With mis-selling of insurance, especially life insurance, being rampant, the media is full of such occurrences. Whenever there is a discussion on this problem in any forum, the usual tendency is to blame the seller. While this is not entirely wrong, some part of the blame must surely be shared by the rules and regulations that incentivise sellers to behave in the manner they do.
Accounting principles: According to the accounting principles followed by the sector, the premium collected by an insurer is booked as its income, while the risk covered is the firm’s liability. A sound business is one that has high income and low liability. What do you think the management will attempt to do? Will it not sell policies where the premium is high in comparison to the insurance cover? A pure term plan is a policy that gives the least income to the insurance company, while creating the highest liability. Hence, it really does make good business sense for insurance companies to sell investment-linked insurance policies, to shore up their income.
Regulations: The sector regulator has some surprising rules regarding continuation of a life insurance agency. Earlier, the Insurance Regulatory and Development Authority of India (Irdai) regulations made it mandatory for an agent to generate insurance business of a certain number of policies in a year, as well as collect a certain minimum amount of premium each year . Now, it is left to the insurance companies to decide these cut-off levels. The earlier guidelines were surprising, as there is no reason why the regulator should decide the amount of premium that an agent should collect to stay in the business. Even if it was doing so, the parameter should have been risk cover, and not premium. This guideline has been changed and renewal criteria have been shifted to the companies. What have they fixed as the criterion — risk cover or premium collected? As explained in the previous section, since income is the main criterion, insurers naturally go for the premium option rather than risk cover.
Income Tax Act: Section 80C of the Income Tax Act provides tax deduction if one makes certain investments or even expenditures. One of these is buying life insurance policies. Here, the tax deduction or the tax relief is linked to the premium paid and not the risk cover. It is the experience of many seasoned financial planners that a large number of insurance clients do not know the amount of life insurance cover they have but they know exactly how much premium they pay each year.
Commission: The seller’s commission is also linked to the premium and not the cover. The seller includes the sales staff of an insurance company and not only the agents. The focus, at every stage, is on the premium amount, not on the risk cover. Not surprisingly, pure insurance policies tend to lose out to investment-cum-insurance products in sales.
Several changes need to be made to alter this state of affairs. It’s true that accounting principles cannot be changed. While the regulator and the media have raised a hue and cry about commissions, there is still a lot of room for further reforms on this front within the sector.
Nothing has been done around tax laws and other regulations. Some measures that can be taken include linking tax deduction under Section 80C to risk cover and not the premium paid. Current laws do not allow deduction if the premium is too high in comparison to the risk cover. However, many taxpayers are not aware of this, leading to either wrong deductions, which cause loss to the exchequer, or disallowed deductions, which result in a loss to the policyholder. Either way, there is mis-selling.
Irdai could push insurance companies to consider risk cover as the criterion for continuation of an agency and not focus on the premium amount. It could also introduce regulations stipulating sellers disclose the commission earned by them, as the Securities and Exchange Board of India (Sebi) has done for mutual fund agents and distributors.
In addition, it can ask insurance companies to provide customers a comparison of various products – investment-linked and pure term plans. This comparison should include the risk cover, premium payable, maturity value (as applicable) and commission payable to the insurance agent, broker or bank.
The best move that the industry can make, without push from anyone, is starting to measure growth in terms of per capita risk cover.
What should buyers do? Buyers need to bear in mind that an insurance policy is supposed to protect one against a financial loss in the event of a casualty or untoward event. In the case of life insurance policies, such an event is the untimely death of an earning member of the family, resulting in loss of future income. The best way to buy protection against such financial loss is to buy an insurance policy for an earning member of the family such that the risk cover (or sum assured) is as high as possible for the lowest amount of premium payable.
The most suitable policy for providing such protection is a pure term plan. Whenever an agent tries to sell you an insurance policy, ask for a comparison of features and costs across the various options available. The first step in buying insurance cover is to calculate one’s need. The next step is to find which insurance policy would serve the purpose.
As for tax planning, many options besides insurance are available. If you want to take risk, invest in an equity-linked savings scheme. If you do not want to take risks, there are longer-term bank fixed deposits that also come under Section 80C. Certain expenses are also eligible for Section 80C benefits:
Children’s tuition fees, the principal repayment part of the home loan equated monthly instalment (EMI), etc. Remember: As a life insurance buyer, your primary need is to get a risk cover. Focus on that. That will save you from mis-selling, too.
The writer is founder, Karmayog Knowledge Academy