So, where does your life insurance premium go?

504724-mutual-fundHave you wondered why your neighborhood financial advisor, call him the insurance agent, always wants to sell you life insurance policies? Hefty commissions are the prime reason.

Commissions paid to agents by life insurance companies touched a whopping Rs 44,585.33 crore in 2015-16, a growth of 4.3% over the previous year, according to Life Insurance Council, an apex industry body of life insurance companies.

In a year when mutual funds paid 497 large distributors 23% lower commissions, the life insurance industry has remained a stable paymaster This hefty commission was paid against equally massive premiums collected during the year by life insurance companies.

They collected Rs 6.56 lakh crore as premium (Rs 5.17 lakh crore of renewal premium and Rs 1.38 lakh crore as first year premium) in 2015-16.

As against these collections, insurers paid 32.1% in the form of commissions if you take into account just new business premium. If you include both first year premium and renewal premium, the commissions worth Rs 44,585.33 crore for 2015-16 account for 6.8% of the total premium garnered in that year.

Typically, life insurance agents get higher commissions through new businesses and renewals fetch them much lower fee. In comparison, mutual funds agents get much lower.

In the mutual funds sector, commissions are mostly paid for accumulated corpus in the form of trail commission.

Over the long term, MF distributors can earn more (through trail commission structure) than insurance intermediaries, if the customer is retained.

In 2015-16, mutual funds paid 497 large distributors Rs 3,647.63 crore by way of gross commissions, less than one-tenth of insurance commissions, and 23% less than what they paid in the previous year.

The mutual funds industry saw net inflows of Rs 1.34 lakh crore in 2015-16 and ended the fiscal with assets under management (AUM) of Rs 12.32 lakh crore.

Rarely does the ratio of AUM to gross inflows cross the 5-7% mark in case of most MF distributors. This figure also has a bearing on MF commissions because trail fees are dependent on AUM. In comparison to insurance, MF agents get peanuts.

This is why there has been a slow and steady drift towards insurance sales. This is because MF agents incur some fixed costs, like insurance agents, but unless you have volumes, that cost can’t be recovered,” says Rajib Dutta, an MF agent.

The 497 distributors for which commissions data is available do not make the entire distributor community. However, they form a significant part of the MF distributor headcount.

The 23% drop in top MF distributors’ commission does not mean that distributors gave lower business in 2015-16. Commissions appear low in 2015-16 as upfront commissions were paid on close ended schemes in the previous year that is 2014-15.

The income from such schemes was reduced in 2015-16. Also, the 1% cap on upfront commissions came into effect, which further lowered commissions.

Detailed MF distributor commissions are revealed by the Association of Mutual Funds in India (AMFI) only on an annual basis. From October 1, gross commission paid to distributors will be mentioned in the Consolidated Account Statement (CAS) sent to investors by mutual funds.

In case of the life insurance industry, the Life Insurance Council discloses the commission figures on a quarterly basis and form a part of ‘expenses by management’.

Life insurance industry commissions have long come under fire from competing ‘product manufacturers’ and even scrutiny by the regulator.

According to the latest quarterly data, life insurers paid Rs 20,244.33 crore in the January-March quarter of 2015-16 and Rs 13,010 crore in the previous quarter.

Insurance sales typically peak in the last two quarters or second half of the fiscal year, when investors desperately look for options to save tax.

This is the top reason why the bulk of the commissions are accounted for in the last quarter of a financial year, says Gautam Sinha, an insurance agent.

At the end of March 31, 2016, the life insurance sector comprised over 11,071 branches, more than 20.16 lakh agents, 2.47 lakh direct employees and 32.56 crore in-force policies.

Earlier, insurance companies were paying commissions as high as 40% in the first year to aggressively get business. The commission rates taper off sharply from the second year onwards, which is one of the reasons cited to explain the high churn rates of customers or low persistency rates. Simply put, sales of new products, and not continuing premiums, were more profitable for agents

“But a lot of things have now changed on the ULIP front. You have some products that cost cheaper than mutual funds. Commissions are an incentive.

A majority of high net-worth individuals (HNIs) do not have any problem with the financial intermediary making some money, if the product is value for them.

However, for newer customers or non HNI customers the cost of advice is often proportionately larger than the ticket size. What customers should do is to compare product costs, returns and then take a call based on hard data.

Merely looking at commissions is not a great indicator. Price is what you pay, value is what you get, says Anil Rego, CEO, financial consulting firm Right Horizons.

Life insurance commissions, as a proportion of respective first year premiums, show a declining trend.

This may be a result of the cracking of whip by regulators, asking companies to reduce initial commissions. For instance, 2015-16 first year premium collection stood at Rs 1.38 lakh crore and commissions figure account for 32.1% of that sum.

In 2014-15, the share of commission of first year premium was higher at 37.7%. The figures for 2013-14 and 2012-13 are expected to be similar and in line with 2014-15.

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