eading the Irdai (Insurance Regulatory Development Authority of India) draft on updating regulations for unit-linked insurance plans and traditional policies, you get the impression that somebody gave an aspirin when what was needed was a heart surgery. Product structures in finance are taking on a new importance globally because mis-selling and unsuitable sales can be reduced by taking the tricks and traps out of these products. This simply means that the costs and benefits are better defined and marked so that investors are able to understand the features of the products properly. Product structure rules also deal with early exits and their costs so that investors are not trapped in products they buy.
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.
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).
Most of you who read this column are now investing in the right way, using a systematic investment plan (SIP). But did you know that your dull, boring SIP is the result of more than 10 years of regulatory change? Most of you have also discarded the low-return endowment plans and now purchase a pure term plan to look after your life insurance needs. But did you know that you got to the right solution not because of regulatory change but despite it. I’ve been mapping the Indian personal finance industry for over 15 years and the behaviour of two regulators in industries that both manage household money has been fascinating. We now have the data to show the impact of regulatory change in the mutual fund and the life insurance industries on firms, sellers and households. I will relate the story through four tables.
I cannot forget the conversation with the chief of a newly born asset management company. The year was 2008. The world as the West knew it was collapsing. And this CEO’s US-based parent company, bang in the middle of imploding all across the world, was on life support paid for by the US taxpayers. The CEO, forgetting that we now live in a flat world and that information is no longer the prerogative of the suits, looked me in the eye and said that despite illiterate journalists, he would be able to sell funds in India because of trust. Trust that his company name invoked. While I was still picking up the pieces that fell out laughing, the company quietly went and stood at the bottom of the assets under management line-up. The investors were, and are, not interested in dealing with a company whose parent is so mired in muck.