Published in Mint on Dec 16 2014
Last week, a select committee of the Rajya Sabha submitted its report on the Insurance Laws (Amendment) Bill, 2008, and the Cabinet approved it, incorporating the amendments suggested by the committee, for presenting the Bill in Rajya Sabha. It’s expected that the Bill will go through during the Parliament’s winter session that ends on 23 December.
One of the most keenly tracked propositions of the Bill is to increase in the foreign direct investment (FDI) to 49% from the current 26% and make the 49% foreign equity cap a composite one. This means that the composite cap of 49% should be inclusive of all forms of FDI and foreign portfolio investments. “Apart from pumping in capital that may be to the tune of Rs.50,000 crore over the next five-year period, it is the practical involvement of the foreign partner in terms of technological advances and underwriting competencies that will benefit our market. We should witness a new regime of awareness and need-based insurance plans coming in the market,” said Atrey Bhardwaj, head, insurance, Probus Insurance Broker Ltd.
But there is more to the Bill than just the hike in foreign capital; it will also pave the way for some important reforms. “The bigger theme running is to empower the regulator and allow it to take ongoing decisions within a framework. So, while there is a framework to ensure that expenses of an insurance company are controlled, mechanics like regulating it through commissions is handed over to the regulator,” said Deepak Mittal, managing director and chief executive officer, Edelweiss Tokio Life Insurance Co. Ltd. This means that while the overall expense of the insurers will stay within limits prescribed by the Insurance Act 1938, the sub-limits, such as commissions, can be decided by Insurance Regulatory and Development Authority (Irda).
Section 17D of the Insurance Rules, 1939, describes the caps on expenses that life insurance companies may incur from the premium income and for a particular class of insurance product, whereas section 40B of the Insurance Act, 1938, restricts the expenses of insurers according to the rules specified in 17D.
These expenses include all commissions and other operational and administrative expenses. The limits depend upon the age of the insurance company, and its business in force calculated in sum assured and the term of the products sold. For instance, for insurers that have completed 10 years of operations with business in force of at least Rs.10 crore, for a regular life insurance policy with a premium paying term of more than 12 years, the insurer can deduct up to 90% of premium in expenses in the first year and up to 15% of the renewal premium.
Within this overall limit is the sub-limit on commission prescribed under section 40A of the Insurance Act. Currently, this commission structure is front-loaded, which means that for an insurance company that is less than 10 years old, the first-year commission is capped at 40% of the premium whereas in the second and the third year, the commission drops to 7.5% of the premium, and to 5% for the rest of the term. If the insurer is more than 10 years old, the first-year commission is capped at 35%.
Staying within the overall caps, Irda, in its product regulations of 2013, pegged the quantum of the first-year commission to the premium payment term: longer the policy, more the commission. The second- and the third-year commissions, however, remained intact.
If the Bill goes through, Irda will have the freedom to institute fresh incentives. “Persistency is a big focus area for the industry, and sometimes the current commission regulations come in the way of solutions like a flat commission structure. The amendment to give freedom to Irda to decide on commissions can allow this flexibility,” said Mittal.
Increase in penalties
The other big takeaway is the increase in penalties. The Bill holds the insurer responsible for a defrauding agent and makes it liable to a penalty of up to Rs.1 crore. The industry lobby, however, protested the penalty. Representatives from the Life Insurance Council, an industry body, for instance, stated that it would be very difficult for the insurance companies to manage the acts of agents as the number of agents is large and they are spread all over the country.
But the select committee report maintains that the insurers cannot absolve themselves from the acts of omission and commission of the agents. It, therefore, recommends that a middle path could be taken by Irda in exercising provisions related to the quantum of penalty, while giving due thought to extenuating circumstances.
Further, the insurance Bill had also sought to increase the overall quantum of penalty from the current Rs.5 lakh per incident of violation to Rs.1 lakh per day per incident, going up to a maximum of Rs.1 crore per incident whichever is less. The report has noted protests from the industry on the penalty being too steep.
“We are moving away from a time when there was lesser understanding of certain aspects. In fact, the world is moving to a system of financial penalties and a mechanism where you are given an opportunity to appeal against regulatory orders. That is a much better way to regulate,” said Mittal.
Even as the report has not reduced the quantum of penalty, the committee has suggested that adequate safeguards be institutionalized by Irda for fixing penalties so that there is minimum scope for subjective interpretation, and they do not deter well-meaning companies from entering the insurance sector. “The industry needs a stronger penalties regime. Financial penalties are an effective way to regulate and enforce the rules, which is something that is being realized even in other markets. The quantum of penalties is not out of sync, as it is the Bill that has prescribed the maximum cap. The penalties proposed are reasonable when compared with financial penalties globally,” said Deepak Haria, senior director, Deloitte India.
The report also seems to have accepted the amendment that a life insurance company will not deny a claim after three years. Currently, an insurer has a window of two years after a policy is bought to reject a claim on grounds of any mis-statement or fraud. After two years, the insurer can still reject a claim on grounds of fraud such as intentional suppression of material information. The Bill, however, gives insurers three years to establish this, after which it will not be able to reject a claim on any grounds.
“This is very good for customers as they will not have to worry about their claims getting rejected. It will also force insurers to exercise due diligence and strengthen the underwriting process. This won’t encourage fraud because when a policy is bought with fraud in mind, it’s mostly executed soon after; not three years later,” said Kapil Mehta, managing director, SecureNow Insurance Broker Pvt. Ltd. But more clarity is needed.
“The recommendations say that the onus to disprove in case of fraud lies on the beneficiary where the policyholder is not alive. This means the insurers could still get the right to repudiate on grounds of fraud. Hence, we are awaiting further clarity,” said an executive from a private insurance company who did not want to be named.
Multiple-corporate agency channel
The Rajya Sabha report has brought the discussion on open architecture in distribution back on the table. The report said that recommendations were made to the committee that multiple-corporate agency be allowed to operate simultaneously for at least 10 insurers as opposed to only one insurer currently. The committee has advised Irda to examine the concept of ‘multiple-corporate agency’ and frame appropriate guidelines in consultation with stakeholders.
In 2012, quashing any hopes of an open architecture, the then finance minister had asked the banks to become insurance brokers if they were interested in selling policies of more than one insurer. A broker represents the interest of the policyholder whereas an agent represents the interest of the insurer. Further, a broker can be taken to court by the policyholder. Banks as brokers is still work in progress as a committee is looking into the details.
“A broker licence puts the onus on the broker to diversify sales across insurers, which may not be possible under the multiple-corporate agency route. Especially in case of corporate agents that have strategic or ownership tie-ups with the insurer. These may opt to become multi-corporate agencies but may not meaningfully sell policies of other insurers. For a true open architecture model to emerge, the way of selling will need to move to research-based advice,” added Mittal.
But this may not be top priority for Irda. “The regulator has been trying to bring in more accountability; pushing banks to become brokers is a step in that direction. A mutliple-corporate agency model, hence, will create confusion as it could endanger accountability. Perhaps instead of working on multi-corporate agency model, we should encourage more entities to become brokers,” added Mehta.
The passage of Insurance Laws (Amendment) Bill, 2008, should bring the next wave of big bang reforms in the insurance industry.
Published in Mint on Dec 16 2014
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