What happens when insurance commissions are cut?

Akshara (0:04)

In today's episode, we'll do one deep dive and cover another story for the day. First, we'll talk about what happens when insurance commissions are cut, and then we'll talk about how much of a credit rating a country's name is.

Welcome back to The Daily Brief by Zerodha, where we cut through the noise to help you understand what's actually happening in the most important stories from business and markets. I'm your host Akshara. Today is Friday, 25th September. Coming to the first story.

So on 24th September, shares of PB Fintech, the company behind Policy Bazaar, closed about 36% lower, and fellow insurance distributor Turtle Mint fell 20%.

The trigger was a consultation paper from India's insurance regulator, IRDAI, proposing big changes to how insurance is sold. Now, banks and non-banking financial companies or NBFCs earn money from selling insurance too. And even their shares fell, though less sharply. But share prices tell only part of the story. The proposals could also lower insurers' costs, improve customers' experience, and change how many people buy cover. And the impact will depend on whom you ask. So the IRDAI sees a problem in the market and wants to step in. Distributors, insurers, and customers each have something different at stake. For now, these are only proposals. And to understand whether the intervention is warranted and whether it might work, we need to start with how insurance reaches customers. So a large share of retail insurance is sold through agents, banks, brokers, and platforms. Insurers pay these distributors commissions for bringing in customers and sometimes helping service their policies. Now, that matters because insurance is often a push product. So someone may need to explain why a customer needs cover, persuade them to act, and help them buy it. And demand doesn't always arrive on its own, so distributors have a real place in this system. Now, before 2023, Irdai set commission limits for different products and sales channels. It then removed those detailed caps, giving insurers more freedom to decide what to pay. There was still an overall limit on what insurers could spend to run their business and sell policies, including commissions. And that limit is called Expenses of Management, or EOM. Now, Irdai wants to bring specific commission caps back and tighten the overall spending limit. The proposed caps vary by product and sales channels, with lower payouts where selling takes less effort. Now, the consultation paper runs to more than 120 pages. But one example gives you a sense of the shift. So on individual term life insurance, first-year commissions averaged 51%, with some reaching 81%.

The proposed first-year cap for multi-year pure-term policies is 25% for banks and brokers, and 30% for agents. So many distributors could have to work with much lower payouts. But what happens after that is less straightforward. Now Irdai's case starts with a striking gap. So in the distribution channels it studied, payments to distributors grew roughly 4-5 times as fast as the premiums they brought in between FY23 and FY25.

Now some of that increase reflects payments being recorded as commissions instead of operating expenses. And Irdai acknowledges this. But total expense ratios have risen too. The broader observation is that as the insurance business grew, distributors captured a growing share of the economic value being generated. Now these numbers alone cannot tell us whether that share was unfair. Distributors may have brought in customers insurers could not have reached otherwise. But still, when their payments grow so much faster than the business they bring in, it's worth asking what insurers and customers are getting from that growth. Meanwhile, the number of individual life policies has remained broadly stagnant over the decade shown in the paper. Now, general insurance policy numbers have grown, though Irdai argues that coverage remains inadequate. Now, policy accounts do not tell us exactly how many new people have been insured, but rising premiums and distribution spending have not produced the expansion and coverage the regulator hoped to see. Now, Irdai traces part of the problem to who controls access to customers. A bank, lender, or vehicle dealer already has a customer in front of it, and insurers can compete for that access by offering higher commissions. The payout may then reflect the distributor's bargaining power as much as the effort needed to explain a policy. Now, there's also the question of what distributors are rewarded for doing. Life insurance has typically paid much more when a policy is first sold than when it is renewed. A distributor may therefore earn more by selling a new policy than by helping someone keep a suitable one. Irdai proposes shifting some of the reward towards later renewals, giving sellers more reason to support a lasting customer relationship. So, taken together, this is Irdai's argument. Insurers are spending more on distribution without bringing enough new people into insurance. And the regulator believes those costs make cover less affordable. It wants less of each premium to go towards distribution, so insurance offers better value and reaches more people. But whether commission caps can make cover cheaper and help more people get insured is the harder question. Now, for an insurer, commission is an expense. But for its distributor, it's revenue.