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Why Mis-selling By Banks ‘May’ Have Gone Up Post-Covid

The basic idea for almost everything I write emanates from some data point that tells me something. But this piece is slightly different and comes from the experiences of people around me and what I have been seeing on the social media.

I think with this limited anecdotal evidence and some data that I shall share later in the piece, it might be safe to say that mis-selling by banks post-covid may have gone up. Mis-selling can be defined as a situation where an individual goes to a bank wanting to do one thing, and ends up doing something else, thanks to the relationship/wealth manager’s advice.

The simplest and the most common example of this phenomenon is an individual going to a bank with the intention of putting his money in a fixed deposit and ends up buying some sort of an insurance policy or a pension plan.

Let me offer some evidence in favour of why I think the tendency to mis-sell post covid may have gone up.

1) Between March 27, around the time when the seriousness of the covid pandemic was first recognized in India, and October 9, the latest data available, the deposits of Indian banks have gone up by Rs 7.36 lakh crore or 5.4%.

Clearly, there has been a huge jump in bank deposits this year. To give a sense of proportion, the deposits between October 2016 and December 2016, when demonetisation happened, went up by Rs 6.37 lakh crore or 6.4%.

The increase in deposits post covid has been similar to the increase post demonetisation. Of course, the post-covid time frame has been longer.

What does this tell us? It tells us that people haven’t been spending. This is due to multiple reasons.

The spread of covid has prevented people from stepping out and there is only so much money that can be spent sitting at home (even with all the ecommerce). This has led to an accumulation of deposits. Further, people have lost jobs and seen their incomes crash. This has prevented spending or led to a cutdown. And most importantly, many people have seen their friends and family lose jobs. This has automatically led them to curtail their spending. All this has led to an increase in bank deposits.

2) Why do banks raise deposits? They raise deposits in order to be able to give them out as loans. Between March 27 and October 9, the total non-food credit given by banks contracted by Rs 38,552 crore or 0.4%. Banks give loans to the Food Corporation of India and other state procurement agencies to help them primarily buy rice and wheat directly from farmers. Once this lending is subtracted from the overall lending of banks what remains is the non-food credit.

What does this contraction in lending mean? It means that people and firms have been repaying their loans and not taking on fresh loans. On the whole, between March end and early October, banks haven’t given a single rupee of a new loan. This explains why interest rates on deposits have come down dramatically. Interest rates have also come down because of the Reserve Bank of India printing and pumping money into the financial system to drive down interest rates.

3) Using these data points, we can come to the conclusion that banks currently have an incentive to mis-sell more than in the past. Why? Banks currently have enough deposits. They don’t need more deposits, simply because on the whole, people and firms are not in the mood to borrow.

All this money that is not lent ends up getting invested primarily in government securities, where the returns aren’t very high. As of October 9, around 31.2% of total deposits were invested in government securities. This is the highest since July 2018.

The trouble is that banks cannot stop taking deposits even though they are unable to currently lend them. They can only disincentivise people through lower interest rates.

Or they can set the targets of relationship managers/wealth managers in a way where they need to channelise savings into products other than fixed deposits.

While banks have to pay an interest on fixed deposits, irrespective of whether they are able to lend them or not, they earn a commission on the sale of products like unit linked insurance plans, pension plans, mutual funds, portfolio management services, etc. This commission directly adds to the other income of the banks.

Basically, the way this incentive plays out explains why mis-seling by banks may have gone up post covid. Also, the risk of repaying a fixed deposit lies with the bank. The same is not true about the other products where the bank is just a seller and the risk is passed on.

What to do?

So, what should individuals do in a situation like this, is a question well worth asking? Let’s say you go to a bank to invest your money in a fixed deposit. As explained above, the bank really does not want your money in fixed deposit form.

The wealth managers/relationship managers will resort to the contrast effect while trying to persuade you to not put your money in fixed deposits. The interest rates on fixed deposits are very low currently. An average fixed deposit pays an interest of 5-5.5%. Clearly, once we take inflation and taxes on the interest on these deposits into account, the returns are in negative territory.

The relationship/wealth manager will contrast these low/negative returns with the possible returns from other products. His or her pitch will be that the returns will be higher in other cases. In the pitch, he or she will tell you that the returns from the other products are as good as guaranteed. A tax saving angle might also be sneaked in (for insurance products). (Of course, he or she will not present this in such a dull way. Typically, relationship/wealth managers tend to be MBAs, who can phaff at the speed of thought and leave you totally impressed despite their lack of understanding of things).

What’s the trouble with this? The returns in these other products are not fixed. In case of a fixed deposit the interest rate is fixed (which is why the word fixed is used in the first place). Now you might end up with a higher return on other products, but there is no guarantee to that. Also, sometimes the aim of investment is different. If you are putting your money in a fixed deposit, the aim might simply be return of capital than return on capital.

Further, the investment in these other products might be locked in for a long period of time, while you can break a fixed deposit at any point of time (of course you end up with lower returns). This is especially true for a tax saving investment.

To conclude, the next time you go to a bank, stick to what you want to do with your money and don’t fall prey to what the wealth/relationship manager wants you to do. Clearly, his and your incentives are not aligned. Also, if you can use internet banking to manage your money, that is do fixed deposits online, that’s the best way to go about it.

How insurance companies robbed the hard earned savings of Indian investors

LIC
The Report of the Committee to recommend measures for curbing mis-selling and rationalising distribution incentives in financial products was released on September 3, 2015.

The financial product which is perhaps most mis-sold in India is insurance. There is enough anecdotal evidence to suggest that hordes of investors bought equity unit linked insurance plans (Ulips), over the years, on the mis-sell that their investment would double in three years. Ulips are primarily investment plans with a dash of insurance.

Ulips, as they used to be structured, paid a very high commission to insurance agents during the first two years of the policy. Also, in case the investors failed to pay the premium during the first three years of the policy, the insurance company was allowed to keep the entire premium that had been invested up until then.

As the report cited at the beginning of this column points out: “The regulation on a three-year lock in period which allowed companies to keep the entire value of the policy if surrendered within three years, left very little incentive to the insurance companies to promote follow-on premium payments from their customers. The rule on front-loaded commissions, which were as high as 40 percent in the first year, incentivised agents to sell products that earned them the highest pay-off.”

In fact, an estimate made by Monika Halan, Renuka Sane, and Susan Thomas in a research paper suggests that investor losses due to policies lapsing mounted to Rs 1.5 trillion between 2004-06 and 2011-12.

This is a huge amount of money. Many investors stopped paying their premiums after the money they had invested did not double in three years. Over and above this, the insurance agents sold Ulips as a three year policy, instead of telling the investors that there was a lock-in of three years.

At the end of three years they got people to invest their redeemed amount back into a fresh Ulip. This was done so as to ensure that they (i.e. the agents) could continue to earn a high commission.

In fact, in a research paper titled Understanding the Advice of Commissions-Motivated Agents: Evidence from the Indian Life Insurance Market, Santosh Anagol, Shawn Cole and Shayak Sarkar point out: “We find strong evidence that commissions-motivated agents provide unsuitable advice. Depending on our treatment, agents recommend strictly dominated, expensive products, 60-90% of the time.”

Also, not surprisingly, the research paper points out that “the selling of unsuitable products is likely to have the largest welfare impacts on those who are least knowledgeable about financial products in the first place.”

This is also visible in the low persistency that insurance policies have in India. As the report of the committee to recommend measures for curbing mis-selling points out: “A manifestation of this is the low persistency of policies in India. Persistency tracks the behaviour across time of policies sold in a year. The 13 month persistency rate for insurance companies ranged between 41 – 76 percent in 2013-14. In the case of LIC [Life Insurance Corporation of India] for example, the 61st month persistency in 2013-14 was just 44 percent. This means that less than half of the policies sold in FY 2009 were retained.”

The low persistency is primarily because of “mis-selling and poor service by agents.”

The question is what can be done to curb this mis-selling. The Insurance Regulatory and Development Authority (IRDA) of India has cut down on Ulip commissions over the years. Nevertheless, high commissions on the traditional endowment plans still remain. If mis-selling has to come down, the commission on endowment plans needs to be slashed.

In fact, as the report on curbing mis-selling points out: “The Insurance Laws Amendment Act, 2015 has led to the removal of the ceiling of 40 percent on the maximum commission, fee or remuneration. IRDA for now has the power to lay down the structure of commission/brokerage for intermediaries as well as the power to determine the expenses of management.”

The question is will IRDA implement this and start limiting the commissions paid on traditional plans. The Life Insurance Corporation (LIC) of India benefits the most from the high commissions on traditional plans. The high commissions on offer on these non-transparent plans, help in collecting a lot of money from people all across the country.

Also, it is worth remembering that LIC comes to the rescue of the Indian government regularly. On August 24, 2015, the government was investing around 10% of its holding in Indian Oil Corporation (IOC). On that day, the stock market fell big time. LIC came to the rescue of the government and picked up around 86% of the shares that the government was selling in IOC.

In this scenario, the government and the IRDA limiting the commission that LIC is allowed to pay to its agents, is highly unlikely.

The column originally appeared on Firstpost on Sep 9, 2015

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

 

Hari Narayan ran Irda like an insurance lobby

 

 
Vivek Kaul
 
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) 

 
 

Why LIC chief is more worried about the agents than policyholders

LIC
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]) 

LIC money: Is it for investors’ benefit, or Rahul's election?


Vivek Kaul

“We’re slowly learning that fact. And we’re very, very pissed off.”
—Lines from the movie Fight Club
The government’s piggybank is in trouble. Well not major trouble. But yes some trouble.
The global credit rating agency Moody’s on Monday downgraded the Life Insurance Corporation (LIC) of India from a Baa2 rating to Baa3 rating. This is the lowest investment grade rating given by Moody’s. The top 10 ratings given by Moody’s fall in the investment grade category.
Moody’s has downgraded LIC due to three reasons: a) for picking up stake in the divestment of stocks like ONGC, when no one else was willing, to help the government reduce its fiscal deficit. b) for picking up stakes in a lot of public sector banks. c) having excessive exposure to bonds issued by the government of India to finance its fiscal deficit.
While the downgrade will have no impact on the way India’s largest insurer operates within India, it does raise a few basic issues which need to be discussed threadbare.
From Africa with Love
The wives of certain African dictators before going on a shopping trip to Europe used to visit the central bank of their country in order to stuff their wallets with dollars. The African dictators and their extended families used the money lying with the central banks of their countries as their personal piggybank. Whenever they required money they used to simply dip into the reserves at the central bank.
While the government of India has not fallen to a similar level there is no doubt that it treats LIC like a piggybank, rushing to it whenever it needs the money.
So why does the government use LIC as its piggybank? The answer is very simple. It spends more than what it earns. The difference between what the government earns and what it spends is referred to as the fiscal deficit.
In the year 2007-2008 (i.e. between April 1, 2007 and March 31,2008) the fiscal deficit of the government of India stood at Rs 1,26,912 crore. Fiscal deficit is the difference between what the government earns and what it spends. For the year 2011-2012 (i.e. between April 1, 2011 and March 31, 2012) the fiscal deficit is expected to be Rs 5,21,980 crore.
Hence the fiscal deficit has increased by a whopping 312% between 2007 and 2012. During the same period the income earned by the government has gone up by only 36% to Rs 7,96,740 crore. The expenses of the government have risen more than eight and half times faster than its revenues.
What is interesting is that the fiscal deficit numbers would have been much higher had the government not got LIC to buy shares of public sector companies it was selling to bring down the fiscal deficit.
Estimates made by the Business Standard Research Bureau in early March showed that LIC had invested around Rs 12,400 crore out of the total Rs 45,000 crore that the government had collected through the divestment of shares in seven public sector units since 2009. The value of these shares in March was around Rs 9,379 crore. Since early March the BSE Sensex has fallen 7.4%, which means that the LIC investment would have lost further value.
Over and above this the government also forced LIC to pick up 90% of the 5% follow-on offer from the ONGC in early March this year. This after the stock market did not show any interest in buying the shares of the oil major. The money raised through this divestment of shares went towards lowering the fiscal deficit of the government of India.
News reports also suggest that LIC was buying shares of ONGC in the months before the public issue of the insurance major hit the stock market, in an effort to bid up its price. Between December and March before the public offer, the government first got LIC to buy shares of ONGC and bid up the price of the stock from around Rs 260 in late December to Rs 293 by the end of February. After LIC had bid up the price of ONGC, the government then asked it to buy 90% of the shares on sale in the follow on public offer.
This is a unique investment philosophy where institutional investor managing money for the small retail investor, first bid up the price of the stock by buying small chunks of it, and then bought a large chunk at a higher price. Stock market gurus keep repeating the investment philosophy of “buy low-sell high” to make money in the stock market. The government likes LIC to follow precisely the opposite investment philosophy of “buying high”.
Estimates made by Business Standard suggest that LIC in total bought ONGC shares worth Rs 15,000 crore. The stock is since down more than 10%.
The bank bang
LIC again came to the rescue of the cash starved government during the first three months of this year, when it was force to buy shares of several government owned banks which needed more capital. It is now sitting on losses from these investments.
Take the case of Viajya Bank. It issued shares to LIC at a price of Rs 64.27 per share. Since then the price of the stock has fallen nearly 19%.
The same is case with Dena Bank. The stock price is down by almost 10% since allocation of shares to LIC. The share price of Indian Overseas Bank is down by almost 19.7% since it sold shares to LIC to boost its equity capital. While the broader stock market has also fallen during the period it hasn’t fallen as much as the stock prices of these shares have.
There are more than a few issues that crop up here. This special allotment of shares to LIC to raise capital has pushed up the ownership of LIC in many banks beyond the 10% mandated by the Insurance Regulatory and Development Authority of India, the insurance regulator. As any investment professional will tell you that having excessive exposure one particular company or sector isn’t a good strategy, especially when managing money for the retail investor, which is what LIC primarily does. What is interesting is that the government is breaking its own laws and thus not setting a great precedent for the private sector.
If LIC hadn’t picked up the shares of these banks, the fiscal deficit of the government would have gone up further. The third issue here is why should the government run so many banks? The government of India runs twenty six banks (20 public sector banks + State Bank of India and its five subsidiaries).
While given that banking is a sensitive sector and some government presence is required, but that doesn’t mean that the government has to run 26 banks. It is time to privatise some of these banks.
Gentlemen prefer bonds
As of December 31, 2011, the ratio of government securities to adjusted shareholders’ equity in LIC was 764%. This is understandable given that the subsidy heavy budget of the Congress led UPA government has seen its fiscal deficit balloon by 312% over the last five years. Again basic investment philosophy tells us that having a large exposure to one investment isn’t really a great idea, even if it’s a government.
The Rahul factor
But the most basic issue here is the fact that the government is using the small savings of the average Indian who buys LIC policies to make loss making investments. This is simply not done.
LIC has turned into the behemoth that it has over the years by offering high commissions to its agents over the years. It sells very little of “term insurance”, the real insurance. What it basically sells are investment policies with very high expenses which are used to pay high commissions to it’s the agents. The high commissions in turn ensure that these agents continue to hard-sell LIC’s extremely high cost investment policies to normal gullible Indians. The premium keeps coming in and the government keeps using LIC as a piggybank.
The high front-loading of commissions is allowed by The Insurance Act, 1938. The commission for the first can be a maximum of 40 per cent of the premium. In years two and three, the caps are 7.5 per cent, and 5 per cent thereafter. These are the maximum caps and serve as a ceiling rather than a floor.
The Committee on Investor Protection and Awareness led by D Swarup, the then Chairman of Pension Fund Regulatory and Development Authority, had proposed in September 2009 to do away with commissions across financial products. “All retail financial products should go no-load by April 2011,” the committee had proposed in its reports.
The National Pension Scheme(NPS) was already on a no commission structure. And so were mutual funds since August 1, 2009. But LIC and the other insurance companies were allowed to pay high commissions to their agents. “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,” the committee had further proposed.
Not surprisingly the government quietly buried this groundbreaking report.
While insurance commissions have come down on unit linked insurance plans, the traditional insurance policies in which LIC remains a market leader continue to pay high commissions to their agents. These traditional insurance policies typically invest in debt (read government bonds which are issued to finance the fiscal deficit).
This is primarily because the Congress led UPA government needs the premium collected by LIC to run LIC like a piggybank. The piggybank money can and is being used to run subsidies in the hope that the beneficiaries vote for Rahul Gandhi in 2014.
Is the objective of LIC to generate returns and ensure the safety of the hard earned money of crores of it’s investors? Or is it to let the UPA government run it like a piggybank in the hope that Rahul baba becomes the Prime Minister?
The country is waiting for an answer.
(This post originally appeared on Firstpost.com on May 15,2012. http://www.firstpost.com/politics/lic-money-is-it-for-investors-benefit-or-rahul-election-309545.html)
(Vivek Kaul is a writer and can be reached at [email protected])