Demystifying Regulatory Changes in Insurance Commissions
Shrirang V Samant 08 April 2023
Where there is insurance, can commission be far behind? Nothing wrong with it, since commission is essentially the distribution cost of the business. Just like any other product, insurance relies a great deal on distribution efficiency and the front end of insurance distribution—be it an agent or a broker, works on commissions. Despite the advent of e-commerce and direct-to-consumer (D2C) nature of distribution, a substantial part of the insurance business still relies on intermediaries who work on commissions. This is a market reality all over the world and where a market reality collides with well-intentioned regulations, a lot of distortions naturally creep in.
In this context, the insurance regulator’s recent announcement removing the cap on commission payments goes a long way towards reconciling the market realities with the noble intent of the market regulator. It is important, however, to see the timing of the announcement. A recent headline in The Economic Times, Mumbai “Tax Probe Against Insurers…” would go a long way in demystifying the regulatory initiative, which, incidentally, is very welcome. The issue is not the payment of commission, but the way it was being routed to the recipients. 
An investigation into the routing of commission payments has been underway by the tax authorities for a while now. The newspaper report says that the income-tax (I-T) and goods and services tax (GST) authorities are investigating 30-odd insurance companies, both life and non-life, over transactions worth more than Rs60,000 crore for alleged tax evasion, with GST evasion suspected to be upward of Rs5,500 crore.
How has this alleged evasion come about? The genesis lies in the regulatory caps on payment of commission—up until now, the commission caps for various classes of insurance products were laid down by the regulator. The fact was that these caps served as the floor for commission payments rather than the ceiling which was the intention.
Distributors of insurance products, be they brokers or agents, used their market access to demand ever higher commissions from insurance companies. In their initial frenzy to acquire and grow market share, insurance companies had to give in to these demands. 
As the companies could not officially show the actual amount of payment to the distributor as commission, various stratagems were used such as “….shell companies to pay high commissions to agents and allegedly accounting for these payments as marketing or advertising expense to reduce the tax outgo” (as per the news item). 
It is possible that the idea was not to cheat the exchequer but to avoid being penalised for a breach of the regulatory cap on commission payments. The whole exercise became problematic with the introduction of GST and the inability of the parties involved to claim input credit for GST. In the words of a cynic, it is the GST challenge that has forced this correction, not any epiphany on the part of the industry participants.
Let us now examine the consequences. One good outcome is that the industry’s accounts will be more transparent and the relatively honest insurers and intermediaries will not be at a disadvantage vis a vis the more imaginative and adventurous players inasmuch as this makes for a much more level playing field. 
In this context, the changed regulatory landscape needs to be taken into account. Instead of a cap on commissions for different types of policies, the regulator has said that general insurance companies can utilise up to 30% of gross written premium towards management expenses. Commissions obviously form a part of overall management expenses. For standa-lone health insurance companies, this cap can go up to 35% and the regulator has the discretion to allow higher management expenses for new entrants into the business. 
It is interesting to note that caps on management expenses (as a percentage of the premium) have been in existence for as long as one can remember and commissions, no matter how they were routed, obviously formed a part of the overall management expenses. 
Given this background, one wonders whether the regulators have the will and the capacity to monitor and enforce the cap! 
In other words, while the taxation-related challenges may go away, powerful distributors will continue to arm-twist insurers for higher payout. And the biggest participants in this game are banks who are more keen on pushing insurance policies to their account-holders than servicing the customer’s banking needs, as any hapless account-holder will testify. 
If the regulators enforce the expense caps seriously, insurers will be forced to cut other management expenses, which, in any case, is a focus area for any business whatsoever. Realistically, there does not seem to be much more scope for a noticeable reduction in overall expense levels. 
One likely casualty of this rule will be the public sector insurance companies. Being in the public sector, these companies carry a number of ‘welfare and social justice costs’ which cannot be pruned easily. Being owned by the government, they are regarded as ‘State’ by the court with the attendant obligation to follow the policies and procedures that apply to various government departments. It will be interesting to see the extent of regulatory forbearance in the matter of management expense limits for public sector insurance companies.
The long and short of it is that the removal of caps on insurance commissions will not necessarily lead to a rise in commissions, as these are driven by the need and greed of the participants. The one good thing to come out of this exercise is that the industry will be more compliant, leading to greater transparency. The customer will hopefully know how much of his premium goes towards commission payment and how much towards the expenses of running the business. 
As the commission comes out of the premium paid by the policyholder, it stands to reason that the commission should be disclosed on the face of the policy. This is already a practice in the mutual fund’s industry, where the information regarding distributors’ commissions is publicly available. 
Overall, although this is merely an acknowledgement of the reality, it is better late than never!
(Shrirang Samant has worked in senior leadership roles in the general insurance industry, both in public and private sectors, in India and abroad. He has been privy to the transition of this industry from public to private sector in the country and was the founding CEO of a multinational insurance joint venture- JV in India.)
Kamal Garg
1 year ago
It is extremely intriguing whether IRDAI is working for the "insured" or the "insurer" ?
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