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