Why have Indian savers taken such a hearty dislike to financial products? Experts have many answers to that question — moribund stock market, poor returns from equity funds and the fascination for gold. But there is one factor that no one is talking about — the vast amounts of retail money lodged in opaque insurance products.

A quick check around the office confirms that most people don’t necessarily own mutual funds or stocks, but they do contribute hefty annual premiums to insurance products, usually a unit-linked insurance plan (ULIP). Ask them how it is doing and you draw a blank. Why did they buy it? To help a neighbour/aunt/friend meet her target! Often, a question is lobbed right back at you ‘‘Should I surrender it for whatever it is worth?’’ This in short, is the story of insurance in India.

Retail patronage

Insurance products have enjoyed a level of retail patronage in India that mutual funds or equity brokers can hardly dream of. Data from the Insurance Regulatory and Development Authority (IRDA) show that insurance companies jointly managed a whopping Rs 16 lakh crore in assets in March 2012. Of that, Rs 3.7 lakh crore was in unit-linked insurance plans. In contrast, equity mutual funds manage Rs 1.5 lakh crore in equity money and the total retail investment in all the listed stocks amounts to Rs 5 lakh crore.

Between 2005 and 2011, while stocks and mutual funds struggled to attract 5 per cent of the incremental household savings, insurers drew in 20 per cent of the money. They were next only to bank deposits in popularity.

Yet, there is little sign that insurers have kept faith with those investors. Let’s start with ULIPs.

Hobson’s choice

When insurers made an all-out pitch for these market-linked plans between 2005 and 2010, their primary argument was that their ‘long-term nature’ would help them outperform mutual funds, despite their high costs. But many years on, there is little proof that this promise is being fulfilled in any measure.

Instead, many insurers make it quite difficult for anyone to gauge the performance of their plans with incomplete or tardy disclosures of benchmarks, portfolios and returns. Then, there are no objective third-party rankings of different categories of ULIPs. How can there be, when every insurer steadfastly claims that his ULIP is ‘not comparable’ to others in the market?

Without such comparisons, hapless investors are hard-pressed to know if his ULIP is indeed beating its peers, leave alone mutual funds.

In reality, effective returns to investors from many of these ULIPs may be nothing to write home about, given their prohibitive upfront charges. With sky-high costs and a front-loaded expense structure, the original crop of ULIPs was designed to line the coffers of insurance companies, rather than investors. In 2010, IRDA stepped in to rectify the flaws in ULIP design through limits on total expenses, lower surrender charges and better disclosures.

Shutting the stable door

But that was shutting the stable doors after the horses had bolted. For, of the Rs 3.7 lakh crore invested in ULIPs today, well over three-fourths was raised prior to 2010.

Insurers were asked to give investors an option to switch to the ‘new, improved’ ULIPs. But it is likely that most investors in those plans didn’t take what was essentially a Hobson’s choice. Either surrender their old plan after suffering sizeable capital losses, or soldier on in the hope that they would one day break even.

Traditional plans

Surprisingly enough, the same saga is being now played out again, with traditional insurance plans. With ULIPs attracting a lot of flak, insurance agents have been hard-selling traditional plans as a ‘safe’ alternative. But that safety comes with anaemic returns.

The product terms for traditional plans are often so heavily shrouded in jargon (survival benefit, maturity benefits, loyalty additions) that, at the time of the purchase, most policyholders are completely clueless about the returns they may earn from them. The truth is that, in many cases, they may not match inflation. Traditional plans, unlike ULIPs, invest a major portion of their corpus in debt instruments. Yet, their cost structures are quite high, thanks to the liberal commissions paid out to agents.

Disclosures from IRDA’s Handbook of Statistics show that, on an average, ULIPs paid out 3.44 per cent of the annual premiums collected as agent commissions in 2011-12, but traditional plans shelled out 7.7 per cent.

Recently, responding to these problems, IRDA notified yet another set of regulations that overhaul the product structure for non-unit linked insurance plans.

On the anvil are new limits on commissions, a minimum death benefit and improved surrender terms and disclosures.

But despite these new rules, traditional insurance products may remain light years behind competing financial products such as the New Pension Scheme or mutual funds on their cost structure and transparency.

The new rules, for instance, cap the commission payable to the broker at 30 per cent of the first year’s premium and 5 per cent of later premiums, on long-term plans.

Compare this to mutual funds, where even the relatively small upfront charge of 2.5 per cent was abolished way back in 2009.

Here again, it will be critical for IRDA to ensure that investors who have already sunk money into traditional plans do not get a raw deal, but enjoy the benefits of the new rules.

Nor do insurers come out smelling entirely of roses in their primary business of providing life cover. For a few years now, IRDA has been leaning on life insurers to repudiate fewer death claims, expedite claims settlement and reduce the incidence of ‘lapsed’ policies.

Overall, these facts suggest that, restoring confidence in the Indian financial sector is not just a matter of tightening mutual fund regulations, curbing stock price manipulation or chasing after unregulated entities that mop up money from rural folk. Legacy issues in the highly visible insurance industry badly need attention too.