Insurance - some honest confessions

It was refreshing to see some honest talk by an insider about insurance policies in today's WSJ. I have often blogged about the extortionist commissions (upto 40% according to this piece - anything in excess of 2.5% is excessive in my opinion, particularly if it is a mutual fund being sold in the garb of an insurance policy) and widespread mis-selling which exists in the area. In IRDA, the insurance regulator, we clearly have the worst regulator in India - ever. I have advocated in the past that SEBI should take over these mutual fund products' regulation - let there be two regulators for the same product - it is by no means a novel concept - many products have more than two regulators e.g. corporate bonds, gold certificates.

See here for the full story. Excerpts:

"After studying mysterious subjects like Nano Technology and Robotics, I asked him why waste life selling insurance policies? My son sounded determined. A bachelor's of engineering degree is for social acceptance, but for making a living, nothing beats insurance sales as a vocation.

...

After all, no salesperson of any other industry can boast of being part of a Million Dollar Round Table and get freebies like all-expenses-paid holidays and expensive gifts like Mercedes cars just by selling a few more policies. Compare this fun with the grime and dirt he would have to deal with on a shop floor if he chooses to take a job as an engineer!

...

He reasoned, after all, that the whole business of life insurance is dealing with life and death: Pure metaphysical occurrences that are pre-engineered by God. In the blurred boundaries of mind and matter, if he is a student of physics, he can be an agent of metaphysics too. The lip-smacking commissions of 40% on policy sales may just be extra levers to drive his motivation.

How many young people are as wayward in outlook as my son?

Just a glance at the education profile of my colleagues in the industry convinced me that my son is not an odd man out. Graduates from premier colleges of engineering and management – IITs, IIMs and even Ivy League schools like Harvard -- ended up in the insurance industry, selling or mis-selling insurance policies.

The fundamental problem is not selling but mis-selling insurance as a wealth creation opportunity. I have heard bank customers being sold policies as bank fixed deposits and stock brokers selling insurance as equity shares. Worse are multi-level marketing networks that sell policies to their unsuspecting members as an investment that helps them multiply their returns by roping more into the chain. Is mis-selling getting rampant because everyone wants to jump on the gravy train?"

Are American Depository Receipts shares?

Today's Economic Times reports RBI is considering American Depository Receipts (ADRs) as 'quasi equity' not carrying voting rights and therefore not be considered as FDI.

This view perpetuates the deeply flawed view taken by SEBI as well, that ADRs/GDRs do not carry voting rights 'till converted into shares'. In fact, ADRs and GDRs do carry voting rights. They are as much shares as are Indian shares held in Indian depositories. To step back, ADR/GDRs are convenient means of holding equity of another country without worrying about the logistics of buying those shares overseas using an overseas broker, converting dividends into local currency etc. For this purpose two sets of 'depositories' are used (to take the example of an Indian company with listed ADRs) in India which effectively holds say 10 million shares of that company and thus taking them out of circulation from the Indian market. Simultaneously, the foreign depository issues ADR/GDR securities for the same number (though often they are issued in a ratio - say 1 ADR to represent 2 shares) to depository receipt holders in the US market. These DR holder have all of the same rights as an Indian shareholder e.g. right to receive dividend, right to vote and right to residual value on liquidation of the company.

As far as the right to vote is concerned, it is governed by the contract between the DR holder and the depository. There are four types of contract terms which could govern a) the depository will take instruction from the DR holder and vote according to that wish b) the depository will vote according to what is in the best interest of the shareholders c) the depository will vote in favour of existing management d) the depository will not vote the shares. Only in the last case are votes not exercised. However, even then, the shareholder has the power to vote the shares - it is just that he has contracted away the power to someone else who will abstain from voting. This is similar to an Indian shareholder who agrees with another person (say a promoter) by way of a shareholder agreement that he will not vote the shares.The law cannot be influenced by the terms of a private agreement on voting arrangements particularly as there is no need for votes not to be exercised by the depository.

SEBI's treatment of ADRs/GDRs as not having voting rights particularly where it gives exemptions from the applicability of the takeover regulations is wrong in principle. The regulations treat ADR/GDRs are securities without voting rights and thus exempt them from the applicability of the tender offer requirements on substantial acquisition. This is particularly perverse where the ADR/GDRs are held by the promoter group itself and they get all the rights without the obligation to make a tender offer to shareholders on large acquisitions. It mixes up the power of voting rights with its actual exercise. It is hoped the RBI does not now make the same mistake in its analysis and mis-brand ADR/GDRs are quasi equity or as equity without voting rights.

Is the US SEC becoming a bit too fat?

The American securities regulator has sought $1.2 billion for its budget next year (a 20% increase in the budget). That is a staggering amount compared to the $15 million odd India's SEBI spends each year. Clearly, with the beating the SEC's reputation has taken over the past nearly decade long period, the extra 20% the SEC is seeking may be of questionable value in terms of output. I'm also not sure an infinitely large regulator is a good think - growth for the sake of growth - in the name of catching more violations. There should be some level of cost benefit analysis done before more money is thrown at the problem.

The other interesting bit the SEC is demanding is ability to control the fees it collects for budgetary use - in other words what SEBI does in India (and the FSA in the UK). Again, I'm not too sure it is such a good model as it reduces political interference but also reduces accountability.See the news on the demand of the SEC chief. See some other criticisms of the self funding proposal in the FT.