Will the new cap on expense limits of insurers benefit policy buyers?

The new rules, issued by the insurance regulator on 26 March, are effective this financial year. Hitherto, insurers paid 30-40% commission on each policy premium sold and also had a separate budget for their other expenses. Now, these companies will have a single budget that includes operating expenses as well as the commissions. Besides, there is an overall cap on such expenses.

The new EOM rule is aimed at helping policyholders get better pricing as the regulator has asked insurers to cut their expenses and pass on the benefit to customers. Industry experts, however, fear that this could lead to potential misselling of policies as insurers revise upwards their annual targets for agents.

As per the new rules, the EOM ceiling on pure risk plans (policies with premium payment terms of 10 years and above) will be 100% for the first-year premium and 25% of the renewal premium in subsequent years. As for other individual plans, the cap on first-year regular premium plans (except pension plans), will be 80%. The EOM ceiling will be 15% for deferred annuity and group term plans (see graphic).

Earlier, there was an individual commission cap on several policies. For instance, the maximum commission payable to an insurance agent or intermediary for the first-year premium was 40% for term plans (see graphic). It was 30% for all individual life plans except pure risk plans (for premium paying terms of 10 years and more) .

Why was EOM capped?

The probable reason for the cap is an increase in EOM costs claimed by insurers year-on-year. The life insurance industry reported a gross EOM of ₹1.07 trillion during 2021-22, which accounts for 15.5% of the total gross premium. Thus, insurers spent around 5.18% on commission payments and 10.31% on operating costs. According to the latest Irdai annual report, “The commission expenses ratio (commission expenses as a percentage of premium) decreased marginally to 5.18% in 2021-22 from 5.25% in 2020-21. However, the total commission increased by 8.77% (total premium growth of 10.16%) during 2021-22 (see graphic).

Besides, operating expenses of the life insurers increased by 17.93% to ₹71,435 crore in 2021-22. The operating expenses ratio (as a percentage of the gross premium underwritten) increased from 9.77% in 2020-21 to 10.31% in 2021-22 (see graphic). While Irdai has imposed a limit on EOM, it has offered ways to insurers to reduce their operating cost and transfer this benefit to buyers.

Regulator’s directive

“Every insurer shall have a well-documented policy approved by its board on an annual basis, which shall, at the minimum, specify: Measures to bring cost-effectiveness in the conduct of business and reduction of the expenses of management on an annual basis and manner of transfer of benefits, arising from reduction of expenses and/or from the directly sourced business to the policyholders by way of reduction in the premium," According to the Irdai notification dated 26 March.

This means life insurers will have to adjust their business models and strategies to comply with the new regulations. Insurers may need to invest in technology and automation to streamline their processes. They may also need to renegotiate their contract with service providers to reduce expenses.

While the regulator does not mandate insurers to sell direct policies, this can be one way to minimize commissions. This will help policy buyers like in the case of people who prefer to invest directly in a mutual fund schemes without the aid of any distributor or agent, which helps reduce costs and get a higher net asset value.

Direct plans

Will the new EOM mean that insurers will shift focus to direct insurance plans? This can help them avoid payment of commissions since subscribers can buy the policy from the inurers’ websites directly.

Yet, insurers claim this have have no impact on EOM. Naval Goel, founder and CEO of PolicyX.com, said, “The insurers already offer direct insurance plans on their websites. EOM costs do not necessarily come down by this because of the processing charges and other formalities involved in selling a plan. However, the automation of distribution and operations can help reduce the premium charges."

Today, term plans can typically cost 5-10% less if they are bought online. For instance, ICICI Pru iProtect Smart and HDFC Life Click 2 Protect Super policies come with a 5% discount if purchased online.

Many insurers prefer to keep mum on their plans for direct insurance policies. They claim that their business is driven mainly by sales of policies by agents and brokers.

Transparency issues

Both insurers and brokers were not forthcoming on the plans to impose a limit on the commission structure. “Now, commission distribution will be determined by EOM. So, insurers can pay more commission to agents who are doing brisk business and less to those who sell very few policies. . While this will increase competition among agents and intermediaries, the latter get an opportunity to miss-sell policies in their quest for higher commissions," said an insurance expert who did not want to be identified.

But the regulator won’t have any of this. In a clarification issued on 31 March, Irdai said that “Insurers shall ensure their commission structure is commensurate with the efforts required to acquire and sustain that type of business. This means intermediaries shall be compensated fairly for their work, regardless of their size or bargaining power."

The regulator wants fair and transparent competition among intermediaries, aligning incentives with customer needs and encouraging efficient and cost-effective distribution.

Commissions on term plans

Insurance experts say the sales of term plans is bound to increase exponentially once the EOM is implemented. Commissions paid to agents are based on the premium size: The higher the premium, the higher the commission. As of now, term plans draw lower commissions. So, how does the EOM promote its sales. Industry experts say that insurers have so far been promoting traditional insurance plans. They can now focus on expanding their other offerings by giving additional commissions to agents promoting term plans.

Abhishek Bondia, principal officer and managing director of SecureNow.in, said, “This will boost insurance penetration and be a positive move for the industry. Insurers would be able to incentivize agents for sales in priority segments such as individual protection plans (term plans), commercial insurance for small businesses, and tier-2 cities."

The persistency ratio

Some insurers expect improvement in persistency levels over time by leveraging agent commission payments. Despite giving higher commissions in the first few years, insurers can now evenly distribute the commission to agents so they don’t miss-sell policies.

The persistency ratio is the proportion of policyholders who continue to pay their renewal premium. It is a barometer for the quality of sales made by the insurer.

N. S. Kannan, managing director and CEO of ICICI Prudential Life Insurance, said, “The expenses of management have increased allowability in the policy’s later years while limiting expenses in the initial year. This will persuade insurers to improve long-term persistency, improving the customer proposition and the company’s profitability."

Mint take

While the new rule will give insurers more flexibility to manage their expenses and fairly distribute commissions to agents and intermediaries, it can help policy buyers only if insurers implement the EOM in the right spirit .

What remains to be seen now is the impact of the new rule on the insurance industry. For one, it could lead to greater competition and innovation in the sector.