The long-term financial viability of a life insurance company depends on three key elements: (1) the actual management expenses incurred for carrying on its life insurance business compared to management expenses as provided in the premium rates, (ii) the spread between the actual rate of return earned on investment of assets constituting the life fund and the rate of return assumed on investment of such assets in the premium rates, and (iii) the difference between the mortality rates assumed in the determination of premium rates and the actual mortality rates experienced by the policyholders of the life insurer.
In this context, problems of expenses of management and other related issues of life insurance companies in Bangladesh and the effect of high management expenses on its long-term financial viability are matters of concern. Management expenses of life insurance companies, in the Bangladesh situation, means all charges wherever incurred whether directly or indirectly including commission payment of all kinds and a proper share of expenses capitalized, and in the case of an insurer having his principal share of business outside Bangladesh, a proper share of head office expense not exceeding a certain percentage of the total net premium. Sub-section (1) of Section 40A of the Insurance Act 1938 provided for limitation of expenditure on commission to life insurance agents.
As per the Insurance (Amendment) Ordinance 1970, payment of commission to insurance agents had to be prescribed by the Rules. It was mentioned in the Amendment Act that while prescribing the Rules for rates of commission, the type of life insurance, the premium payment term, the amount of business procured by the agent during a calendar, and the proportion of business not lapsing out of the business procured by the agent to the business so procured would be taken into consideration.
However, the amendment was not made effective in Bangladesh and as such no Rules taking into consideration the guidelines as provided in the Amendment Act were prescribed. There was no provision either in the Act 1938 or in the Rules for payment of commission and or remuneration in any form to employer of agents who procure insurance business for a life insurer by employing or causing to be employed on behalf of the insurer.
In the absence of such provision either in the Insurance Act 1938 or in the Insurance Rules 1958 and the unavailability of adequate number of skilled manpower in the insurance sector, the practice of payment of commission to the insurance agents that was followed in Bangladesh was not in line with the international best practice. It was very difficult for the insurers to contain the agency commission within the tolerable limit with the result that that overall management expense far exceeded the allowable limit.
Profit (surplus) of a life is calculated, in line with the current regulation in-force, as the difference between the life fund and the policy liabilities as at a given date. The higher the amount of excess management expenses, the lower will be accretion to life fund and as a result there will be a fall in surplus. If a life insurer continues to incur expenses exceeding the regulatory limit, it could end up with a deficit unless the rate of return on investment of assets exceeds significantly the rate of return assumed in the determination of premium rates and that the lives assured shows favourable mortality experience.
In recent times, the rate of return on investment of life fund in Bangladesh has declined partly because the market rate of return has declined and partly because some of the insurers have not managed their investment portfolio in a prudent manner. The insurers should not only contain their management within the regulatory limit but also reduce expenses to such an extent that the excess expenses incurred by the insurers in the recent past could be offset within the next few years.
As per section 40B(1) of the Insurance Act 1938 no insurer shall, in respect of life insurance business transacted by him in Bangladesh, spend as expenses of management in any calendar year an amount in excess of the prescribed limits and in prescribing any such limits regard shall be had to the size and age of the insurer and the provision generally made for expenses of management in the premium rates of the insurer. Similar provision has been included in the Insurance Act 2010 under section 62.
Rules 39 of the Insurance Rules 1958 prescribed the maximum limit of expenses of management. Management expenses include both commission and other forms of remuneration incurred for acquisition of life insurance business and operating expenses. No rules or regulations with regard to limitation of expenses of management have yet been prescribed under the Insurance Act 2010. But section 160(1) of the Act provides that any prescribed rules or regulations, not being inconsistent with the provisions of this Act 2010, will remain in force until annulled or amended and will be regarded as prescribed under this Act. This means that Rules 39 are still in force, and the insurers are required to comply with the provisions of these Rules. But unfortunately, most insurers failed to comply with this regulatory requirement.
Insurance Development and Regulatory Authority (IDRA) was established in January 2011. Excess management expense as per cent of allowable expenses of life insurance companies in 2011 was 16.70. Management expense as per cent of total premium income in 2011 was 43.62. As soon as the Chairman and the members of IDRA took office in 2011, they made a study on various aspects of expenses of management including the effect of prevailing high management expenses on the long-run financial viability of life companies and the measures that could be taken to reduce the high rate of growth of expenses.
Based on the study, IDRA issued a circular in 2012 on maximum limit of commissions and other forms of remunerations payable to life insurance agents and employers of agents for acquisition of life insurance business. Since then IDRA have been keeping vigilant watch on the trend of management expenses and taking various measures including holding frequent meetings with the chief executives of the companies and issuing guidelines in an effort to reduce the expenses of management. While discussing the issue with them, some of them at times requested IDRA to raise the limit of management expenses on the ground that the expenses incurred by a life company for managing its affairs including the commissions have increased manifold since the time the Rules 39 were specified.
IDRA made them understood that the Rules have not specified any limit on expenses in absolute term but as percentage of premium income and, therefore, allowable expenses for a life company in absolute terms have also increased owing to the manifold increase in the size of average sum assured. Moreover, digitization is now playing an important role in reducing the cost of management. If allowable management expenses are raised enabling the insurers to raise their expenses of management, the premium income that will be available after meeting the expenses together with the investment income will not be sufficient to honour the basic contractual obligations, not to speak of any addition in the form of bonuses to the policyholders.
Owing to the frequent discussions with the management of life companies, the management of these companies have understood the magnitude of the problem and have started taking various measures to contain the level of management expenses within the regulatory limit and as a result there has been some improvement in recent times.
To be continued in tomorrow's issue of the FE in its views page. The writer, who is an actuary, is chairman, IDRA, Bangladesh.
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