IRDAI and the avoidable art of regulatory jaywalking

Last week, the Insurance Regulatory & Development Authority of India (IRDAI) published the draft of a major policy revamp under their consideration. IRDA stated, though not in as many words, that their earlier experiment with light-touch regulation by conferring greater pricing autonomy to the regulated entities has failed, and they want to walk back to the earlier days of scruff-neck regulations. Though it was positioned as a discussion paper, the market apprehended, rightly, that most of the proposals would find their way to the final regulation, and priced in the expected impact of these proposals into stock valuations. That repricing resulted in a mini bloodbath in the market; value of stocks in the insurance and allied sectors tumbled en-masse. As per reports in different media channels, 1.2 to 1.5 trillion rupees of investor value was wiped out in the two trading sessions following the announcement. At a realistic estimate, at least 25% of these losses, i.e. thirty-thousand crores rupees, may remain permanently embedded in the valuations of the affected companies, causing corresponding real erosion in investor net-worth. This is not a notional loss, these losses would show up subtly in the portfolio values shown against our demat accounts, the NAVs of the mutual funds we hold, and the future cost of capital of the affected companies, all in the name of protecting investors.

We have seen the damage, now let us look at the problem statement made by the regulator as the justification for wielding the whip. The regulatory ire was about the excessive rise in commissions and other incentives paid by insurance companies to their agents, brokers and other distributors after the 2023 deregulation. According to the IRDA paper, insurance premiums in 2025 grew by only 6.8% while commission payouts grew by 18%, which is flagged as a major worry. But a nuanced look at the numbers tells a slightly different story. As per FY25 data, the total payout to such intermediaries was around Rs.1.08 trillion (lakh crores) against the total premium of around Rs.12.3 trillion across all products, life and non-life, or around 9% of the premium collected. IRDA’s contention is that this average hides many outliers and the first-year payout on certain policies even exceeds 30%. Such outliers are certainly a matter of concern, but the ideal regulatory tool to be used to counter such anomalies is the nudge and not a sledge hammer, at least not in the first instance and certainly not across all insurers, especially when the numbers clearly show that the overall policy premiums have actually come down over the years.

The following table will illustrate the fact.

As we can see from the tables, the cost of insurance as measured by the premium per one lakh rupees of cover has gone down steadily in respect of both life and health policies, the two largest insurance segments. In other words, health and life policies have grown cheaper in the last 5 years, despite the purported increase in distributor remuneration. While the corresponding verifiable figures for other non-life products are not easily retrievable, broad trends in the growth of number of policies and premium collections indicate that the same may hold true for the other sub-segments as well.

However, it is a fact that the rate of growth of commission payout has far exceeded the growth of the premium receipts in this reference period as can be seen from the following table.

So, the regulator’s concern about the spurt in commissions is not altogether misplaced though the problem is no way as dire as it is picturised because front-loading of commission payments means that when portfolio grows at a brisk pace, it will result in a disproportionate increase in commission payouts in the initial years. Further, the IRDAI itself had conceded at the time of the last regulatory reset in 2023 that a lot of distribution related costs were getting booked outside the commission framework, thereby supporting the case for deregulation. Once we adjust the commission figures for these two factors, the increased distribution costs attributable to the 2023 deregulation will not be more than ten to fifteen thousand crore rupees. Even assuming the entire commission savings from the proposed new caps in commission gets passed on to the policy buyers (a most generous assumption), it will still take 2-3 years to make up for the losses incurred by the investors in the last one week. That makes it a very costly reform indeed.

Part 2

In the first part we saw how the new IRDA regulations cost the investors dearly. But the issue is not merely about the losses. The bigger concern is the sudden and unanticipated about-turn in the regulatory philosophy with no prior warnings or consultations. As we saw, the regulator’s concerns were not without basis but the regulatory response was way too disproportionate and damning, by any yardstick. Ironically, the earlier deregulation of pricing was also touted as part of reforms by the regulator and the present rollback is also declared as the next major reform. Clearly, only one of these claims can be true. Let me be clear, I am not arguing for a Laissez Faire system nor am I trying to downplay the menace of over-aggressive and unconscionable methods of selling, especially in the bancassurance domain. As an ex-banker I am fully aware of the power and influence bankers have over customers and how many banks knowingly exploit that influence to sell unsuitable and over-priced products to clients. This is a problem that needs addressing with vehement and ruthless determination, but not by breaking down the entire distribution channel.

Let us now dwell a bit on regulatory dharma. A good regulatory framework should be based on well enumerated principles, consistent rules and sound logic and therefore largely predictable. Of course, the regulator should act decisively to nip unhealthy tendencies but even there the principle of proportionality should not be abandoned. But instead, we saw an episode of regulatory jay-walking, an abrupt crisscrossing from one side to the other with a nonchalance that would add to the general unease of doing business in India these days. Let me suggest a few useful thumb rules when framing regulations. A good place to start will be by acknowledging that businesses generally know what they are doing and are in the best position to decide what business model is right for them. The other principle is to heed market signals and try to give weight to those signals while framing regulations instead of trying to use the fiat of regulations to counter the market’s natural dynamics. I have no intention of claiming that the market is always right, but I do believe that market signals are almost always directionally right. Anyone who has bought a non-mandatory insurance policy for him/herself will know it is not an easy decision to make. We deliberate for days, sit on it, sleep over it, and generally vacillate until the last moment. Flip that statement around, and you have on good authority that insurance is not an easy product to sell. The reward metrics for the distributors merely reflects this difficulty. The distribution fee earned by a broker/agent is a compensation not only for the effort he/she took in selling the product, but also for time and effort spent in the many unsuccessful efforts that did not result in a sale. If we try to deflate the market determined reward levels to some notional ideal, it will merely push some distributors out of the market. Over time, the insurance distribution network will shrink and fewer policies would get sold at higher premiums, pinching the policy holder. In short, tying up the industry in stringent regulatory knots may actually work against the interests of the policy holders in the long run.

Does it mean we should abandon all notions of customer welfare and ignore the right of the consumer for a fair, and equitable deal. Not at all, but a normal customer is not truly concerned about how the price he pays is distributed across manufacturing and selling costs, but only about how much he is paying for the product and what value he is getting from it. And we saw that the customer actually benefited in the last few years from falling underwriting costs resulting from faster sales growth. So even from a fair-pricing practices perspective, the metric to measure is the average and incremental costs of buying a new insurance cover. We should also ensure that all customers buying comparable products from the same manufacturer pay prices that are largely similar, if not exactly identical. Similarly, every insurer should be mandated to formulate a standardised product-wise reward structure for all their distributors belonging to a particular category. These principles, implemented properly will considerably reduce the problem of unfair pricing and selling practices at the distribution point. Further, where an insurance holder needs greater protection is not at the point of purchase but at the point of enforcement. That is where facades fall off and mis-sales become self-evident. This is the point where we need the most emphatic evidence-based regulation and remediation. Regulators should closely monitor and measure the grievances, disputes and litigations against different insurers and use that information to fine tune and individualise the regulatory prescriptions at an issuer level. An insurer with a sub-par claim to settlement ratio or high percentage of customer grievances, especially those settled in favour of the customers, should be subjected to tighter regulations and, if the problem persists, they should even be proscribed from writing fresh policies until the situation improves. On the other hand, companies with high settlement rates and low customer complaints should benefit from light-touch regulation and higher degrees of operational freedom. By customising regulations at an entity level, the regulator acquires the ability to reward good outcomes and penalise undesirable ones. Judiciously used, this power can steer the industry to best practices without holding the entire industry at razor’s edge.

Tail piece

The new regulations may adversely affect most of the existing players. However, a new entrant with strong digital distribution capabilities may hold an advantage over existing players who have to reinvent their existing distribution model and develop a lower-cost, digital heavy distribution system from scratch. Interestingly, some months back a large Indian conglomerate with a strong digital arm entered into a joint venture with a leading global insurance firm to provide insurance services in India. While announcing the partnership, they declared that “this partnership brings together the Indian partner’s leading digital capabilities and distribution reach with the foreign partner’s expertise in insurance to support the national vision of Insurance for All.” What a remarkable coincidence that the distribution strategy of the new entrant seems to be well aligned to the digital-centric, low-distribution-costs business model being hailed under the new regulations. Of course, it is just a lucky coincidence, I am sure. Caesar’s wives are beyond suspicion.