pay premiums after the first three years, the policy continues. This is essentially an option to help those who cannot continue paying premiums due to some reason. Agents, however, have turned this into a selling point, giving policyholders the impression that they have an option to stop paying premiums after three years. This is done to later sell a new policy to the existing policyholder, and earn higher commission. This, of course, leads to lapsation of policies. 
The insurance industry is up in arms against this proposal. J Hari Narayan, chairman of the Insurance Regulatory & Development Authority (Irda) recently told a television channel, “It is a very premature step, given the width and the depth and the different types of the Indian market and the need to nurture much closer relationship between the policyholder and the agent. Therefore, I think it (the commission) will have to be embedded in the premium in times to come.”

This means the regulator wants the agents’ commissions to continue being a part of the premium paid. This way of operating has changed in case of mutual funds.
Mutual funds are now not allowed to charge investors any entry load, which was earlier used to pay commission to the agents. The commission is to be directly decided between the agent and the investor. This is a very investor-friendly move, given that the person buying the mutual fund can decide on the amount to be paid as commission given the level of service he receives. But with the insurance regulator not batting for the policyholders, the insurance agents can continue to earn high commissions irrespective of the level of service they give to the policyholder.

One bogey offered by insurance agents is that the average income of an agent is too low. In a statement released sometime back, the Life Insurance Agents Federation of India (LIAFI) said, “It is a matter of pity that the average income of life insurance agents today is around Rs57,000, which is much below the salary of a Class IV employee.”

Now, even after earning Rs16.25 out of every Rs100 paid as premium, if insurance agents earn only Rs57,000 annually, the conclusion is this: Insurance agents and companies haven’t been able to expand the insurance market sufficiently over the years.
Given that the market is not big enough to support so many insurance agents, if they are unhappy earning lower than Class IV employees, why continue being an insurance agent? The bigger question, of course, is why should policyholders pay for the overall inefficiency of the insurance agents as well as companies?

Also, insurance companies largely sell Ulips, which are quasi-mutual funds with some amount of insurance built into the plan. Keeping this in mind, Ulips are directly comparable to mutual funds. And what do fund house pay their agents? A commission of 2-3 per cent on investment in equity funds and less than 1 per cent in case of debt funds, until recently. With the ban on entry load, that figure has dropped further.

To this charge, the insurance agents say that comparing the commission of insurance agents and mutual fund agents is not proper because insurance is long-term and mutual funds are short-term. This is nonsense. Mutual funds can be as long-term as the investor wants them to be, and come with the flexibility of the investor opting out of one scheme and moving on to another, which is very difficult in case of Ulips. Also, the expense structure of Ulips offered by different insurance companies is different. This makes it impossible for individuals to figure out which are the best-performing Ulips, unlike in the case of mutual funds.

These are the issues that insurers and the regulator should address for the benefit of the policyholders, instead of trying to bat for the insurance agents.