So it comes to pass. The ministry of finance, which could have laid to rest the uncertainty that faces millions of retail investors, in the best tradition of bureaucratic ennui, has passed the buck to the courts to sort out the differences between the capital market and insurance regulators. While the post-retirement sinecures are no longer at threat due to bold decisions the ministry could have taken, this example of cynical buck passing will cost India in terms of the lost opportunity of fixing the retail financial market.
The seeds of the conflict between the Securities and Exchange Board of India (Sebi) and the Insurance Regulatory and Development Authority (Irda) began when, around 2002, the insurance regulator suddenly banned life insurance companies from outsourcing fund management to asset management companies.
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Insurance companies such as Tata AIG Life Insurance Co. Ltd, HDFC Standard Life Insurance Co. Ltd and ICICI Prudential Life Insurance Co. Ltd used the fund management services of mutual funds such as Templeton Asset Management (India) Pvt. Ltd and Prudential ICICI Asset Management Co. Ltd and focused on their core business of life insurance. That is the global standard, where an insurance product gets “wrapped” around a mutual fund for those who want bundled products.
The Irda notice shocked the industry because this meant that each insurance company would have to set up a full asset management function, duplicating what the mutual funds were doing. On digging around, it was found that the decision was influenced by two large insurance companies— one Indian and one with a foreign name. The then chief executive officer of the foreign company used to genially boast about how he wrote the guidelines on unit-linked insurance plans (Ulips) for Irda. In fact, when the issue does go to court, they could examine some strange notices passed by Irda during those years. And trace their origin to notes prepared by some companies that became notices almost verbatim.
Had that rule not been changed, and if insurance companies had continued outsourcing fund management to mutual funds, the Sebi rules for fund management would have gradually prevailed, as both industries matured. And this leads directly to the next question. Are the Sebi rules for mutual funds good? I seriously doubt that anybody can find fault with the current state of mutual fund regulation in India. We’re at the cutting edge, and I don’t say it, the global businessmen who are setting up shop in India say it. In the last few months, whenever I have spoken to financial experts from the US, the UK, Singapore or Hong Kong, they have only one thing to say about the Indian mutual fund industry: it is the one with the best regulations in the world. What do they like? The no-loads structure that takes the conflict of interest away from selling the product with the highest commission and makes the agent really work for the investor rather than the mutual fund. This agent-principal conflict is currently the subject matter of a global debate and seeks to turn even the broker-dealer into an “adviser” since the product he sells carries a load. The Indian mutual fund industry is a global first to achieve a no-load structure.
The other pieces are also in place. There is just one other cost that investors need to worry about—the annual asset management charge. By comparing the performance track record and looking at one cost number, the investor can get the key information about a fund she wants to buy. She can compare products, choose on the basis of similar parameters and exit the fund at no cost.
Now look at the Ulip product. It has deception at its very core. It is sold like a mutual fund, with an insurance cover thrown in gratis. The key advertising pitch is around corpus growth and not life protection. The costs keep getting hidden away under various heads. If it was a front load earlier, it is administration costs now. Worse, there is nothing that prevents the bank “relationship” manager, who has sold a front-loaded product, from churning his customer to another front-loaded product after the first few years of high commissions pass.
But, argues the insurance industry, life insurance is difficult to sell, so we need high first-year front-end commissions. Just the fuel component of an agent’s costs is quite high as he makes repeated visits.
For the sake of argument, if we were to accept the public good of a tough sales pitch to sell a life cover to unwilling customers, then surely the investment component of an average Ulip would not be 98% of the total premium, with less than 2% going to pay for the insurance cover, as it does today? I think we should flip the question to ask: Could it be that the product is difficult to sell because there is something wrong with a Ulip? Could it be that the regulator is colluding with the insurance industry to sell retail investors a lemon? Listen to any financial planner—the people who work largely on a fee model rather than a commission model—and you hear the advice: Don’t buy a Ulip in its current form.
Monika Halan works in the area of financial literacy and financial intermediation policy and is a certified financial planner. She is consulting editor with Mint and can be reached at firstname.lastname@example.org