Three Reforms That The Indian Life Insurance Industry Desperately Needs

Over the years, the Life Insurance distribution business in India has gained notoriety for sharp selling practices that have resulted in heavy losses for uninformed retail investors. A 2012 Harvard Business School study on the Indian Life Insurance market summed up the root cause of this problem succinctly, providing conclusive evidence that "agents appear to focus on maximizing the amount of premiums (and therefore commissions) that customers pay, as opposed to focusing on how much insurance coverage customers need". Needless to say, a thorough clean-up of the ecosystem is the need of the hour. Here are three steps that the new IRDAI Chairman may want to consider taking, in order to reform the industry.

Bring Back the minimum Persistency Clause
Persistency, or the number of Life Insurance policies that go on to get renewed in a given year, is in many ways the litmus test for ethical sales practices. In 2011, the IRDAI had attempted to come up with a hard-handed strategy to shore up persistency numbers, when it had mandated that a minimum 50% achievement on this key business parameter would be required for the renewal of an agent's license, going up to 75% in a few years' time. However, the regulator was forced into a row back of this clause in 2014, in light of the steady attrition within the industry's agent-force. If anything, the fact that the regulator could be arm-twisted into reversing such a landmark decision, and that agents could attrite from the work force when mandated to sell policies sustainable and honestly, stands to highlight the deep-rootedness of the problem even further.

Rationalise Commission Structures and do away with "rewards"
In 2017, the IRDAI introduced a new category for agent compensation known as 'rewards' -  which is in simple terms, an incentive paid by the insurer to agents and intermediaries, over and above the maximum payable commission. Given that Life Insurance first year commissions are already exorbitant (especially for traditional plans or "non-linked plans", these rewards should ideally be done away with, as they effectively just cannibalise investor returns over time. In fact, the roots of mis-selling lie within commission structures themselves. Here's a simple example: "traditional" policies that have poor liquidity, terrible returns and generally have severely obfuscated clauses ingrained within them, offer payouts of anything from 25% to 50% of FYP's (First Year Premiums) to agents. Reformed ULIP's, having better wealth creation potential, more liquidity and vastly better transparency, offer barely 1% to 4% these days. No prizes for guessing which kind of policies sell like hot cakes! Clearly, the most desperate need of the hour is to create parity between commissions on the sales of all kinds of Life Insurance products.

Reform Traditional Products in order to improve their returns
It may shock you to know that the government mandates that 50% of funds mobilized from traditional life insurance policies, need to mandatorily be deployed towards buying Government Securities! In effect, by buying these policies, you're doing two things - one, you're donating approximately 40% of your FYP (First Year Premium) towards your agent's financial wellbeing. Two, you're investing your long-term savings (anything from 20 to 40 years for most traditional policies) into low return, fixed income assets! In many ways, this rule represents financial repression - after all, the government is forcing long term household savings to be utilised towards funding its own fiscal deficit! Considering that most traditional plans are locked in, long term products, the new IRDAI chief definitely needs to re-look at hiking the allowable equity allocation within these products, while doing away with the repressive clause that mandates G-Sec purchases. Once these products start earning double digit returns for investors, they'll be a lot better off.