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The choice of withdrawal of all financial products, except those pertaining to pensions, should remain with the investor, according to a committee set up by the government to rationalise distribution incentives for financial products and curb their mis-selling. A report by the committee, headed by former finance secretary Sumit Bose, said Indian markets should be guided to an advisory model, in which customers sought advisors and remunerated them directly for holistic portfolio advice.
"Financial products should have flexible exit options. The cost of exit must be limited," the report said.
Currently, products such as unit-linked insurance plans (Ulips) have a lock-in period of at least five years. It was increased from three years following a spate of customer complaints prior to September 2010, when market volatility led to poor returns for policyholders, who exited early.
For mutual funds, the committee recommended making cost caps under the total expense ratio not fungible. Other recommendations included abolishing up-fronting of commission, reducing trail fees, no advance payment of commission to distributors and lowering of cost caps with a rise in assets under management.
While the Bose committee said the Securities and Exchange Board of India's norms for mutual funds and the Insurance Regulatory and Development Authority of India's rules pertaining to Ulips were robust, it added these principles should govern the surrender and lapse costs for traditional plans and form the basis for future products.
Asked about Ulips, Bose said, "The report is not calling for an end to lock-in periods. We have recommended greater freedom for customers in deciding when they want to withdraw from their investments in a product. What we have given are a set of suggestions which are obviously customer-friendly.
"The most important point in terms of insurance products is a clear difference should be established between the quantum of money to be used for mortality and the amount to be used in investments. That should be made clear to a customer."
Addressing concerns about some life insurers booking large sums of surrender profits when policyholders didn't keep the policy in force, the committee said lapsation profits, or profits from exit charges, shouldn't accrue or be booked by product providers.
It said customers should easily be able to compute their net investment return by considering the point-to-point net asset value of the fund.
Upfront commission for investment products and the investment portion of bundled products skewed seller behaviour and led to mis-selling and churning, the panel said, adding these should be phased out. It, however, said a complete ban on commission would be counter-productive, as commission played an important role in incentivising distributors.
To ensure distributors are incentivised for sales in regions such as rural areas, the committee recommended they be given special incentives. It asked regulators to be harsh on manufacturers violating the spirit of the cost recommendations by hiding costs paid to distributors under other heads such as marketing or business promotion.
"It is commonly recognised that tax breaks and assured returns work as pull strategies. What is perhaps not commonly recognised is presence of assured returns and/or tax breaks can, in fact, make the product more susceptible to irresponsible sales where the products also have opaque or mis-aligned cost structures as well as opaque benefits, as can be seen in some traditional insurance products," the report said.
The report said banks and other institutions tend to over-sell (and, as a result, often mis-sell) products belonging to their group companies. It asked regulators to consider putting additional disclosures requirements on banks.
WHAT THE PANEL RECOMMENDS
- Choice of withdrawal remain with the investor for all products, except pension ones
- Up-fronting of commissions be done away with for mutual funds
- Risk meter/colour-coding system to show risk of asset allocation in participating insurance products
- 'Net return' to be used in place of 'bonus' to indicate return
- Banks should disclose products from group companies and show comparable products when selling group company products
