There’s no justification for paying commission

When the agent’s income is directly linked to sales, it is inevitable he will look after his own
interest rather than that of the consumer and is likely to withhold the information that may
jeopardise the closure of a transaction

. This structure of commission encourages agents to sell policies that give them the highest
commission.

Generally, the agent lacks the qualifications and expertise of an adviser to assist consumers in
evaluating and identifying a suitable product according to his requirements. Hence, the concept
of commission-based agent is fundamentally flawed as it shortchanges consumers.

Hitherto, the primary focus of the legal framework governing financial products was to ensure
that companies dealing in them do well and not go bust. The product design, cost structure and
marketing incentives are built in a manner so as to maximise sales but shift the risk and cost on
the unsuspecting, and often, ill-informed, buyer.

Australia, Japan, Netherlands and Singapore have moved to a ‘fee-for’ model as opposed to
commission-based model and numerous other countries, including the US, are thinking about it.
The UK will go no load from 2012.

In India, Sebi found that commission to agents selling mutual funds was not justified and made it
load-free this year. Recently, PFRDA introduced the New Pension Scheme (NPS) that has no
load. In the insurance sector, commissions are still very high as they determined by policies that
were enacted way back in 1938. The scenario today is completely different.

There are dozens of insurance companies offering a wide range of products from plain vanilla to
complex insurance-cum-investment schemes. Evaluating them requires information, time and
expertise. In such a scenario, the utility of the agent to a consumer is greatly reduced to mere
service provider, at best, and gives way to a qualified adviser.

This necessitates segregating the role of agents and financial adviser. Those consumers who want
advise should pay for it and a regulatory framework for advisers would be desirable. Insurance
companies can re-train their over one million agents if they want their services. There is no
justification to make an exception, for commission, for insurance products.
Agent has to be compensated by his principal

It has been argued that insurance companies should shift to a model where investors pay fees
after negotiations instead of commissions. One must understand that this changed pattern,
applicable to mutual funds (MFs), is only a few months old. MFs have a very limited retail base
with 75% of investments coming from corporates/high networth Individuals. MFs are not
mandatorily required to sell products in rural areas. Their collections are from 16 major cities.
Even the New Pension Scheme (NPS) has negligible retail participation.

These entities have to deal with literate urban investors, with financial awareness. Even in these
sectors with limited retail and predominantly urban presence, the new model is yet to prove
successful. MFs have already increased exit charges even for existing customers who entered the
schemes after paying full entry load including commissions (load free structure?).

Life insurance companies, on the other hand, have a huge retail base of 30 crore policies with a
statutory obligation to sell 18% new policies in rural areas. Does one seriously expect people
with low levels of literacy and awareness to decide and negotiate fees with agents and arrive at
an informed decision?

Changeover is being recommended due to a mistaken belief that commissions and not
customer’s interest drive the entire sales process. If that be the case, how does one explain the
fact that insurers collected more than Rs 1,25,000 crore as new premium over the last four years
at a commission of 1.5 to 2%, less than the entry load then prevailing for mutual funds. Agents
would have earned much more even if half this amount had been diverted to other insurance
schemes with a higher commission structure. One also needs to ask why mutual funds did not
capture this business as they could pay higher entry-loads.

Insurance companies are also different from entities selling other financial products as they carry
additional risks on liabilities side. One bad risk would entail huge claim outgo. An agent plays a
pivotal role in risk assessment

process and therefore represents only one company and has to be compensated by his principal
and not the investor.