BATTLE BETWEEN MARKETS SEBI AND IRDA HAS EXPOSES SERIOUS SHORTCOMINGS OF THE INDIAN INSURANCE INDUSTRY

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INDIA'S market and insurance watchdogs are at each others' throats, growling and snarling. It's said that this is a struggle for one upmanship between two independent and headstrong regulators, a battle for turf in financial markets. That's only part of the story. Early this month market regulator Sebi barred 14 private sector insurers from issuing instruments — popularly known as Ulips — without asking its permission.
 
This effectively meant that no insurer would get to issue new Ulips, insurance vehicles that use the premiums gathered from people to invest in equity and debt markets. The order infuriated insurance regulator Irda, which asked insurers to ignore Sebi's instructions and go ahead and sell Ulips anyway. Soon, the spat escalated and the battling regulators were summoned to North Block in Delhi and told to take their spat to court.
 
Till the Bombay High Court takes a call, insurers won't know whether they can issue new Ulips, so that hangs in limbo. People who've already bought into Ulips have been told that their investments won't go belly up. But that's about all the light that's come out of so much heat. The real issues have been buried in the din.
 
Whenever you invest in a Ulip, you're offered some insurance cover and some returns that are based on how, say, equity markets perform. In other words the insurer offering you the Ulip put your money to work betting on stocks and the returns you get, if any, will depend on whether those stocks go up or down.
  
But apart from the insurance cover, isn't that what a mutual fund, which invests in equities does? It is, with a very major difference. When you buy a mutual fund you pay nothing to the company running the fund to buy in. When you buy a Ulip, you pay the insurer a huge amount of money, in some cases around 70% of your first premium for the privilege of allowing it to accept your money. Till recently insurers were also allowed to gouge you with slightly lower fees up to four times over the life of the policy.
 
Since your money will chase stocks (and sometimes debt) in both cases, there's absolutely no reason for a company issuing Ulips to charge you more than a company running a mutual fund. Sometime ago, market regulator Sebi made sure that MFs wouldn't charge you anything when you buy a fund, by scrapping the so called entry load. It also banned funds from paying commission to agents who sold those funds. Today you can still buy funds from agents, but you have to pay them a small fee, typically around 1% of your investment, as an advisory charge.
 
Given that, Sebi wonders, why would Ulips charge so much from investors? I wonder about the same thing. I also wonder why people would invest in Ulips when they could pay much less — and therefore make higher returns on investment — by going the mutual fund way.
 
The answer to that riddle is something called ‘mis-selling': the way agents who sell Ulips hound their marks, make outlandish promises that they know they can't deliver, to gouge those first few premiums out of you. The fees that you'll pay on those first few premiums are the real killing for insurers and their agents.

MIS-SELLING investment instruments isn't just limited to India or Ulips. Across the US, so called ‘smart' investors bought instruments called CDOs till 2008, when they realised that these things were actually packages of housing mortgages taken by folks who couldn't afford to pay after the first instalment. And America's market watchdog SEC has indicted Goldman Sachs, supposedly the smartest investment banker in the US, of fraud because it mis-sold at least one CDO to a gullible mark three years ago.
 
Insurance regulator Irda recently woke up to the charges of hidden costs and misselling of Ulips. It asked insurers to cap the charges at 3% of total returns for all policies up to 10 years. That's still 3% higher than the cost of buying a mutual fund, but nevertheless it was a sign that the watchdog wasn't totally comatose.
 
But despite Irda's cap on upfront charges, insurers can still goose you with other charges with fancy names that mean nothing but are designed to make you poorer. They'll also be written in very small print in some corner of the documents that the agents will not bother to open for you.
 
This is the can of worms that Sebi has opened up. Instead of referring the dispute to a court, the government should have taken a position on the dispute between the two regulators. The government should have asked the insurance watchdog to do exactly what Sebi has done for mutual funds: no insurer should be able to pay its agents any commission to sell Ulips. And no investor should pay any entry load on these instruments.
 
These would have made one very important difference: it would have eliminated the difference in incentives offered to agents selling Ulips and mutual funds. That would have taken most of the misselling out of the Ulip market. Without higher commissions, agents would be indifferent between pushing a Ulip or a mutual fund. Would it make it tougher for insurers to sell plain vanilla insurance schemes, ones that aren't linked to market investments? Not at all. Those things, called term policies, could have the same incentives that exist today.
 
 After all Ulips do manage to collect a lot of money from gullible people and pump them into stocks. Will that flow turn into a trickle?

To answer that one, remember that mutual fund investments didn't dry up after Sebi scrapped agent commissions and entry loads. Investors were happy when the entry load went to zero. Agents can, and do, charge investors for advice and help. Fears that Ulips with lower costs will bring markets crashing down are overstated. Instead, Ulips with lower costs might actually attract more customers.
 
There are times when regulators crack down too hard or miss the real point or over-regulate. But this time it's hard to disagree with Sebi's position. Instead of slugging it out in court, Irda should crack down on the incentives offered to sell Ulips and make them the same as mutual funds. The longer this state of things continues in the insurance industry, the longer Irda will be seen as a toothless watchdog.

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