Two days from now, a regulatory Mahabharata is going to begin. On the one side is the heavily-armed insurance lobby, which mistakenly believes that in order to sell its products, consumers need to be fleeced through a web of sinfully high and opaque commission structures. These commissions for a 15- to 20-year product need to be expropriated upfront. And once filched, the industry’s agents need not serve the consumer, let the product lapse, and sell another high-commissions-opaque-product to the same consumer every three years.
On the other side are financially illiterate consumers of financial products, who are succumbing to institutionalised mis-selling by agents with the tacit understanding of insurance companies unleashing the astras of abominable incentives that encourage this malpractice and a regulator, Insurance Regulatory and Development Authority (IRDA), that over the past decade has blessed this practice and looked the other way. (The finance ministry officials who are supposed to safeguard investor interests in banking and insurance are conspicuous by their sublime silence and complete absence from an issue that’s definitely going to interest the investor-friendly Finance Minister Pranab Mukherjee.)
But on September 9, when insurance and mutual fund companies, banks and individual agents-advisers that sell these products and pocket the commissions, regulators, government officials and other stakeholders including the media gather in New Delhi to discuss a consultation paper titled ‘Minimum Common Standards for Financial Advisers and Financial Education’ under the chairmanship of D Swarup (he is the chairman of Pension Fund Regulatory and Development Authority), it is going to be a fight that has been simmering for many years but is going to explode only now. I promise, it’s going to give the Wachoswski brothers who wrote, produced and directed the Matrix troika, a run for the (intellectual) violence.
Having failed to elicit any sympathy when Securities and Exchange Board of India (Sebi), through its June 20 circular, ended all upfront commissions from August 1 from either the behind-the-scene lobbying in Ministry of Finance or the Delhi High Court (a July 24 order dismissed a petition seeking a reversal of this order), mutual funds are reluctantly going to be on investors’ side. Their plank is going to be: give us a level-playing field. And rightly so. If an investor pays no commission while buying a mutual fund, why should he lose 40 per cent commission to an investment product from an insurance company? Since most fund companies have related insurance businesses, they have been rather quiet and helpless. “I’ll get fired if I raise this publicly, boss,” a mutual fund head told me.
From various discussions I’ve had with insurance companies and their lobby face, Life Insurance Council, I’ve homed in on four smokescreens that the industry is going to throw at the Committee on Wednesday. All of which need to be thrown out of the window.
Smokescreen 1: “It is difficult to sell insurance products so sellers should get adequate compensation.” Initially, yes — on two counts. One, when Life Insurance Corporation (LIC) was the sole provider of insurance products in the country and most of its products offered guaranteed returns, it did not matter to investors if the agent was paid 1 per cent or 40 per cent commission. An investor’s return was assured and what LIC did to sell it was its business. Not so today, when the risk has been transferred to investors and cost influence returns. Two, competition should have ensured that as more products enter the fray, costs reduce. That hasn’t happened and IRDA has done nothing about it. Adequate compensation, as the Committee suggests, should come from transparent fees, not invisible commissions. Small savings carry a load but it makes not difference to an investor’s returns.
Smokescreen 2: “The livelihoods of 3 million (30 lakh) agents will be affected.” My question here is rather simple: what about the returns of 300 million (30 crore) investors? Most investors who consciously buy a 15- to 20-year financial product, do so because they are seeking oldage security or some other long-term financial goal like funding their children’ education. Leaving such a consumer in the lurch is a political folly, as Pranab Mukherjee knows very well. He also must know that harnessing this constituency’s savings, by creating a transparent and low-cost regulatory infrastructure is an important lever to get the economy back on the 9 per cent plus growth trajectory.
But on this point, I believe, the Swarup Committee has not gone far enough. By allowing high commissions on insurance products to go on till April 2011 (Recommendation 10 says that commissions should be cut from 40 per cent to 15 per cent rightaway, to 7 per cent in 2010 and to zero the next year), the Committee is furthering the cause of mis-selling (which both IRDA as well as the Committee acknowledge as a fact) for 18 months. This is unacceptable.
Smokescreen 3: “The regulator for financial advisers exists in IRDA so a self regulatory organisation (SRO) is not required.” Really? According to IOSCO (International Organisation for Securities Commissions, an organisation whose members, including India, regulate 90 per cent of the world’s securities markets), a “regulated entity” is one that faces a set of compliance examinations, a system of continuing education, a process of registration and regulatory filings, an ongoing system of monitoring, a system of compliance and well-defined enforcement procedures, and faces punitive action.
If anyone is suggesting that the current crop of advisers or sellers of financial products in India are regulated, he needs to re-read regulation. An SRO — with punitive powers — for sellers and advisers of financial products, as Recommendation 9 of the Swarup Committee suggests, is necessary.
Smokescreen 4: “This has not been done anywhere else in the world, so why do it here?” This is an incorrect statement. British super-regulator Financial Services Authority (FSA) has declared that all financial products will go no-load by 2012. Given that Sebi has already removed entry loads on mutual funds, I see no reason why other products — notably insurance but equally pension funds — should carry loads. The Committee is wrong in presuming that pension funds are a no-load product — every transaction costs Rs 20 and with a minimum of four transactions a year, an investor pays Rs 80. Now you can call this number a charge, a load, a cost or whatever, but as long as the investor is bearing it, it needs to be removed.
If this Mahabharata results in a no-loads and transparent world, it will not only be consumers but entire industries that will benefit. Pick up your war conches and blow.