How insurance companies robbed the hard earned savings of Indian investors

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)


For every rupee sold by Indians, foreigners have invested Rs 6.2 in the stock market

indian rupees Vivek Kaul 
The BSE Sensex has been flirting with new highs these days. It touched an intra-day high of 22,030.72 on March 18, 2014. The Sensex had touched similar high levels in January 2008, more than six years back. It is interesting see how the Indian investors and foreign investors have behaved since then.
The foreign institutional investors (FIIs) have bought stocks worth Rs 1,56,517.42 crore between January 2008 and March 14, 2014. During the same period the domestic institutional investors have sold stocks worth Rs 25,184.3 crore. Given this, for every rupee worth of stocks sold by the Indian institutional investors, the foreigners have invested Rs 6.21 (Rs 1,56,517.42 crore divided by Rs 25,184.3 crore) in the Indian stock market.
Why has that been the case? There are number of reasons for the same. The investment bank Lehman Brothers went bankrupt in September 2008. This unleashed the current financial crisis. In order to tackle this crisis, the Western nations have run an easy money policy, which includes maintaining low interest rates as well as printing money, in order to get their economic growth going. The idea being that people will borrow and spend money at low interest rates, which will benefit businesses and in turn lead to economic growth.
The easy money policy has allowed the big institutional investors to borrow money at very low interest rates and invest it in financial markets all over the world. That is the major reason behind foreign investors investing Rs 1,56,517.42 crore since January 2008, in the Indian stock market.
In fact, things get even more interesting if we consider data from December 2008 onwards, given that the western nations started to run an easy money policy towards the end of 2008. Since December 2008, the foreign investors have invested Rs 2,59,354.8 crore in the Indian stock market. During the same period the domestic investors have sold stocks worth Rs 96,244.8 crore.
What explains this contrast? The easy money policies explain one part of the argument, they clearly do not explain why Indian domestic investors have stayed away from the stock market. Lets look at some data that might throw up some clarity.
Data provided by the Association of Mutual Funds in India(Amfi) shows that in January 2008, around Rs 1,72,885 crore was invested in equity mutual fund schemes. It is important to understand here that the money was invested in equity mutual fund schemes and not necessarily stocks. A mutual fund scheme that invests more than 65% of the money that it manages in stocks is categorised as an equity mutual fund scheme. Money invested in equity mutual fund schemes formed around 32% of the total money managed by mutual funds at that point of time.
In February 2014, the amount invested in equity mutual fund schemes stood at Rs 1,57,227 crore. Money invested in equity mutual fund schemes formed only around 17% of the total money managed by the mutual funds.
In January 2008, the amount of money managed by mutual funds stood at Rs 5,48,064 crore. This has since then gone up to Rs 9,16,393 crore. Hence, mutual funds are clearly managing more money than they were a little over six years back, but the amount of money they manage under equity schemes has clearly come down.
Since August 2009, the Securities and Exchange Board of India (Sebi) made it mandatory for mutual funds not to charge any entry load on mutual fund schemes. Prior to this, out of every Rs 100 put in by an investor in any equity mutual fund scheme, Rs 2.25 used to be charged as an entry load and passed onto the agent as a commission.
With almost no commissions on offer, agents stopped selling equity mutual fund schemes to retail investors. Hence, the amount of new money coming into the equity mutual funds and through them to the stock market has come down dramatically. What has also not helped is the fact that investors have redeemed their investments in equity mutual fund schemes big time since January 2008.
Investor interest has also gone away from unit linked investment plans (Ulips) offered by insurance companies. Ulips are essentially investment cum insurance plans which offer the investor an indirect option of buying stocks among other things.
In the bull market that ran from 2004 to 2008, banks and insurance agents mis-sold Ulips big time given the high commissions on offer and in a large number of cases promised to double the money invested in three years. By now a large number of Ulip investors have figured out that the only person who gained in case of Ulips was the insurance agent. Hence, investors have stayed away from investing in Ulips and through them into the stock market.
Given this, unlike the foreign investors, the Indian institutional investors have found it difficult to raise money to invest in the stock market over the last six years. And that explains to a large extent the fact that foreign investors have invested a lot of money in the stock market, whereas the Indian investors have stayed away.
The article originally appeared on on March 19, 2014

(Vivek Kaul is a writer. He tweets @kaul_vivek)