13 June 2008

Mutual Fund versus Insurance commission structures

For the nth time the Mutual Fund industry has weeped about the differential commission structures between fund agents and insurance agents. What irks them most is that several products including something called ULIPs have only a fig leaf of insurance and are in fact wholly mutual fund products. While SEBI, the securities regulator, sets caps on various fees and loads and also mandates strict disclosures of such fees, the insurance regulator lives in the wild west of no fee cap and inadequate disclosures. This means that insurance companies part with as much as upto 80% of the first premium as commission with their agents and distributors, fund distributors can only get in the region of 2.5% commission with other expenses. Clearly, the hardsell will be targetted towards selling insurance products leaving mutual fund products unloved by the selling chain. But it's not clear to me why sufficient disclosure would not cure or at least partly remedy the problem - if an investor knows that out of his Rs. 100 investment only Rs. 20 will be invested on his behalf, the homo economicus will stay away from the product. Assuming that insurance customers are not sophisticated enough or that disclosures on fees and commissions, despite being mandated, are buried in the fine print, then clearly the insurance regulator has to step in to put regulatory caps on fees - such a mandate is also important to close any regulatory arbitrage between the two. It is also possible for the securities regulator to seize simultaneous jurisdiction over these products as they are nothing but mutual fund products and would clearly fall within the definition of securities under S. 2(h) of the Securities Contracts (Regulation) Act 1956.
What is not acceptable is the race to the bottom as is being advocated by AMFI, the mutual fund trade body, by allowing the mutual fund industry to also charge extortionate commissions - the existing 2-6% commission per annum, charges, loads and expenses are very generous by international standards.
In the Business Standard today, the new Chairman of the insurance regulator has asserted that the regulator would look after the interests of the customers and the industry - I hope it is strictly in that order.
PS. Prof. Somashekar (not the securities lawyer) of National Law School, Bangalore has done some interesting research on a slightly different topic of insurance investments in the capital markets - more on that later.

PPS. Since writing this piece I went to the extension branch of ICICI head branch of Delhi (near Jawaharlal Nehru Stadium) for a long pending complaint. As I entered, an insurance seller told me about a ULIP 'scheme' where I would make 35% returns. When I asked whether this 35% was in the present continuous, he immediately backtracked and said this was the past year's return. When I asked if there was a possibility of a 35% fall, he nodded his head. I smiled and told him that he was misselling the product. Here was a person, who was selling a clear mutual fund product (no reference to insurance), who was misselling by indicating future returns without indicating potential future losses by referrring to past returns, and was clearly well informed that he was misselling (he corrected himself on being prompted). If this kind of event happens in the head branch of ICICI, I dread to think of promises made in smaller towns by even less scrupulous distributors - and the consequences when the five year old bull run hiding the malpractices of such sellers recedes and people see huge losses sitting on their conservative 'insurance' investments.

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