For the more than 25 crore policyholders of Life Insurance Corporation of India (LIC), the LIC-IDBI Bank headlines are very upsetting. LIC will use up to ₹ 13,000 crore of policyholder money to buy up to a 51% stake in IDBI Bank, an asset nobody wants to touch. With stressed assets of ₹ 55,588.26 crore and bad loans a huge 28% of the total loan book, IDBI Bank is probably the worst of the bad banks of India. With its own paid-up capital at just ₹ 100 crore as on 31 March 2017, LIC will use policyholder money entrusted to it to make this equity investment.
LIC has been the gilt-edged long-term safety net for most of post-Independence middle India. “LIC kara lo” is a refrain heard in Indian homes the minute the first salary of the young adult of a family begins to come in. There is public anger when this security of savings comes under threat. There are lots of reasons the policyholders are worried. They are worried about the safety of their money—what if the entire money goes down the drain. They are worried about this being a precedent to more such toxic asset purchases. They are worried about the haste with which the insurance regulator has interpreted a rule to allow this sale—insurance firms are not allowed to hold more than a 15% equity stake in a single firm to prevent concentration of risk.
The news of the appointment of Subhash Chandra Khuntia as the insurance regulator on 1 May 2018 came as a surprise to most financial sector watchers. Of the eight people shortlisted for the final round of screening, Khuntia was the only bureaucrat, the rest were insurance industry insiders, including the serving Life Insurance Corp. of India chairman V.K. Sharma, New India Assurance chairman and managing director (CMD) G. Srinivasan, member Life at Insurance Regulatory and Development Authority of India (Irdai) Nilesh Sathe, and K. Sanath Kumar, CMD, National Insurance. The choice of a person with limited domain knowledge over others who have spent their entire careers working in this very technical industry was the surprise. Remember that it took an earlier outsider, J. Hari Narayan, the first three years of his five-year term to understand the sector. In fact, by the time he demitted office, he understood the sector so well that it went against the then government’s own agenda to allow him to continue. So what has gone into the decision to appoint an outsider as the head of a regulatory body that watches over Rs28 trillion of household savings and over Rs2.2 trillion of general insurance money?
Every time people who have defined benefit retirement plans make rules for the market, their lack of understanding comes across clearly. Take people in the Ministry of Finance for instance, and then look at what subsequent Budgets have put in place. Not only is there arbitrage between asset classes on the definition of long term, there is arbitrage within an asset class too on the basis of which product you choose to buy. If tax policy is used to nudge behaviour, there is some serious malfunction in the Indian policy that is nudging in all the wrong directions and all the wrong products.
In India we answer the question, ‘How many years does it take for an asset to become long-term?’ in different ways depending on the asset. You have to hold equity for 1 year, real estate for 2 years and debt for 3 years for the profit made to become ‘long term’. This classification of assets is against Finance 101, since both equity and real estate are asset classes that cook slowly over time. They give their best performance over a long period of time. How long is long? Data analysis done by my colleague Kayezad E. Adajania (read it here) shows that it takes about a 7-year holding period to iron out volatility in equity. The thumb rule for real estate puts the cycle at about 10 years. Market-linked debt (as opposed to relatively fixed-return debt products such as bank deposits) as an asset class for retail investors is mostly used for short-term purposes for emergency funds, for near-term cash needs and for income generation. It would be more logical to make debt go long term at 1 year and keep a 5-year threshold for long term for both equity and real estate. At the very least, policymakers need to equalize the definition of long term across asset classes.
A recent story reports on mis-selling and fraud by a bank in rural Rajasthan where they allegedly made bank deposit customers put their signatures on life insurance products of a group firm. While the story of people of small means being cheated out of their money is worrying enough, what is of greater concern is that this problem is not limited to one insurance company or bank, or location. Life insurance mis-selling and fraud by bank branches is systemic in the country. The evidence to this statement comes from three sources. The first is anecdotal: almost everybody who has a bank account has a mis-selling or fraud story to tell about life insurance. For those who superciliously turn away from anecdotes, there are three academic papers that nail the problem. In 2014, two economists and I, wrote a paper estimating that policyholders lost over Rs 1.5 trillion from mis-sold life insurance plans between 2007 and 2012. In 2017, I published another paper that mystery shopped bank branches to catch mis-selling. I found that bank officials lied most of the time on features around costs and costs of early redemptions to potential customers. A 2015 paper by Anagol et al find that agents overwhelmingly recommend life insurance products that are unsuitable to the customer but get the agent high commissions. Three, two government committees, Swarup and Bose, have found life insurance to have very high front incentives that cause sharp sales and fraud. (Disclosure, I have served on both the committees).
When you move a system from personality-based solutions to rule of law, there is a painful period of readjustment of the old way of doing things to the new. People, institutions and analysts all need to readjust to the new reality. The recent commentary around the Financial Resolution and Deposit Insurance (FRDI) Bill that is up for debate in the winter session of the Indian Parliament has picked up on one section (section 52) of the Bill, ignoring everything else in the 125 pages, and has resulted in panic about the safety of bank deposits if this bill gets passed. I read the Bill over the weekend and this is my understanding of what the aim of the Bill is and what it means for you.
Bank deposits are the one true friend of a middle class Indian and any threat to their safety is terribly upsetting. The government will introduce a new bill in Parliament in the winter session called the Financial Resolution and Deposit Insurance (FRDI) bill. One section of this bill is causing bank depositors to fear for the safety of their money. I read the bill over the weekend and this is my understanding of what the aim of the bill is and what it means for you.
If you have had the occasion to have economist and Nobel laureate Richard Thaler sign a book for you, it’s likely that you have one that says, “Nudge for good” or “Misbehave for good”. Nudge and Misbehaving are books written by Thaler. Nudge, written earlier than Misbehaving, is about tweaking the choice architecture so that people make better decisions. For example, if we know that people will choose one item out of the first three on a menu card, a nudge would put healthy food in those spaces, while keeping all the other choices at number four and below. Nudges work to help us overcome our biases that prevent us making good decisions. Bad nudges have been used by corporations to trick us into doing what they want and may not be in our interest. For example, an auto tick on a travel insurance policy on an airline website is a bad nudge. Thaler wants nudges to be used for good. He wants them used for setting up the game so that average people take decisions that work for them. For example, a positive nudge is the Save More Tomorrow programme (bit.ly/2hYxfGy) that allows people to promise to save more next year.