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?
“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])