It takes 4 zeros to cause a blowout

This is a story that has been waiting to build scale, to add the four zeros it takes to gather the critical mass to declare something a scam, a bubble, trouble or just messy management. On Tuesday, Mint broke the story about the notional ₹ 14,000 crore valuation deficit in three plans run by Life Insurance Corp. of India (LIC) and about the ₹ 120 crore loss in the LIC-sponsored LIC Mutual Fund (LIC MF). While the ₹ 46,000 crore solvency margin money will take care of the insurance hole and protect policyholders’ interests, this is a good time to open up the mutual fund piece and take a close look at how that business is run. And to ask what the government will do to stop the localized problem from becoming systemic in the insurance company.

Also Read Monika Halan’s earlier columns

That something was wrong with the way LIC MF was run has been clear to those covering the area. Mint mutual fund editor Kayezad E. Adajania had, in fact, scooped the mess in LIC MF in 2008 (http://bit.ly/9vEo90) where he found that the fund had invested in dodgy real estate bonds to indicate high returns on its fixed maturity plans (FMPs). When the 2008 bust-up took place and LIC MF was left with a hole in its FMP portfolio, the parent firm had to bail out the fund by buying the illiquid paper—some of it from dodgy companies with less than investment-worthy credit ratings. Mint had reported the ₹ 1,755 crore bailout by LIC of LIC MF (http://bit.ly/bNPlH2) in December 2008. The question that went unanswered at that time was this: Was the policyholder’s money used to bail out dodgy management decisions? May be now will be a good time for the three-member ministry of finance panel looking into the issue to get an answer to this question as well.

It also looks as if few lessons were learnt from the 2008 blow-up. LIC MF has the rare honour of actively managing its index fund—a fact admitted to this newspaper on condition of anonymity by those that run the fund. An index fund’s business is to mimic the index as perfectly as possible and not take active stock calls. To actively manage an index fund is changing the investment mandate of the fund and is against the rules of mutual fund investing.

A third question that those who are examining the running of the insurance firm and its mutual fund arm is this: Why do LIC MF’s equity-oriented funds find themselves at the bottom of the performance pile with all of its 10 equity and balanced funds at the bottom quartile of performance? A Value Research ranking (http://bit.ly/cp7sF9) shows that LIC MF’s equity funds are the worst or the second worst performing funds in their categories. In fact, its Sensex Advantage fund has the privilege of being ranked 30th out of 30 funds, delivering 5 percentage points less than the benchmark it tracks!

Government-owned large companies, especially if they were monopolies in industry segments, have this problem. Of believing that they are outside the regulatory system. India’s first mutual fund, the government-owned Unit Trust of India (UTI), used its special position to remain outside the regulatory purview of the capital markets regulator till 2002 while all other mutual funds had to abide by the 1996 Securities and Exchange Board of India mutual fund regulations. Not having to mark its assets to the market, UTI managed to lose money and hide it. When the scam finally broke, it cost investors money and trust. And the taxpayers ₹ 14,500 crore in the form of a bailout package by the government to salvage what was left. The same error of keeping the erstwhile insurance monopoly outside the regulatory framework was not made in the case of LIC. But the problem was more nebulous. The insurance regulator was populated heavily in thought and personnel by ex-LIC staff who had deep ties with their erstwhile organization.

The larger issue in this story is the role of the government as the owner of LIC and the insurer having the war chest to bail out floundering issues or stock markets, and the government’s unwillingness to address an issue till it acquires many zeros. While it is true that the ₹ 14,000 crore hole is not even a dent in the ₹ 12 trillion asset base of LIC, it takes little time to add a few zeros if a problem is left unattended, like it did in UTI. Now that the spotlight is on the company and its subsidiaries, it may be a good time to clean out the fund business as well as get the insurance piece more in sync with markets that are more open than before.

Monika Halan works in the area of financial literacy and financial intermediation policy and is a certified financial planner. She is editor, Mint Money, and can be reached at expenseaccount@livemint.com