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Opinion

The secret behind LIC’s high agent commissions


Life Insurance Corporation (LIC) of India on Sunday filed the draft red herring prospectus (DRHP) for an initial public offering (IPO). One of the interesting details to emerge from the DRHP is that LIC has a significantly higher commission ratio than top private insurance companies.

Take a look at the accompanying chart which plots the commission ratio of LIC as well as the top five private insurance companies. The commission ratio is the commission paid as a proportion of the new business premium collected by an insurance company during a particular year. New business premium is the premium collected by selling new insurance policies sold during a year.

 

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By Vivek Kaul

 

In 2021-22, the current financial year, LIC’s commission ratio has been at 11.5%, which is more than double that of the median commission ratio of 5.4% paid by the top five private insurance companies. Interestingly, the difference between LIC’s commission ratio and that of private companies has increased since 2019-20. The reason for this will become clear later in the piece.

Even when it comes to commission paid as a percentage of total premium collected during a year, LIC pays a higher commission than the top 5 private insurance companies. In 2020-21, LIC’s commission rate stood at 5.5% and the median commission rate of the top 5 private insurance companies stood at 4.4%. In the current financial year, the commission rate for LIC and the median commission rate of private companies were at 5.2% and 4.2%, respectively.

Why is this the case? The bulk of LIC’s individual policies are sold by individual agents. In 2020-21, individual agents brought in 93.8% of the new business premium collected. None of the big five private companies were anywhere near this. Bajaj Allianz was the highest with 41.6% of the new business premium being brought in by individual agents. In case of HDFC Life, this was just at 12.3%.

Further, many private insurance companies are part of a larger financial services business, at the heart of which is a commercial bank. Take the case of SBI Life, where the banking channel of insurance sales brought in 65.4% of the new business premium in 2020-21. In case of HDFC Life and ICICI Prudential Life, the ratios were at 45.8% and 46.8%, respectively. What this means is that these private insurance companies are selling a lot of new insurance policies through the banks of the financial services business that they are part of.

Further, private companies have bet big successfully on direct sales, much of which happens through their websites. In case of LIC, only 2.2% of the new business premium came through the direct channel. It was 32.9% in case of HDFC Life.

Basically, selling through individual agents leads to a situation where LIC has to pay higher commissions to offer enough incentive to agents to sell its policies. When it comes to direct sales through the website, companies can take commissions totally out of the equation. This is what private companies have been doing much better than LIC, and taking LIC’s massive individual sales channel gradually out of the sales equation. It has also helped them drive down their commission ratio.

LIC recognizes this problem. As it points out in the DRHP: “We plan to increase direct sales of our individual products on our Corporation’s website by increasing the marketing of our Corporation’s website and leveraging social media platforms to reach the millennial segment.”

Private companies also sell through web aggregators. In 2020-21, Bajaj Allianz got 6.2% of its new business premium through them. In case of LIC this was at 0%. Recently, LIC tied up with Policybazaar for the digital distribution of its products.

The slow movement towards digital sales can be explained by looking at how many industry leaders tend to behave when a new way of doing business opens up. Initially, the channel is too small to pique their interest. But gradually it becomes big enough to interest them, but by that time other players have already moved in. Also, no one wants to disturb the status quo. LIC has fallen into this trap as well, which it is now trying to correct.

Vivek Kaul is the author of Bad Money.

 

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