Buyers of insurance and mutual funds have for long been treated as suckers. Insurance and mutual fund companies appoint agents to sell their products to investors, but do not pay these agents. That is done by investors, at rates decided by the manufacturers of financial products.
Illustration: Jayachandran / Mint
The result is rampant misselling of financial products by agents whose interests are aligned with financial companies rather than investors. It is common to see people hold the most expensive insurance policies and high load mutual funds just because agents have incentives to dump precisely such products on clients.
It is good to see some initial moves to curb such practices. The Securities and Exchange Board of India has already asked mutual fund companies not to load their distribution costs on to investors. A committee headed by Pension Fund Regulatory and Development Authority chairman D. Swarup has recommended that insurance buyers should not be asked to pay agent commissions that can be as high as 40% of first-year premiums.
These changes in the rules of the retail finance game were long overdue. It should not surprise anybody that mutual fund and insurance companies are not happy, since they will now have to bear distribution costs and hence settle for lower profits.
The issue is that there could be short-term problems. The most intractable problem in many financial services is laying out the last mile to the consumer’s doorstep. Agents are foot soldiers who often use local networks and knowledge to sell financial products, something suits sitting in offices would find hard to replicate.
But the sheer potential size of the Indian retail finance market should be incentive enough for financial firms to start paying distribution costs from their own capital. Most of the big players are in the game for the long term and are bound to see that volume growth will be more than enough to make higher costs worthwhile.
What happened in the stock market over the past 15 years is a telling parallel. Brokerage rates used to be as high as 3% of the transaction value; they have since dropped to as low as a few basis points as a result of stock market regulatory reform. But volumes exploded and brokerages are doing roaring business, despite the inevitable ups and downs in equity prices over this period.
The point is that lower transaction costs usually expand a market and make it more efficient. The same is likely to happen in mutual funds and insurance as well—despite the obvious short-term costs.
Who should pay for distribution costs in retail finance: the seller or buyer?
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