Blasé Capital INSURANCE SLIPS

A few days ago, the Reserve Bank of India (RBI) issued draft guidelines for banks against mis-selling of products, and what constitutes irregular selling of products, even with complete customer’s consent. This nudged investors to sell insurance stocks, and most of them were down by one per cent the day after the guidelines were posted on the central bank’s website. Although the new rules, which will be incorporated after feedback by the stakeholders, impose restrictions on the banks, put huge penalties (including the payment of the entire extra amount charged) on them, and talk about re-training and re-skilling the staff, the impact will be felt by the insurers for several reasons.

First, according to a media report, “Banks are one of the most important distribution channels for both life and general insurance… through the bancassurance model. A significant portion of new policies, especially protection and saving products, are sold via bank branches.” Second, the bulk of mis-selling, irregular selling, and even fraudulent ones involve insurance products. So, if the banks are under pressure to curb the practices, and fear the consequences, the insurers are likely to get hit. The latter will lose huge businesses, and will need to rejuvenate their selling and distribution channels, which will hike costs.

Experts agree that mis-selling generally involves insurance. One of the most mis-sold products is unit-linked insurance product (ULIP), which is pitched by the banks as akin to, and even better than, fixed deposits (FDs). Customers are repeatedly coaxed to invest in ULIPs, rather than FDs, as the former provide higher returns, which are ‘guaranteed’ by the banks. In most cases, the ULIPs are launched by the sister concerns of the banks. In practice, ULIPs are the riskiest products, as they are linked to the vagaries of the stock markets, which can fluctuate wildly. According to an expert, “ULIPs, deferred annuities, and guaranteed income plans are the most mis-sold products.”

Bundling is another area of concern. This involves mandatory linking of insurance products with loans. For example, a bank may insist that if a customer wants to get a home loan, she needs to buy home insurance with it, or she will not get the loan. “Many life-related, property, fire, stock, and machinery insurance policies are sold as a condition to get loans,” says an expert. The customers are made to feel that they have no option or choice in the matter, and need to buy both, or get none. In some cases, banks sell health policies that are bundled with group schemes, with the former having limited coverage.

Experts cite tax reasons as another way to mislead customers. Although this practice has declined over the years, as the finance ministry has reduced options that offer lucrative tax breaks. But in the months of February and March, and now even earlier, as taxpayers rush frantically to search for choices to reduce tax burdens, or get refunds, the banks urge them to buy relevant and irrelevant insurance products. This, along with the above-mentioned practices lead to extreme over-insurance, as well distinct possibilities for losses, and lock-ins. There are cases where individuals have dozens of different insurance policies accumulated over the years, largely for tax-related reasons.

For the banks, the benefits are several. First, it boosts the money in their accounts, especially in the case of FDs. ULIPs seem an attractive proposition on paper, given the stock returns in the past, and nudge people to invest in them. Insurance allows the banks to earn forward commission and fees that act as hedges against potential losses. Explains an expert, “Banks generate huge revenues from loans, but loans are risky. To avoid the latter, they aim to earn upfront commission or fees from other financial (insurance products). An insurance premium of INR 5,00,000 can earn a commission of INR 1,50,000 on a loan amount of, say INR 20,00,000 or INR 25,00,000.”

In many cases, the bank’s logic may seem strong. A home loan of, say, INR 1,00,00,000 may land the family in deep trouble if the borrower dies before the payment. The bank will then take over the property unless, of course, there is an allied insurance policy to cover the loan. But there is a catch. Instead of simple term insurance, the bank nudges the purchase of a fancier, more expensive insurance. In some cases, the product is such that if a borrower dies in an accident, the family gets the coverage. But if the cause of death is natural, there is no payment, and the family finds itself in a bind despite the double payments.

A recent documentary, ‘Mis-sold,’ draws attention to the “growing importance of financial awareness in today’s complex investment landscape.” “I have myself been a victim of mis-selling. It feels terrible to lose your lifetime savings,” says Kanan Bahl, co-director of the film. “Mis-sold (documentary) is about learning, asking questions, and completely understanding what they (customers) are buying,” adds Batul Kapasi, another co-director. Thus, instead of pointing a finger at the banks or insurers, contend the directors, the film is about how to make informed decisions, and ask the right questions before investing.