Abstract: The rising rate of policy lapsation and surrender in the life insurance sector is creating challenges for insurers’ financial stability, market discipline, and consumer protection. Economic instability, mis-selling, poor customer service, and an excessive upfront commission-based sales culture are among the major causes of this issue. In this context, the “Commission Clawback” system seeks to improve the quality of sales by making agents accountable for policy persistency. Since the current Insurance Act 2079 does not contain a clear provision regarding Commission Clawback, it appears necessary for the Nepal Insurance Authority and insurance regulators to revisit this issue in order to build a healthier, more responsible, and sustainable insurance environment in the years ahead.

Across global life insurance markets, distribution systems are generally commission-based, where agents and intermediaries receive significant upfront commissions immediately after selling a policy. However, life insurance is inherently a long-term financial contract, and if a policy lapses or is surrendered during the initial years, insurers may face substantial financial imbalance. Insurers incur commission, underwriting, administrative, and distribution costs at the beginning, whereas the expected premium income is realized only over the long term. For this reason, many countries around the world have adopted “Commission Clawback” or “Chargeback” systems through regulatory or contractual arrangements.

The primary objective of Commission Clawback is to make agents accountable not only for sales but also for long-term policy persistency. Under this system, if a policy lapses or is surrendered within a specified period, the agent is required to return part or all of the commission received. This mechanism discourages short-term sales-oriented behavior and prioritizes long-term customer interests.

“High lapsation and surrender rates are not solely the result of customers’ financial problems; they are also directly linked to mis-selling, weak financial advisory services, and a short-term sales culture.”

In reality, high lapsation and surrender rates in the life insurance sector are not merely caused by customers’ financial difficulties. They are also associated with mis-selling, inadequate financial advice, excessive upfront commission structures, and weak sales ethics. In some cases, agents sell policies without properly assessing customers’ actual needs, income capacity, or long-term financial obligations. This increases the likelihood that customers will be unable to continue premium payments in the initial years, leading to policy lapsation.

Globally, the average lapsation and surrender rate in life insurance ranges between approximately 15%–25%, while in Nepal, the average rate across different companies is also estimated to be around 20%. Such rates raise concerns regarding the quality of the insurance market, the level of customer awareness, and the sustainability of the distribution system.

Major Area	Causes of Rising Lapsation and Surrender	Possible Impact
Economic Condition	Declining income, unemployment, inflation, and cash flow problems	Difficulty in paying premiums regularly, rise in early lapses
Sales Practice	Selling policies without understanding customers’ needs, risk-bearing capacity, and financial goals	Increase in mis-selling and probability of early surrender
Financial and Insurance Awareness	Lack of understanding regarding long-term insurance benefits, surrender loss, and policy value	Short-term decision-making and weakened long-term financial protection
Customer Service and Follow-up	Lack of regular servicing, reminders, and policy counselling by insurers or agents	Customer dissatisfaction and policy discontinuance
Behavioral Factors	Immediate cash needs and short-term thinking	Weak savings discipline and increased surrender rate
Market and Commission Structure	Excessive upfront commissions and short-term sales-driven culture	Policy churning, high lapse ratios, and weak market discipline

 

In this context, it is not appropriate to view Commission Clawback solely as a punitive mechanism. If properly designed, it has the potential to improve market discipline, sales quality, and consumer protection.

 

International Practice

Country	Clawback Period	First-Year Lapse	Second-Year Lapse	Regulatory Nature
Australia	2 years	100%	60%	Strictly regulated
Canada	1–3 years	Up to 100%	30–60%	Contractual
United States	1–5 years	100%	50–80%	Contractual
United Kingdom/Europe	1–2 years	Full or partial	Partial	Regulated
Nepal	No provision	Undefined	Undefined	Lack of legal provision

 

Australia’s Life Insurance Framework is considered one of the strictest examples implemented globally, where 100% of commission must be returned if a policy lapses in the first year and 60% in the second year. The objective is to discourage short-term sales culture and ensure long-term customer protection.

In the context of Nepal, the current Insurance Act 2079 does not contain any clear legal provision regarding Commission Clawback. Although some insurers may have internal arrangements, there is no standardized market-wide system. As a result, the evaluation of agents still tends to be largely based on new business premium rather than persistency or policy retention. This situation may affect insurers’ financial stability. Failure to recover initial acquisition costs can put pressure on profitability, create challenges in capital management, and weaken consumer confidence over the long term. Moreover, policyholders themselves may suffer financial losses when policies are surrendered early, which can further create negative perceptions toward insurance.

“In life insurance, growth in new business alone is not sufficient; long-term policy persistency is the true measure of the quality of the insurance market.”

Role of Stakeholders

Stakeholder	Expected Role and Responsibility	Expected Impact
Insurance Companies	Transparent information flow, digital reminder systems, persistency-based incentives, effective customer service, and grievance handling	Improved customer satisfaction, better policy retention, and reduced lapse ratio
Agents / Agencies	Need-based selling, regular servicing, and ethical sales practices	Reduction in mis-selling and improvement in long-term policy persistency
Policyholders	Selecting policies according to income and financial capacity and paying premiums regularly with a clear understanding of long-term objectives	Strengthened financial security and reduced surrender loss
Regulatory Authorities	Strengthening persistency monitoring, disclosure requirements, consumer protection frameworks, and market conduct supervision	Improved market discipline, transparency, and consumer confidence

However, the Commission Clawback system also has its own challenges. Excessively strict clawback provisions may create income instability for small agents and reduce the attractiveness of the sales profession. Therefore, a balanced approach is necessary while implementing such a system. Rather than being treated only as a punitive measure, clawback may be more effective if linked with a persistency-based incentive system.

In Nepal, Commission Claw back could become a suitable option for reducing lapsation and surrender rates in the future. However, its implementation should be based on a clear legal framework, transparency, and a phased structure. For example, necessary amendments to the Insurance Act 2079 could introduce provisions requiring 100% clawback in the first year and 60–70% in the second year. Alongside implementation, strengthening customer awareness and financial literacy would also be essential.

“Commission Clawback is not a complete solution, but it can serve as an effective policy tool for improving sales quality, increasing policy retention, and strengthening consumer protection.”

In conclusion, Commission Clawback is not a complete solution, but it can become a useful policy instrument to control the growing lapsation and surrender rates in the life insurance sector. International experience demonstrates that such systems can improve sales quality, increase policy persistency, and strengthen consumer protection. In Nepal’s context as well, if a balanced and practical clawback mechanism is introduced through appropriate amendments to the Insurance Act 2079, it could make a significant contribution toward building a more sustainable, responsible, and reliable life insurance market.

Assistant Director
Nepal Insurance Authority

(This article is based on the personal views of the author and does not represent the official position of any institution.)