Mis-selling of financial products: Bose panel suggestions remain relevant

Many of the recommendations made by the Sumit Bose Committee are yet to be implemented by regulators

The Sumit Bose Committee report on curbing mis-selling and rationalising distribution incentives in financial products had appeared in August 2015. Most people had given up hope that its recommendations would see the light of the day. However, at the recent meeting of the Financial Stability and Development Council (FSDC), chaired by the Finance Minister, implementation of its recommendations was discussed. Much of what the committee had recommended three years ago remains relevant even today.

Assess product suitability: The report emphasises that a financial product’s suitability must be assessed before it is sold to a client. “In India, products often get sold en masse. During the recent SIP (systematic investment plan) craze, everyone was sold an equity SIP without taking into account the client’s age, current financial status, risk-taking ability, and so on,” says Prithvi Haldea, founder and chairman of Prime Database, and a member of the Sumit Bose Committee. 

Regulate by function, not form: The crux of the committee’s recommendations, said another member of the Bose Committee who wished to stay anonymous, is that a financial product’s function should determine who regulates it, and not its form. The thought within the committee was that until a unified regulator is formed, the rule of the lead regulator should prevail. Ulips, for instance, should remain under the Insurance Regulatory and Development Authority of India (IRDAI) but the rules around its investment part should be the Securities and Exchange Board of India’s (Sebi) rules for funds. The Pension Fund Regulatory and Development Authority’s (PFRDA) rules should apply to all pension plans, and so on.

Multiplicity of regulators leads to varying levels of regulatory oversight. Cost structures also vary. “Parity of commission structures across financial products is a big issue today. If a distributor feels that mutual funds are not lucrative enough, he will start selling insurance products because they offer higher commissions, even if they may not be suitable for all clients,” says Kaustubh Belapurkar, director-manager research, Morningstar Investment Adviser India. “Once you have regulation by function, many of these problems will get taken care of,” says the committee member mentioned earlier.

Move from upfront to trail commission: The committee favoured shifting the incentive structure for sellers from upfront to a trail commission model. An upfront commission should only be paid for pure insurance products, or for the insurance portion of bundled products, since selling insurance requires a lot of effort. In the case of pure investment products, or the investment portion of bundled products, sellers should be compensated via a trail commission. Sebi recently moved mutual fund sellers to a trail commission model.

Higher upfront commissions increase the probability of mis-selling. “Sellers push products having higher upfront commissions, irrespective of their suitability. They take their commissions and run, and are not bothered about whether investors stay with the product for long,” says Deepesh Raghaw, founder, PersonalFinancePlan.in, a Sebi-registered investment advisor (RIA). Adds Haldea: “With a trail commission model, the seller has an incentive to sell a suitable product so that the customer stays with him, and both benefit over the long term.”

Steer clear of mis-selling by banks: The committee also took note of a form of mis-selling where the seller does not reveal the full array of products to the buyer, and instead pushes him to buy from a limited set of products. The report contains data which shows that a high concentration of the mutual funds sold by banks belong to the fund house from the same group.

Today, bank employees are set aggressive targets. Their level of training in financial products is limited. “There is also a high level of churn among relationship managers. You may deal with one today and he could be gone tomorrow. Such a person has a greater propensity to mis-sell than someone like a financial advisor, who has to live and work in the same community for his lifetime, or one who depends on advice-based fee,” says Vishal Dhawan, chief financial planner, Plan Ahead Wealth Advisors.

Improve transparency of traditional products: The Bose Committee report makes a case for making traditional products (moneyback, endowment, etc) more transparent. “In a bank deposit, you know that you will get a 6-7 per cent return on the amount you have invested. In a traditional product, to calculate the internal rate of return requires a level of ability that most retail investors may not have,” says Dhawan. The rules governing early surrender of these policies are also not investor friendly.

R M Vishakha, MD & CEO, IndiaFirst Life Insurance, however, argues that traditional products remain relevant. “The returns that traditional plans offer should be looked at in conjunction with the fact that they give guaranteed returns. If there is a shortfall, it is made good by the shareholder’s capital. And these products do not have a call option,” she says.