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Published in Mint on 17 February, 2016, Written by Kapil Mehta
Earlier this year, the Insurance Regulatory and Development Authority of India (Irdai) issued an exposure draft on compensation for insurance intermediaries such as agents and brokers. The number of industry stakeholders who have responded to the draft is among the highest ever. Why? Because compensation affects everyone deeply—insurers, intermediaries and buyers.
The exposure draft is wide ranging but my focus is on three aspects: the proposed increase in maximum first-year compensation in individual life insurance, up to 49% of premium in certain cases; the proposed reduction in compensation for group health insurance from 17.5% to 1% of premium; and the short 75-day timeline to implement changes. The final regulations will factor in the considerable feedback, particularly in group health insurance, however, the final outcome remains to be seen.
Increase in first-year compensation in individual life insurance: Main issue in India’s life insurance, a $48-billion market, is that buyers are discarding their insurance in droves due to mis-selling, even if it means a substantial financial loss. According to Irdai’s statistics handbook 2013-14, 13 out of 21 insurers that have been in business for over five years reported a persistency of less than 30% after five years. Two of three customers surrender insurances well before the full term. I am inundated with requests to review insurance portfolios. I usually recommend surrender even if at a loss or retain just because surrendering is prohibitively expensive.
In this context, the priority is to modify insurance intermediaries’ compensation so that they take a long-term view of their customers’ requirements. The current front-loaded commission structure—where payment in the first year is four times compensation in later years—has to be made uniform. Australia provides a refreshing alternative. It is transitioning from a model similar to India to one of uniform annual commissions. In their scheme, an intermediary makes money only if customers renew insurance each year. Increasing first-year payments as proposed in the exposure draft will worsen an intermediary’s short-term orientation.
Reduction in compensation of group health insurance:Health insurance in India is a success story, nurtured by market demand and good regulations. This $3-billion business has been growing rapidly. It now offers larger cashless networks, fewer exclusions, several specialised products and lifelong renewability. The compensation reduction proposed, if implemented, will curtail distribution with no benefit to policyholders.
Excluding government business, half of health insurance is individual cover and the other half group insurance bought by companies. Anyone who has built a business-to-business focused distribution knows that companies are price sensitive and minutely focused on value. They will negotiate and buy insurance only if completely convinced. Increasingly, they are opting to work with insurance brokers who account for 43% of corporate sales.
The table (Unbalanced growth) tells an interesting story. The price per life in group health insurance is near half of individual insurance and has been decreasing over the years; individual health insurance prices, on the contrary, have increased 38% each year. Given that brokers are actively involved in group insurance, the unstated assumption in the exposure draft is that brokers are responsible for excessive competition and curtailing them through lower commissions would make prices rise and insurers profitable.
That is a fallacy. Prices are low because insurers choose to cut prices. They have the option of not issuing insurance if prices are unsustainable. A look at the incurred claims ratios confirms this hypothesis. The ratio must be less than 100 if an insurer is to make money. In health insurance, there is a wide variation among insurers, which suggests that poor underwriting by specific insurers, rather than intermediary behaviour, is driving low prices.
If compensation in group health insurance were reduced, smaller companies would be the worst off because intermediaries will find them unviable and these companies would not have the wherewithal to negotiate with insurers. This goes against the grain of the existing policy to develop the health insurance market. That’s why compensation in the commercial business should remain untouched. There is no need to fix something that is intact.
Short implementation timelines: The draft circular was issued on 13 January, comments invited by 27 January, and implementation scheduled for 1 April. In less than three months there may be a significant change in industry structure. Contrast this with the compensation change in retail life insurance in Australia. An initial report was prepared in October 2014 after several years of discussion, an interim report prepared in December 2014, a final report prepared in March 2015 and then a three-year transition plan. This was a first rate effort led by John Trowbridge, a highly respected independent-minded insurance professional. Regulatory certainty is important for companies to flourish. Changes that make businesses unviable overnight are disconcerting.
The regulator is engaging with several stakeholders to decide the way forward. My three suggestions to modify the draft guidelines are: align compensation in individual life insurance to address low persistency; in group health insurance, don’t fix what’s intact; and give much more time to implement significant changes.