The investor cries alone

Effective competition is in the interest of consumers, it is said. As Columbia Business School faculty Sheena Iyengar writes in her new book The Art of Choosing, “We like to think that free market functions in a way that protects us from inferior or unnecessary products.”

But that does not seem to be the case with retail investors in the country who must choose between the high commission paying unit linked insurance plans (Ulips) and very low commission paying mutual funds.

Essentially, unit linked insurance plans are mutual funds, which come with a dash of insurance but are allowed to pay a commission of as high as 40% of the premium paid by the investor during the first year of the policy. In comparison, in case of mutual funds, 100% of the investor’s money gets invested.

This, despite the fact that in the last five years, the average return of equity mutual funds has beaten the average return of equity oriented Ulips by more than 20%. The 25 top mutual funds have in fact given absolute returns of more than 80% compared with equity oriented Ulips.

Clearly, if performance was the sole criterion and the free market was functioning, money would be going into equity mutual funds. But it is not. In the last financial year, equity mutual funds saw a net inflow of Rs 595 crore where as Ulips collected 194 times more money at around Rs 1,15,314 crore.

Blame it on the perverse incentives at work. Ulips can pay high commissions to agents using the investor’s money, whereas mutual funds have to largely pay from their own pockets. Insurance companies can use celebrities to advertise their products; mutual funds cannot.

But, the mutual funds have themselves to blame, too.

Iyengar gives an interesting example. “The two best-selling brands of bottled water in the US are owned by Pepsi (Aquafina) and Coke (Dasani), you’d be… unlikely to see them aggressively advertising their health benefits relative to soft drinks, one of the few they could legitimately make.”

Moral of the story: A bottled water brand cannot say it is healthy to drink water if it happens to be owned by a company which also sells soft drinks.

Similar is the case with the Indian mutual fund industry. In the last five years, no mutual fund has made an effort to communicate its better performance over Ulips. Not one has made an effort to communicate its low commissions vis-a-vis Ulips.

And why? It’s because the biggest mutual funds are all promoted by companies, which also have insurance subsidiaries, whether it is Reliance, Birla, SBI, ICICI, HDFC, Kotak, Religare Bharti Axa, ING, Tata, HSBC, Canara or LIC. It would not be in their promoters’ interest if they came out and compared their performance with Ulips.

Most of these promoters run banks, too. And for banks, insurance commissions are lucrative and an easy way of boosting their other income. 

A recent survey titled the “India Bancassurance Benchmarking Survey 2010”, carried out by Rajagopalan Krishnamurthy of Towers Watson, says, “The responses to the survey confirm the assessment that bank distribution in the case of life insurance is currently highly skewed in favour of unit-linked products. Ulip sales account for more than 85% of premiums generated by banks.”

Would they want to disturb the equation? As Iyengar writes, “Mega corporations exactly decide how much variety their brands will offer… and it’s not in their interest to create true variety. Rather, they aim to maximise differences in image, thereby generating the illusion of variety and attracting the greatest diversity of consumers at the least cost to themselves.”

Need we say more?