Imagine that there is a very crowded city, bursting at the seams. A state-of-the-art satellite city comes up and is ready for settlement, but remains largely empty. All the shiny new infrastructure is wasted because the citizens seem to want to stay in the polluted, congested space they currently occupy. The local authority wants people to crossover and keeps thinking of new ways to incentivize this. Tax breaks, cheaper medical facilities, better schools…. But no go. The citizens are blamed for being foolish. But the truth is that the only thing the local authority is unable to resolve is the extremely high crime rate in the new city area. Roads have no rules, gangs of criminals roam around, plunder and kill at will. The authorities turn a blind eye saying that this tribe of criminals has traditionally robbed and killed for livelihood and, therefore, they must be left alone since their livelihood is at stake. The local authority does not tell the real reason—that it gets a cut from the criminals. Perversely it uses some of this money to give further incentives to people to move! The new city remains empty, and every year during the annual budget, experts pontificate on how to incentivize the silly citizens to move. But the smart guys don’t. They prefer the safety of the known problems.
Finance minister after finance minister has spoken about incentivizing the household saver to move from land and gold to financial products, but the share of households who trust their savings to financial products has fallen from 11.6% in FY06 to 7.1% in FY13 as a percentage to gross domestic product (GDP). Over the same period, the share of physical assets grew from 11.4% to 14.8%. Each budget time, the cry for sops to households to invest more in financial products gains strength. If the government was serious about its desire to move household savings towards a more efficient use, it would inquire into why otherwise value-seeking Indians are not making this transition. Contrary to what the pundits want us to believe, Indian households are financially savvy, and are not moving because they distrust the financial sector. And with good reason.
There are two parts of the financial market—the regulated and the unregulated. The unregulated part is in the news with various scams such as emu breeding or Saradha, which are essentially ponzi schemes that make retail money disappear. Investors lost more than Rs.2,000 crore in the Saradha scam.
While the risk of fraud and capital erosion is high in any unregulated market, what should really worry the government is the role of a regulated sector like life insurance when it cheats households of savings. Using Insurance Regulatory and Development Authority of India (Irdai) data for just two years (FY12 and FY13) and making an assumption that the premium is one-fifth and one-tenth of the sum assured for each year, I find that the money that has been lost due to lapsed policies is more than Rs.60,000 crore.
How is this money lost? Very high first-year commissions that pay the agent up to Rs.40,000 on a premium of Rs.1 lakh is the incentive for a very sharp sales push. A complicit regulator allows the industry to couch the real return of a product in illustrations that deliberately obfuscate. This column by Mint’s Deepti Bhaskaran illustrates how: http://bit.ly/1AyTEg0. Investors get trapped into products that destroy value if held for the long term with a 2-4% annual return. They could choose to exit the policy within the lock-in of five years, but then they would lose their entire investment. This money goes into what are called ‘lapsed profits’ of life insurers. This number is not publicly disclosed, and Mint’s attempt to get it under Right To Information from Irdai failed as we were told that the regulator does not have this information. Industry insiders, however, tell us that not only is this data collected by companies, it’s disclosed to the regulator in the Appointed Actuaries Report, in the section titled ‘Analysis of Surplus Report’.
Before it doles out more sops at budget time to the life insurance industry in particular and the financial sector in general, the government should ask this: what is wrong with the industry that the product it manufactures and sells is so useless that less than half the people who buy it keep funding it after five years? The 61st-month persistency for Bajaj Allianz Life Insurance Co. Ltd, according to Irdai data, is 4.02%. This means that just 4% of policies sold in FY09 are still alive after five years. The persistency metric sees if the policy lives beyond the first premium; a 61st-month persistency metric of 10% means that just 10 out of 100 policies sold five years ago are still funded. This number is 23% for HDFC Standard Life Insurance Co. Ltd, 10% for ICICI Prudential Life Insurance Co. Ltd, 17% for SBI Life Insurance Co. Ltd, and 43% for Life Insurance Corp. of India. Statement 28 in Irdai’s annual report for FY13 has this data.
The failure to check this institutional loot of household savings will keep Indian money in gold and real estate. We won’t crossover to the new city if you can’t check the goons.
End note: Two questions to Irdai. One, why do you understate the sum assured loss for four companies in statement 27 in the FY13 annual report? For the industry, the sum assured in lapsed policies is shown as Rs.0.8 trillion, the actual number (got from inside Irdai) is Rs.2.3 trillion. Two, why have the two most damning statements on the industry been kept out of the annual report 2013-14? The statement on lapsed policies and on persistency is missing. It seems the numbers look really bad. Just asking.