From Ulip To U-turn

If you were one of the hapless many to have been saddled with a ULIP (Unit Linked Insurance Plan) in the early 2000’s, the odds of you having exited profitably are ludicrously slim. Back then, ULIPs were a novelty; pitched as a silver bullet that catered to one’s investment and insurance needs simultaneously. But before long, it became apparent that ULIPs weren’t quite as hunky-dory as they were made out to be. Investors soon found out that their ULIPs were heavily front loaded, infused with a plethora of recurring charges, and to top it off — were grossly mis-sold.

The ULIP story began unravelling amidst the cataclysm of 2008, when clients began inspecting their statements more closely and gaping holes in the sales processes of most intermediaries came to the fore. Complaints began pouring in to the ombudsman and consumer courts; ranging from unfulfilled promises of astronomical returns, to ULIPs being creatively peddled as three-year “guaranteed return deposits” to unsuspecting senior citizens. Most investors weren’t even aware that their first-year premiums were getting consumed, by and large, as allocation charges or ‘commissions’. Indeed, distributors were raking in between 40 per cent and 100 per cent of their first-year premiums, mobilised as their earnings for making the sale; at the expense of the investor, of course.

Remedial measures in ULIPs or ‘linked’ plans followed between 2008 and 2010; including the drastic reduction in commissions payable, the increase in the minimum lock-in period from three years to five, and the increase in the minimum associated life cover to ten times the annual premium from five. In other words, linked plans were made a lot more customer friendly and useful. Over time, online ULIPs surfaced, eliminating commissions altogether in some cases. Significant improvements in ULIP fund performances over the past five years have been the icing on the cake.

Here’s a baffling trend, though: in 2009, the share of ULIP as a percentage of premiums paid was close to 41 per cent. A slew of reforms and seven years later, the share of the revamped ULIP has plummeted to barely 12.77 per cent in 2015-16. The same community of agents that was actively engaged in discrediting non-linked plans as low-return products with limited value creation potential, seems to have made a collective about turn over the last seven years. And now, non-linked plans are back in vogue.

What Are ‘Non-Linked’ Plans?
It’s a fact that non-linked or “traditional” plans resonate with a large cross section of the Indian populace that is essentially risk-averse. The dynamics are simple: you commit a fixed sum of money each year, you are provided with a life cover while the policy remains in force, and receive a guaranteed lump sum of money at maturity. Depending upon the policy structure, this maturity amount could be paid out by the insurer in a single tranche or multiple.

Unfortunately, non-linked plans also provide returns that fail to outpace inflation. Plus, they aren’t exactly the bee’s knees from a life cover standpoint. And while it’s the fiduciary responsibility of insurance agents to inform clients of these shortcomings, few ever do.

Even a rudimentary cash flow table will demonstrate that the annualised returns earned from most non-linked plans range from 3.5 per cent to 7.5 per cent per annum. Factoring in inflation, this is tantamount to capital erosion or stagnation, at best. We witnessed a colossal Rs 3.2 lakh crore (Rs 3.2 trillion) of India’s household savings flowing into these plans in the last financial year alone. It’s also worth noting that despite reforms, exit options from traditional plans remain abysmal. The opacity of the returns or ‘benefits’ that accrue from these policies acts as an added incentive for agents, as they no longer have to answer uncomfortable questions related to charges, fund performance or markets.

Conflicted Advice — A Deep Concern
A 2012 Harvard Business School study titled “Understanding the Advice of Commissions-Motivated Agents” has only confirmed what anecdotal evidence has pointed towards all along. The working paper suggests that most life insurance agents in India“overwhelmingly recommend unsuitable products, which provide high commissions, and cater to the beliefs of uninformed consumers, even when those beliefs are wrong”. The researchers also discovered that in the clear majority of cases, life insurance agents view the relationship with a customer as “essentially over” after the product has been sold.

Suddenly, the reason behind the mystifying ULIP-related trend becomes evident; that is, the incentive to sell them has all but vanished after the commission quantum crashed. It’s ironic that clients flocked to ULIPs when they were expensive and flawed, only to shy away from them after they were rehabilitated into potentially value-creating products.

More importantly, this trend brings to the fore the disturbingly “commission centric” nature of the life insurance advisory ecosystem in India. Put differently, clients are by and large driven to purchase insurance products on the behest of intermediaries; and intermediaries in turn, by the size of the pay-outs they receive. Such an arrangement is a far cry from the fiduciary nature of the financial advisory profession that is ideal.

When one considers that a sizeable chunk of the trillions flowing into low return non-linked plans each year are being earmarked to fulfil critical life goals such as children’s education or retirement, it becomes evident that the rot must be stemmed quickly to prevent a deeper crisis of insufficient savings in the years to come. After all, inflation will continue to gnaw away unabated at investment returns.

Exclusion from Investment Advisor Regulations
Sebi’s recent push for more comprehensive investment advisor regulations is a clear statement of intent: the regulator views the cleaning up of ‘advice’ as a key priority, and would like to see product sales and advisory as two very distinct professions; with the latter completely delinked from commissions. This is probably the only feasible way to establish a much-needed fiduciary relationship between clients and their advisors, and doing away with conflicted advice.
It’s unfortunate that life insurance agents are likely to be excluded from the stringent reporting, ethics, and knowledge standards that the regulations entail. Considering that a large segment of retail investors in India relies on insurance agents for financial planning, this is certainly a step backwards. The regulatory turf war between Sebi and IRDA isn’t new; previously, they had tussled over the control of ULIP back in 2010, with the government finally deciding in IRDA’s favour.

The LIC “Clout-Factor”
It’s no secret that LIC dominates the life insurance market in India; the life insurance behemoth had a 72.61 per cent market share last year. What you might not know is that the bulk of LIC’s sales take place in non-linked plans. It’s also a well-known fact that LIC regularly doubles up as the government’s saviour when it comes to stabilising markets. Case in point: when the government disinvested Rs 9,379 crore worth of shares in Indian Oil Corporation in 2015 and the markets trembled, LIC absorbed nearly 90 per cent of the stake sale and cushioned the blow.

The only viable solution to this problem of conflicted advice is to level the playing field by drastically reducing commissions on traditional plans, and effectively bringing them at par with ULIP’s. But considering LIC’s “clout-factor” and the power dynamics described above, this would be unlikely.

A Word of Caution for Investors
Fortunately, we live in an age where information is readily available; real-time, and transparent. Before you sign above the dotted line for your traditional plan, check all the facts thoroughly. Evaluate the product in the light of its long-term returns and the life cover on offer. If your agent is recommending a non-linked plan over a linked plan, question why; post reforms, many low-cost, high-performing ULIPs have become worthy of consideration today.