Rs1 trillion. That’s just a small introduction to the full extent of investor funds lost due to badly sold life insurance products in India. We’re used to investors having issues with stock market-related events, but a growing mass market in retail financial products introduces us to the first large-scale investor issue in retail financial products. If the subprime crisis was the result of badly constructed and mis-sold home mortgage products, life insurance products in India are on the same road. They are badly structured and are being mis-sold.
What would you call a product that allows an investor to walk in, but not walk out, without losing his shirt? A trap. Life insurance products in India are traps. Insurance regulation allows insurance companies to collapse sales commissions over 15-30 years into the first year. What would have been a Rs5 annual commission on a Rs100 premium each year for 15 years, becomes a Rs40 (legally, though illegally it is up to Rs60) commission in the first year. The agent commission, thereafter falls to between zero to Rs10 per year. It is an economic decision for the vendor of the product to make Rs40 each year by selling fresh load-bearing policies each year, rather than service the low income-generating old ones. A floating agent population (private insurers appointed 943,000 agents in 2008-09 and terminated 677,000) does this with impunity as it moves across companies hitting investors with products and running.
Illustration: Jayachandran / Mint
When investors realize their error in buying a product they did not understand fully and turn to product details, they find they are caught in a trap. Regulation ensures that they lose the first- and second-year premium fully and get a tiny fraction of their total investment after year 3. Life insurance products take up to 10 years before they work for investors. People who stopped paying premiums after year 1 in India in 2008-09 contributed Rs1 trillion as agent income and to insurance companies, some of whom are sitting on hundreds of crores of rupees as income from lapsation. Could a part of this corporate income be wilful? And these are just the numbers for traditional policies. Add the figures from the more popular unit-linked policies, or Ulips where lapsation rates are said to be around 40-50% for private insurers, and we could be looking at a multiple of this number. This is pure retail money down the drain. Also down the drain is retail investor confidence in insurance, markets and financial products. The damage could cost India its pace of growth as domestic funds will scare away into unproductive assets.
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