How much commission should agents get? This is a debate which is stirring up much controversy both in the mutual fund and the insurance industry today. Both mutual fund and insurance products essentially compete for the wallet of the same Indian investor. One sells the prospects of market-linked returns while another offers protection with savings.
But it is when you look into their commission debate you wonder whether both products even operate in the same planet!
Capped at 40%
With the passage of the Insurance Laws Amendment Bill, there is much rejoicing in the insurance industry that the caps on agent commissions specified by the Insurance Act 1938, have been done away with. The removal of these caps, it is being said, will help the industry properly remunerate agents and prevent them from quitting insurance selling.
So what were the caps that the industry was concerned about, before this change? Well, under section 40A of the old Insurance Act, traditional insurance plans with regular premiums could charge upto 40 per cent of first year's premium, 7.5 per cent of the second and third year's premium and 5 per cent for every premium thereafter, if the insurance player was less than ten years old. For seasoned insurers who had completed ten years, the first year premium was capped at 35 per cent, with the remaining caps the same.
So, upto a third of the cheque the investor wrote out in the first year could go to the agent. And the industry (and its regulator) still felt that the commissions were too little!
Is 5% too much?
Cut to the mutual fund industry, where there's a raging controversy about whether upfront commissions paid to agents should be capped at 1 per cent. This debate has sprung up because some leading industry players, keen to make the most hay while the sun shines, have been paying as much as 5-6 per cent upfront to their agents to sell their close ended New Fund Offers (NFOs).
This has been a departure from the balanced commission model most MF players have followed in recent years with their open end funds. Usually funds have been paying 1 or 1.5 per cent upfront and 0.5-0.75 per cent as an annual trail fee to agents. The trail fee is calculated as a percentage of the assets of the fund and the agent could earn it as long as investors stayed invested in a scheme.
Now, the upfront commissions in the mutual fund industry, even in their current NFO avatar, are very different from those paid by insurers. While the 35-40 per cent commission in insurance from the first year premium comes out of the money the investor puts in, mutual funds are allowed to make no upfront payments from the investor's money, ever since entry loads were banned by SEBI way back in 2009. It is therefore, the AMC which foots the bill for these upfront incentives.
This is often reason for the mutual fund industry to pat itself on the back. CEOs of leading firms ask - "See, not only are our upfront commissions so small in relation to insurance products, we also pay them out of our own pocket. So why do you give us such a hard time about upfronts?"
Well, the answer is that while the insurance industry may still be stuck in Stone Age as far as commissions go, most other financial products have moved on.
After SEBI banned entry loads on MFs, the government's post office schemes too streamlined the commissions given to agents in 2011. For most post office products, the commissions today stand at 0.5 per cent upfront. For those trading in stock markets, brokerage rates have simply crashed, with discount brokers offering state-of the-art execution at a few paise per trade. Even commissions on risky corporate FDs which used to be at 3-4 per cent upfront have since declined to more moderate levels.
In fact, the only 'financial products' which continued to offer 30-40 per cent upfronts to agents until recently were ponzi schemes such as Saradha which needed highly "motivated" agents to lure in unwary investors.
Stick with it
There are two messages from this for the MF industry. One, the MF industry has reached where it is today (inflows have resumed and AUM has hit a new record recently) by pruning costs and turning progressively more investor-friendly over the last twenty years.
Not all retail investors may be convinced about investing in MFs today, but those who do invest come in because they believe in the return potential of the vehicle. They haven't been suckered into buying something they don't understand by a highly "motivated" agent.
Two, in a world where most intermediaries suffer from some kind of conflict of interest, the trail fee structure used by MFs has proved to be a great idea to align the advisor's interests with that of the investor. It is a model that other financial products will do well to emulate.
If the bulk of an agent's income comes from the performance of your portfolio (which it is what happens with a trail fee) why will he try to mis-sell unsuitable products or churn your portfolio every month? He would instead encourage you to pick the best performers and hold on to them, so that his trail fee can expand. In fact, the trail model is in some ways far fairer to the agent too. Through trail fees, the agent gets to share in the wealth created by his clients without having to just make do with one-off payments.
Therefore, whatever the insurance regulator may do today to agent commissions in the insurance sector after the new Insurance Bill (it is possible commissions may head even higher), it is best that the MF industry doesn't follow suit.
Over time, it is insurance players who need to recognise market realities and transition to more investor friendly commission structures. There is no need for the MF industry to regress into the Dark Ages.