In a conversation with this reporter, an official from the Ministry of Finance, who did not wish to be identified, admitted that rampant misselling in the life insurance industry has been a matter of concern for the ministry for some time now. “Misselling has always been on our agenda and the kind of money that investors have lost is worrisome. I think it is deliberate on the part of the insurers to not publish how much the investors have lost but we will now take it up with the insurers,” he said.
That insurance policies have been missold in the past years is a known fact. But this murky reality has always existed without a crucial link—the impact of misselling could never be quantified. For an industry that has been privatised for now 12 years and is still fighting the ills of misselling, it is unfortunate that it still does not publish the losses faced by investors. However, Mint in its research has estimated a loss of Rs.1.5 trillion to the investors from FY05 to FY12.
What has led to misselling?
While it can’t be denied that product structure, which until a couple of years ago favoured the insurer, is one of the main reasons why misselling has continued unabated, lack of accountability and incentive structure have also contributed equally. “The insurance regulator is extremely weak in penalizing the industry. Owing to a weak regulator and the legal system there is a sense in the industry that they can get away. It should not be so,” says Bejon Mishra, Consumer Online Foundation, an organisation that works in the field of consumer protection.
The incentive structure has also encouraged misselling. “Investors don’t lose out because of insurance products, they lose out because of misselling. And this can be checked only if you incentivize the agent to sell for the long term. With front-loaded commissions what incentive are you giving an agent to service an insurance policy for the long term or even sell the policy for the long term?” asks Deepak M. Satwalekar, former managing director and CEO, HDFC Standard Life Insurance Co. Ltd.
It is true that commissions are front-loaded and since the incentive structure is provided by the Insurance Act, 1938, insurance companies are bound by the regulations. According to the Act, for an insurance company that is less than 10 years old, the agency commission for life insurance policies in the first year can be up to 40% of the premium. In the second and the third years, the insurance company can pay a renewal commission up to 7.5% of the premium and 5% for the rest of the policy term. For insurers who have been around for more than 10 years, the first-year commission is capped at 35%.
What should be done?
On the product front, the costs in the widely missold unit-linked insurance plans (Ulips) have been capped and the sting has been taken out of early exits from the policy. Traditional plans, too, which are gaining traction, are expected to undergo similar changes anytime now.
But there is still room for improvement. “Insurance companies should publish the list of the bottom five products that have had the maximum number of lapses/surrender. If a product is listed in the bottom five for three years or more, the Insurance Regulatory and Development Authority or Irda should get the insurer to stop selling that product,” says Lalitha Jayabalan, a Mint Money reader, who is also a Chennai-based certified financial planner.
And the government has a role to play, too. “The government should consider appointing a body with an exclusive task to audit the accounts of insurance companies on a yearly basis. Upon finding malpractices such as moving lapsed money to the profit and loss account, strict action should be taken,” says Jayabalan.
But the biggest piece of misselling—distribution—is still not being addressed the way it should. “The legislation around commissions needs to change. They are so many years old and are not relevant to the current situation. We need to put more focus on renewals to ensure persistency. The legislature needs to be a part of this change,” says Satwalekar.
Harsher penalties for wrongdoers should also be in place. “One has to use a carrot and stick approach. Commissions should be allowed to be spread over the life of the policy, but there should be stringent action against the defaulters. Termination of license, claw-back of commissions, and persistency driven commissions are some solutions to misselling,” says Sanket Kawatkar, practice leader (life insurance), Milliman India Pvt. Ltd, an insurance consultancy firm.
Moreover, the complaint mechanism needs to be strengthened. “There is already a consumer rederessal cell within Irda. That should be strengthened and wherever misselling can be proved, class action suits should be taken,” says Satwalekar. And it’s already happening in developed countries. The Financial Services Authority (FSA), regulator of financial services industry in the UK, has ordered major banks in the UK to compensate customers who have been missold financial products. This compensation goes into billions of pounds.
But it may be difficult for victims of insurance misselling to recover their money simply because it is almost impossible to establish misselling. “How do you establish misselling. At the end of the day the customer signs the proposal form that has policy details. Unless the signatures are forged how does one prove there is misselling. So to compensate the victims here may be a far-fetched idea,” says Kawatkar.