Rethinking Household Finance Policy Framework: From Financial Literacy to Seller Beware Monika Halan Consulting Editor, Mint 11 July 2017
Issues in household finance • Policymakers and governments worry over gold and real estate preference of the Indian household over financial assets • Academia and policy have remained focused on the supply side, calling household decisions ‘irrational’ and ‘non - sophisticated’ • One FM pleaded with Indian households: “Stop buying gold!”
Household behaviour is rational • Regulated parts of the market have caused loss of household savings • Investors into Ulips lost more than Rs 1.5 trillion over a 7 year period due to mis-selling • Investors in traditional policies continue to lose over Rs 30,000 crore a year even now • Banks are chasing fee income and mis-selling both insurance and mutual funds
Households respond to the marketplace • But households are not irrational • Their asset preference reveals a lack of trust in the financial product market place • Households are confused by a fragmented market place • Multiple regulators with turf issues • Regulatory focus on AUM growth rather than investor protection
Supply side reform • The Indian market for household finance needs supply side solutions – we must stop blaming households • It needs a change of regulatory mind-set – it took the RBI 10 years to accept that banks mis-sell, IRDAI in denial on mis-selling • There is already a body of work on the credit part of the market, I will focus on the investment and insurance part of the market
Current market structure • The current ‘buyer - beware’ market is run on the following rules: • Financially literate utility maximizing economic agents will choose the products they need once firms make full disclosure • It is a buyer beware market that rests on the twin legs of disclosure and financial literacy • We know that financial literacy has very limited impact on behaviour change • But disclosure?
Do disclosures work? • Indian regulators have taken the lazy way to interpret disclosures • Throwing masses of information at the consumer is disclosure • Most disclosure is fuzzy and obfuscating • Even this crude regulatory requirement is poorly met or ignored totally
Fuzzy: life insurance • Rs 25 trillion AUM industry • Plenty of disclosures, but ineffective • Regulatory confusion on what is 'material' to the consumer Example: 1. Return illustrations refer to a number that is not the invested amount 2. No way to understand IRR of a product 3. Costs not comprehensive 4. Claims experience not easily available
Fuzzy disclosures life insurance • Premium paying term: 10 years, policy life, 20 • End of year 10 - 50% of sum assured (SA) • End of 11 th year: – 12% of sum assured each year for 9 years – This increases by 3% each year – 12%, 15%,18%… – End of 20 th year – sum assured + 30% of SA – Disclosure says: return is 396% of SA – But policy returns an IRR: 4.2%
Fuzzy: mediclaim policies • Plenty of disclosures • But not made from customer point of view • Regulatory confusion on what is 'material' to the consumer Example: 1. Claims disclosure not segregated on group and individual 2. Needed – product wise claims disclosure 3. Public disclosure data is error filled
Disclosure norms ignored: mystery shopping bank branches • Audit study of 400 bank branches in Delhi in March and July 2015 • Auditors search for a tax saving product • Naive ask for any tax saving • Sophisticated ask for an ELSS • Invest Rs 25,000 or Rs 1 lakh • Paper to be printed in the Journal of Comparative Economics
% of incorrect disclosure Product Bank deposit Life insurance Mutual fund features Returns 35 99 86 Guarantees 2 34 36 Costs 4 100 85 Lock-in 7 36 50 Optimal 12 62 86 holding period
Immediate change needed in regulatory thought on disclosures • Disclose features to consumers that help in making a choice • Put the most important features that matter to an investor in a manner that is easily understood • Allow comparisons • Should be comparable across regulatory domains for similar products • Should be machine readable
Deeper change: supply side reform in retail finance • Regulatory focus on product structure – putting all the costs in a box, making return illustrations meaningful, removing trap like features • Align incentives – take away front loads, design a cost structure that makes it work for the manufacturer, seller and investor • Big ticket fines on mis-selling and fraud. Design the road rules well and then catch the joker in the BMW who kills the people on the pavement
Any evidence? • Is there evidence that product structure reform and aligning of incentives works? • Case one: mutual fund industry • Case two: life insurance industry
Case study: Indian mutual fund market • 10 years of reform • Costs sit in a box with maximum limits • No front loads • 1% cap on upfronting • Sebi took the monkey out of the product • Disclosure is machine readable • Third party analysts give ratings and rankings
Mutual fund SIPs • Industry is manufacturing and selling SIPs • Retail fund flows into equity are above Rs 4,100 crore a month • Investor persistency in equity is rising • Market falls get fresh inflows instead of outflows • Behaviour change due to the regulator taking the monkey out of the product
Case study: Indian insurance industry • Two products in the market • The traditional or endowment product that is opaque and high cost • The Unit linked plans that got a regulatory makeover in 2010 and became transparent • Arbitrage within the industry, caused this the industry to flip Ulips and begin selling traditional plans
100.00 September 2010 Ulip rules 80.00 changed 60.00 40.00 Annul Sensex return in % 20.00 % of 1st year Ulip premium 0.00 -20.00 % of 1st year Traditional premium -40.00 -60.00
Did this reform help? • No, on the metric of persistency, or how many policies stay alive after the first 5 years in a 15- 20-30 year product. • 56 out of 100 polices sold die in the first 5 years of sale • For some firms, 80-85 out of 100 policies die in first 5 years • IRDAI does not disclose data beyond 5 years • Why is this a problem?
Problem: investors lose money • Product features ensure that product is a trap • If investors stop policy renewal in the initial years, the money is forfeit • Insurers book it as profit • Investors lost Rs 1.5 trillion in mis-sold Ulips • Investors are losing upwards of Rs 30,000 crore a year on lapsed traditional plans • Then we wonder why they buy gold
Supply side problem • We have a supply side problem in India that regulators and the government are unwilling to fix • Pull this thread and it leads to financial repression • Much easier to blame the silly uneducated household • We need to move from a buyer beware market to a seller beware market in retail finance
Rethinking Household Finance Policy Framework: From Financial Literacy to Seller Beware Monika Halan Consulting Editor, Mint 11 July 2017
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