Introduction
Pursuant to Sections 40B and 40C of the Insurance Act, 1938 (“Insurance Act”), the Insurance Regulatory and Development Authority of India (“IRDAI”) is empowered to regulate and impose limits on the amount that insurance companies may spend on Expenses of Management[1] (“EoM”). Further, in terms of Section 40 of the Insurance Act, no insurer is permitted to pay, or agree to do so, to any insurance agent or intermediary, commission or remuneration in any form other than in the manner specified by the IRDAI through a regulation.
The IRDAI has recently notified the IRDAI (Payment of Commission) Regulations, 2023 (“Commission Regulations”), IRDAI (Expenses of Management of Insurers transacting General or Health Insurance Business) Regulations, 2023 (“EoM General Regulations”) and the (Expenses of Management of Insurers transacting Life Insurance Business) Regulations, 2023 (“EoM Life Regulations”) (collectively, “EoM Regulations”). The Commission Regulations are effective from the commencement of FY 2023 and supersede the erstwhile regulations governing the EoM and commissions.[2]
The erstwhile regulations dealing with EoM and commission limits were considered to be restrictive and stringent, although they empowered the IRDAI to grant forbearance in enforcing EoM limits. Even after being in operation for over a decade, several insurers found it challenging to adhere to the prescribed EoM limits. This observation led the industry to recognise the need to increase flexibility in determining how operating expenses may be apportioned. Consequently, there was a strong industry-wide consensus on the importance of devising commensurate incentives for distribution channels to promote higher insurance penetration in India.
Relaxation of Commission Limits
The IRDAI has replaced the erstwhile regime of ‘product-wise capping’ of commission payable to intermediaries. This is, however, subject to insurers maintaining overall EoM limits set by the IRDAI. The IRDAI has now permitted insurers the flexibility to determine the quantum of commission[3] payable to intermediaries and agents as may be provided in the board-approved policy on payment of commissions. The quantum of commissions paid in a financial year shall not exceed (i) the overall limits of EoM as provided in the EoM General Regulations; and (ii) the segmented limits calculated in accordance with the EoM Life Regulations.
It is pertinent to note that, historically, only insurance intermediaries whose revenue from insurance-related activities exceeded 50% of their total revenue in a financial year, were entitled to ‘rewards’.[4] This effectively meant that banks that acted as corporate agents were ineligible to receive ‘rewards’. However, through the Commission Regulations, the IRDAI has also subsumed the terms ‘remuneration’ and ‘reward’ within the definition of ‘commission’. This key inclusion highlights the principle that any ‘compensation’ payable towards distribution of insurance products will be classified as ‘commission’ payments. Consequently, there is no longer any classification of payments (under different headings) from insurers to intermediaries in connection with distribution of insurance products.
The regulations are expected to provide great impetus to insurers who will now be able to incentivise agents and intermediaries in a manner that is suitable to their business. These regulations are also likely to have material economic implications for intermediaries.
Rationalisation EoM Limits
The IRDAI has simultaneously also overhauled the regulatory regime in relation to EoM. In relation to the EoM of general and health insurers, the IRDAI has taken a simplistic approach in the EOM General Regulations, allowing general insurers to incur EoM up to 30% and standalone heath insurers to incur up to 35% of Gross Written Premium (“GWP”) in India in the preceding financial year. By introducing a single limit, basis the total GWP of the general and health insurer, the new regime has removed the erstwhile segmental product-based calculation of allowable limits.
In relation to EoM of life insurers, the EoM Life Regulations continue to consider the calculation criteria by aggregating separate allowable limits basis the premium received on different life insurance products. In our view, the retention of segmental limits was warranted due to the complexity and nature of products offered by life insurers and we believe it is not possible to rationalise the allowable limit for the entirety of the portfolio to a single all-encompassing limit (the way it has been done for general and health insurers). We note that the IRDAI has rationalised the segmental calculation under the EoM Life Regulations to the extent possible such that a reasonable product-based segmental approach is retained, thereby simplifying the calculation process.
Over and above the aforesaid limits set out under the EOM Regulations, the IRDAI has allowed additional limits for expenses in relation to setting up of foreign branches and branches in the International Finance Services Centre,[5] business conducted in the rural and social sector, government insurance schemes,[6] insurtech and insurance awareness.[7]
The IRDAI has also retained the provision of providing forbearance to insurers on a case to case basis. However, the eligibility criteria for forbearance have been limited for insurers having ‘duration of business’ up to five years. Further, in the event an insurer has incurred actual EoM in excess of the allowable limits for the financial year 2022-23, the IRDAI may grant forbearance and direct the insurer to bring its expenses within the allowable limits within a period of 3 years i.e. by the end of financial year 2025-26.
The Way Forward
The EoM Regulations and the Commission Regulations were notified on March 26, 2023 and have come into effect on April 1, 2023. Note that these regulations are only applicable for a period of three financial years from April 1, 2023. The presence of a sunset clause provides an indication that the IRDAI will be closely monitoring the benefits reaped by the industry.
The impact of these regulations is yet to be gauged at an industry level. Insurers in India have traditionally banked heavily on the bancassurance models for distribution of insurance products. Considering the same, the IRDAI notified the Guidance note – Board policy of the insurer on the commission structure on March 31, 2023, specifying certain key elements that are required to be included in the policy on commission structures for intermediaries. These include: clarity of the objects and principles of the policy, fairness and reasonableness, good distribution practices, and market conduct.
It is understood that the industry had adopted certain practices due to the restrictions imposed on payment of ‘commission’ or ‘remuneration’.[8] The Commission Regulations are also expected to eliminate such practices from the industry by removing the caps on payable commission, consequently permitting greater flexibility to insurers for incentivising their distribution channels. However, historical non-compliance is likely to remain the subject of investigation for the authorities.[9]
The flexibility in relation to payment of commissions is subject to financial hygiene standards imposed by the EoM Regulations, which in turn is heavily dependent on sourcing of business. Insurers will be looking to strike a fine balance between spending heavily on commission payments to transact more business and maintaining all other operating expenses within the prescribed limits. The IRDAI has provided the industry with an opportunity to spur greater growth and improve insurance penetration in India.
[1] Expenses of Management includes all expenses in the nature of operating expenses of life insurance business including commission, remuneration/brokerage, rewards to the insurance agents, intermediaries and insurance intermediaries and commission on reinsurance inward which are charged to Revenue Account. However, it shall not include ‘charges’ as defined in the EOM Regulations.
[2] IRDAI (Payment of commission or remuneration or reward to insurance agents and insurance intermediaries) Regulations, 2016, Expenses of Management of Insurers transacting General or Health Insurance Business) Regulations, 2016 and Expenses of Management of Insurers transacting Life Insurance Business) Regulations, 2016.
[3] Commission has been defined to mean any compensation including remuneration, or reward, by whatever name called, paid by an insurer to an insurance agent, intermediary or insurance intermediary, as applicable, for soliciting, procuring or transacting insurance business.
[4] “Reward” as defined under the IRDAI (Payment of commission or remuneration or reward to insurance agents and insurance intermediaries) Regulations, 2016, means the amounts paid, whether directly or indirectly, as an incentive by whatever name called by an insurer to:
i. an insurance agent towards benefits such as gratuity, term insurance cover, various group insurance covers, telephone charges, office allowance, sales promotion gift items, competition prizes and such other items.
ii. an insurance intermediary towards services such as risk analysis, gap analysis, plan design, predictive modeling, data management, infrastructure, advertisement and such other items including any additional incentives by whatever name called.
[5] 10% of the gross premium income written outside India through such branch office or International Financial Service Centre Insurance Office (IIO) during the year.
[6] 15% of the incremental premium over the previous financial year, sourced from the rural sector and the specified schemes: Pradhan Mantri Suraksha Bima Yojana (PMSBY), Pradhan Mantri Jan Arogya Yojana (PMJAY) and Pradhan Mantri Fasal Bima Yojana (PMFBY) business or such other schemes as notified by the IRDAI.
[7] “Insurtech Expenses” means expenses incurred towards technology-enabled innovation in insurance services (Policyholder oriented) that could result in new business models, applications, processes or products.
[8] See: https://www.business-standard.com/economy/news/insurance-firms-to-face-gst-audit-tax-authorities-to-check-irregularities-123062200993_1.html.
[9] See: https://economictimes.indiatimes.com/industry/banking/finance/insure/tax-probes-against-insurers-may-go-on-despite-irdais-new-commission-norms/articleshow/99222967.cms?from=mdr.
