“We’re slowly learning that fact. And we’re very, very pissed off.”
—Tyler Durden in the movie Fight Club
Chandrasekhar Bhaskar Bhave, the chairman of Securities and Exchange Board of India (Sebi), is no Tyler Durden.
Neither is Prashant Saran, wholetime member of Sebi, who signed the order barring 14 private insurance companies from selling unit linked insurance plans (Ulips) late on Friday night.
Or for that matter K N Vaidyanathan, executive director, Sebi, who on Sunday said “the order against other insurance companies, including LIC, will be passed once the investigation is complete.”
But it’s a safe bet they are all very, very pissed off. And they have reasons to be.
Since August 1, 2009, Sebi has 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 go towards agent commission.
Insurance companies, however, continue to pay enormously high commissions to their agents, especially on Ulips.
The Insurance Act 1938 allows companies to pay a commission of as much as 40% in the first year of a regular premium policy (excluding pension plans where the upper limit is 7.5%).
This seems to have skewed the field in favour of Ulips, at the cost of the mutual funds.
Mutual fund agents have stopped selling equity mutual funds since August. As a result, equity mutual funds have seen a net outflow of Rs 6,837 crore. However, tax-saving mutual funds, which are also equity schemes in nature, have seen a net inflow of Rs 1,437 crore during this period. Factoring this in, the net outflow from equity mutual funds has been Rs 5,400 crore since August.
On the other hand, in the six months between July and December, the insurance companies collected Rs 76,487 crore, of which nearly 68%, or Rs 52,238 crore, was through Ulips.
That’s why Sebi is pissed off.
After all, Ulips are part-investment and part-insurance plans. Money raised through Ulips is largely invested in stocks and bonds, which makes their structure very similar to that of a mutual fund.
As per a DNA analysis (Insurance data prove Sebi’s point) published on April 12, a minuscule 1% of the premium paid in an Ulip goes towards the insurance cover, while the balance is allocated to investment. So the insurance industry’s premise that Ulips are very different from a mutual fund does not hold much water.
As Table 1 shows, around 18% of the first year’s premium in Ulips was paid as commission during 2008-09 (that’s the latest data available). So, for every Rs 100 collected as a premium, only Rs 82 was allocated towards the policy.
No wonder the financial services industry prefers not to sell mutual funds but absolutely loves the Ulips. With an 18% commission, who wouldn’t?
And Sebi does not like it.
Insurers argue that the commission is high only during the first two years and that the commissions fall dramatically afterwards. Fair point. But as Table 1 shows, commissions paid on renewal premium over a period of five years are in the range of 4.56-5.63%.
More interestingly, and contrary to the logical course, the amount collected through renewal premiums isn’t significantly higher than the first-year premium collection. If an individual purchases a policy agreeing to pay a premium of Rs 50,000 each year for a period of 10 years, after paying Rs 50,000 during the first year, he still has to pay Rs 4.5 lakh (Rs 50,000 x 9) over the next nine years. Add up all such policies in their second year or later and the renewal premium collections ought to be way higher. But as Table 2 shows, that is hardly the case. In fact, in 2005-06, the amount raised in first year premiums was as much as that raised in renewal premiums.
Obviously, investor money is getting churned. A commission of 5% on renewal premiums seems paltry compared with a commission of 16-18% on first year premiums. So there is incentive for insurance agents in getting a policyholder to close a policy after the lock-in period and enter a new one using the money received from the old one. In this way, the agent continues to earn high commissions at the cost of the investor.
This isn’t all.
Sebi regulations for mutual funds are in line with the recommendations of the Committee on Investor Awareness and Protection, which was headed by D Swarup. This committee has proposed that all retail financial products go no-load by April 2011, which is just one year away.
“Insurance policies need to remove the bias towards selling the policy with the highest commission… 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 has noted.
The mutual funds are compliant with this already.
But neither the insurance industry nor the Irda has shown much interest in the proposal.
How could Sebi not be pissed off?