Insurance & Investment

On the last day of 2007, SEBI brought in new regulations that forbade mutual fund companies from charging load from investors in cases where investments were made directly to the fund company. And on the first day of 2008, another financial services regulator, the Insurance Regulatory and Development Authority (IRDA), also brought in a new regulation that has the potential to bring benefit to the public. However, the IRDA's action has brought almost no media attention, perhaps because its positive effects will be indirect and are thus not clearly understood. The change is very simple. From February 1, insurance companies will have to inform policyholders buying Unit Linked Insurance Plans (ULIPs) exactly how much of their money is being invested and how much is being consumed by other charges that the insurance company is deducting. The IRDA's circular specifies the exact format in which these charges will be documented, and this document, which will be signed by the ULIP buyer and the insurance seller will become part of the policy document.

Why is this important and why does it potentially have the power to change the way ULIPs are bought? Simply because ULIPs are being mis-sold (mis-sold being a polite way of saying con job) like no financial product has ever been mis-sold in this country. In India, ULIPs are a product which have been cynically designed to maximise profits to insurance agents (or 'advisors' as they are supposed to be called now) and insurance companies while hiding the true numbers from investors. Nominally, a ULIP is a product that combines insurance and investment characteristics. In reality, they combine an extraordinarily high cost structure (meant primarily to feed agent commissions) with a non-standardised revelation of expense so that any meaningful comparison of investment performance between different ULIPs or between ULIPs and mutual funds is impossible. In other investment products, either there are no agent commissions (as in bank FDs) or agent commissions range from 0.25 per cent to 2 or 3 per cent. In ULIPs however, commissions range from 15 per cent to (hold your breath) around 70 per cent and are typically 25 per cent. And for some bizarre reason, this is considered acceptable by everyone concerned. On 31st December, one financial regulator (SEBI) moved to push commissions down from 2.25 per cent to zero while another (IRDA) is OK with 25 per cent for what is essentially a competing product!

Basically, ULIPs are expensive and opaque mutual funds disguised as insurance. This permits the so-called insurance companies to circumvent the strict transparency, expense, and commission-related laws that govern mutual funds. It also enables them to escape the scrutiny of SEBI, which has historically been a tougher regulator than IRDA. Will the new regulations stop these abuses? No way. All I'm hopeful of is that a handful of alert and aware investors will read this new document and ask some tough questions. Anyhow, the realistic situation is that there's almost no chance that anyone will step forward and fix things. As someone responsible for your money, you need to be sensible yourself. Insurance is a great idea and most of us need it. But we need real insurance, which is to say term insurance. Here's what you should do. Make a liberal estimate of how much money your family will need if you die suddenly. Shop around and buy the cheapest term insurance you can find. You'll be stunned at how cheap term insurance is and also at how difficult it is to buy (The quickest way to get rid of an insurance agent is to say that you're interested only in term insurance). You probably won't be able to think logically about insurance as long as you don't realise that it's an expense. It's a necessary expense, like buying a helmet or going to a doctor, but it's not an investment. You need both insurance and investment. To get the best deal in both, don't mix them up.