While the insurance industry is lauding the objectives of the Committee on Investor Awareness and Protection, the recommended course of action has come under scrutiny.

"The committee has taken extreme view points. In India, distributors play an important role in transforming inaction to action and, therefore, they should be appropriately incentivised. In the absence of distributors, a scheme like NPS, even with its merits, hasn't been completely accepted by the mainstream,"said Max New York Life Insurance chief executive officer Rajesh Sud.

The committee, spearheaded by D Swarup, Pension Fund Regulatory and Development Authority chairman D Swarup, had yesterday released a draft consultation paper. The report tried to plug loopholes in various sectors of financial service.

It proposed the phased elimination of upfront commission paid to agents by April 2011, to curb mis-selling in case of financial products.

Industry body Life Insurance Council has also questioned the data used to make recommendations. "(The report) has used fragmented and uncorrelated data. In the last four years, the industry has collected more than Rs 1,25,000 crore of first year business premium. The commission doled out by companies for this was in the range of 1.75 to 2 percent — less than the entry load charged by mutual fund schemes then. The report has criticised the industry and made sweeping comments without substantiating it with credible data," said secretary general S B Mathur.

Players have also questioned the success of the mutual fund and pension industry that does not charge any entry load.

3/9/2009

Insurance buyers will no longer have to foot the bill for agent commissions, if the government accepts the game-changing recommendations of a committee headed by D. Swarup, chairman of the Pension Fund Regulatory and Development Authority (PFRDA).

The six-member committee also recommended that the government set up a Finance Well-Being Board of India (Finweb) to establish common minimum standards for financial advisers and to increase financial literacy in India. The committee's consultation paper was placed on PFRDA's website on Wednesday.

The current system of sale incentives encourages insurance agents to tailor advice in such a way that it promotes the interests of the life insurance industry rather than the insurance buyer, Swarup said. India's life insurance industry collected annual premiums of over Rs 2 trillion in 2007-08 through sale of new policies and renewals.

These suggestions come a month after the Securities and Exchange Board of India asked mutual fund companies not to load their distribution costs on investors.

Current rules allow insurance firms to deduct as commission up to Rs 40 of every Rs 100 paid by policyholders as first-year premium. Insurance firms invest only the residual amount on behalf of the policyholder. In the second and third years, firms can deduct up to Rs 7.50 for every Rs 100 premium and a maximum of Rs5 thereafter.

The Swarup panel's recommendations are designed to combat rampant mis-selling of financial products in India, a result of skewed incentives in the distribution chain for financial products. Mis-selling by India's three million financial advisers can harm the interests of about 188 million investors, the report said.

Separately, insurance regulator, Irda (Insurance Regulatory and Development Authority), has in its 2007-08 annual report termed “lapsation” of life insurance policies as a 'major bane'. Lapsation happens when the policyholder prematurely stops paying premium for any reason, including being sold an unsuitable policy. In 2006-07, 8.6 million life insurance policies lapsed, the Irda report said.

According to the Swarup committee's consultation paper, when financial incentives for agents are loaded on to a financial product and thus borne by the investor, for all practical purposes the agent functions as an adviser. Therefore, changing the incentive structure for agents strikes at the root of inappropriate financial advice.

Financial advisers are spread across segments of the financial sector, each of which has an independent regulator and legislation.

The Swarup committee's recommendation on the legislative backing for Finweb would not trespass into existing laws. "What we are suggesting is a coordinating model and preventive measures," Swarup said. The finance ministry would invite all stakeholders for a meeting next week to get their view, he said.

Gautam Bhardwaj, head of consultancy Invest India Economic Foundation, who has worked on pension markets, agreed with the broad principles of the Swarup committee's recommendations on financial incentives. He, however, felt the implementation of the recommendations would have to be done cautiously.

According to Bhardwaj, with just about 3 percent of India's population falling in the income-tax bracket (a minimum annual income of Rs 1.6 lakh), reforms on removing financial incentives have to be paced in a way that would ensure insurance agents continue to have the motivation to reach out to potential customers capable of paying only a small premium.

It is important to ensure the distribution does not withdraw from sections of customers it might consider unattractive in the absence of embedded loads on premium, he said.

The central role financial incentives play in distribution of retail products have made the Swarup committee suggest the legislation backing Finweb be built on a platform of reforming the incentive structure. On this platform, the committee wanted the legislation for Finweb to be principle-based as against the current rules-based system followed in India.

The report described principle-based regulation as one where the regulator articulates broad principles and allows market players to innovate around them. In rules-based system, regulators use a checklist to see if market players have complied with the law.