When the insurance business was opened up to the private sector and to international players in India about 15 years ago, the government was hoping that the new entrants would be able to increase insurance coverage across the country.

Unfortunately, insurance penetration and density continues to remain at abysmally low levels. The new insurance companies, on the other hand, are focusing on the metros and tier-1 and tier-2 cities, ignoring the masses.

And even many of the existing clients of the private insurers are getting disenchanted with their services and sharp methods adopted by some of the companies and their agents, including banks. Despite the presence of an insurance regulator, there are an increasing number of pain points that consumers encounter and which the insurers refuse to deal with.

Last week, the Reserve Bank of India (RBI) unveiled a new set of guidelines, allowing banks to act as brokers for insurers, but with some clear-cut rules. ‘Bancassurance,’ a concept where banks join with insurers to sell policies to consumers, has been at a nascent stage in India thanks to the absence of norms either by the central bank or the Insurance Regulatory and Development Authority of India, the industry watchdog.

After the opening up of the insurance sector in 2000 — when private companies were given permission to start operations and even foreign direct investment (FDI) of up to 26pc was allowed into the sector (this was raised to 49pc last year) — several public and private banks rushed in to sell policies.

While state-owned institutions were cautious in their approach, many private lenders were aggressive in selling policies of companies that they had tied up with as agents. Many banks had also set up insurance subsidiaries and were eager to push their products.

The results were awful, to say the least. Banks and their sales executives had a perverse incentive to push products to gullible customers, even though many were obviously aware of the risks involved in selling such policies.

When the Life Insurance Corporation of India (LIC), the state-owned life insurance giant, was a monopoly player till 2000, it had hundreds of thousands of individual agents who were selling insurance policies in urban areas, mostly to salaried employees and businesspersons, mainly in a bid to cut down their tax liability. Life insurance premiums up to a certain limit enjoy tax deductions, and it was the primary reason consumers bought policies.

So the LIC was content with selling traditional endowment policies where the returns appeared significant on a long-term basis. Life insurance was considered a risky product, not an investment instrument, and the sum assured and whatever bonuses were declared would make up for a neat post-retirement package.

This changed after 2000, when many of the new players began hawking policies as investment tools. Many banks increasingly began pushing the policies as they were getting hefty commissions from the insurers, without having to invest in the business. They had a readymade network of branches, a large number of customers (many gullible, but importantly also greedy to swallow all the promises) who were willing to pay hefty premiums on promises of huge returns over a 20- or 25-year period.

What the banks perhaps did not clarify, or the buyers did not seek out, was that most of the policies were investment-linked and the returns would depend on the performance of the markets.

Many banks pushed all their front-end employees to become insurance salespersons, pitching their products. Lenders began hiring sales and marketing executives instead of finance and banking professionals. Senior sales executives who were successful in meeting their targets naturally got hefty incentives and paid holidays abroad, even as the fee income of banks soared.

Sadly, many banks were guilty of adopting sharp practices. When ordinary people, including retired persons, visited the branches to rollover their fixed deposits (which naturally earn modest returns), the bank staff would promise them double-digit returns if they bought investment-linked insurance policies by liquidating the deposit and paying huge premiums.

When banks act as corporate agents of insurers, their commissions are huge: it works out to nearly 40pc of the first year’s premium. Ordinary customers are not aware about the lopsided incentives — which are paid from their premiums. They continue earning about 7.5pc of the premium amount as commission in the second and third years, and 5pc annually from the fourth onwards till the maturity of the policy.

With the RBI now insisting that banks become brokers or distributors — when they will have to sell policies of different insurers and not just one — they will not only get lesser commissions, but will also have to be fair to their customers.

“Pure risk term products with no investment or growth components, which are easy for the customer to understand, will be deemed universally suitable products,” say RBI’s guidelines. “More complex products, with investment components, will require the bank to necessarily undertake a customer need assessment prior to sale. It should be ensured that there is a standardised system of assessing the needs of the customer and that initiation, transactional and approval processes are segregated.”

Banks can also take up insurance agency as a departmental activity, but will have to follow all the norms stipulated by the insurance regulator. As brokers, banks will necessarily have to work for the interest of the customer, not of the insurer. They will have to comply with the norms and also take on legal responsibilities.

Mis-selling of policies, which was rampant all these years, will hopefully be a thing of the past. Naturally, most banks are not keen on taking up the brokerage business. But bankers are worried that their hefty commissions will come down sharply over the coming years, affecting their bottom lines.

Published in Dawn, Economic & Business, February 2nd, 2015

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