It is no secret that financial awareness is low in our
country, and many issues can be traced to this. One of this is mis-selling,
which is fairly widespread because of financial illiteracy and also due to
customers’ own apathy towards personal finances.
There has been some regulatory tightening to ensure
that mis-selling is reduced and that customers are not taken for a ride. Now,
there is a new initiative to curb mis-selling and rationalisation of incentives
in financial products in the form of the Sumit Bose Committee report. The
report primarily focuses on mutual funds and insurance.
If some of its provisions are implemented, it will greatly benefit the investing public. Consumers at large have been bearing the brunt of mis-selling and have lost huge sums of money in the bargain. Many people have been sold low yielding insurance policies, for every conceivable goal.
Incentive structures can also be a factor in
mis-selling. The report observes that this needs to be aligned with goals and
their tenors. If products offer upfront incentive for long tenored products,
mis-selling can happen. Availability of multiple products with diverse
incentive structures allows agents to choose one that gives them the highest commissions
upfront. To modify the behaviour of agents, incentive structures and their
timings needs to dovetail with customer requirements. It also specifically
prohibits companies dipping into future expenses or their profit/capital.
Banks are one of the main participants of mis-selling,
the report pointed out. The main problem is that banks use their clients’
privileged banking information to pitch products. This is gross misuse of
information. Banks should only perform banking functions. All their product
sales should be done through a completely different entity which cannot access
data of banking clients. This will address the problem of misuse of privileged
client information and will create a level playing field for other product
sellers. The report, however, does not address this point.
The suggestions are radical in certain ways—they focus
on function rather than form. Functions defined are: insurance, investment and
annuity. The report suggests that the lead regulator should fix the rules of
the game—the Securities and Exchange Board of India (Sebi) for investment components, Pension Fund Regulatory and Development Authority for annuities,
and so on. This will ensure that there is no regulatory overlap and there is
uniformity across products in terms of costs and commissions. It will also
remove any future altercations on jurisdiction. This is a good way to remove
regulatory arbitrage and bring the focus back to customer needs.
Another major suggestion is that the investment
portion would have no upfront commissions and would follow an assets under
management (AUM)-based trail model across products. Upfront commissions would
stay only on the pure risk components in insurance products. This is another
radical suggestion that tries to remove distributor-behaviour-distorting
commissions. This would mean that insurance products will become a lot cheaper.
Flexible exit options with limited costs, too, have
been suggested. Lapsation or exit costs are not to accrue to product providers.
All these are lacunae in existing products the report is trying to plug.
A big problem customers face is on return
expectations. The committee report suggests that returns on investment should
be disclosed at the point-of-sale as a function of amount invested (as opposed
to based on sum assured or premium). Also, many times, customers do not have
access to important information—product costs, returns, benefits and holding
period—which are usually a part of long, convoluted documents. This study,
hence, suggests disclosures in a crisp form that could be understood by
customers.
The importance of documenting the sale process was
stressed upon. Proper documentation needs to be maintained to ensure that
client goals, financial situation and risk tolerance have all been taken into
account, before suggesting a suitable product. Merely taking a signature on
benefit illustration does not ensure the product being aligned with the
client’s requirements.
The report calls for no upfront, and a level or
reducing trail in mutual funds. This can induce churning. In fact, it should be
the other way round. It should gradually increase till, say, five years and
stay at that level from then on, to disincentivise churning. Also, mutual fund
expenses have crept up. There is a proposal to do away with the incentive for
beyond top 15 (B-15) cities. Association of Mutual Funds in India has also
proposed a phased withdrawal of this, which is good for the consumer and the
industry. Fund houses and distributors should increase the pie dramatically and
earn more, rather than earn higher commissions per unit of sale.
The report recommends upfront commissions in insurance
just on the mortality portion and trail commissions on investments, which it
suggests should be level or declining. Though this is a good suggestion, in my
opinion, the trail here too should start small and increase over the years and
stabilize at a higher level for the rest of the period, to naturally wean away
distributors from churning.
The Sumit Bose Committee report has the potential to
radically transform the landscape of financial product distribution. It will
make the financial services landscape far more responsive to needs of
customers, curtail mis-selling, increase transparency and even bring down costs
for customers. Overall, this is a very transformative effort. Let us hope it
sees the light of the day.
The article written by Mr. Suresh was published on livemint.com on 10th Sep2015
Office@ladder7.co.in
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