Photo: iStock
Photo: iStock

New rule on market conduct does little to curb insurance mis-selling

Insurers should ideally disclose the actual return on investment in life insurance

More than a decade ago, a senior citizen (then 64 years of age) bought a unit-linked insurance plan (Ulip) in anticipation of bumper market-linked returns on his investments with the added advantage of insurance. Virender Pal Kapoor, a retired scientist living in Lucknow, paid 50,000 towards a single-premium Ulip that came with a lock-in of five years. Kapoor was shocked to find out that in five years, his investment of 50,000 was reduced to 248 and one of the primary reasons for this dismal erosion of wealth was the mortality cost or cost of insurance that’s understandably steep for older people.

Kapoor dragged the insurer to court (you can read the story here) but his experience exposes two major blind spots in regulations that govern sales practices in the life insurance industry: lack of proper disclosures and suitability assessment. Kapoor is not alone, but just one example of how a fat incentive structure coupled with lax sales regulations of complicated financial products can lead to mis-selling.

So when the latest guidelines on market conduct was put out by the Insurance Regulatory and Development Authority of India (Irdai), it felt like a huge opportunity to set some of the things right in the sales practices of the intermediaries. However, a closer look brought home huge disappointment. Mint’s personal finance team that keeps consumer interest at heart, has been asking for greater disclosures to improve the level of transparency in an otherwise complicated product that is the insurance-cum-savings plans. And one way to do that is to publish returns in the benefit illustration document of an insurance policy.

When disclosures cloud understanding.
When disclosures cloud understanding.

A benefit illustration is a year-by-year summary of costs and benefits in a bundled life insurance policy meant to help policyholders understand their investments better. In Ulips, the more transparent brethren of traditional plans, the benefit illustration gives you a detailed description of how much the insurer deducts from the premium by way of fund management charge, mortality charge and other administrative costs; it also gives the net corpus left at the end of the year at assumed growth rates of 4% and 8%.

The idea is to show how costs eat into the fund’s performance, but this simple summary of cost and benefits showcased through a benefit illustration became problematic when in 2010 the policy regulations capped the costs in Ulips by defining the maximum reduction in yield—the difference between the gross and net yields. So if the fund grew by, say, 8%, the reduction in yield, say, for a policy term of over 15 years couldn’t be more than 2.25% or the net yield would have to be at least 5.75%. The regulator also made it mandatory for the insurers to show this net yield in the benefit illustration. However, this did more damage than good because the calculation of this net yield leaves out certain costs like mortality charges (cost of insurance) and guarantee charges.

Of course, for the purpose of cost caps, including insurance charges is impractical because the charge would vary depending on the age of the policyholder, but allowing for the same net yield to be showcased in the benefit illustration for, say, a 50-year-old as well as a 30-year-old, when in reality the net yield for the older person would be much lower given the high mortality cost, distorts the net return for lay investors. Kapoor, for instance, paid dearly for buying into a plan that bundles insurance by default. By allowing the same method to calculate the net yield, even in the new guidelines, the regulator is asking the policyholder to make sense of investment return by looking at the fund value accumulated alone. But imagine the confusion it will cause when you look at the paltry fund value, but an impressive net yield on the same benefit illustration? In the current scheme of things, the regulations expect the buyers to be aware and smart.

We flagged this issue way back in 2010 and have been consistently pointing out how showcasing net yield that doesn’t factor in all costs does more damage than good. Nearly a decade later, nothing has changed. In fact what’s also pending is a similar treatment for traditional plans especially non-participating products that guarantee investment benefits upfront. To be fair, the new rules now mandate the benefit illustrations to carry the surrender value at the end of each year, but given the high surrender costs, an improved level of disclosure should also mean showing the net return on these surrenders. In fact, an official privy to internal discussions mentioned the topic was up for debate but upon realizing that this would translate into a negative net return for many years initially, the idea to put another column of IRR (internal rate of return) next to surrender value was quashed.

Benefit illustration is a disclosure document that makes prospective customers aware of how costs eat into the investment corpus and in the spirit of disclosures, insurers should ideally disclose the actual returns. Very few insurers follow this as best practice. The regulator, of course, shouldn’t bank on the insurer’s intent, but hard-code rules for fair and proper disclosures. So in that sense, the recent market conduct guidelines, applicable from December, was an opportunity missed. The guidelines also talk about suitable sales, but isn’t fair disclosure the first step?

Deepti Bhaskaran is editor, personal finance, Mint

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