Opinion: Risks in bancassurance

By Seela Subba Rao Prior to 2003, banks were not allowed to take up ‘insurance’ as a permissible form of business. Subsequently, they were permitted to undertake referral activities such as insurance business. Consequent to the announcement by the then Finance Minister in the Budget speech 2013-14 to permit banks as insurance brokers, the Reserve […]

By Seela Subba Rao

Prior to 2003, banks were not allowed to take up ‘insurance’ as a permissible form of business. Subsequently, they were permitted to undertake referral activities such as insurance business.

Consequent to the announcement by the then Finance Minister in the Budget speech 2013-14 to permit banks as insurance brokers, the Reserve Bank of India (RBI) allowed all commercial banks, excluding regional rural banks (RRBs), to undertake insurance business by having a tie-up with insurance companies.

RBI Guidelines

Through an arrangement known as bancassurance between a bank and insurance company, banks sell insurance products of more than one insurance company to their client base. They undertake this business through their branch network or a subsidiary/JV subject to the following conditions laid down by the RBI:

• Bank should not follow any restrictive practices of forcing a customer to either opt for products of a specific insurance company or link the sale of such products to any banking product

• Should make it clear that the purchase by a bank’s customer of any insurance product is voluntary and not linked to availment of any other facility from the bank

• Details of fees/brokerage received in respect of insurance broking/agency business undertaken by them should be disclosed in the ‘Notes to Accounts’ to their balance sheet

• It must be ensured that no incentives (cash or non-cash) should be paid to the staff engaged in insurance broking/corporate agency services by an insurance company

Merits and Demerits

Banks, as well as insurance companies, derive many advantages due to the bancassurance arrangement. These are:

• Since banks have a huge network of branches, insurance companies have tied up with them to sell their products. It is a source of income for banks. Fee-based income can be increased by selling products to existing bank clients

• Insurance is a long-term contract. It encourages customers of banks to purchase insurance policies and helps in building a long-term relationship with the bank

• People who are unaware of various insurance policies (life and non-life) can benefit through widely distributed networks and better marketing channels of banks

• Increase in number of providers/insurers means increase in competition and hence people can expect better premium rates and services as compared with traditional insurance

However, bancassurance is not bereft of disadvantages. These are:

• Sometimes, poor and illiterate borrowers are forced to pay premium for insurance for getting their loans sanctioned. These borrowers fail to continue the policies. Afterwards, due to insufficient means, the loans become bad

• In certain instances, the banking staff gets incentives and gifts from the representatives of JV business. They ignore their basic banking activities impacting their performance

• Often, higher scales of targets, coupled with front-ended high commissions, result in mis-selling which is highly objectionable. The RBI has viewed the mis-selling as a serious issue

• Bank employees dealing with insurance products are not well versed with insurance and are not trained in such matters. In the case of multiple bancassurance agreements, bank staff may have conflict incentives. They may recommend one product over another out of self-interest

• As per the recent guidelines by the Insurance Regulatory and Development Authority of India (Irdai), banks would have to take the responsibility for policies sold through them

• Because of onerous rules framed by the insurance regulator and threat of penalties imposed by the banking regulator, banks are wary of the insurance business

Business Models

Insurance and banking have distinctly different business models, operating priorities and financial requirements. After banks started having tie-ups with insurance companies a few anomalies came to light. Recently, the RBI imposed a penalty of Rs 2 crore on one of the public sector banks for violating rules. The central bank pointed out that the bank had not followed its specific direction on payment of remuneration to its employees in the form of commission.

Banks which work as corporate agents of insurance companies are allowed to solicit insurance cover only for policies where the sum assured is not more than Rs 5 crore per policy as per Irdai’s regulations. However, it is observed that some banks are not following these regulations in true spirit.

It is necessary to ensure that assets that are hypothecated to the bank are properly insured with optimal coverage. In some cases, the quality of insurance cover is compromised due to commercial pressure from customers. If assets are not adequately insured, banks may lose out heavily in case of a loss.

In certain cases, banks buy policies without involving customers and the premium is debited to the customer’s account. Customers are not aware of what is covered and what is not as the policy copies are never shared with them. This non-participative and opaque insurance buying process results in poor risk transfer outcomes for the customer when there are claims.

Avoidable Conflict

It is not an easy task to integrate the business of two sectors which are quite different. Though the RBI had permitted ‘insurance’ as a permissible form of business for banks, it is felt that banks as lenders and sellers of insurance products should be ideally kept at arm’s length. The mixing of two functions can create an avoidable conflict of interest and lead to poor risk management.

Instead of carrying out insurance broking/corporate agency services, many banks prefer to be equity partners so that they have better control over the ecosystem. Initially, the RBI allowed banks to set up subsidiaries/joint ventures with equity support up to 50% of the total holding. However, recently the RBI restricted the stakes of banks in the holdings of insurers/companies to 30%. This would shield banks from the risk arising out of their non-banking business and ensure that the focus is on boosting credit growth in a slowing economy.

Their business activities are quite different too. Insurance is a ‘long term’ business and capital gets locked up for longer cycles than banking. If banks get deeply involved in the insurance business, their core functions such as lending and other banking activities would be seriously affected as cash flow cycles of insurance may not be conducive to the needs of banking.

Insurance and banking are two different verticals regulated and controlled independently by two different regulators. Keeping them separate with adequate facilities for them to work together smoothly will go a long way in the development of both sectors.