Economy Oct 5, 2012
There's nothing more thrilling than nailing an insurance company.
- Deck Shifflet (played by Danny DeVito) in The Rainmaker
Around three years back, I suddenly got a call from my bank. "Sir, I am your relationship manager," the female voice at the other end said. "Since when did journalists start to have relationship managers," was the first thought that came to my mind. It turned out she wanted to help me plan my finances.
Fair enough. But why did the bank have a sudden interest in planning my finances? I had been banking with them for close to four years and they hadn't shown any such interest earlier. I checked my bank account and realised that there was a fair amount of cash lying around in my savings bank account. A friend had just repaid some money back and a fixed maturity plan which I had invested in had matured.
So the reason behind the bank's sudden interest in planning my finances became clear to me. I asked my new relationship manager to come and meet me immediately. I was curious to see what financial plan she had in mind.
What she did not know was that my area of specialisation as a journalist was personal finance. The relationship manager soon turned up and in 10 minutes she offered me the solution to all my financial problems in life, which, as expected, turned out to be a unit-linked insurance plan (Ulip).
The bank she worked for also has an insurance company and this particular Ulip was from that insurance company. I just checked the brochure she had brought along and was not surprised to find that the premium allocation charge for this Ulip for the first year was a whopping 60%. What this meant was that if I were to pay a premium of Rs 1 lakh, only Rs 40,000 would be actually invested. The remaining Rs 60,000 would be deducted as an expense.
A major part of the Rs 60,000 deducted as expense would be given to the insurance agent (in my case the bank) as commission. And it would help my relationship manager meet her rather stiff targets.
I pointed this out to my relationship manager and she realised the game was over. I wouldn't fall for her sales pitch. Then we got talking about other things and realised that we grew up in the same town. Before leaving she apologised for trying to sell me such a plan. She also told me that in the pressure to meet her target last year she had sold the same policy to her brother.
He had taken a policy with a premium of Rs 1 lakh of which Rs 40,000 had been invested. The stock markets had taken a beating since then and the value of the investment had fallen to Rs 32,000. "He doesn't talk to me properly anymore," she said, as she left with a tinge of regret in her voice.
Those were the heady days of mis-selling in insurance when even sisters sold Ulips to brothers so that they could earn a high commission and meet their targets. Since then commissions have been reduced and as a result the mis-selling has come down.
But if the finance minister P Chidambaram has his way with things, mis-selling is all set to return in the days to come. But before I get to that let me just share some numbers that the Insurance Regulatory and Development Authority, the regulator, has released in its September 2012 journal.
For the period April 1 to June 30, 2012, the insurance companies in India collected Rs 12,015.5 crore as first year's premium by selling around 67.9 lakh new policies. Given this, the average premium per policy works out to around Rs 17,690 (Rs 12015.5 crore divided by 67.9 lakh).
The total sum assured (or what is in general terms referred to as a life cover, i.e. essentially the money the nominee will get if the policyholder dies) on these policies was Rs 150,902.8 crore. So the average life cover per policy works out to around Rs 2.22 lakh (Rs 150,902.8 crore divided by 67.9 lakh).
Hence, for the first quarter of 2012, the average premium on a life insurance policy was Rs 17,690 and it had an average life cover of Rs 2.22 lakh. If a 35-year-old were to just buy a pure life cover of Rs 2.22 lakh, the premium works out to around Rs Rs 500-700 per year on a 25-year policy. Assuming that a pure life cover of Rs 2.22 lakh can be bought for a premium of Rs 700 per year that would mean a premium of Rs 17,000 is left over.
And this is the amount that is invested by insurance companies after deducting the commission paid. In the year 2010-2011(i.e. between April 1, 2010 and March 31, 2011), the average commission paid on the first year premium was 8.89 percent. This is the latest data that is available.
Assuming this to be the rate of commission, the commission on a premium of Rs 17,690 works out to Rs 1,573 (8.89% of Rs 17,690). Deducting this from Rs 17,000, around Rs 15,417 is left over.
This is the amount that is invested depending upon the mandate chosen by the policyholder which could vary from 100 percent stocks to 100 percent debt.
So what this basically tells us is that Indian insurance companies do not sell life insurance, they sell high-commission paying mutual funds. As my calculations show less than 4 percent (Rs 700 expressed as a percent of Rs 17,690) of the total premium goes towards actual insurance. Around 9 percent is paid as commission and the remaining amount is invested depending on the mandate given by the policy holder.
Finance Minister P Chidambaram now wants to encourage the sales of these high-cost mutual funds masquerading as insurance policies. He is in the process of offering a series of sops to insurance companies so that they can sell more. Among the proposed sops are greater tax deductions on insurance premiums, banks being allowed to sell policies of more than one insurance companies etc.
This is being done so that insurance companies are able to sell more policies and in the process more money from the domestic investors is channelised into the stock market. Since the beginning of the year domestic institutional investors have sold stocks worth around Rs 38,475 crore. The government wants to turn this tide in order to ensure that the stock market continues to go up.
This is very important if the government hopes to divest its stake in a lot of public sector companies. The disinvestment target for the year is Rs 30,000 crore. But a lot more shares will have to be sold if the government wants to control the burgeoning fiscal deficit. (you can read a detailed argument on this here).
So the higher the stock market goes the more the number of shares that the government will be able to sell. And for that to happen, more and more money from domestic investors needs to come into the stock market. And that will only happen if the insurance companies are able to sell more policies.
As anybody who does not make money selling insurance policies or is honest enough, will tell you that mutual funds remain a better investment option. So the question that crops up here is why does Chidambaram want to encourage only insurance companies to sell more and not mutual funds?
Mutual funds are much more transparent. Their performance when it comes to generating returns is much better than insurance companies. They don't pay 9 percent commission to their agents. And it is very easy to figure out which are the best mutual funds going around in the market. I haven't seen anybody who makes a living out of selling insurance talk about returns generated by insurance policies till date.
There are a couple of reasons for Chidambaram encouraging insurance companies and not mutual funds. One is that commission offered by mutual funds is very low compared with the commission offered by insurance companies. Hence, agents of all kinds prefer to sell insurance rather than mutual funds. Chidambaram needs a lot of money to enter the stock market and he needs it to come quickly. That being the case, it's easier for insurance companies to do this than mutual funds.
The second and more important reason is the fact that Life Insurance Corporation (LIC) of India which is India's biggest insurance company, is government-run. Between April and July of this financial year LIC collected 76.5% of the total first year's premium. So three fourths of insurance in India is basically LIC.
The money collected by LIC can be directed by the government into specific stocks. If the stock market does not have enough interest in shares of a company being divested by the government, LIC can be instructed to pick up those shares.
If Chidambaram had encouraged mutual funds instead of insurance companies he wouldn't have had this flexibility. So once these measures to help insurance companies are pushed through, insurance companies and agents will be back to doing what they do the best i.e. mis-sell. Don't be surprised if in the days to come you run into insurance agents promising you the moon, from your investment doubling in three years to you having to pay premiums only for five years.
And in this case this renewed attempt at mis-selling will be a result of Chidambaram's preference for insurance to mutual funds. The more insurance agents mis-sell, the greater will be the money invested in the stock market which will lead to the stock markets rallying and thus help the government sell more shares than it had originally planned.
(Vivek Kaul is a writer. He can be reached at firstname.lastname@example.org)
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