WHY THERE IS A BAD SMELL ABOUT LIFE INSURANCE
Arecent story reports on misselling and fraud by a bank in rural Rajasthan where they allegedly made bank deposit customers put their signatures on life insurance products of a group firm. While the story of people of small means being cheated out of their money is worrying enough, what is of greater concern is that this problem is not limited to one insurance company or bank, or location. Life insurance mis-selling and fraud by bank branches is systemic in the country. The evidence to this statement comes from three sources. The first is anecdotal: almost everybody who has a bank account has a misselling or fraud story to tell about life insurance. For those who superciliously turn away from anecdotes, there are three academic papers that nail the problem. In 2014, two econo- mists and I, wrote a paper estimating that policyholders lost over Rs 1.5 trillion from mis-sold life insurance plans between 2007 and 2012. In 2017, I published another paper that mystery shopped bank branches to catch mis-selling. I found that bank officials lied most of the time on features around costs and costs of early redemptions to potential customers. A 2015 paper by Anagol et al find that agents overwhelmingly recommend life insurance products that are unsuitable to the customer but get the agent high commissions. Three, two government committees, Swarup and Bose, have found life insurance to have very high front incentives that cause sharp sales and fraud. (Disclosure, I have served on both the committees).
Why is there a bad smell about life insurance in India? We need to follow the money to get answers. Life insurance agents earn Rs 42,000 on every Rs 1 lakh of premium in the first year of sale of traditional plans that make up 87% of the market. This is what is legitimately allowed. Illegal payments, say ex CEOS from the industry, reach 80% of the first premium. Commissions come down in subse- quent years, giving agents the incentive to just push that first-year sale. Now the game begins, insurance rules in India allow firms to appropriate all the money if the policy holder of a traditional plan does not renew the policy in the first two years. Firms are allowed to book ‘lapsation’ profits after two years. The game is set up to mis-sell and defraud the customer. That first sale is made anyhow, the agent makes his commission and the insurance company swallows the entire premium if the second or third premium does not come. The product is a trap, once they get you, either you keep paying for 20 years or you lose your money. Indian life insurance shows a dismal 44% 5th year persistency.
Why does the regulator not do anything? There are two regulators in this picture. The Insurance Regulatory and Development Authority is the product regulator and the Reserve Bank of India is the sales-through- banks regulator. Both have consumer production at the bottom of their agendas. The insurance regulator is in a time warp, unwilling to give up on the way business was done in the 1970s and its regulatory philosophy is deeply influenced by India’s erstwhile monopoly Life Insurance Corporation of India that grew the business in a particular way.
It has moved in the opposite direction to global lessons on retail finance regulation and has actually hiked first year commissions and, worse, legalised what were hitherto illegal payments in April 2017. It actually diluted persistency targets in 2014.
The very high front incentives are triggering massive mis-selling and fraud in life insurance. I worry that as the unbanked now get into the formal financial system, we are setting them up for financial disaster. The insurance regulator needs to rationalise front commissions, put in place persistency targets and reduce the loss policy holders take if they stop the policy after one premium. Life insurance in India must stop being a trap.
THE HIGH FRONT INCENTIVES ARE TRIGGERING MISSELLING IN LIFE INSURANCE. I WORRY THAT AS THE UNBANKED NOW GET INTO THE FORMAL FINANCIAL SYSTEM, WE ARE SETTING THEM UP FOR FINANCIAL DISASTER