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Want to end mis-selling? Read this evolutionary report

Gautam Chikermane’s tweets

Released yesterday, the Sumit Bose Committee report to recommend measures for curbing mis-selling and rationalising distribution incentives in financial products puts, for the first time, the consumer at the centre of all regulations and recommendations. Drawing philosophical inspiration from the Indian Financial Code drafted by the Srikrishna Financial Sector Legislative Reforms Commission (FSLRC), it harmonises the clunky, wasteful, piecemeal and sometimes contradictory regulations across regulators and gives them a cohesive, strategic and clear direction.
If you want one word to capture this report it is: Evolutionary.
The 103-page tome takes the regulatory structure in hand that industry has been abusing to mis-sell financial products to households, often in the garb of two apparently noble ideas — deploying household savings in financial assets and serving the government’s funding needs — and irons out the deficiencies. Taking a historical view of things, with great storytelling thrown in to make it readable to consumers rather than merely gather dust, the report itself is as structured as its own recommendations — a perspective on the current state of affairs, product-wise breakdown and the recommendations spread out over product structure, costs and commissions, and disclosures.
“The Committee believes that consumer interests will be served by more transparent disclosures that enable consumers to understand products, compare them, and consequently choose those that serve their interests,” the report states.
And as a result, the broad principles follow. From ensuring that all financial products must have product structures that a consumer can understand to insisting that all products be easily comparable, the mind of the committee is clearly aligned with consumers. This is probably the first time that the consumer interest has been so directly served in any committee examining financial products — most committees so far have been interested in insuring growth of the industry, abstract terms like ‘penetration’, and of course, creating regulatory turfs for post-retirement sinecures for the bureaucrats writing the reports. “It should be remembered that this Committee is thinking first of the consumer and her welfare,” the report says.
The industry, particularly insurance, is going to be very unhappy. That is natural for a group of companies that have perfected mis-selling into an art form, through an institutionalised non-disclosures of costs, returns and benefits. Between the industry and the household lies an entity that loves this product — the distributors, who, with commissions as high as 35% have incentives to sell wrong products, the results of which will come up only 20 years later. This is done through bad product structure as well as below-board selling practices. Within insurance too, the big culprits are traditional plans, on which “the Committee spent most of its time trying to find a way to suggest disclosure and cost changes.”
The 25 recommendations for traditional plans expose the industry for what it is. “Lapsation profits, if any, should not accrue or be booked by the insurance companies,” it says. Which means, when consumers let go of a policy, the insurance companies make a profit, so there is an incentive in the system to induce consumers into letting policies lapse. Or: “There should be a clear split of the premium, at least for the investor, into mortality and investment.” This tells us that the industry has been mixing mortality and investment, leaving consumers confused.
Further, “the costs of surrender should be reasonable” and should belong to exiting investors. And all charges should “collapse into one single charge called the expense charge”. The report is unrelenting: “Returns should be disclosed keeping basic tenants of finance in mind. This means that all returns should be disclosed as a percentage of the investment made by the customer and not as a function of a third number, such as a sum assured or the maturity benefit.” One wonders what successive regulators have been doing about an industry running amuck and abusing households.
Reforms happened in ULIPs (unit linked insurance plans) when the then capital markets regulator CB Bhave said the structure of ULIPs brought it under the ambit of Securities and Exchange Board of India. In a hastily-devised compromise, a June 2010 Ordinance handed ULIPs to Insurance Regulatory and Development Authority of India (IRDAI), which thankfully turned the product transparent and consumer-friendly. But it was too late: an April 2013 paper, ‘Estimating losses to customers on account of mis-selling life insurance policies in India’, captured the losses to consumers of Rs 1.5 trillion.
Beyond households, but firmly in their interests, the biggest idea this report unleashes is clarity and efficiency of regulatory oversight. “Going forward, in order to bring uniformity and proper oversight, the function should decide the regulatory framework,” it states. “This means that, IRDAI and PFRDA should harmonise their investment regulatory function with that of the lead investment regulator SEBI. IRDAI should take the lead on insurance and annuity function. With a base uniformity founded on function, IRDAI and PFRDA should have additional regulations related to the function only to the extent they are necessary for the specific needs of products regulated by them. For instance, in case of IRDAI and PFRDA, these could be on account of products being closed-end and of longer tenure.”
This is a disruptive idea whose time has come. With financial markets becoming intensely complex, regulators need to work with deep knowledge and sharp focus. Otherwise, industry is very happy shopping for the weakest regulator, in this case IRDAI. By saying that functions should decide the regulator, the report understands that expertise is required to manage large groups of financial services providers, informally known as universal banks. This recommendation in particular and the report in general is in tune with the Indian Financial Code as drafted by Justice Srikrishna’s FSLRC report — the future of Indian financial sector (you can read the report here).
It is time regulators realised who they are working for — households, not mis-selling entities. And this report takes the next evolutionary step in that direction. The government must accept these recommendations. One caution: being selective about recommendations will not help the cause of consumers; this is an integrated approach to end mis-selling in the financial sector by tilting the regulatory architecture in favour of 1.25 billion consumers rather than a handful of fat cats and their emissaries. The comments on this report will be largely from angry agents, whose vested interests will end. It is up to the government to not get its vision clouded by them, the industry or regulatory turfs.

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