Why Life Insurance Commission Structures Need To Be Rationalized

It’s a fact that life insurance commission structures in India need an overhaul. Industry captains will diplomatically tiptoe around the topic and distributors will (obviously) beg to differ, but that doesn’t change the immutable truth that commission structures are inextricably linked to a plethora of aspects related to the life insurance ecosystem – first and foremost, the product mix itself. Second, the way these products are sold – translating, eventually, into the client experience.

Over the past decade, two things have been firmly established. One, life insurance is sold, and not bought, in India. While anecdotal evidence pointed to this all along, the mind-boggling U-turn in ULIP sales once commission structures became rationalized around 8 years back firmly drove the fact home.

Second, the profession of life insurance sales is becoming more and more ‘transactional’ in nature – most agents now view the relationship as essentially ‘over’ after the sale is made.

Gone are the days when your trusty old LIC agent was like a family member who would pop into your house on occasion for a cup of chai. In fact, a 2013 Harvard study titled “Understanding the Advice of Commission Motivated Agents” confirmed this.

The steadily mushrooming online channels for life insurance selling are pushing this trend. Barring ULIP’s, which may require some active management (which most life insurance agents are almost certainly ill-equipped to provide!), life insurance is meant to be passive and transactional. And agent’s job is to determine the client’s life coverage requirement, and solve the problem.

If the life coverage requirement changes due to life events (perhaps, a one in a half decade occurrence), the agent needs to up the cover. It isn’t very different from buying a new fridge for your home every five years, if needed.

However, persistency figures (5th year: 22 percent on average) tell a different story. Clearly, the current approach isn’t solving the problem for most people, and smart clients are realizing that midway and dumping their policies, instead of throwing good money after bad. It’s like buying a 410 litre fridge, only to realize a few years later that it was a 190 litre one!

Needless to say, something needs to change if the industry is to buck the trend and ensure a cleaner distribution ecosystem, a better client experience, and a genuine problem (the risk of accidental poverty for your family) getting solved effectively. That “something” is the way commissions are paid to intermediaries.

Many will balk at my suggestion, and will point to the dwindling number of life insurance agents (down from 29 lakh to roughly 20 lakh in the past five years). Some may even say that rationalizing commissions will drastically bring down industry numbers in the medium term. Some players may even exit the business. All true.

Three steps need to be taken. First, we need to encourage agents to sell pure risk policies (term plans) which invariably command smaller premiums, by drastically re-pricing the payout on them – even at the cost of 20-25 percent higher premiums for clients. Second, the front ended nature of commission payouts for traditional non-linked plans need to give way to a more evenly spaced, “annuity” structure. Third, the disparity between linked and non-linked plans needs to be finished off with immediate effect, giving agents no financial incentive to recommend one over the other.

Needless to say, this will lead to disruption, pain and much indignation among the life insurance distribution community. There may even be a further exodus of agents. Roll back to the time when SEBI rightfully and bravely did away with entry loads on Mutual Funds, thereby bringing down intermediary commission payouts and making them more trailing in nature, with the intent of reducing mis-selling and churn. A lot of players exited. There was pain. And now, 8 years hence, the industry’s AUM is now more than 19.2 lakh crore, having more than doubled in the past 3 years. The industry is cleaner, better, stronger. The numbers are looking good.

The same can be expected for the life insurance industry if commissions are rationalized. More and more innovative, tech-enabled, low cost platforms will eventually emerge to serve the new “digital natives” of India. Players will focus on increasing the breadth (instead of share of wallet) of their bases and ensuring that clients are adequately covered through term plans. The ‘transactional’ nature of  life insurance sales will no longer be a bane, but will instead become an enabler of more efficient, cleaner, low cost selling.

India is underpenetrated in terms of life insurance, and even most of us who have purchased policies are in fact not adequately covered. There’s a real problem to be solved here; and technology, coupled with the right kind of alignment, will help solve it. There are structural issues preventing the ecosystem from getting cleaner – including but not restricted to the clout exercised by a single large, powerful player. Will the problem ever really be solved? Only time will tell.