My phone rings. It is an uncle who has just turned 60 wanting to know if he was doing the right thing with his retirement corpus. He’d called in a neighbour’s kid for advice. The kid works in a large private sector bank. She offered a bouquet of unit-linked insurance plans (Ulips) at once. Not a single premium plan or even an annuity, but a regular premium 100% equity-oriented Ulip that would need a premium infusion each year for the next 10 years.
A cameraman in a television station where I did a regular show last year came up with his portfolio of funds to ask if he had done the right thing. His salary account bank had sold him one fund that invests overseas and one that invests in the infrastructure sector. The banker would have known that his monthly income flow was less than Rs20,000 a month. He would have noticed that the customer was not financially smart and was going more by his trust in the bank than by an offer document he did not understand. The cameraman, with zero appetite for risk, had been sold the riskiest funds in the market.
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My driver, overhearing my conversations (he is not supposed to, but what to do), tentatively asked if I could examine his insurance policy. No surprise there, he has a 100% equity Ulip sold by his previous employer, who was an agent by evening and weekend and government employee by weekday. He says he bought a three-year product and can’t see himself funding it for the next 10 and mutters under his breath that he should have crashed her car before leaving.
Mis-selling is a touchy subject with regulators. The banking regulator waits for complaints to build up to a certain level before it will appoint a committee that will gently ask banks to reform. And then it may take another 20 years for regulation to come. The insurance regulator is in denial. Mis-selling, it believes, is a figment of the media’s collective imagination. Its 15-day free-look period makes sure that there are “very very few cases” of mis-selling. In the mid of this denial and feet-dragging, the securities market regulator has gone ahead and belled the cat. Work is in progress to find a systemic solution to the mis-selling problem. Of course, for the market as a whole this will work best when we replace the words “mutual funds” with “all retail financial products”, but then that is some way off. At least what we have is a start.
The first step in putting out a framework that seeks to curb mis-selling is to club financial products in baskets. The baskets could be sliced in many ways—there can be a basket of all products that work for the accumulation stage of a person’s financial life, like equity funds. There are products that work for the retirement phase of a person’s life, like a monthly income plan. Within each basket there is a further gradation of risk. Within the accumulation basket there can be low-, medium- and high-risk funds. Index and exchange-traded funds on the market benchmarks of the Nifty and the Sensex will fall into the low-risk equity basket. Those with a slightly higher risk attribute will be the managed large-cap and diversified equity funds. The medium-risk basket may have balanced funds. The sector funds, mid- and small-cap funds and index funds on them could be in the high-risk accumulation basket.
Now look at a system of profiling investors. Attributes such as age, stage in life, existing net worth, risk-bearing capacity and goal of investment will go into compiling a profile of a person. The product and person profiles can now be matched. A typical profile will look like this: a 30-year-old, growth-seeking investor, who generates a surplus that is higher than his spending but does not like to take much risk with his money, is a typical candidate to be offered a product out of the medium-risk accumulation basket.
But what happens when you get a case this like: a 60-year-old retired person whose wife still has six years of service left. His living expenses are adequately covered by his current family income and then from their combined pension. Their house on rent gives an additional spending elbow. His goal is make a cushion for emergencies and then aggressively grow his money to leave his kids a legacy. A dumb profiling system would try and nudge this person to the medium- or even high-risk retirement basket. But his goal is actually accumulation.
Any profiling and suitability system that is conceived will have to deal with issues like this. The aim would be to allow the exceptions to the profiling process to buy what they want, but not allow the current mis-sellers (banks and national distributors) the exception loophole to circumvent the regulation. This is where an effective system of documentation will come in handy. To repeat a story that has become an urban legend, a planner in an Australian bank was made to pay damages to the widow of a customer who was not advised “strongly” to buy a life cover. He was advised cover. He declined. Died. Widow sued. Judge looked at the document trail that recorded the sales transaction and said that the push for a life cover was not as “strong” as it should have been.
The Indian rules are still being written. If you have a view or a suggestion on how India will solve the last mile regulation problem, write in.
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.