How to actually reform insurance | Value Research Proposed reduction in insurance commissions just draws attention to how absurdly high they are to begin with
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How to actually reform insurance

Proposed reduction in insurance commissions just draws attention to how absurdly high they are to begin with

A few days ago, IRDAI, India's insurance regulator, published a document that was an 'exposure draft' of new rules on expenses and commission that it is proposing. This draft proposed a 20 per cent limit on commissions for general insurance companies, down from the 35 per cent now. The regulator also proposed life insurers whose expenses were under 70 of the maximum permissible limit to set their own commission rates. For those who are above this threshold, the highest commission allowed is proposed to be reduced sharply from the current 40 per cent peak.

There's also a proposal for commissions to be paid in the 5th, 10th, and 15th years of the policy tenure. This could, in theory, increase the incentive for agents to recommend and sell policies that have a chance of being sustained by customers for a longer period of time. Whether it will actually do so, only time will tell. Of course, these are draft proposals right now and feedback can be given till September 14. What happens after that, whether these lower rates of commission are actually implemented, only time will tell.

However, one thing is certain. Anyone who is familiar with the scale of commissions or intermediary fees of any kind in any other financial service is always stunned by the scale of commissions in insurance. In consumer financial services, be it mutual funds or equity or anything else, the maximum permissible commissions are always 1/10th or 1/20th or some such tiny fraction of what they are in insurance. To someone used to paying from nothing to perhaps 2 per cent in equity trading and mutual fund investing, the idea that 40 per cent is permissible and now a reduction to 20 per cent is being presented as an achievement is utterly flabbergasting.

Not just that, if you read the various news articles where industry executives are being quoted, you will find that they are uniformly of the opinion that this reduction will be detrimental to the interest of the policyholders. With a (presumably) straight face, they are all saying that a cost reduction will be harmful for customers.

In fact, the fundamental problem with insurance is that customers do not know where their money is going when they pay a premium. The premium goes into a black box whose inside is a secret from you. I propose a simple reform that makes the customer aware of where the money is going. When you buy an insurance policy, you pay a certain amount and you get some combination of life cover and future investment value out of it. Imagine if each part of the money that you pay was billed separately and was paid separately according to what it was used for. Broadly, the money that you pay for a policy goes into four buckets. Some is used to fund a life cover for you. Some is an investment, which you will eventually get back at a (hopefully) enhanced value. Some is paid to an agent as a commission and some is kept by the insurance company for its own expenses and profits.

Suppose you were billed separately for each. You could pay as one transaction for convenience but you get a clear and simple statement showing how much of your money went in each of these heads. My guess is that you would become a much smarter shopper of insurance products and insurance companies and agents would have a much harder time selling to you. When you write a cheque for Rs 1 lakh and in front of you there's a statement showing that Rs 18,000 of it would go straight to the agent and Rs 12,700 to the insurer's expenses and profits, then you would start thinking hard, very hard. If every insurance customer in the country had this information, then real insurance reforms would not only happen easily, they would be hard to avoid.

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