As a Rule, Guaranteed Products Underperform the Market – Mint Interview

After having worked in the life insurance industry for about 15 years, P. Nandagopal, managing director and chief executive officer of IndiaFirst Life Insurance Co. Ltd, is ready to hang up his boots. As someone who has seen the industry get privatized in 2000, Nandagopal has been witness to all the ups and downs in insurance and the many regulatory reforms that were directed towards product design and distribution. He has also worked under all the four chairmen that the Insurance Regulatory and Development Authority (Irda) has ever had. In an interview with Mint, Nandagopal talks about what is pulling the industry back and chalks out a road map.

What were the defining moments under each Irda chairman?

Personally, I feel the most defining moment had been under N. Rangachary, the first regulator who oversaw the historic privatization of the sector. He inspired the trust of the common man, who till then insured only with the Life Insurance Corp. of India (LIC), to look beyond and insure with the private sector.

The second most defining moment belonged to J. Hari Narayan, when the unit-linked business was under fire from the market regulator for being investment-oriented. It was an existential issue for the industry. But for Hari Narayan’s fierce defense of the sector, the industry would have lost its legitimacy to bring in market-linked long-term saving products. He further led reforms in unit-linked insurance plans (Ulips) to make them fairly priced, and perhaps the best products for long-term investments.

C.S. Rao was instrumental in de-tariffing of the non-life industry to bring in genuine competition, and T.S. Vijayan initiated the digitization of insurance. Electronic insurance accounts can reduce the current administration costs from about Rs.150 to Rs.10 per policy. Imagine the savings for the customer and the industry.

The industry has moved to traditional plans. But for investment, you prefer Ulips. Why is that?

Traditional plans have some advantages. For instance, the fear of a market crash and consequent erosion of value is not there. Also, in fixed income, instruments can be held to maturity, unlike in Ulips, which are marked to market and are affected by the current environment even if fundamentals are intact. But Ulips are a far superior product because they are transparent and the design lends to open market competition. If an insurer’s charges are steep, open markets will beat that insurer down. But if the insurer selling an opaque product, the charges and benefits are neither known nor comparable, and it get away with selling an inferior proposition with high pitch marketing.

Unlike in a Ulip, there is no meaningful limit on the expenses in a traditional plan; the insurer can pass on all expenses to the policyholder in the initial years. An inefficient company with high operating and distribution costs can pass on its cost to the policyholders without their knowledge.

Then there is arbitrage. All the money from all generations of policyholders is pooled into a common fund and bonuses are paid out of it. This means that regardless of the returns the market delivers, the insurer pays uniform bonuses to all. This also means the fund manager takes conservative calls and is more interested in steady performance than maximizing opportunities. One fund manager called it a socialist regime, where everyone gets the same return in spite of their risk profiles and timing, while a Ulip is a capitalist product. Traditional participating plans for savings are long outdated in developed markets such as the UK. They are present only in Asia and West Asia due to underdeveloped regulations.

But what’s popular at present is non-participating plans that give fixed returns. Their drawback is that they don’t disclose the internal rate of return (IRR).

If returns are poor when compared with the other options, naturally companies will shy away from disclosing them. The basic problem is that high operating and distribution costs take away a part of the customer’s money. So, savings through insurance delivers net returns inferior to bank deposits or even mutual funds and the strong case for long-term savings through insurance gets diluted. Offering a return guarantee can further suppress potential returns as fund managers go conservative. Unlike banks, insurance companies cannot leverage high yielding lending portfolios to get better returns in their fixed-income portfolios. Insurers invest primarily in government securities and corporate bonds and suffer from high capital, operational and distribution costs that knock off the returns further. Mutual funds, too, invest in similar asset classes, but their costs and consequently penetration are low. As a rule, guaranteed products underperform the market. If we address the high cost issue, we can truly marry the consistency of traditional plans with the low costs and transparency of Ulips.

You are talking about variable insurance plans (VIP). But ever since product regulations put these plans in line with Ulips, insurers stopped launching them.

VIPs entail low margins and do not cover high retail distribution costs. They can be profitable in large-scale corporate portfolios. In traditional plans, the margins are comparatively higher and consequently, customer returns are low. As an industry, we must urgently find ways to reduce distribution costs. But most of us pamper our agents and ignore customers. For us, the agent is the end customer. This is not sustainable as technology is opening up markets, and competitive returns of other products would lay bare the drawbacks of life insurance as a long-term saving option unless we cut costs and improve return.

One way to make sure that agents care is to level the commissions instead of having a front-end structure. Mutual funds are talking of a trail commission now.

Mutual funds are open-ended, so trail commission could be a natural way of rewarding distributors. Insurance locks in your savings, so upfront effort is involved to convince a customer, and therefore, an agent needs to be compensated front–ended. What we need are serious agents who concentrate on persistency. We need to have stringent norms to weed out the non-serious agents so that the industry expands meaningfully. What we should also do is make the job of an agent easy. An agent has to make several visits and collect many documents to sell one policy. If we can simplify the process and digitally empower them for better productivity and customer service, things could get better. At IndiaFirst, we have completely moved the cumbersome sales process to a seamless digitally controlled work flow.

You will be leaving insurance after having worked in it for almost 15 years. Where do you think the industry is still struggling and what road map do you envision?

The key struggle is distribution. We must make it a level playing field in a cost efficient manner without sacrificing agents’ income. The answer lies in expanding the market through process re-inventing, bundled options and end-to-end digitization. We also need to fully leverage alternate distribution models.

What I foresee is financial convergence in about a decade’s time. People would use wrap accounts where they can load different benefits of protection, savings, investments, health and pensions into one bundle serviced by different product providers basing on their core competencies. Digitization would bring portability and fungibility where a policy is sold by an insurer but its fund could be managed by a mutual fund. This already happens in developed markets. Digital India will drive the next wave of growth with division of work and core specialization bringing in efficiency.


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