Mutual funds and life insurance are two distinct products
There were some announcements recently by the Life Insurance Council, a lobbying body formed by life insurance companies. Broadly, these announcements appeared to say two things: that the terminology of unit-linked insurance plans (Ulips) would be made uniform and that insurance companies would refuse to underwrite insurance-linked schemes issued by mutual fund companies.
Behind these announcements is the ongoing struggle between life insurance companies and mutual funds. Mutual funds and life insurance are two distinct products, one intended as a savings vehicle and the other a safety net. However, this distinction has blurred over the last few years. Indeed, one gets a feeling the life insurance companies are also in the business of running mutual funds, categorised somewhat differently as unit-linked insurance plans (Ulips).
Ulips have a mix of characteristics of both insurance and mutual fund schemes.
Crucially, however, the mutual fund aspect of Ulips is regulated by the government under a very different set of rules compared with the real mutual funds.
From the investors’ point of view, the biggest difference between the two categories pertains to how much of his money is actually used for his insurance and his savings and how much is taken away to pay commissions to agents and towards the insurance company’s expenses. The second big difference is in the quality of the information he is given about his investments.
Mutual funds deduct less than 2.5% as the agent’s commission. And as per current norms, there is no deduction if investors don’t use an agent and go directly to a fund company.
In Ulips, on the other hand, the agent’s commission varies, but in the first year, it could be as high as 25% and more.
Next is the issue of transparency.
There is a vast difference between the meaning of net asset value (NAV) of Ulips and mutual funds.
In a mutual fund, the NAV announced is net of all expenses and charges the fund company deducts. If your investments were worth Rs 1 lakh when a fund’s NAV was Rs 22, then it will be worth Rs 2 lakh when the fund’s NAV is Rs 44. That’s it.
The arithmetic of insurance companies is different. NAVs of Ulips are effectively pre-deductions. The NAV may double, but your investments won’t double because the insurance company will reduce the number of units you hold to pay for expenses and commissions etc. This means the announced NAV has no clear and transparent relation to what the unit holders are actually earning.
However, Ulips have been the more successful of the two. News reports say that last year, a total of Rs 55,000 crore was invested (if invested is the right word) in Ulips. In the same period, around Rs 16,000 crore was invested in mutual funds.
We are often told by the insurance industry that this is because Ulips are a superior product. That’s complete rubbish. Ulips are successful because the ultra-high commissions and charges make insurance agents far more aggressive salesmen than those of any other financial products. These charges also enable insurance companies to spend far more on advertising, all from the unit holders’ money. The net result of high-pressure sales is that savings that would otherwise have ended up in mutual funds, bank FDs, PPF, post office deposits and many other asset types is ending up in Ulips, where a good proportion is diverted to pay commissions.
The direction India’s insurance industry has taken in the last few years amounts to regulatory failure. This industry was opened up to foreign capital and provided with a relatively lenient regulatory framework so that it could bring insurance to India’s under-insured masses. Instead, it has ended up focusing its energies (and capital) on selling expensive and opaque mutual funds dressed up as insurance.
It’s tragic that there is no move to even recognise that this problem exists. Indeed, even higher foreign ownership is on its way, supposedly because more capital is needed to Ulip the under-Uliped masses.
But, even the mutual funds don’t seem to be very interested in highlighting these issues, perhaps because many of them are part of financial conglomerates with flourishing insurance businesses.
It is therefore left to the investor to understand the issues and do what he thinks is in his best interest.
