Irdai proposes specific caps on insurance commission

Why in the News

The Insurance Regulatory and Development Authority of India (IRDAI) has proposed specific caps on insurance commissions, in place of the single overall expense ceiling that governs distribution cost today. A consultation paper also proposes significantly lower overall expense limits for insurers, with a glide path for bringing down commissions and management expenses. The proposal reverses the approach of the Insurance Regulatory and Development Authority of India (Payment of Commission) Regulations, 2023, which withdrew product specific commission caps and left commission to be paid under a board approved policy within an insurer’s overall expense ceiling. The contested point is whether distribution cost is better disciplined by one aggregate ceiling the insurer manages, or by product level caps the regulator sets.

What is the expense of management limit?

1. What the limit covers: Expenses of management are the commission and operating expenses an insurer charges against its business. The limit is expressed as a share of premium.
2. Why the ceiling exists: Every rupee of distribution and administration cost is a rupee not available for policyholder benefits, so a ceiling protects the return the buyer gets.
3. The 2023 shift: Product specific commission caps were withdrawn and each insurer was left to fix commission through a board approved policy, inside the aggregate ceiling.
4. What an aggregate ceiling cannot do: A single ceiling says nothing about how the expense is distributed across products and channels. An insurer can load cost onto one product and still stay within the limit.

What do the proposed commission caps do?

1. The basis of the cap: Caps are proposed by segment, line of business, distribution channel, product complexity, and the effort involved in selling and servicing the product.
2. Agents on shorter tenure individual plans: For individual non linked plans, participating or non participating, and unit linked plans with a policy term of up to five years, first year commission for an agent is capped at 6.25 per cent.
3. Other distribution entities: The same plans carry a 5 per cent cap on first year commission for other distribution entities, including corporate agents, brokers and composite brokers.
4. The channel split: The same product therefore carries a different permitted acquisition cost depending on who sells it.

What changes on the overall expense limits?

1. Lower ceilings: The paper proposes a significant reduction in the overall expense of management limits that insurers work within.
2. A phased reduction: The cut in commissions and management expenses is to come through a glide path rather than at once.
3. Why phasing matters: An immediate cut would strand distribution agreements and agent payouts already written on current terms.

Why is distribution cost a regulatory question at all?

1. The cost is recovered from premium: Commission and management expense come out of what the policyholder pays, so a higher distribution cost lowers the return on the policy.
2. Front loaded payouts reward the sale: A high first year commission pays for the act of selling rather than for servicing the policy over its term, which is the incentive structure behind mis selling and policy churning.
3. Lapses destroy both sides of the contract: A policy sold to earn a first year commission lapses more often, and a lapsed policy leaves the buyer without protection and the insurer without a book.
4. Trust decides market width: Insurance penetration in India remains low, so the terms on which a product is sold decide whether the market deepens or the buyer withdraws.

Challenges to capping insurance commissions

1. A cap moves the cost rather than removing it: Where the commission head is capped, the same payment can reappear as rewards, incentives, reimbursements or marketing support. Eg. Payments to a bank distributor can be routed under heads such as marketing or infrastructure support rather than as commission.
   The Fix: Bring every payment to a distributor, under whatever head, into a single reported remuneration figure disclosed product by product.
2. Differentiated caps steer sales toward the better paying product: A cap that varies by segment and complexity gives a distributor a reason to recommend the product that pays more rather than the one that fits. Eg. Two products sold to the same customer can carry different payouts under the proposed structure.
   The Fix: Require a suitability record for every sale, stating why the recommended product matches the buyer’s stated need.
3. Bank led distribution sells to a captive customer: A bank selling insurance to its own depositor faces little competitive check on what it recommends, whatever the commission rate is. Eg. Mis selling of unit linked and single premium policies at bank counters is a standing grievance before the insurance ombudsman.
   The Fix: Publish channel wise complaint and persistency data for every insurer, so the distribution channel carrying the problem is identifiable.
4. A percentage cap bites hardest where the ticket size is small: The agent servicing low premium rural policies earns least from a cap expressed in percentage terms, so the least profitable business is served last. Eg. The individual agent remains the primary life insurance channel outside metropolitan markets.
   The Fix: Allow a higher cap for policies below a stated premium threshold, so low value business remains viable to sell and service.

Conclusion

The regulator is moving back from an aggregate ceiling the insurer manages to caps it sets itself, because an aggregate limit never governed where the money went inside it. Whether the buyer is better off depends on which heads a payout can be shifted into once the commission head is capped. The proposal is at the consultation stage, so the next step is the comment period. The final regulations are where it will become clear how long insurers get to reach the lower limits, and whether the disclosure obligation on distributor payments is tightened alongside the caps.

Back2Basics: Insurance Regulatory and Development Authority of India

1. Governing Act: IRDAI is a statutory body established under the Insurance Regulatory and Development Authority Act, 1999.
2. Headquarters: It has been headquartered at Hyderabad since 2001.
3. Composition: It is headed by a chairperson, with whole time members and part time members appointed by the central government.
4. Mandate: It regulates the insurance and reinsurance business, licenses insurers and intermediaries, and protects the interests of policyholders.

Matching Previous Year Question

“[2013, GS2, 10 marks] The product diversification of financial institutions and insurance companies, resulting in overlapping of products and services strengthens the case for the merger of the two regulatory agencies, namely SEBI and IRDA. Justify.”