Regulatory arbitrage means more mis-selling

While Irdai recently raised commissions, Sebi has been aggressively cutting them for distributors

A typical year-end pitch from a bank relationship manager asks customers to put money in tax-free schemes offering good, often double-digit, returns. A customer who understands financial products will immediately realise there is no mutual fund product that can offer an assured return as well as a tax benefit. Only when questioned more aggressively will the relationship manager or seller admit it is an insurance product and, most likely, a traditional one.
 
The regulatory arbitrage between MFs and insurance products has existed for a long time. The Securities and Exchange Board of India (Sebi) has been aggressively pushing for cutting commissions to distributors. While the Insurance Regulatory and Development Authority of India (Irdai) recently increased commissions permitted for both pure risk (term plans) and bundled products (read unit-linked insurance plans and traditional plans).
 
No wonder, Dhirendra Kumar, chief executive officer (CEO) at Value Research, feels there should be a separate regulator for investor protection. “Regulatory arbitrage is primarily responsible for mis-selling of products. I believe that Sebi and Irdai should regulate market players and insurers. But, all investor-related issues should be governed by a separate regulator. This will bring balance to the system,” he says.
 
Different stance of regulators: Irdai recently increased the commissions for agents. Called (Payment of Commission or Remuneration or Reward to Insurance Agents and Insurance Intermediaries) Regulations, 2016’, the new rules have raised overall payments in the insurance sector to agents and intermediaries from April 1. In fact, these regulations have introduced rewards for agents and intermediaries. Rewards will include sales promotion, gift and other such items. Says the insurance head of a leading financial firm: “These things were already happening on the sly. Now, they have been legalised.”
 
Amitabh Chaudhry, managing director (MD), HDFC Life Insurance says : “The new commission structure rewards agents for retention of customers and makes life easier for insurance companies. Also, the focus is on transparency.” Sebi, on the other hand, is clamping hard on commissions. In its March 2016 guidelines, it clearly said that MFs have to declare the amount of actual commission paid by asset management companies (AMCs)/(MFs) to distributors (in absolute terms) during the half-year period against investor’s total investments in each MF scheme. “The term ‘commission’ here refers to all direct monetary payments and other payments made in the form of gifts/rewards, trips, event sponsorships, etc, by AMCs/MFs to distributors,” said the Sebi note.  

 
Making term plans more attractive: Insurers argue a pure term product, a necessity for every portfolio, is tough to sell and retain. “Overall premiums will increase. But, this is a step in the right direction. Right now there is a huge gap in protection plans. Insurance companies had clamped down on commissions and it had become unviable for agents to sell protection plans. Take the example of the National Pension Scheme. It is one of the best products but it has not taken off due to low remuneration,’’ says Vighnesh Shahane, CEO and whole-time director, IDBI Federal Life Insurance.
 
The revised commission structure could make it more remunerative for agents to sell protection plans, say experts, as both first year and renewal commissions have increased.
 
“If the customer stays during the duration of the policy, say 20 years, the effective commission works out to only two per cent per year. The problem is not as much to do with front ending of commissions as much as a combination of the commission and customers’ staying the duration of the policy. Renewal commissions will encourage the agent, giving him some skin in the game to sell term plans,’’ says R M Vishakha, MD and CEO, IndiaFirst Life Insurance.
 
What about bundled products? The real problem lies with bundled products which are insurance-cum-investment plans. Here, while the first-year commission for agents and intermediaries has been retained at 35-40 per cent, the renewal commission has been raised to 7.5 per cent a year. Compare this with a MF and there is a huge arbitrage. MF distributors get around 1.5-2.5 per cent commission for the first year in equity schemes. For an exchange-traded fund, it would be lower at 0.5-1 per cent. For debt funds, it can be as low as 0.2 to 0.8 per cent. And the trail commission is around 0.5-1.5 per cent for equity funds. Says Sandeep Parekh, founder, Finsec Law Advisors and former executive director, Sebi: “The scope of mis-selling will  go up with large commissions being given for 
 
insurance-backed investment products. Many people are disillusioned with high margin products as it take years for return of capital, with little scope for return on capital. It’s high time the regulatory arbitrage is minimised and harsh action is taken for mis-selling products, which under securities market laws amounts to fraud.”
 
Mis-selling galore: As the Sumit Bose Committee report had pointed out,” Any upfront commissions in any investment products and the investment portion of any bundled products skew seller behaviour and lead to mis-selling and churning, therefore these should be phased out completely.” The report had also recommended that for investment products, and investment portion of bundled products, commissions should move to an all-trail model, which should be either maintained at specific levels or should keep declining as the product matures.
 
Kumar makes a valid point: “Such kind of arbitrage makes the least knowledgeable person the most vulnerable. And this leads to mistrust in the system.” Something that the financial sector does not need. 
 
Meanwhile…: It would make sense for all investors and policyholders to ensure that they know the tenets of the products. If someone is trying to sell bundled insurance products under the garb of MFs. Remember, mutual funds do not give assured returns. Only equity-linked savings plans are tax free. Don’t be shy to ask questions to the agent, including the commission.  It is better to look foolish than be fooled.