One of the major changes in insurance rules effected by the Insurance Laws Amendment Ordinance is scrapping of section 40A of the Insurance Act, 1938, that prescribes the caps on commissions that an agent can get while selling you an insurance policy.
With the section scrapped and caps gone, the Insurance Regulatory and Development Authority of India (Irdai) will have the power to prescribe fresh commission structures and change commissions as required. But before we take a step ahead, let’s take a step back and understand the rules applicable till now.
Previous Structure
The expenses of life insurance companies, including commissions and other operational and administrative expenses, are capped under section 17D of the Insurance Rules, 1939. This rule describes the limits on expenses that life insurance companies may incur from the premium income for a particular class of insurance products. Section 40B of the Insurance Act, 1938, restricts the expenses of insurers according to the rules specified in section 17D. The limits are decided based on multiple factors such as age of insurer, its business in force and the term of products sold. Section 40A came within this overall limit and made commissions front-loaded.
So, if an insurer is less than 10 years old, the first-year commission was capped at 40% of premium, at 7.5% in the second and the third year, and at 5% thereafter. For older insurers, first-year commission was capped at 35%.
The Step Ahead
In case of life insurance, it seems the Authority is not in a hurry, because product regulations in life insurance came into effect last year. This had brought in cost caps for unit-linked insurance plans (Ulips) in the form of maximum reduction in yield to 2.25% by the 15th year and thereafter. It had also altered the commission structure to some extent, and, therefore, the industry has a commission structure to adopt for as of now. Hence, the immediate focus is commissions on non-life plans. The caps on commissions in the case of non-life policies are leveled.
Staying within the overall limits on commissions as prescribed by the Act, product regulations in life insurance pegged the quantum of the first-year commission to the premium payment term: longer the policy, more the commission.
So, in case the premium paying term of a policy is five years, the commissions are capped at 15%. As the premium paying term increases to 12 years and above, the commissions payable in the first year increases up to 35% in case the company is at least 10 years old and 40% in case the company is less than 10 years old. The second- and the third-year commissions, however, remain intact.
This is the commission structure that’s currently applicable for life insurance companies, although we are yet to hear of the new commission structure for non-life policies.
