What is it with outgoing Indian bureaucrats and their tendency to become remarkably honest about all that is wrong with the Indian system, once they retire?
The latest to join this long list is Jandhyala Hari Narayan, the recently retired chief of the Insurance Regulatory and Development Authority(IRDA) of India, the insurance regulator. In an interview to the Mint newspaper, a few days back, Hari Narayan said “I think there is a philosophical problem.I think the regulators are probably closer to the industry than they ought to be.”
While I don’t know whether its a philosophical problem, it definitely is a problem. Much through Hari Narayan’s stint at IRDA, the regulator acted more like an industry lobby, rather than an institution which was also supposed to protect the interests of those buying insurance policies.
Allow me to elaborate.
During Hari Narayan’s reign IRDA put out advertisements urging people to buy unit linked insurance plans (Ulips). Ulips are essentially investment plans carrying a dash of insurance. Ulips used to pay very high commissions to insurance agents, which has since fallen. So to put it in another way, they are high cost mutual funds, which also provide you with some insurance.
Now which regulator puts out advertisements asking people to buy the product that it regulates? This would be like the Securities and Exchange Board of India(Sebi) putting out advertisements asking people to buy mutual funds. Or the Telecom Regulatory Authority of India, the telecom regulator, putting out advertisements, asking people to buy mobile phone connections.
And if that wasn’t enough, Hari Narayan also cleared highest NAV guaranteed plans without understanding the damage they would cause to those investing. These plans were typically 10 year plans. Some of these plans guaranteed the investor the highest NAV achieved during the first seven years of the plan. Some others guaranteed the highest NAV achieved during the entire duration of the plan.
What is ironic is that these investment plans had the flexibility to invest up to 100% of the money they collected in the stock market. And how can the stock market and any guarantee go together? Those who still believe in this need to be reminded of this institution called Unit Trust of India (UTI), which tried to provide investors with assured returns by investing in the stock market and failed spectacularly.
Hari Narayan conveniently blamed the clearing of this product on the actuary at IRDA at that point of time. “I think there was a process of understanding even at Irda and I don’t think the then member actuary was really so clearly focused on policyholders’ welfare as he ought to have been. So it took some time to really figure it out,” he told Mint. Why clear a product which you don’t understand? I am amazed that this is how decision making happens at one of India’s foremost regulators.
What is interesting is the way these plans were sold by insurance companies. These plans were made to look like 100% stock market products. They gave an impression that the money collected would be invested in the stock market and the money would continue to remain invested in the stock market. And the highest NAV that the plan achieved during the course of its tenure would be paid out in the end, irrespective of the prevailing NAV.
Let me explain through an example. Let us say initially the NAV is Rs 10. The money collected is invested in the stock market. The value of these investments rises by 50% and the NAV increases to Rs 15 (Rs 10 + 50% of Rs 10). After this the stock market starts to fall and by the time the policy matures the NAV has fallen to Rs 12. So as per the terms of the policy the highest NAV of Rs 15 would be paid out to the policy holders.
This of course meant that the insurance company would have to pay out Rs 3 from its own pockets. Now it need not be said that insurance companies are in the business of making profits and not losses. So the way these plans were really structured was different. In all likelihood these plans would have a higher exposure to equity initially and gradually move the investments into debt as the date of maturity neared. Also, gains made on investing in stocks would be regularly booked and moved to debt, so as to ensure that the NAV did not rise beyond a certain level. But this is not how the product was sold.
This was misselling at its best. And this was not the only form of misselling that happened. There were other standard techniques of misselling. Investors were promised that there investment would double in three years. There was also a lot of churning. Investors were made to stop their investment in Ulips after three years and the new premium was directed into newer Ulips. This was done because Ulips paid higher commissions during the first two years. Irda turned a blind eye to all this.
And the results of all this misselling are now coming out. Those who invested in Ulips are now finding out a few years later, that instead of their investments doubling, they are still losing money on it. This is primarily because a lot of money they invested went to pay commission to insurance agents. In fact payments made to insurance agents have been more than what the Insurance Act permits. “These payment are more than what the (Insurance )Act permits,” Hari Narayan told Mint.
The losses have led to more people surrendering their insurance policies before they matured. As a recent report in The Hindu Business Line points out “According to IRDA (Insurance Regulatory and Development Authority) data, in fiscal 2012 life insurers had to pay Rs 71,208 crore on account of surrenders (withdrawals), of which, LIC paid Rs 41,531 crore and private sector insurers, the balance. In fiscal 2012, ULIPs accounted for 68 per cent of the total surrender for LIC, and 97 per cent of the total for private insurers.”
So between April 1, 2011 and March 31, 2012, policy holders surrendered insurance policies worth around Rs 71,000 crore. And a major portion of this was Ulips.
An earlier report in the Mint points out that investors may have lost more than Rs 1,56,000 crore in the seven period ending on March 31, 2012, due to misselling by insurance companies. And that is clearly a lot of money. Hari Narayan was in-charge of IRDA during much of this period. What these losses also do is that they make the so called small or retail investor wary of anything to do with the stock market. And that is not a good sign in a developing economy like India which needs a lot of money to keep growing.
To give Hari Narayan due credit during the second half of his tenure he did try and set things right by cutting down Ulip commissions and also tried to do a thing or two about misselling. But by then the damage had already been done. It was a case of too little too late. The insurance companies simply moved towards selling traditional insurance policies, where the commissions continue to remain high. The guaranteed NAV plans continue to be sold.
Also, the bigger problem with Ulips remain. An investor still cannot figure out which is the best Ulip going around given that returns across different Ulips remain incomparable.
Hari Narayan has been replaced by T S Vijayan, a former Chairman of Life Insurance Corporation of India. Predictably the insurance companies have upped the rhetoric with one of their own taking over as the regulator. As a recent story in the Business Standard pointed out that insurers felt that there was no need to ban highest NAV guaranteed products. The story quoted a chief executive of a private life insurance company as saying “The products, per se, do not have any fundamental problem. The problem is it these have a tendency to be mis-sold, since the customer does not understand market fluctuations could be risky. Hence, disclosures should be made clearer, rather than banning the product.” As the American writer Upton Sinclair once wrote “It is difficult to get a man to understand something, when his salary depends upon his not understanding it!”
Given this, I expect the misselling in insurance to continue.
The article originally appeared on www.firstpost.com on February 26, 2013
(Vivek Kaul is a writer. He tweets at @kaul_vivek)