Of late, ULIP or the Unit Linked Insurance Plans, have caught the eyeballs of investors in the insurance arena. It all started when SEBI, the stock market regulator, passed an order prohibiting 14 insurance companies from selling units of ULIP to investors. IRDA immediately came to the rescue to the insurance players asking them to continue their operations in spite of the SEBI order.
Lots of discussion has also taken place regarding its jurisdiction and multiple regulators. Also the issue is a little different when it comes to the investors. It should hardly matter to an investor who regulates an industry or certain products as long as there is regulation and it keeps the interest of the investor paramount.
The battle here is not between two regulators, say SEBI and IRDA, two industries, insurance and mutual funds or for that matter between two products viz.ULIPs and mutual funds. It is between transparency and opacity, it is between low cost and high cost. It is about being fair to the consumer.
Now the question arises that while choosing any investment product, what should an investor look for? As mentioned earlier, one should keep an eye on costs and in order to know the costs, transparency is a must.
The regulators have made good moves in the direction of transparency. The Pension regulator has designed the product such that there is no commission to the intermediaries. SEBI (regulator of the mutual fund industry) last year removed entry loads on mutual funds and thus reduced the commission that can be earned by mutual fund distributors. IRDA, the insurance industry regulator, has asked insurance companies to disclose the commission paid on selling of certain policies. These are important developments and really empower the investors to take informed investment decisions – provided the investor wishes to use these arms. As has been seen often, the investor does not bother to know about his or her own rights and then when something goes wrong, blames the system.
Now coming back to the development discussed about empowering the investors, the intermediary (a.k.a. agents, distributors, sellers, relationship managers, brokers) can earn money in two ways, firstly, through commission from insurance or mutual fund companies, and secondly by charging fees from the clients. The difference between the two is that while the commission is decided by insurance or mutual fund Company by looking at volumes, the fees is a function of the perception of the investor about what value one gets from the advisor.
In an investor-advisor relationship, the investor pays the price either directly or indirectly and the advisor is expected to offer some value. The value can be divided into three broad categories: advice, service and transaction facilitation.
Advice includes how one should invest the money, analysis of various options and help in selection of appropriate ones. Service includes monitoring of the portfolio performance, handling various non-commercial transactions (as and when) like change of address, change of bank details, change in nomination, etc. Transaction facilitation is nothing but implementation of the investment advice, buying various products as per the plan or changing the investments, or taking money out of some investments as needed.
Out of three, advice requires highest level of skills, knowledge and abilities, whereas transaction facilitation needs the least. Let us now come back to the fees v/s commission discussion. The commission becomes due only when a transaction especially purchase takes place. The insurance or a mutual fund company pays the commission based on the volume of business generated and not on the basis of whether the intermediary offers any advice or any service to the investor. The recent developments across the regulators, have only reduced (or made transparent) the margins earned by the intermediaries on account of transaction facilitation.
Now the service and advice that the intermediaries offer can be judged only by the investor. The investor is now empowered to decide what is appropriate amount of cost to the investor and earning for the advisor based on one’s assessment (and not perception) of the advice and services offered.
Now that IRDA has asked insurers to disclose the commission payable to agents, someone argued that this may lead to passing back of commission by the intermediaries.
Let us consider two options:
(1) paying reasonable fees to your advisor after buying low cost and right products, or
(2) buying costly and appropriate (?) products and then taking some part of the commission back from the broker.
We have put a question mark after the word appropriate in option (2) with a reason.
It is human psychology to work for the benefit of the one who is closest in the entire chain of cash flow. In spite of the investor paying everyone in the chain, the intermediary would try to offer maximum benefit to the insurance or mutual fund company to get maximum commission since these companies can influence how much commission they can pay the intermediary. In such a case, although the economical costs to the investor may be the same under both the above options, one is likely to end up with inappropriate products in option 2. The probability is definitely high. We do not want to suggest that all intermediaries are bad and work against the interest of investors – many keep the investor’s interest as their primary goal. However, the reasoning we offered is only logical.
Why costs are important? Isn’t a cheap product generally associated with low quality? Well, the argument is sound, but when it comes to investment products, one must understand that the final output, i.e. return on investment, only goes down if the costs are high. At the same time, in order to offer superior investment advice, the advisor need to incur some costs and must be compensated for the same. If the compensation comes in form of higher returns on investment or in form of convenient service, the higher cost may be justified. In all other cases, it is better to buy something that does not cost much – you might end up getting the same product at much lower cost, in turn increasing your return on investments.
In the end, we recommend the investor should consider using the empowerment that the regulators have offered them. We recommend the following steps:
(1) Asking questions about costs should be the starting point
(2) It is better to pay fees to an advisor than to get pass back from an intermediary. By paying fees to an advisor, one is putting responsibility on the advisor.
(3) The fees should be in line with the value you get from your advisor. Once again, asking questions will help you get the right and desired information. Satisfy yourself about the credentials and credibility of the advisor.
