Why LIC chief is more worried about the agents than policyholders

Vivek Kaul
Seth Godin, one of the leading marketing gurus of the world, talks about the rock n roll band The Rolling Stones in one of his blogs.
Keith Richards (guitarist and vocalist of The Rolling Stones) tells a great story about Charlie Watts, legendary drummer for the Stones. After a night of drinking, Mick (Jagger, the lead vocalist of The Rolling Stones) saw Charlie asleep and yelled, “Is that my drummer? Why don’t you get your arse down here?” Richards continues, “Charlie got dressed in a Savile Row suit, tie, shoes, shaved, came down, grabbed him and went boom! Don’t ever call me “your drummer” again. You’re my … singer. No drums, no Stones,” writes Godin.
As The Rolling Stones wouldn’t have survived without Charlie Watts and his drums, no insurance company can survive without the policyholders who go out there and buy there products. Then they pay premiums which keep these insurance companies going.
But the Life Insurance Corporation(LIC) of India clearly doesn’t seem to believe in this. In an interview to the Daily News and Analysis (DNA), D K Mehrotra, the Chairman of LIC, said that the Insurance Regulatory and Development Authority (Irda), the insurance regulator, should rethink its plan to reform the traditional products offered by insurance companies.
For the uninitiated insurance companies in India largely sell two kinds of insurance plans. These are the unit linked insurance plans(Ulips) and the other are the endowment plans. The endowment plans sold by insurance companies are typically referred to as traditional plans.
In an endowment policy the policy holder is insured for a certain amount. This amount is referred to as the sum assured. A portion of the premium paid by the policy holder goes towards this insurance cover. Another portion helps meet the administrative expenses of the insurer. And a third portion is invested by the insurance company on behalf of the policy holder. The investment is largely made in debt securities which are deemed to be safe. (For a more detailed discussion on endowment plans click here).
The interesting thing is that The Insurance Act 1938 allows insurance companies allows insurance companies to pay as high as 35% of the first year’s premium as commission to insurance agents. This means for every Rs 100 that is paid as premium in the first year as high as Rs 35 could go to the agent as a commission.
The insurance regulator, Irda, over the last few years has cracked the whip on the commissions that insurance companies can pay to their agents for selling Ulips. Ulips are essentially investment plans masquerading as insurance.
The fall in commission on Ulips has led to insurance companies and agents suddenly discovering ‘good’ attributes in endowment plans given that they continue to pay high commissions. In the days when commissions on Ulips were high LIC and its agents had taken to pushing Ulips in a big way.
As Mehrotra told The Economic Times in September 2011 “Earlier, we had Ulips and traditional products at a 60:40 ratio, which has now reversed.” This ratio has further fallen and the ratio of sales for LIC between traditional plans and Ulips is now 80:20.
Irda in its proposed reforms for traditional products plans to cut down on commissions on offer to insurance agents, as it had done in case of Ulips earlier. And if that happens sales of traditional plans which now get in the bulk of the premium for LIC will be impacted. “.If the existing ones(the products i.e.) have to be withdrawn, we will be at loss,” Mehrotra told DNA. As has been clearly seen in the case of Ulips, lower commissions have impacted sales big time. And that will happen with traditional plans as well once the monstrous commissions are cut.
This is something that Rajeev Kumar, chief and appointed actuary at Bharti Axa Life Insurance told www.moneycontrol.com sometime back. “if you cap charges and you apply the same logic as unit linked then these plans will have same fate as unit linked plans which means commissions will go down, if commissions will go down, distributors will not be interested and distributors are not interested, the market share of these products will go down,” he said.
The Committee for Investor Awareness and Protection had envisaged an era of totally commission free financial products in its reports a few years back. As the report of the committee had pointed out “All retail financial products should go no-load by April 2011. The pension product in the NPS is already no-load. Mutual funds have become no-load with effect from 1 August 2009. Insurance policies need to remove the bias towards selling the policy with the highest commission. Because there are almost three million small agents who will have to adjust to a new way of earning money, it is suggested that immediately the upfront commissions embedded in the premium paid be cut to no more than 15 per cent of the premium. This should fall to 7 per cent in 2010 and become nil by April 2011.”
While the commissions on almost every other financial product have fallen to 0%, the insurance companies continue to offer high commissions to their agents, at the cost of the policyholder who in the process gets lower returns.
But low commissions are not in the interest of the insurance companies neither is it in the interest of the government which needs LIC to buy the shares of public sector companies that it is trying to sell to bring down the burgeoning fiscal deficit. Other investors are not interested in buying shares being sold by the government.
When Mehrotra was asked by DNA in another interview if there was pressure from the government to buy shares “No, at least I have not experienced it. There is no pressure on me to buy any particular share,” he said. Being a government employee we couldn’t have expected him to say anything but this. A recent report in The Economic Timessays that the LIC lost over Rs 5,000 croreby buying public sector shares of ONGC, NMDC and NTPC.
Given this the last thing on the minds of Mehrotra and LIC is the policyholder who has bought the LIC policy. As Godin wrote in his blog “Who’s playing the drums in your shop?” In case of The Rolling Stones it was Charlie Watts. For LIC its clearly not the policyholder. 

The article originally appeared on www.firstpost.com on December 13, 2012 

(Vivek Kaul is a writer. He can be reached at
[email protected]

‘The average lifespan of good govts is just 7-8 years’

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When it comes to the growth sweepstakes, it’s like a game of snakes and ladders. It’s not easy for any country to avoid all the snakes, says Ruchir Sharma, head of Emerging Market Equities and Global Macro at Morgan Stanley Investment Management. Most recently he has authored the bestselling Breakout Nations – In Pursuit of the Next Economic Miracles.He generally spends one week a month in a developing country somewhere in the world. Based on those experiences he even refers to his book as an ‘economic travelogue’. Sharma was speaking a literary festival in Mumbai on Sunday. Here are a few excerpts from what he said.
The past has no prologue
One of the first rules of the road that I would like to set at the outset is that the past has no prologue. Because what we do is extrapolation and we take what happened in the past and draw straight lines out into the future and say this is what is going to happen in the future. That is just one of the basic rules that does not work.
If you look at it, there are very few countries in the world that can sustain economic success. Only about one third of all economies are able to grow 5% or more for on an average in any decade. Only about one third of the 180 economies in the world. Of the 180 economies in the world only about 35 are developed economies, everyone else is emerging.
What this basically means is that there are these countries which grow for a short span of time and then come back down. It is like the game of snakes and ladders. You sort of go up and get bitten by a snake and come down. Some countries find a lucky ladder and leap frog and get to the top. Very few countries are able to get to the top and very few countries are able to sustain economic success.
Given this, one of the biggest negatives against India at this point is that they have had such an extraordinary decade. And after this extraordinary decade the complacency had set in where we thought of demographics and other factors we would be able to cruise control and nothing else matters as far as growth is concerned and that really has been thrown out of the window.
The average life of a good government is seven to eight years
The other rule is that the average life of a good government is about seven eight years. Typically governments tend to do well for seven to eight years, maximum to a decade and after that the performance of the governments typically tends to decline. This is true even for Russia where the first two terms of Putin was relatively fine. In the UK Margaret Thatcher did very well for about eight nine years and was booted out after that. François Mitterrand faced something similar in France.
There are some exceptions like Lee Kuan Yew of Singapore who are outliers. Usually the average life of good government is seven to eight years and which is why we are concerned about governments that remain in power for too long and very concerned about countries which try and change the constitution to hold onto power for too long. Then there interest is only in ensuring that there power and vested interests are taken care of and they run out of fresh ideas.
So that is the thing with the current government that it has been in power for a long period of time. But typically after seven to eight years governments don’t do well. That is the life cycle. There are very few who do well for a decade or more.
Markets reform when in crisis
The other sort of rule that I have figured about markets is that they only tend to reform when they have their back to the wall. Crisis is what focuses your mind. Otherwise you have a boom, you fitter the gains away and then you sort of slide away and then try and stop it.
That is why I said that of the 180 economies in the world today only 35 are developed because very few are able to grow for a sustained period of time. So you get these sort of growth spurts because they don’t reform.
India’s case is very interesting to look at it. Every 10 years at the start of the decade India seems to consistently have a some sort of a macroeconomic crisis. This was there in the early 1970s, early 1980s, 1991, the early 2000s period when we had the tech boom bust cycle and the growth rate slipped. You can argue that this year has turned out to be similar. The good news for India is that every time we have this macroeconomic crisis or a threat or a currency weakness that is when we take to reform. In 1981 we did that under the IMF, in 1991 we did that, 2001-2002 the same thing happened and we seem to be doing that now.
Very few emerging markets have taken to reform in a proactive manner. They tend to reform with their backs to the wall and that is what China did with such an exception. China pro-actively reformed every 4 to 5 years and came up with some big bang reform. They were proactive about it and not complacent about it. You can argue that complacence is setting in now. But the last thirty years has been a stream of pro-activeness.
Premature populism is a bad sign
The other sort of rule is to look for is populism. This is one of the things which is very hard to say because it is politically incorrect, but building a welfare state pre-maturely creates the wrong incentives. Schemes like NREGA keep too many farmers at the farm. A mass form of populism which has taken place in India over the last ten years. On the other hand if you look at the successful economies like Korea, Taiwan or even China, they did very little in terms of the welfare state at this stage of their economic development. There focus was lets get grow, and make the pie big enough. And then we will share the the pie later.
Today you can argue that countries like Korea and Taiwan don’t do enough of a welfare state. The Korea story is very fascinating. It is one of the most equal societies. And it is a very well educated society and Korean women are very well educated. Yet their participation in the labour force is very low. And that is because many of them are not able to leave their children at home and go to work because they don’t have a good enough child care support system. They don’t spend enough on those kids. In Korea’s case I can argue they need more welfare and in India’s case I can argue that there is too much welfare.
Social spending as a share of GDP for Korea and India is equal even though Korea’s per capita income is more than ten times higher than India’s per capita income. So to have too much populism prematurely is a bad sign.
The billionaire’s index
One of the popular parts of the book that resonated with many people was the billionaire’s index. Forbes publishes a billionaire’s list in March. It sort pours over across the world to see who are the good billionaires, who are the bad billionaires and stuff like that. I think the key dimension will be to look at the billionaire’s index which is that you need to figure out that in case of how many of these billionaires the wealth has been created because they are genuinely productive billionaires. They are creating wealth in sectors such as technology, pharmaceuticals, manufacturing etc. When you have wealth created in those sectors you are respected but when you have wealth created in so called sectors where the benefit has happened because you had a good government connection, that is just not good. In India’s case we saw many such billionaires rise over the past decade which is what made me somewhat concerned. It is a bad sign for democracy as well .
Other thing to see in the billionaire’s index is that you need churn, you need new people to come up the list. You don’t need holders of the past always there. The third thing is that you need the concentration of the billionaires as a share of the economy to not be that high. That leads to resentment. Having said that India respects its billionaires a lot.
The James Bond moment
When I go and meet billionaires in countries such as Mexico, Brazil, or even Russia, in all those countries you have all these billionaires with a whole bunch of armed bodyguards. There are scared to go out on the streets on their own because they fear that they are going to be attacked. In places like Brazil, you will find a sale of luxury cars is quite low for a country of that size, because people are scared to display that kind of wealth. And if there are luxury cars they are all bullet proofed because they are scared about what is going to happen.
On the other hand Brazil tops the list of maximum number of helicopters sold. The only time I feel like James Bond is when I go to Sao Paulo in Brazil. In Sao Paulo the traffic is really bad but the permission to fly helicopters is quite easy to get unlike what happens in Mumbai.
My sort of James Bond moment is after you finish your meeting they will take you to the roof of the building where there is a helipad waiting for you, you run to the helipad, you take the helicopter and go to the next destination. And you see the aerial view of Sao Paulo and there is a whole bunch of helipads up there on top.
That is a sign. It is a sign of poor infrastructure and you are using these helicopters to short circuit roads and to sort of not care about what is happening on the street and take a helicopter across it. And then you got gated community where they you behind these fortresses. And I think that is just a bad sign. Brazil is the most extreme and my James Bond moment will remain and therefore I relish my trips to Brazil.
The Four Seasons Index
What I do not relish going to Brazil let me tell you are the costs. And this is one my other rules in terms of the cost with the Four Seasons index. I am fortunate that I get to stay in the Four Seasons hotel in all these countries. And I think its good benchmark to look at a country to figure out whether its cheap or expensive?
In Brazil when I go I find the rates are exorbitantly expensive. To get a top hotel on a trip to Rio de Janeiro you pay $800-1000 a night. And that is really exorbitant. You go to East Asia, places like Jakarta and Bangkok, you pay about $200-300 a night, and that is pretty competitive. In places like Brazil and Russia you pay $800-1000 a night. And the currency seems very expensive. My colleagues went to Brazil last year and one of them bought a a t-shirt. The t-shirt cost more than $100 and it did not last even a single wash. So terrible quality and you are like paying a huge price for that.
Hence, Brazil has been one of the big laggards because of expensive currency. This year the Brazil’s growth rate will be only 1%. When you have expensive currency it is bad news. India on the other hand one of the positive would be currently is that the currency is extremely competitive at this point of time.
But isn’t a weak rupee a sign of weakness?
People are concerned that this is a sign of real weakness in India and whether India is about to face a balance of payment crisis? Is money going to leave the country in a huge way because is the currency is quite weak?
One of the rules of the road I watch out for is that one of the first people who take money out of the country when they think that the country is going to face a crisis are the locals. And this is counter-intuitive because most people like to believe that its the foreigners who flee when they sight trouble.
So I am always watching what are the locals doing? Are they taking money out of the country? Or are they bringing money in? This happened in India in 1991. Similarly in East Asia in the late 1990s.
The good thing for India on a balance of payment front is that we don’t have too much outflow on that front. We don’t have mysterious outflows which show up on the RBI balance sheet. You know that is going on when the hawala rates are way way more expensive than what your official rates are. You don’t see such signs in India. So it seems that the currency weakness is happening in an orderly manner. The currency is adjusting for the overvaluation because of our inflation.
Efficient Corruption
The businesses are complaining about investing in India. They are saying that listen we are better off investing abroad rather than India because the cost of India doing business has become very high. So they are even going to places like Indonesia etc. So I asked one businessman in India, that isn’t Indonesia also very corrupt? So why are you investing in Indonesia? His answer was very interesting. But Indonesia is something what you call efficient corruption compared to India which is like in Indonesia if you pay money to somebody the work is done.
And I have got first hand evidence of efficient corruption. I went to Indonesia and I was struck in Jakarta in a traffic jam. The person who was taking me around Jakarta called a number up and without me knowing police escorts arrive. What you do there you pay a $100-200, and call up a number, police escorts arrive, who clear the traffic for you and take you to the airport. That is efficient corruption for you as far as that country is concerned.
The second city rule
One of the other rules that I looked for is the second city rule. If you look at all the successful economies across the world that whenever there is a growth spurt you get the rise of second cities in that country.
As far as India is concerned we don’t have one prominent city and everything else below that. We have four to five mega cities. And here is the difference with China. You look at India’s mega cities with populations of 10 million, 16% of India’s population lives in these mega cities. And that is why these mega cities are bleeding because that is way too high a number. You take the case of China 5% of the population lives in the mega cities of China .
The question is why? Because there has been a huge rise in the second -tier cities in China. If you look at the last fifteen year or so more than 20 second tier cities have come up in China. And second tier I define as cities which had a population of a less than 100,000 but now have a population of a more than a million. In India’s case only six such cities have come up over the last forty to fifty years. And that is the real difference and so there is big pressure on the big cities in India.
A 5% growth rate is a big disappointment
So is India going to be a breakout nation or not? And here is what I find quite fascinating as far as India is concerned. When the book came out this year, the general response was that by giving India a 50% chance of becoming a breakout nation, you are being too pessimistic.
And how I define breakout nations? I define breakout nations as those countries which are going to do better than other countries in the same per capita income class and countries which will grow faster than expectations.
So those are two my major major definitions of breakout nations. And why those two? Because if people tell me that if India grows at 5% what is the big deal because that is still faster than the US or many of the European countries. And my response to it is that is the wrong way of looking at it because if India grows at 5% per year, India’s per capita income is really low and it is far too low to satisfy India’s potential and for India to get people out of poverty.
And which is why India’s case of a 5% growth rate is a big disappointment and specially when you take into account that at the beginning of the year there was an expectation that we will do 9% this year.
A bit conflicted on India
On most countries in the book I was quite categorical. Like I was quite negative on Brazil as you have guessed by now. Even on Russia. I had a fixed view on China. On India I was a bit conflicted. I came out with the book and the most common response here was that are you being a bit pessimistic by giving it a 50% chance. Fine. Six months later by August, the response of most people was that you are being too optimistic on India by giving it a 50% chance of being a breakout nation. So that is how dramatically sentiment has swung on India this year. We went from euphoria on a straight line extrapolation. And how great we are. And how are going to concur the world.
And then there was complete disappointment by August. Last couple of months sentiment has shifted back again. The needle has shifted again. The good news is that expectations are much lower now for India to be a breakout nation.
Indian democracy versus authoritarian China
Gone is the story that how we are going to be the next China out there. One thing I find do disturbing is that a lot of people respond to this by saying you know the reason India cannot be the next China is because we are democracy. And that is the price we pay for being a democracy. China is a authoritarian state. It can implement reforms the way it wants. It can displace people and acquire land. It can set projects up.
India is a democracy therefore we have to pay a price by accepting a lower growth rate. And this argument irritates me. If you look at the high growth instances of the last thirty years, a high growth instance is a situation when a country is able to grow at 5% per year or more in any particular decade. And there are hardly 120 such cases over the last 30 years. How many of them were democracies and how many of them were authoritarian? Its a 50: 50.
For every successful China following an authoritarian regime, there are failures like Vietnam, which was built as the next China, and which has turned out to be a real disappointment, following the authoritarian system. A whole bunch of countries in Africa including the dictatorship of Zimbabwe have failed.
So what matters is the quality of economic leadership and not whether you are democratic or authoritarian. A lot of democracies have done well over the last twenty thirty years. Democracy lets remember is a relatively new concept in much of the emerging world and that is something that we should celebrate.
India is 28 countries with almost distinct identities
There are some state leaders in India who are able to do quite well because they are focussed much more on economic growth. And that to me is a real positive about India as to how India is emerging as a land of 28 independent states, almost 28 countries with distinct identities. We have many good state leaders and the relationship between economic growth and getting re-elected is increasing.
If you manage to grow above the national average and at a past faster than the preceding five years the chances that you as a state leader will get re-elected are extremely high. I think that’s the big message. So therefore you get states like Gujarat where you keep getting victories and then you get a state like West Bengal where you finally get defeated after a very poor performance. This is being backed by data over the last five years.
The picture for India for me is still one that is mixed. But it is improving and improving principally because our expectations have been balanced compared to where we were at the start of this decade. Gone is the era of straight line extrapolations. India still has a reasonable shot at being a breakout nation. But if we got to do it we got to do it state by state. This really is a land of 28 countries like no other emerging market I know. For example China is a very homogeneous society where as India is a lot more heterogeneous. And this bottom up model of economic growth state by state gives up the best hope. 

The article originally appeared on www.firstpost.com on December 11, 2012.
Vivek Kaul is a writer. He can be reached at [email protected]

Sahara’s numbers don’t add up: ads confuse, don’t clarify

Vivek Kaul and R Jagannathan
The Sahara group sure has a way with numbers. A separate number for separate occasions.
On 1 December this year, an advertisement issued by the group said two of its companies — Sahara India Real Estate Corporation (SIREC) and Sahara Housing Investment Corporation (SHIC), which fell foul of Sebi – had returned Rs 33,000 crore of money collected through optionally full convertible debentures (OFCDs).
The ad read: “We started OFCD in these two companies in 2008/2009. Most of the money deposited with us was for 5 to 10 years. But now we have cleared around Rs 33,000 crores liability.”
On 5 December, a Supreme Court bench headed by Chief Justice of India Altamas Kabirextended the deadline for repayment till February. It ordered Sahara to pay Rs 5,120 crore immediately to Sebi, Rs 10,000 crore by January, and the rest by February. This suggests that the court still thinks nearly Rs 25,000 crore may be owed to investors.
A Sahara ad released on 9 December claimed it owed investors only Rs 2,620 crore as on date. It mentions that “Total liability was around Rs 25,000 crores of both the OFCD companies” (N
ote: since there are no dates, nothing can be verified), but then says only Rs 2,620 crore of this Rs 25,000 crore was left unpaid, for which it had given Sebi a cheque – adding an extra Rs 2,500 crore in case there were any discrepancies.
Sahara has a lot of explaining to do. The group, whose attitude has been described as “shaky” by the Supreme Court, is not telling us the real story.
The Supreme Court judgment of 31 August 2012 takes note of an outstanding of Rs 24,029.73 crore as on 31 August 2011 between the two companies that was owed to 29.61 million OFCD investors.
 (Read the full judgment here)
One wonders at what point did Sahara managed to pay investors Rs 33,000 crore when the figure was only around Rs 24,029 crore in August 2011?
The only way the group could have repaid Rs 33,000 crore over the lifecycle of the OFCD investment was if there was a huge churn even in the initial years of the scheme in 2008-11. Sebi banned them from continuing the scheme in June 2011.
Sahara offered investors three types of bonds through SIREC – the Abode 10-year bond, where early redemptions were possible only after five years; the Real Estate bonds of five years, where no early redemptions were possible; and the Nirmaan four-year bond, where redemptions were possible after 18 months.
The bulk of the investors opted for the first two bonds – Abode and Real Estate, where no redemptions were possible for five years. Since the SIREC OFCDs were issued only from 2008 (SHIC began only towards end-2009), how is it possible that such a large bulk of OFCDs were refunded to investors when they were not due?
Firstpost noted earlier, a majority of SIREC’s investors (13.036 million) preferred to invest in Real Estate bonds worth Rs 7,120 crore. And Abode bonds came in for second preference, as 7.06 million invested in them, but the amount invested was larger at Rs 8,411 crore. Nirmaan bonds had a small following of 13.06 lakh investors with an investment of Rs 1,959 crore.
The big question is this: how can Sahara claim that it repaid nine-tenths of the money collected (only Rs 2,620 crore left out of Rs 25,000 crore or more) when the two biggest OFCDs issued by SIREC did not have any clause for premature encashment before five years – which meant only in 2013 and not earlier?
There was, of course, a provision for premature refunds in case of deaths, but Sahara is not claiming that most of its investors had passed away during the term of the OFCDs.
The refund patterns disclosed in the Supreme Court’s judgment tell their own story.
Of the total amount of Rs 19,400.87 crore collected by SIREC till 13 April 2011, only 11.78 lakh investors out of 23.3 million had cashed out with Rs 1,744.34 crore by 31 August 2011 – leaving a balance of Rs 17,656.53 crore.
In the case of SHIC, premature redemptions were a meagre Rs 7.3 crore (involving just 5,306 investors) out of total collections of Rs 6,380.50 crore – leaving a balance of Rs 6,373.20 crore.
These numbers are a part of the disclosures made by Sahara to the Securities Appellate Tribunal, which heard and threw out its appeal against Sebi, as on 31 August 2011, and remained part of the Supreme Court order a year later.
The questions are clear:
Why did Sahara not tell the Supreme Court what it owed investors during the hearings on the case? How come the Rs 2,620 crore figure came up only when the Supreme Court ordered it to pay Rs 24,029 crore?
How did Sahara manage to refund most of the money when the bulk of the bonds were not meant to be prematurely redeemed till 2013? How did dues of Rs 24,029 crore become Rs 2,160 crore, or even Rs 5,120 crore?
Did Sahara really refund the money or shift it to different schemes? Or why else would Sebi issue ads warning investors to avoid Sahara approaches? 
Business Standard clearly reports that investors under pressure are  moving their money.
The newspaper reported that agents of the Sahara group were being pushed to collect 
sehmat patras (consent letters) from investors to show that their money had already been returned to them. “Agents, estimated to be a million strong, who sold OFCDs, often termed housing bonds, have been ordered to collect these letters, failing which their commissions are being stopped. With these consent letters, many of which are pre-dated, with dates ranging from as early as April to show that refunds were spread over a long period, documents such as account statements and passbooks in the hands of the customers are being collected,” the newspaper reported.
Also, money was being transferred to the new Q Shop venture launched by the group. The newspaper adds: “While this documentation process has been on, a significant portion of the money deposited in the accounts have already been transferred to the Q-Shop plan, another money raising plan being marketed as a retail venture.”
What is interesting nonetheless is that the December 1 advertisement of Sahara makes a slightly different point. “Surprisingly in the Hindi belt particularly, we find the name of hundred of different persons, even the area names, including Village, Mohalla, Towns, Cities match. Most surprisingly many many fathers/husbands names also match, so it is very difficult to authentically ascertain the pattern of reinvestment, but through verbal conversations and also through computer data matching we try to understand the pattern. There is always persuasion by field workers out of their good relation with investors for reinvestment. We have vaguely observed that a good percentage of depositors/investors do not come back and go away with 100% of maturity/redemption amount. Another good percentage keep back their principal investment amount but they accept field workers request and reinvest the amount of earning with the company and a big percentage reinvest the full amount”.
How different is good percentage from a big percentage? Why can’t the company put out some real data especially when the advertisement goes onto to claim with utmost confidence that “if you go through the figures, you shall see a similar behaviour in all other institutions where commission is paid like Post Office, LIC etc.”
If Sahara can be so confident about the money going into Post Office investment schemes, and premium being paid towards Life Insurance Corporation of India’s insurance plans, then it can surely give us a little more detail about the money that it raises.
Sahara has a lot of explaining to do. The group, whose attitude has been described as “shaky” by the Supreme Court, is not telling us the real story.

The article originally appeared on www.firstpost.com on December 10, 2012.

Sahara and Ponzi schemes: What are the parallels?


Vivek Kaul

Dr K M Abraham of Securities Exchange Board of India (Sebi), in his June 23, 2011 order, against two Sahara group companies, Sahara India Real Estate Corporation Limited and Sahara Housing Investment Corporation Limited, had alluded to the possibility of a Ponzi scheme.
In his order Abraham had said “The Learned Counsel, at one point in the submissions before me, mentioned the fact that there are no investor complaints at all, from any investor in the OFCDs (optionally fully convertible debenture) raised by the two Companies. Going by the history of scams in financial markets across the globe, the number of investor complaints has never been a good measure or indicator of the risk to which the investors are exposed. Most major ‘Ponzi’ schemes in the financial markets, which have finally blown up in the face of millions of unsuspecting investors, have historically never been accompanied by a gradual build up of investor complaints.”
A Ponzi scheme is essentially a fraudulent investment scheme where money brought in by the newer investors is used to pay off the older investors. This creates an impression of a successful investment scheme. Of course as long money entering the scheme is greater than the money leaving it, all is well. The moment the situation is reversed, the scheme collapses. (For a more detailed and historical treatment of Ponzi schemes click here).
So does that mean that Sahara is a Ponzi scheme where money is simply being rotated? While there is not enough information available in the public domain to come to this conclusion nevertheless several interesting points can be made.
One of the characteristics of a Ponzi scheme is that the scheme appears to be a genuine investment opportunity but at the same time it is obscure enough, to prevent any scrutiny by the investors. The optionally fully convertible debentures that the two Sahara group companies issued to raise money from nearly 3 crore investors do fall into this category of investment which sounds genuine enough and at the same time is obscure enough to prevent any scrutiny by investors. Further, Sahara raises its money from the lowest strata of the society, a lot of whom do not even have bank accounts. So the chances of questions being asked are very low.
Another characteristic of a Ponzi scheme is that the operators of the Ponzi Scheme persuade the investors to roll over the profits into the next investment cycle. So the returns remain on paper. Since the money remains with the operator the Ponzi scheme keeps running.
This is exactly what was done by a host of Non Banking Financial Corporations (NBFCs) in the nineties. Billboards promising exorbitant rates of return started showing up all over small town India. Money from the later investors was used to pay off the earlier investors. In many cases, once their investments matured, the investors were persuaded to reinvest the principal and interest on the investment back into the scheme.
This seems to be true in case of Sahara by their own admission. As their spokesperson recently told the Business Standard “Right from last 30 years, we have observed that our field workers try their best to pursue the depositors/investors to reinvest in some other scheme of the group because they get their livelihood from that since they earn commission on it. They always impress and hold their introduced depositor/investor by giving best human service throughout the tenure of the scheme.”
Most of the Ponzi Schemes start with an apparently legitimate or legal purpose. Hometrade started off as a broker of government securities, Nidhis were mutually beneficial companies and Anubhav Plantations was a plantations company. They used their apparently legitimate or legal purpose as a façade to run a Ponzi Scheme. Same stands true for the present day Ponzi schemes. Speak Asia was in the magazine and survey business. Emu Ponzi schemes were in the business of rearing and selling emus. And Stockguru claimed to be making money by investing in the stock market.
Similarly Sahara is into a variety of businesses from running hotels to making films and television serials and building homes, which are all legitimate. The money raised by Sahara supposedly finances these businesses. What is questionable however is that are any of these businesses making money? Also has all the money that has been raised put to use?The film business of the company has been scaled down majorly over the years. The listed businesses of the group can’t be said to be doing terribly well either. Very little financial information regarding the group is available in the public domain to perform any reasonable financial analysis on it. (You can access some financial information regarding the group here).
Brand building is also an inherent part of a Ponzi Scheme. MMM, a Russian Ponzi scheme marketed itself very aggressively. In the 1994 football World cup, the Russian soccer team was sponsored by MMM. MMM advertisements ran extensively on state television and became very famous in Russia. Hometrade also used the mass media to build a brand image for itself. It launched a high decibel advertising campaign featuring Sachin Tendulkar, Hrithik Roshan and Shahrukh Khan. When the company collapsed, the celebrity endorsers washed their hands off the saying that they did not know what the business of Hometrade was.
Sahara is the official sponsor of the Indian cricket team. Given this the entire Indian team has been advertising the new Q shop venture of the group. So who are investors more likely to believe while parting with their hard earned money? Sachin Tendulkar, cricketing great and a Member of Parliament, or dull advertisements put out by SEBI asking investors not hand over their money to Sahara Q shop?
In an advertisement headlined “Don’t be forced, don’t be misguided” the Securities and Exchange Board of India (SEBI) had asked investors “not to yield to any pressure from any person, including Sahara or its agents, for converting or switching their existing investments in the bonds to any of the other schemes like Q-shop, etc.”
Sahara also owns the Pune IPL team. It also has a stake in an F1 racing team Sahara Force India, whose other high profile owner is Vijay Mallya.
A final point to remember about Ponzi schemes is that the finally become too big and collapse under their own weight. Let us say someone decides to start a Ponzi scheme with the intention to defraud people.
He gets 100 members to start with and each one of them contributes Rs 10,000 to become a member of the scheme. The members in turn are promised Rs 50,000 back in a period of one year. Given that the scheme is a Ponzi scheme, there is no business model to generate returns and give out the Rs 50,000 promised to each investor. So the guy running the Ponzi scheme has to take the money being brought in by the newer investors to pay off these original investors.
Now every investor has been promised Rs 50,000. To enter the scheme Rs 10,000 is required. Hence to get Rs 50,000 to pay off one original investor, five new investors have to be roped in. Each one of them pays Rs 10,000 each and thus Rs 50,000 is raised to pay off the original investor.
The point to note here is that the Rs 50,000 that each original investor gets is basically the money being brought in by five new investors. Hence, the money gained by the original investors is basically the money brought in by the five new investors. And that is what makes a Ponzi scheme a zero sum game. The original investors gained only because the latter investors were willing to pay. No new wealth has been created.
This also means that to pay off the 100 original investors 500 new investors need to be brought in.
So that’s the first level of the Ponzi.
What happens next?
After the original lot has been paid off, the 500 investors who entered the second level of the Ponzi need to be paid off, to keep the scheme going. To pay off each of these investors five new investors are required, which in total means 2500 investors. If the fraudster running the Ponzi manages to get 2500 or more investors, the scheme continues.
Let us say the fraudster manages to get 2500 investors and each of these investors pays Rs 10,000. The money thus collected is used to pay off the 500 investors of the second round. In the third round 2500 investors have to be paid, for which 12,500 investors need to invest money in the Ponzi scheme.
If the scheme continues successfully by the ninth round nearly 19.5 crore new investors need to be brought in to keep the Ponzi scheme going. India’s population as per the latest census is around 120 crore. This means that for this hypothetical scheme to continue nearly 16% of the population of India needs to invest in it.
So any Ponzi scheme if it becomes sufficiently big has to collapse because the number of people required to keep it running it simply way too big. One way to avoid this to keep get investors to reinvest their money back into the scheme and live to fight another day.
But all Ponzi schemes collapse in the end under their own weight. A mutli level marketing(MLM) kind of Ponzi scheme is a very good example of a Ponzi scheme that ultimately collapses under its own weight.
In an MLM scheme a company appoints independent distributors, who are not employees of the company. The products of the company are sold to the distributors, who not only sell these products to make a profit, but also appoint more distributors and so the cycle goes on.
The company goes about appointing distributors but the catch is that the products the distributors buy rarely get sold and is just there to build a façade of a business model.
A major part of the commission earned by a distributor comes from appointing new distributors to the company, and thus creating a new level. And so the scheme goes on, with newer levels being created. The return to the upper levels comes from creating new levels rather than the sale of the product. The wealth gained by participants at the higher levels is the wealth lost by participants at lower levels.
Like any other Ponzi Scheme there are only a finite number of people who can enter the scheme. So after some time the number of people required to keep the scheme going becomes very large and the scheme goes bust.
As Debashis Basu wrote in a recent column in Business Standard “Now they(MLM schemes) come under the garb of selling you some expensive products or some vague services: gold coins (Gold Quest), lifestyle products (QNet), surveys (Speak Asia), and so on. So, at any time, they have the fig leaf of providing some “value”. Even Amway, Oriflame and Tupperware rely on a model with recruitment and ever-expanding chain. For those at the end of the chain to get some crumbs and to sustain the whole chain, products have to be hugely expensive. Even then, most people make no money. New recruits are shown a dream — what people in the second link of the chain have achieved. But they are not told that no one beyond the top two or three layers really makes any money.”
While Ponzi schemes keep going bust newer ones keep coming and taking their place. This is sad because for the economy as whole, they are undesirable. Every time a Ponzi scheme is exposed, the confidence of the investor in the financial system goes down. Investors become reluctant to part with their money. This in turn hampers the ability of the capitalist system to raise capital for newer ventures.
The attraction of easy wealth is something that investors cannot resist. Ponzi Schemes offer huge returns in a short period of time vis a vis other investments available in the market at that point of time. With good advertising and stories of previous investors who made a killing by investing in the scheme, investors get caught in the euphoria that is generated and hand over their hard earned money to such schemes going against their common sense.
Greed also results when investors see people they know make money through the Ponzi Scheme. As economist Charles Kindleberger wrote in his all time classic Manias, Panics and Crashes There is nothing so disturbing to one’s well being and judgement as to see a friend get rich”. In a country like India where the per capita income is low the chances of people falling for Ponzi Schemes continue to remain high.
The only way out of this menace is by punishing people who run Ponzi schemes quickly. Rather than assuming investors are knowledgeable about investment opportunities, and instead of providing investors with more information about particular investments, disseminating information about investments gone awry may be a better bet to control this problem.
As Basu writes in his column “The ministry of finance and financial regulators may like to believe that they oversee the financial sector well. They are really deluding themselves. The money people lose in pyramid schemes is a few times the size of equity mutual funds or life insurance plans, on which millions of words are written and thousands of regulatory man-hours are spent. And all the literacy workshops funded by the government and industry would seem such a joke if pyramid schemes are allowed to flourish.”
Hence, its time the government woke up to this and did something about this menace, starting by punishing some of the big boys.

The article originally appeared on www.firstpost.com on December 12, 2012.

(Vivek Kaul is a writer. He can be reached at [email protected])

Fear is the key: What Sushma, Rajiv and i-pill have in common


Vivek Kaul

It’s around midnight as I write this and I am just back from a late dinner with a friend. Before we started to have dinner my friend insisted that I use a hand sanitiser. While I have nothing against people pretending to be clean all the time, but the smell of a hand sanitiser really puts me off and can even make me sneeze.
Given that I refused to use it.
“How can you not use a hand sanitiser before eating?” she asked.
“Well I have washed my hands,” I replied.
“But that’s not enough,” she insisted.
“Why not?” I asked.
“Because a hand sanitiser kills all the germs.”
“What germs?” I asked, ripping into the tandoori chicken.
“Ah. End of conversation. Guess cleanliness isn’t really your thing!” she exclaimed at my ingratitude.
The idea of using hand sanitisers has caught on(especially with women) after the recent global swine flue scare. But does it really help? As brand management expert Martin Lindstrom writes in his latest book Brandwashed – Tricks Companies Use to Manipulate Our Minds and Persuade Us to Buy “Neither swine flu nor SARS can be prevented by the use of antibacterial cleansing gels. Both viruses are spread via tiny droplets in the air that are sneezed or coughed by people who are already infected. ”
In fact as Lindstrom told me in an interview “What’s ironic is that none of those products…actually do any better job than soap and water.”
That being the case why are women so in love with hand sanitisers? As Lindstrom puts it in Brandwashed “The idea of an unseen, potentially fatal contagion has driven us into nothing short of an antibacterial mania.”
And companies making hand sanitisers have simply captured this mania as a profitable money making proposition. As Lindstrom told me “The companies have done a extraordinary job in building their brands on the back of the fear created by those global viruses – indicating that we’ll be safe using these brands…The ironic side of the story however is that the life expectancy in Japan is decreasing for the first time in history – why – because the country simply has become too clean – the Japanese have weakened their immune system as a result of overuse of hand sanitising products.”
What this little story tells us is that fear of something happening (or not happening for that matter) is a great selling strategy and you can’t argue with a woman who has made up her mind.
As Lindstrom put it “we’re all hardwired to be seduced by fear – fear is the number one soft button in our brain – it is a survival instinct. Fear is used by most insurance companies and even Colgate who claimed in one ad that they could remove the risk of cancer by the usage of their toothpaste,” said Lindstrom.
The fact that fear is a great selling strategy makes companies build it directly into their advertisements. The advertisement of i-pill, an emergency contraceptive pill, shows a mother telling her daughter “Kyun risk le rahi hai?” when the daughter calls and hints that she has had unprotected sex.
Or take the case of Saffola oil which has run a highly successful campaign over the years on the fear of a heart attack. It used to run an advertisement for years showing a man being wheeled into the operation theatre, with the sound of the ambulance siren in the background (Let me concede I also use Saffola oil for cooking).Fair and Lovely, which claims to be a skin lightening cream, has run on a plank of the fear of rejection for a “dark” girl. This despite protests from several quarters. The advertisement of the health drink Complan is built around the fear that those not having Complan will not grow as tall as those having it.
Almost every insurance company uses fear as a selling strategy. This can vary from the fear of death, to the fear of not having enough money to meet hospital bills, to the fear of not having enough money for the son’s or the daughter’s education or not having enough money for the daughter’s wedding and so on.

As Tyler Cowen, an economist at George Mason university in the US, writes in the book, Discover your Inner Economist “Often , buying insurance is about investing in a story about who we are and what we care about; insurance salesmen have long recognised this fact and built their pitches around it.”
Having given these examples, let me concede that some of these advertisements do push consumers towards buying the right product. But most of these advertisements are misleading. As the Business Standard recently reported “Whether it’s Complan or Horlicks, they claim to make a child taller and smarter. But their promises are not based on any scientific data….Abu Hasem Khan Choudhury, minister of state for health and family welfare informed the Lok Sabha in a written reply on November 30 that the food regulator had begun prosecution proceedings against manufacturers of 19 leading brands and issued show cause notices to 19 others for making false claims regarding the nutritional value of the product in advertising and on the label.”
As the story further pointed out “ For instance, Complan, a leading drink brand, claims it makes children grow twice faster. Horlicks promises to make children “taller, stronger and sharper”. Kellogg’s Special K claims people who eat low fat food in their breakfast tend to be thinner than those who do not, without providing any scientific study to back this claim. Products like Saffola oil, Rajdhani Besan and Britannia Vita Marie biscuits have been booked for making false claims of being “heart-friendly” and “reducing cholesterol”.”
All these products play on the fears and insecurities of consumers. If my kid doesn’t drink Complan/Horlicks he won’t grow tall. If I don’t eat Kellog’s Special K I will become fat. And if I don’t have Saffola oil I will have a heart attack.
Lindstrom summarises this phenomenon very well in a paragraph in his book Buyology – How Everything We Believe About Why We Buy is Wrong “That if we don’t buy their product, we”ll somehow be missing out. That we’ll become more and more imperfect; that we’ll have dandruff or bad skin or dull hair or be overweight or have a lousy fashion sense. That if we don’t use this shaving cream, women will walk by us without a glance…That if we don’t wear this brand of lingerie no man will ever marry us.”
Politicians are looking to do exactly the same thing when they practise the politics of fear. The recent debate on FDI in big retail had Sushma Swaraj saying things like “Will Wal-Mart care about the poor farmer’s sister’s wedding? Will Wal-Mart send his children to school? Will Wal-Mart notice his tears and hunger?”
She also said that “The remaining 70 percent of the goods sold in these supermarkets will be procured from China. Factories will open in China, traders will prosper in China while darkness will befall 12 crore people in India.” This is scaremongering of a kind similar to that indulged in by companies to sell their products.
Arun Jaitley, the leader of opposition in the Rajya Sabha, also indulged in the same when he said that “India will become a nation of sales boys and girls.”
And before I am labelled to be a Congi by the internet Hindus let me clarify that politicians from across the political spectrum have practised this strategy at various points of time.
“When a big tree falls, the ground shakes,” said Rajiv Gandh after his mother Indira Gandhi was assassinated by her Sikh bodyguards.
A section of the Indian National Congress (back then known as the Congress-I) whipped up mass frenzy against the Sikhs after the assassination. In the pogrom that followed Sikhs were killed all across northern and eastern India. And the Congress Party got 415 seats out of the 540 seats in the Lok Sabha, a feat not achieved even by Jawaharlal Nehru, the biggest leader that the party has ever had.
Kanshi Ram, had formed the the Dalit Soshit Samaj Sangharsh Samiti or DS4, before forming the BSP. The rallying cry for DS4 was”Thakur, Brahmin, Bania Chhod, Baki Sab Hain DS4.” This worked so well that when Ram decided to form the BSP he came up with a similar sounding but a more subtle slogan. “Tilak Tarazu aur Talwaar, inko maaro joote chaar.
The late Bal Thackeray was a master of this craft first putting fear of Tamils in the minds of the Marathi Manoos and then Muslims as times changed. His nephew Raj, who left to form his own party the Maharashtra Navnirman Sena, took this strategy further and has put the fear of Bhaiyyas and Biharis in the minds of the Marathi Manoos.
Varun Gandhi made front page headlines when in a speech he said “Ye panja nahi hai, ye kamal ka haath hai. Ye kat** ke galey ko kaat dega chunaav ke baad.” Then there are also examples of parties like DMK, which have been built on creating the fear of the loss of culture and language.
When politicians try to create fear in the minds of the citizens their aim is similar to that of companies trying to create fear in the minds of consumers. Fear “is what our brains remember…”writes Martin Lindstrom in his book Buyology. Fear creates what Lindstrom calls “somatic markers” or brain shortcuts that link the brand sold to what needs to be done to take care of the fear: “Want you kid to grow tall? Get him to drink Complan!”
“Want a healthy life without a heart attack? Eat Saffola oil.”
Or in a political context “Don’t want the Chinese take away Indian jobs or sell goods in India? Vote for the Bhartiya Janata Party.”
“Want freedom from the oppression of upper castes? Vote for the Bahujan Samaj Party.”
“Want to revenge the assassination of Indira Gandhi? Kill Sikhs but don’t forget to vote for the Congress.”
While it is not as simple as that, but that is what it essentially means. Fear also gives rise to anxieties and insecurities of people and helps politicians come up with a war cry and make themselves easily heard. As Bill Bonner and Lila Rajiva write in Mobs, Messiahs and Markets “Men are ready to die for the group and kill anyone who resists its will.”
The war cry before the Babrji Masjid was destroyed was “Ek dhakka aur do, Babri Masjid tod do!”.
As Lindstrom writes in Brandwashed in the context of marketers “So whether it’s germs or disease or some feared version of a future self, marketers are amazingly adept at identifying a fear out of the zeitgeist (a German word which means the spirit of the times, italics are mine), activating it, amplifying it and preying on it in it in ways that hit us at the deepest subconscious level.”
Politicians do the same thing. They identify the prevailing fear, like Wal-Mart will get in all low cost Chinese goods (as if Indian companies are not) and destroy the kiranawallas. And then they activate it and amplify it by talking about it in their speeches. And if the comments on this piece that I wrote a couple of days back are anything to go by, they have been successful at it.
And so was Rajiv Gandhi!

The article originally appeared on www.firstpost.com on December 7, 2012.

(Vivek Kaul is a writer. He can be reached at [email protected])