Established in 1992, the Securities and Exchange Board of India (SEBI) has actively protected the interests of small mutual fund investors.

In contrast, the Insurance Regulatory and Development Authority of India (IRDAI), established in 1999, has been somewhat less proactive in safeguarding policyholders. This analysis maps the directions both regulators have taken over the years to protect the interest of investors.

To reduce churning among mutual fund distributors, SEBI began reforming mutual fund distributor upfront commissions in 2009 by banning “entry loads”. An “entry load” fee, paid by investors at the point of entry into the fund, primarily covered the distributor’s upfront commissions charged by Asset Management Companies (AMCs).

Regulating commissions

Subsequently, SEBI encouraged the Association of Mutual Funds in India (AMFI), a mutual fund industry self-regulatory body, to regulate these upfront commissions. By 2015, AMFI had capped upfront commissions for mutual fund distributors at 1 per cent.

Continuing its regulatory efforts, SEBI prohibited all upfront commissions to mutual fund distributors in 2018 and mandated that all asset management companies adopt trail commission models. This policy was extended to Portfolio Management Services (PMS) products in 2020, when SEBI completely banned upfront commissions.

In contrast, the life insurance industry remains less regulated in this aspect; companies can pay commissions within the overall management expense limits as per their board-approved policies. This aligns with earlier IRDA proposals but deviates significantly from its August 2022 draft, which suggested reducing the commission cap from 35 per cent to 20 per cent by March 31, 2023.

Moreover, IRDAI has finalised the surrender charges for linked and non-linked life insurance products, such as traditional endowment policies, effective from April 1, 2024 — a deviation from the December 2023 consultation paper to reduce surrender charges.

This decision favours the life insurance companies and shows a complete disregard for the interests of policyholders. High commissions further incentivise distributors to push policyholders into long-term policies, sometimes resulting in mis-selling. The mis-selling of policies is reflected in high surrender values at an industry level. Per IRDAI annual report 2022-23, the total surrender amount was ₹1,98,839.42 crore, accounting for 40 per cent of the total benefits paid to all policyholders in 2022-23. The surrender value is around 55 per cent for private insurers and 33 per cent for public insurers of the total benefit paid to policyholders.

Why do such large policy values end up in early surrender? Do insurance agents nudge policyholders to withdraw earlier for higher commissions?

The divergent regulatory approaches taken by both SEBI and IRDAI are reflected in the actual expenses incurred by investors in financial products. This, in turn, affects the profitability and commissions paid by mutual fund companies and insurance companies. According to IRDAI’s 2022-23 annual report, life insurers paid a total amount of ₹42,322 crores as commission.

The commission expenses ratio (commission expenses expressed as a percentage of premium paid) slightly increased to 5.41 per cent in 2022-23 from 5.18 per cent in 2021-22. However, total insurance commission outgo increased by 17.93 per cent (total premium growth 12.98 per cent) during 2022-23 as compared to previous year.

Mutual fund distribution commissions typically range from 0.1 per cent to 2 per cent of the purchased mutual fund units’ value. Each mutual fund company has its own commission structure for paying commissions to distributors and also has varying percentages of commissions for different categories — debt, equity, hybrid, etc.

Generally, you can consider it to be about 1 per cent to 1.5 per cent for equity funds paid as a trail commission, although in some cases, it might be higher. For debt funds, the figures are much lower.

The profitability variance

The policy regulations by SEBI and IRDAI are also reflected in the profitability of insurance and mutual fund companies. According to IRDAI’s annual report, profits of life insurance industry grew by 452 per cent in 2022-23, with profit after tax of PAT ₹42,788 crore as against ₹7,751 crore in 2021-22.

On the other hand, the net profit of the mutual fund industry reached ₹8,300 crore in FY23, up from ₹7,700 crore in FY22, a growth of 7 per cent. Of the 39 AMCs, 12 companies reported a net loss.

The data clearly shows that insurance policyholders suffer significant losses when policies are mis-sold. Distributors and insurance companies continue to thrive due to high commissions and greater profitability.

Financial distributors serve both the investment and insurance sectors, and the stark differences in commission structures expose investors to financial products that do not align with their long-term objectives. This discrepancy is evident in the volume of mis-selling complaints filed with regulators.

Both the IRDAI and the SEBI should collaborate to protect investors from financial products that compromise their interests.

The writer is Professor of Finance, IMT Ghaziabad