Published in Mint on 6 December 2015, Written by Kapil Mehta
Businesses deal with conflicts of interest routinely. Most such conflicts are harmless. The worst outcome of a pushy, incentive-driven salesperson is that like P.G. Wodehouse’s Bertie Wooster you, too, may end up with horrible purple socks never to be worn. In some cases, though, conflicts of interest are harmful. For example, if a hospital recommends unnecessary surgery to make money or a bank forces you to buy life insurance instead of getting a fixed deposit because insurance commissions are higher. The insurance industry has its fair share of such conflicts. Some of these dilemmas are well understood but a few are not. The conflicts have one thing in common—they weaken insurance delivery.
The most visible and discussed conflict is that commission to insurance agents skews their client recommendations. Because commission varies by product and is linked to premium, an agent often makes most money when she sells a high premium investment product instead of a more relevant and cost-effective term cover. This is why agents push traditional insurance where they earn over 25% commission even though the effective return on these products is less than fixed deposit rates. The simplistic solution, sometimes put forward, is to have buyers pay the fee to the agent rather than the insurer. That would be disastrous because the discussion on fees generally results in postponement of an insurance purchase, and there is no evidence that the outcomes will be better. With the exception of the UK, no big market has implemented this concept. A better way to address this conflict of interest is to structure commissions such that an agent is neutral to the product sold. She should earn as much selling term insurance as a unit-linked insurance plan (Ulip) or traditional insurance. Because premiums of pure risk insurances like term plans are so low, this may require commission rates on pure risk to be increased.
The incentives issue also creeps up in the role of the surveyor for general insurance claims. For many claims, a surveyor is required to make an independent loss assessment that forms the basis for claim payment. However, in practice, the surveyor is appointed and paid for by the insurer and is loyal to the insurer. Increasingly, insurers are doing away with using an independent surveyor and depend upon their own in-house assessments. That further reduces the independence of loss assessment.
A second conflict of interest is that the central government, which promotes the largest insurers in the country, also supervises the insurance regulator. Life Insurance Corp. of India (LIC), the largest life insurer with a market share of 70%, is fully government-owned. The four general insurers account for over 50% of general insurance sales. These are dominant market positions. The government’s control on the regulator exists because it is responsible for appointments and, according to law, has the last word on insurance regulation. A recent report in The Hindu Business Line indicated that the finance ministry has asked the Insurance Regulatory and Development Authority of India (Irdai) to reconsider its order to SBI Life Insurance Co. Ltd to pay Rs.84 crore to certain group insurance members. I’m not commenting on the merits of the case, but if the news item is true, there is an obvious conflict of interest. Many regulatory changes that are needed will impact state-run insurers most. For example, making returns on traditional insurance transparent and comparable to other financial products impacts the dominant state-run insurer first. The regulator should be unfettered as it regulates and this can best be done if the government takes a backseat and makes the regulator fully autonomous.
A third conflict is between claimants and insurers and has to do with the manner in which claims are structured. The claimant and insurer relationship is adversarial. The insured has little incentive to keep claim costs low. Insurers always suspect claimants of inflating damages. In motor insurance I’ve seen a few cases where a vehicle had a small dent but the garage wrecked the car so that the entire cost could be picked by insurance. What should have cost Rs.4,000 to repair cost the insurer Rs.40,000. The solution is to market products with high co-pay or deductibles. This means that a claimant has to bear a part of the claim’s cost and has less incentive to inflate costs. There is a resistance to co-pay and deductibles in the market. In the Mint Mediclaim Ratings (www.livemint.com/mintmediratings) that we do, health insurance products without co-pay are preferred. It’s now time to change that outlook and encourage more risk sharing.
Another conflict is the manner in which the industry self-regulates. There are two industry bodies, the Life Insurance Council and the General Insurance Council. These are meant to be a platform for insurers to collaborate. However, by statute, the insurance regulator is also an active part of these councils. So, the practical outcome of these councils is communication between the industry and regulator and there is no formal structure for the industry to self-regulate. The industry should create such structures as these have many advantages—consumer issues can be speedily resolved, market practices more openly discussed and regulatory intervention limited to matters of policy.
Finally, the way customer complaints are handled has significant conflict of interest. If you are unhappy with an insurer’s decision, you need to appeal to the insurer itself. It is rare for an insurer to overturn a decision they have already taken. A complainant could reach out to Irdai but the regulator will guide her back to the insurer for adjudication. Approaching genuinely independent bodies such as the ombudsmen or courts is so difficult and time consuming that most people will not make the effort. The solution is in insurers setting up their own independent adjudicators, or Irdai looking into the merits of the complaints, or the independent Financial Redress Committee getting set up fast.
Conflicts of interest will always exist. What’s important, though, is to list these out so everybody understands them and takes conscious decisions to ensure insurance buyers’ interests are foremost.