Investment, insurance plans to become investor-friendly

To curb mis-selling of policies and rationalise commissions, radical changes have been proposed to help investors.

After adopting a child, Jayant Anand wanted to save for her future. 

His agent pushed for a traditional life insurance plan, saying he could also save tax through it.

However, when he checked, Anand realised opting for an online term plan, along with a long-term tax-saving fixed deposit, would give him higher cover, better returns and also the tax incentive compared to the traditional insurance plan. 

To curb such mis-selling and rationalise commissions, the finance ministry constituted a committee. Headed by Sumit Bose, former Union finance secretary, it has some radical recommendations. 

Regulatory

The committee suggests dividing financial products into three broad categories - protection, investment and annuity.

Today, many product manufacturers bundle these. For example, insurance companies offer unit-linked investment plans (Ulips) that combine protection and investment. 

The key recommendation is that the lead regulator, according to function, should fix the rules of the game.

This means in the case of bundled products like Ulips, the insurance part will be governed by the Insurance Regulatory and Development Authority of India; the Securities and Exchange Board of India will set rules for the investment part.

The report also suggests there should be no difference - in costs, commissions or transparency - between a standalone investment product, like a mutual fund, and the investment component of a product like a Ulip. 

Impact: This will help to rationalise commissions and bring products at par. The regulatory framework will improve, too. 

Commission

Another key suggestion is that all upfront commission in investment products should be stopped and moved to an all-trail model.

The trail commissions (money an agent periodically receives from a fund house based on your investment) should also be either the same all through the tenure or declining. 

Impact: Upfront commissions have been one of the biggest reasons for mis-selling. Financial products should be based on a person's goals and tenure.

For example, distributors are given high upfront commissions to sell new fund offers (NFO).

Agents usually mis-sell by comparing NFOs to an a company's initial public offer, which is incorrect. If upfront commissions are stopped, the agent would sell a better suited fund for the investor, rather than one where high commission are paid. 

"The trail commission should decline because the role of the agent in servicing the customer becomes lesser with time," says Partha Ray, professor at Indian Institute of Management, Calcutta, a member of the Bose committee. 

Disclosures

All information related to product costs, returns, benefits and holding period, should be made in a crisp form that can be understood by customers, suggests the report.

It recommends a single-page distributor-investor form should state the key features of a product, suitability and costs, in bold. 

Impact: This will also ensure a distributor understands a person's requirement and risk profile before making the sale. This will also increase accountability. 

Mutual funds

The committee wants benchmarks to be more relevant and schemes should stick to their label. 

Impact: Many times, fund houses launch schemes based on what's hot in the stock market. When those themes are no longer in favour, the schemes turn into a diversified fund to pep the returns. The recommendation will ensure funds stick to their stated mandate. For example, a balanced fund manager should not go overboard on equity but stick to the asset allocation. 

Investors should be told about past returns of the scheme being sold, along with the benchmark returns, at the time of sale. The report also says customers should be informed of a range of past returns. 

Impact: While selling, distributors show investors the scheme's performance in the past one year only to lure them. Say, a sector fund that did well during a rally. More disclosures will help investors take informed decisions. 

Insurance

The committee suggests companies clearly state which portion of the premium is getting allocated to the insurance cover and the investment portion.

Also, rather than showing expense under each head, manufacturers should show it as one cost. 

Impact: Ray says the cost structure in insurance products are opaque, especially in the case of a traditional plan.

In Ulips, too, costs are shown under each head rather than as a whole. It's difficult for a customer to compute how different costs impact his or her total investments. This will give consumers clarity on charges. 

The current practice of showing future returns benchmarked to four per cent and eight per cent should be discontinued, is another suggestion. 

Impact: Suresh Sadagopan, a certified financial planner, says the current illustration that accompanies Ulips does not give clarity on the actual return.

While selling insurance, agents usually give customers a different sheet to look at the performance of a scheme. 

The committee also suggests all returns be disclosed as a percentage of the investment by the customer and not as a function of a third number, such as a sum assured or the maturity benefit. 

Impact: At present, insurers cancel units from the fund as policy allocation and mortality charges. This affects the returns significantly. 

NPS

The Pensions Funds Regulatory and Development Authority should enable digital transactions for the National Pension System (NPS), including account opening.

Consumers should be able to transact online and over mobile apps. 

Impact: NPS has not taken off in the private sector. While the low commission does not motivate the distributors, the reach of NPS cannot be compared to that of mutual funds.

Account opening also requires the person to go to a point of presence and apply for a permanent retirement account number.

Taking the process online will help cut down this administrative hassle.