You are doing great harm to your financial well-being if you continue to fall into the trap laid down by life insurance companies, their agents and now the shareholders of these companies, under the benevolent gaze of the insurance regulator. How many of us are still buying these traps? In financial year 2018-19 (that is the latest data available), individuals bought almost 30 million new life insurance policies, pumping almost ₹1 trillion of household savings into them.
Which policies are the most harmful? Traditional plans that include with-profit money-back, whole-life, endowment policies and guaranteed plans are the worst. These make up 85% of the entire market. Ulips are not traps and are much better products but don’t do well on disclosures and flexibility as compared to mutual funds. Term cover, the best kind of life insurance that you must have, are hardly sold. They are largely self-bought as smart people figure out what to buy. They buy online, cutting out the agent.
A tweet from @TheMFGuy started the debate on social media a few weeks back. The tweet read: “Like wallets @SEBI_India should now make rules for mutual fund portability allowing to switch from one fund house to another.” Portability in a service is the option to move your business to another service provider without losing the identification number (as in a telephone number), or losing the history your account has built up (as in a medical insurance policy where a no-claims-bonus builds up for every claim-free year) or having a tax implication when an investment is switched rather than redeemed.
What does portability in a mutual fund mean? There are four kinds of portability that we need to understand in a mutual fund. First, between asset classes, for example, between stocks and bonds. Second, between schemes, for example, from the large-cap to a multi-cap fund of the same fund house. Third, between fund houses, for example, from the mid-cap fund of one fund house to the mid-cap fund of another fund house. Fourth, between various options in a scheme—for example, switching between growth and dividend or between regular and direct.
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.
Is a unit-linked insurance plan (Ulip) a good product? The question is asked quite often on my Twitter timeline. Life insurance industry chief executive officers talk about this all the time. And there is some media chatter on the coming of age of Ulips. What’s the truth and how should you think about it? Let us apply the principles first. A financial product is bought because it solves a financial problem you have. It should perform on metrics of cost, benefits, tax efficiency and ease of transaction. It should compare well with other products that solve the same problem.
The Insurance Regulatory and Development Authority of India (Irdai), in its draft Investment Regulations released on 2 July 2015 (http://mintne.ws/1dJok3K ) , has proposed that the unit-linked insurance policy (Ulip) investment rules be modified and that at least a quarter of the assets under management be invested in central government securities (G-secs). This is a strange time for such a 1970s kind of a proposal. The 70s, if you remember, was the decade when state control took on harshly repressive tones. As a Financial Express editorial points out, this draft flies in the face of the attempts to make institutional investing more market-linked. For instance, there is pressure to get the Employees’ Provident Fund to invest more in the stock markets and to remove the restrictive 50% in equity investment threshold in the National Pension System. At such a time for the insurance regulator to announce a rule that hobbles investment choices of households is strange.
Imagine that there is a very crowded city, bursting at the seams. A state-of-the-art satellite city comes up and is ready for settlement, but remains largely empty. All the shiny new infrastructure is wasted because the citizens seem to want to stay in the polluted, congested space they currently occupy. The local authority wants people to crossover and keeps thinking of new ways to incentivize this. Tax breaks, cheaper medical facilities, better schools…. But no go. The citizens are blamed for being foolish. But the truth is that the only thing the local authority is unable to resolve is the extremely high crime rate in the new city area. Roads have no rules, gangs of criminals roam around, plunder and kill at will. The authorities turn a blind eye saying that this tribe of criminals has traditionally robbed and killed for livelihood and, therefore, they must be left alone since their livelihood is at stake. The local authority does not tell the real reason—that it gets a cut from the criminals. Perversely it uses some of this money to give further incentives to people to move! The new city remains empty, and every year during the annual budget, experts pontificate on how to incentivize the silly citizens to move. But the smart guys don’t. They prefer the safety of the known problems.
When one lives in a country of over a billion people, big numbers seldom come as a surprise. But when I looked at the number of Rs.1.5 trillion, I was astounded. That’s about 1.5% of the Indian gross domestic product, was the first thought. But the number in the excel sheet looked back with the certainty of coming out of a formula run on actual premium data sourced from the regulator: that’s the money retail investors have lost from mis-sold life insurance policies over seven years. Knowing that the industry will come after this number, as my colleague in this work so graphically put it, with their bazookas, we did the numbers again. And again. And several times again. Checked and re-checked the methodology with insurance industry experts, actuaries and academics. We used another, totally different method to see if we were way off the mark. But the final number refused to back down. Retail investors lost a minimum ofRs.1.5 trillion to the insurance industry and its agents over a period of seven years that ended in the financial year 2011-12. You can read the full story of this lost money that appeared in Mint on 6 February 2013 here: http://bit.ly/X3YJDY.
How long have you driven your car? How long has that toaster lasted? I’d assume that unless you bought some untested Chinese brand that is built to self-destruct on one use, they’ve lasted a reasonable time and you’ve not had reason to take them back to the store. And assuming you bought a “good” brand, any large-scale manufacturing level defect would have been solved by a product recall—the way Honda recalled its cars last year or Apple products are replaced without a question on defects and now even chocolates at airports are taken back if white and brittle (I kid you not, I managed to do that, though I thought the surly guy behind the counter at Chennai airport would hit me, even as an awestruck, chocolate-deprived teenager watched). What is it about financial products that we do not think about product recalls as an option?
Take a 1970s French scheme that “worked” in what are now seen as medieval times in finance. Add a government department desperate for a new idea, having botched up the retail part of the financial market by creating situations where regulators fight and investors get swindled. And you get the proposed Rajiv Gandhi Equity Savings Scheme (RGESS) that gives a tax break to small investors who invest directly in equity. The scheme will give first time equity investors who earn upto Rs10 lakh a year, that is Rs83,333 a month, or a post-PF and tax amount of about Rs50,000 a month, a 50% deduction on investment up to Rs50,000 directly into stocks.
Armed with basic knowledge of an Excel sheet and some dribbles of wisdom after a basic capital markets course, when I opened a unit-linked insurance plan (Ulip) brochure five years ago and tried to do the math, I fell off my chair. The sheet showed me a product that was so inherently unfair and loaded against the investor that I thought I had mis-understood it. But long hours spent decoding various products (with lots of work put in by a trainee who is now India’s ace insurance reporter and works in Mint) told me that the conclusion was right: The Ulip product was a trap. What do you call a product that allows the entire first-year investment to be used as cost? What do you call a product that swallows the entire first- and second-year investment if you dare stop funding the product? What do you call a product that pushes forward a lifetime of costs in the first two years and then pushes you to exit—leaving your money behind? All those who were mis-sold the Ulip product in the last few years are now understanding the extent of the fraud.