Empirical evidence in a new paper quantifies what we’ve always known anecdotally — losses to investors on account of mis-sold life insurance products, 70% of which were ULIPs (unit linked insurance plans), added up to Rs 1.5 trillion or Rs 150,000 crore. In ‘Estimating losses to customers on account of mis-selling life insurance policies in India’, Monika Halan, Renuka Sane and Susan Thomas bring the rigour of academics to produce not merely new evidence but establish causality between investor losses and mis-selling practices by insurance companies in collusion with their agents.
Halan et al have arrived at this number using two disparate methodologies. “The first approach uses the number of lapsed policies from the annual reports of the insurance regulator, IRDA, while the second method uses the persistence of premium payments that are reported in the annual reports of individual insurance companies,” the authors say. “Both these methods arrive at a similar estimate a loss of about Rs.1.5 trillion, or $28 billion, to investors owing to mis-selling over the 2004-05 to 2011-12 period.”
Enough has been written about the mis-selling of ULIPs — you can follow them in the links below. Insurance regulators had been alerted. Nothing was done. It took an April 9, 2010 order from the capital markets regulator Securities and Exchange Board of India (SEBI) — not IRDA — to change things. The order restrained 14 insurance companies that had launched ULIP products to sell them. The next day, a response from IRDA read more like a vested industry association rather than a regulator. IRDA directed the 14 companies to carry on with “business as usual including offering, marketing and servicing ULIPs”.
Suddenly, the issue of mis-selling ULIPs became a turf war between SEBI and IRDA — the consumer was out of the picture. But when the ball was dropped at the Ministry of Finance, the response was mixed. A June 18 band-aid in the form of Securities and Insurance Laws (Amendment and Validation) Ordinance, 2010 stated that only IRDA would control ULIPs. I sense there were some behind-the-scene lessons in financial and regulatory literacy for IRDA that soon transformed into a regulator and ended all wrong incentives on ULIPs.
“Our understanding of the product was quickened by the SEBI issue,” J Hari Narayan said in a mea-culpa exit interview. “Two things happened at that time. Apart from SEBI issue, there were lots of articles in the media about what was wrong with insurance products. So SEBI was the departure point. It gave us much greater insight into the practices being followed by the insurance companies, product designs, the downsides of it and so on.” If only he had had this realisation early enough, investors wouldn’t have lost the money. Today, ULIP is no longer a toxic product — but the toxicity of insurance products has not ended, as the crude incentives on ULIPs have now shifted to other plans.
Clearly, the ULIP fiasco is a case study for wrong incentives, advisory conduct that borders on the criminal and a regulatory capture that took a finance ministry intervention to fix. But fixing future crimes is not enough. The Rs 150,000 crore that consumers have been defrauded of needs to go back to where it belongs — to consumers. The financial products industry likes to use the analogy of soaps and cars to push an argument that distribution is a cost and, therefore, commissions must be embedded and not disclosed to consumers. Excellent. So, just like cars are routinely recalled, sometimes replaced, for safety concerns, the old ULIP products must be recalled and the money refunded to investors.
But if anyone thinks that ULIP was the last retail scam in India, think again. The best minds, armed with the best legal advice and serving the god of profits-at-any-cost will continuously come up with novel ideas on defrauding investors. And regulators will always be one step behind. What is the way forward? The Financial Sector Legislative Reforms Commission (FSLRC) report and the draft law have some path-breaking ideas.
Being at the receiving end of information asymmetry, consumers need protection. The report recommends six protections for all consumers and three additional protections for retail consumers. Basic protections include right to professional diligence; protection against unfair contract terms; protection against unfair conduct; protection of personal information; requirement of fair disclosure; and redress of complaints by the financial service provider. But it is the additional protections for retail consumers that could deliver impact. These are:
Assessment of suitability: Retail consumers may often be in a situation where they are not able to fully appreciate the features or implications of a financial product, even with full disclosure of information to them. This makes a strong case for a thorough suitability assessment of the products being sold to them. The draft Code provides this protection by requiring that any person who advises a retail consumer in relation to the purchase of a financial product or service must obtain relevant information about the needs and circumstances of the consumer before making a recommendation to the consumer.
Dealing with conflict of interests: One of the best ways to ensure good consumer protection is to align the incentives of financial service providers with those of consumers and ensure that in case of a conflict, the interests of consumers take precedence. The draft Code incorporates this principle of prioritising the interests of retail consumers over those of the provider. It also requires advisors to inform retail consumers about any conflicted remuneration they stand to receive, which may influence the advice being given to the retail consumer. The regulator may, in addition, specify the nature, type and structure of benefits permitted to be received by an advisor for a particular financial product or service.
Access to the redress agency for redress of grievances: The redress agency will function as a unified grievance redress system for all financial services. This means, if a bank has mis-sold an insurance policy it will now come under the grievance agency and not hide between regulatory cracks, as Reserve Bank of India stood back and watched the ULIP fraud play out right before its eyes. To ensure complete fairness and avoid any conflicts of interest, the redress agency will function independently from the regulators. It will follow a five-step process while looking into consumer complaints — receipt of complaints; screening of complaints: mediation; adjudication; and appeals.
Halan et al have clearly established that a fraud was perpetuated on consumers in the garb of selling insurance. It has diligently calculated, using two methodologies, its value at Rs 150,000 crore. In the short term, this money must return to investors. And in the long term, recommendations of the FSLRC report must be implemented by the government to prevent future frauds.
Finally, it would be naïve to assume that insurance fraud exists only in India. Along with the companies, these have been imported from across the world. Smart scholars would do well — and make their research relevant to consumers — by attempting to transpose this methodology in their countries. Looking at this fraud in the larger context of the changing face of global regulation, it is time leaders of countries put their citizens right upfront while redesigning the global financial architecture.
Some links on the ULIP fraud: