It’s time Kumbhakaran woke up

Mumbai: Legend has it that Kumbhakarna, one of Ravana’s brothers in the Ramayana, had a boon from Brahma, which allowed him to sleep for six months at a stretch. He woke up to eat and then went to sleep again. A similar thing seems to be happening with the Insurance Regulatory and Development Authority of India (IRDA), the regulator, which has turned a complete blind eye to the mis-selling that has been going on in the insurance industry.

Every few months, the Hyderabad-based regulator evinces concern about the mis-selling, makes a few right noises about it and then goes to sleep again. The inactivity makes one wonder if it, too, has a “boon” from some higher power.

Most mis-selling typically involves selling a high-cost unit-linked insurance plan (ULIP) to an unsuspecting investor. Depending on the insurance company, the premium allocation charges can vary from 15 per cent to 71 per cent in the first year.

What this means is that if an ULIP charges a premium allocation charge of 30 per cent in the first year of the policy, only 70 per cent of the total premium paid actually gets invested. The premium allocation charges remain high even in the second year of the policy. These high charges are essentially used to pay fat commissions to insurance agents (which may be banks or individual agents or big corporate distributors).

Insurance agents do not inform the individuals taking such policies about the high upfront expenses involved. Also, most agents tell their customers that an Ulip is a three-year policy and that they can stop paying premiums after three years, which is far from the truth.

The reason agents do this is simple. Their commissions are not as high in the latter years of the policy as they are in the first three years. So, it is in their interest if the individual stops paying premiums after the first three years.

Once three years are over, the same agent can sell a new Ulip to the same individual and continue getting his high upfront commission. The sad part is that most individuals who are the victims of mis-selling belong to the great Indian middle class, who work hard to earn their money.

Insurance firms tell us that they can’t be held responsible for their agents’ mis-selling. Well if they are not responsible, who is? Agents are the face of an insurance company, considering an agent can sell policies of only one company. Logically, therefore, if the agents of a company behave inappropriately, it is the company that must be blamed.

And why do agents mis-sell?
Primarily because of they can earn a high upfront commission. In fact, a lot of new generation private sector banks and foreign banks have lately been concentrating primarily on selling Ulips, because the reward per unit of effort is much more compared to other financial products.

The high upfront charges mean that an individual taking the policy is left completely dependent on the insurance company’s performance. If a mutual fund does not do well, investors have an option to exit the scheme. Also, they can stop making further investments into the mutual fund. Besides, most mutual funds do not charge an exit load if the holding period of the investment is more than six months.

In case of an ULIP, however, the investor has little choice even if it does not give him good returns. He has the option to exit, of course, but after three years. By then, he would have already paid a lot by way of premium allocation charges and the amount he gets back, if he cashes out at the end of three years, may not even match the total premium paid.

Indeed, the high upfront charges make ULIP a very inflexible way of investing. If your ULIP does not perform, you are stuck. Insurance companies would like us to believe that their expense structure works out to be a lot lesser in the long run. Point taken. If that is the case, why not spread out the expenses over a longer term? Why is there such a haste to recover as much as they can from the investor in the first two to three years?

The rationale given is that selling insurance is much more difficult that selling other financial products and hence the agent needs to be adequately compensated. This argument is questionable.

Another argument is that the world over, ULIPs have high upfront charges. How does that justify having high upfront charges in India as well? Do two wrongs make a right?

So what is the solution? Instead of a premium allocation charge of say 60 per cent in the very first year of the policy, why not have a premium allocation charge of 3 per cent every year, over a period of 20 years? This will at least ensure that distributors stop getting the high upfront commissions, and hopefully stop mis-selling.

However, to implement this, IRDA must first wake up from its deep slumber, and wake up before it is too late, since a lot of private sector insurance companies have big plans for the rural market. Imagine the kind of mis-selling possible in the rural markets.

The regulator and insurance companies must remember that many retail investors have turned away from the stock market following the various scams over the years. Unless necessary action is taken at the earliest, the same story could be replayed in the insurance business as well.

Source: DNA Money