Saturday, April 10, 2010

SEBI bans ULIPs – but what about other similar “insurance” products?

SEBI has rightly banned ULIPs by its recent Order. It was also the next logical and even bold step to deal with this product that is aggressively and misleadingly sold by several unscrupulous agents under the head-buried-firmly-in-sand attitude of several insurance companies.


But what about other products including endowment policies which share the traits of ULIPs? They are less worse only to a smaller extent. ULIPs have attracted attention since they have already gained a fair measure of disrepute – thanks also to the obscene commissions often paid to agents on them which obviously goes out from the “premiums” paid by unsuspecting applicants. SEBI would surely get moral support from the now well-aware public in its ban. Sure, the Order will face serious litigation and an almost certain interim stay – particularly because SEBI has stopped further subscription even on existing sold ULIPs. But the other interesting issue is - how about applying the same reasons for ban to other insurance products too?


Lets understand first what was found wrong – legally and morally – with ULIPs. Summarised and simplified, it is found that ULIPs are almost predominantly investment products. The insurance portion (to borrow the cute phrase used by Sandeep Parekh, who has also lauded this Order in his blog), is merely a fig-leaf and constitutes less than 5% of the “premium” collected. The predominant portion is allocated for investments made in a manner akin to mutual fund products (actually, even these calculations of SEBI are wrong – the allocation is only after the huge commissions paid to the agents). If a product of an insurance company, under the garb of being an “insurance” product, is really an investment product, SEBI should rightly get a jurisdiction – in fact, an exclusive one. This, highly simplified, is the legal part. The morally reprehensible part is the manner in which these products were sold with promises (consistently “unofficial”, of course) of sky-high, impossible-to-achieve returns.


But what about most other “insurance” products that are similarly constituted? Take a typical endowment policy. Since premiums vary according to age of insured and term, let me take my own example some years ago. Typically, a 35-year old person would be charged an annual premium of about 5% (approximately and just to make the point) annually of the insured value for an endowment policy. However, if I take a “term” policy, I will be charged a premium that is just 0.50% of the same insured value.


Why am I charged 10 times for the endowment policy when the insured value is the same? This is because, in an endowment policy, I get the insured value at the end of the term if I am alive. In case of a term policy, I don’t get it. Of course, in both products - and this is the real essence of an insurance policy - if I die in the policy period, I get the full insurance amount.


Thus, actually, I am charged 10 times for an endowment policy and the extra 9 times is really invested, of course after commissions and expenses, for my benefit and is not for pure insurance.


And if that is the case, why not ban these products too, since here too a predominantly investment product is mis-sold as an insurance product?


Of course there are some differences in case of ULIPs and products such as endowment policies. An important difference is that the endowment policy-holder does not bear the risk of downfall that is inherent in ULIPs. The endowment policy-holder is assuredly paid the insured value – in fact, he is paid bonuses above it too, though these are not assured in terms of specific percentage. But at the end, the 90% is still, I think, an investment product. And, as SEBI has observed in its Order, “..the ULIPs launched/offered by the said entities are not purely in the category of “contracts of insurance” but have components of investment products…ULIPs are a combination of insurance and investment. Therefore…they must be regulated under relevant/applicable Acts and Regulations. The investment component should be registered with and regulated by SEBI”.


However, another reason why such other products do not create as big an uproar as ULIPs is that they are far better and conservatively managed.


Unduly high commissions are also not paid. Of course, the commission on term policies on the same insured value will be a very small fraction of the commission on endowment policies or similar products. Hence endowment policies are expectedly more aggressively pushed by agents, at least in my experience.


Another critical distinction is that the “investment” portion in the endowment policy is not separately identified (not “unit-linked”) with multiple choices, as in the case of ULIPs.


Still, consistent with the legal stand that SEBI has taken in its recent Order, even these products are not “insurance” products.


At the end, however, the issue is not purely a legal one. It is not solely a “turf war” as almost certainly this Order will be criticized to be - also, IRDA can be as good or as bad as SEBI. At the end, it is about how a mutual fund, an insurance company or even a company operating a collective investment scheme is fair about its products. ULIPs have been banned not solely because of legal reasons nor solely because of turf wars but because that they were unfairly presented products.


It will also be interesting to see the next developments post this order that is surely to be appealed. There are certain technical and other reasons too for appeal. For example, the insurance companies may argue that they were not given a personal hearing which fact the Order specifically records.


More importantly, SEBI has banned even further subscriptions on existing ULIPs already sold. This ban is obviously logical and consistent with SEBI’s stand that if the product is an illegal one to start with, further payments would also need to be stopped. However, it is this that will cause immediate grief to ULIP holders and will also give an excuse to insurance companies to attack the whole order.


The argument will be that ULIPs are long-term products and if the existing ULIPs are terminated prematurely, there will be a huge loss to the holders. Of course, the real reason for the loss is the huge commissions paid to agents in initial years. Still, investors may suddenly find that, far from any positive returns, they will get back a fraction of what they had paid as premium.


It would also be interesting to see whether the insurance companies will be required to compensate ULIP holders for the losses caused to them for ULIPs illegally sold as SEBI has held. It will be also be interesting to see whether they are penalized too for this. Whatever the end may be, one thing seems certain. The hot legal and press debates on this issue will surely create more awareness of the real nature of this product and make it for this reason itself commercially unviable.


- Jayant Thakur

15 comments:

Anonymous said...

Some of Insurance compnies are still selling ULIP .
What action will be taken against them ?

A said...

The root of this problem lies in the socio-economic mindset of Indian masses. While worldover Term Plans sell the most, in India the legacy Endowment and Money back plans are preffered by people themselves. Getting money if alive at the end of term is the attraction...which as rightly pointed out is not the purpose of insurance.
Insurance in India is not only considered as a security or back-up for any unfortunate incidence but also as savings for old-age...this has now been imbibed in the minds of people through generations.
What does a Child Plan mean afterall...it is just a hoax...but it still works well...at least people "save and invest" for their future needs. Once an insurance contract is entered, a high percentage of people honour it for the term of contract, thus mobilising resources.
Another reason for insurance growth in India is the tax benefit...it is easy to observe that since premium on Term policy is low, tax benefits would also be low...hence the preference by the 'insured' himself to go for other kind of policies...even the government has been treating total premium paid as insurance premium...does this also call for a review then???? Of course, with modification and expansion of 1 lakh rebate alternatives and DTC, this is now not a strong case but was earlier.
Lack of education is also a major cause. IRDA should force insurance companies to educate people on life insurance and restrict misleading 'investment' advertisments.
Every kind of insurance policy is broken into pure term insurance premium+investment+charges. So as rightly observed by SEBI, insurance companies are acting as investment managers and in that sense they need to compete with mutual funds, etc and show case their money management skills. What if mutual funds are allowed to offer term insurance (even if through tie-ups) along with their investment products...is there any differential left?
Finally, the problem lies with expectations of people themselves...they do not expect any kind of returns from General insurance (car, theft, fire, etc) but when it comes to life insurance, the thinking changes. Hence, the issue cannot be dealt only with a legal angle but socio-economic conditions need to be brought within the ambit.

vswaminathan said...

Well written: - This, in my perception and conviction, is the line of action / follow on required to be adopted in any such or like matter,- which entails the objective of safeguarding /securing the larger interests of the so-dubbed - 'common - man'(?!)

vswaminathan

Jayant Thakur, CA said...

An update-IRDA asks Insurance Companies to ignore SEBI Order and continue the collections under ULIPs. Ball now back in SEBI's court.

@A - thanks for your insightful inputs. For the common man who can't do financial analysis, ignorance is bliss and while they get far lower returns when they buy endowment & similar "insurance" policies, they do get something & their "principal" is safe.

However, wont you agree that if a policy like endowment has at least 90% investment portion, a separate regulatory policy is required for more transparency for this portion akin to what SEBI does for investment products. And, to me, it does not matter if this is done even by IRDA.

On your point that term insurance has lower premium and so lower tax benefit, it is possible - as I too have done - to take a higher value term policy and be better protected and get higher rebate too. Also, PPF is alternative for the amount saved and gives far higher and tax-free returns and same tax rebate as compared to what one gets in endowment policy.

Thanks again!

@vsswaminathan - Thanks!

amith said...

A very well written article. Nowadays, there are few ULIPs which sound too good to be true. One of the latest ULIP offers highest NAV in a period of 7 years.

Would request your inputs on the sustainability and permissibility of such ULIPs, in light of the ongoing tussle between IRDA and SEBI.

Anonymous said...

article is really alarming and informative. nice work. carry on

Hardik Shah said...

If, I've read it carefully LIC was not included in the list. Why?
under wright by government?

yogesh said...

Update - http://www.business-standard.com/india/news/round-1-to-irda-bansaleulips-lifted/391712/.

vswaminathan said...

SEBI vs IRDA - the ongoing Ego / Turf War
1. Business Line, has in its Issues of 11th and 12th April, published a few reports / write-ups; also an article in its Issue of 12thApril – Should ULIPs be stopped?
They cover and focus on the several issues that have come to be surfaced by SEBI’s recent Order banning ULIPs.
The Reports bear out the mutually varying reactions to the sensational Order of SEBI. Knowing the traditionally governing ‘fundamentals’, the diagonally opposite stance of IRDA could not have surprised anyone.
Every regulatory authority invariably opts to confine itself to its rules / regulations so framed as to take care of only the interests of the given sector within its purview. The rules are framed in a manner that, – they address themselves to only the 'parochial’ concerns of the players in the respective sector. As a matter of convention, most rules or regulations are not founded on any ‘principle’ -in its profound and idealistic sense.- from a socialistic point of view.
The inevitable consequence is, in the event of being faced with a conflict of interests, to say more precisely, such as herein - a conflict of ego or turf war- each authority strives and sticks to its own gun, ignoring or bypassing what the other authority has to say, – ‘Come What May’. So much so, the rules as also the steps taken by each one of them on a peremptory basis blatantly tend to overrule or bypass the most vital objective they are expected to serve or sub serve – namely, the larger interests of the investors or insured.
2. Somewhere it has been said: “No wrong becomes right simply because it has been routinely done for over 10 years, said a senior legal expert who did not want to be identified: “This kind of thing does not hold in law”.
To briefly comment: – One has no clue which law he had in mind. For that matter, one wonders whether he himself had a clue. Certainly, no ordinary investor or his roadside broker is not a ‘legal expert’; hence, could not be so equipped as to understand even an iota of what the unidentified legal expert has said or meant to say.
3. Both regulators claim that their sincere objective is to protect the interests of the investing or the insuring public. The finance ministry is unlikely to resolve the issue to satisfy both the regulators. The apprehension is, - should the conflict last longer, that could send wrong signals to the market. Also, lead to funds collected through ULIPs being diverted to investment in the equity.
4. Hats off to Mr PM, in his role as the FM, for having shared publicly his great feelings:
“Financial markets needed to increase depth and expand financial literacy so that inclusive growth can be achieved. Simultaneous move for investor protection and education will enlarge markets' reach and ensure more inclusion.” -
Whatever the quoted words mean or truly meant to convey.
Even so, what he seems to have had in mind are long-term measures. If so, it is anybody’s guess as to how long it is likely to take, for even the initial step of giving a shape to the venerable senior most political leader’s ‘feelings’ –

Albeit, not to so much worry, for the nonce, as to how long the concerned investors / insurers are destined to wait for any action, more so constructive one at that, from the quarters up-above.
5. The predominant soul searching questions is this: – Could not the close- to- crisis situation have been avoided or obviated, had SEBI realized its own statutory powers and, if at all, diligently invoked them at a much desirably earlier point in time– 5 or 10 years, - to approximate.

THE FRONT PAGE NEWS IN TODAY'S BL ISSUE ON– SEBI, IRDA TO JOINTLY APPROACH COURT - HAS NO DOUBT COME AS A BREATHER. BUT ADDS A NEW DIMENSION TO THE HITHERTO NOTED ISSUES. THAT GIVES RISE TO CERTAIN CORE ISSUES - INTRINSICALLY TECHNICAL /LEGAL ONES- WHICH THE WARRING PARTIES MIGHT BE OBLIGED TO ADDRESS BEFORE THE COURT FOR ADJUDICATION.

vswaminathan

Jayant Thakur, CA said...

as readers have already pointed out, the ULIPs matter is reversed to status quo ante and the matter is to be decided by a "Court" though it is not clear how and which court will get jurisdiction.

In the meantime, do also read the eerily timely article in the New York Times, which is written without reference to the controversy in India (i got the reference from Ajay Shah's blog):-

http://bucks.blogs.nytimes.com/2010/04/12/why-life-insurance-is-not-an-investment/

a quote from this article:-

"..the problem is confusion about the purpose of life insurance. So let’s clear that up right now. For most of us life insurance has one purpose — to replace an economic loss.

That’s it.

It’s not for education savings. It’s not for retirement savings, or to provide a tax-free loan later in life."

Lawman said...

Hi Jayant,

Thank for your post. However, with all due resopect I dont think SEBI can usurp jurisdiction over ULIPs with its current regulations. SEBI's regulations do not envisage a product like ULIP and infact spcifically exempt contracts of insurance.

Even though investment is a huge component in ULIPs, the very fact that investment and insurance are inseparable, it makes ULIPs a contract dependant on life and hence life insurance business.

Insurance cos. can never fulfill the requyirements for registration as mutual fund (sponsor, trust, AMC).. it is impossible for life insurance cos to register as mutual fund without breaching provisions of Inurance Act (which requires them to do solely life insurance business).

The haste in which SEBI acted and placed ban on ULIPs and utter disregard to millions of policy holders' interest iself reflects upon SEBI's understanding of this product.

If SEBI wants to exercise jurisdiction over ULIPs, the policy needs to change. Legally speaking, SEBI has a weak case.

My two bits!

Kind Regards,
Lawman

Anonymous said...

A consumer is paying his hard earned money as premium to cover the risk of his life and his payment is subjected to market risk by the insurance companies. I think IRDA should have the answer to this question, Does the consumer practically feel relieved of one risk (life risk) by hiring another risk (Maturity amount), as expected by the policy makers? Isn't it the right time to to ask the investors and admit that ULIP are not insurance products?

A B said...

The question is not only about regulation but whether insurers are supposed to mobilize funds for investment...we need to clear this in the first place. Few more questions arise...
1) What is the relationship between insurance and investment?
2) Why investment elsewhere would not accrue better returns?
3) Why do insurance companies want to act as money managers? What will be size of impact if investment plans are pulled off?
4) Why they should not sell investment as an "add-on" product...why they want to sell it as a "hydbrid"? and so on...

Jayant, as far as endowment plans are concerned, most of the money is conservatively invested in money market/debt instruments and hence the concern shifts to ULIP where major weightage in equity steps in (it is just as government won't allow more than a small percentage of pension funds in equity)
Finally, the issue is not entirely unique to India. It is not that internationally it is only term insurance that sells...I believe insurers outside India have packages which include investment plans.
http://www.lifecoverpro.com/life_insurance_articles/life-insurance-companies.htm

S R Nayak said...

Dear Jayant, I am sorry to write this with due respect to your qualification. Do you know that in a traditional product there are hidden charges as high as 70-80% in the first year then it tapers down but not drastically? Otherwise how commission of 25-37% can be paid to the agents in 1st year then 15% in 2nd year then onwards not less than 10% throught the policy term. Compared to this for ULIP the commission paid is around 12-15% in 1st year then around 5% in 2nd year then around 2% theeafter. The invested amount in traditional plans are defenitley not 90% as written by you. If such an amount is invested then I should have got huge amount as maturity amount in my traditional policies after paying 30 years of premium which I paid like an ass. I don't know in ULIPs where on this earth an agent gets 45% when the allocation charges are not more than 30% maximum in 1st year then around 10% in 2nd year and then around 4-5% thereafter. Unless the foreign partner brings dollars or uros by shipment. Will someone get a documentary proof of "high Commission" paid to ULIP sellers? I have been in life and general insuarnce for the past 8 years after my retirment from Bank during which I have experience of utilising all kinds of investments unlike the present young generation which relies mainly on web sites for information and thinks it is gospel truth. Not to be left behind are the self proclaimed CFPs they are the most dangerous elements in India now. I have studied both life and general insurance as a subject as well as the working, selling of policies. My life's own experience of LIC policies are so bad I can write a book on it, I mean the "loot" of my hard earned money in the name of insurance. Here I agree with you that there should be some control on traditional policies and strip them stark naked as ULIPs then any sane person will not buy one policy. Still if one buys he is the biggest fool in the entire universe. As to the term insurance though the premiums are low they are good only for covering ones loan amount say housing, education et., The main problem is the sum assured taken gets reduced in value due to inflation over a long period as it happened in my case when I took a LIC policy in 1971 Rs10000 was a respectable amount but when the maturity came near that Rs.10000 would not have sufficed my funeral expenses if I were to die befoe the policy matured. Now in ULIPs one can increase the sum assued in the same policy, this point nobody cares whether he is a CA or CFP or etc., etc., ULIPs ae like sharp weapons one should be exta carefull in utilising it, compaing diffeent products. My own ULIP gave me the double the amount which I paid in just 3 and 1/2 years as compared to the same amount I got from LIC after paying premiums for 30 years. This meely because I looked after LIC and its agents during the entire policy term.Of course any amount of this kind of writing of my pesonal experience will not be acceptable to the present generation which has some kind of fixation for term insurance just because the premiums ae low no matter whether the purpose for which it is taken is served or not.

Anonymous said...

Who will save investors from NON-ULIP products ? There are many non-ULIP products by private insurance companies sold as Investments (example - HDFC Assured Saving Plan). No SEBI there and the Agents & Insurance companies continue looting investors...