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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
• n 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 11th year:

– 12% of sum assured each year for 9 years – This increases by 3% each year – 12%, 15%,18%… – End of 20th 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 features Bank deposit Life insurance Mutual fund

Returns 35 99 86 Guarantees 2 34 36 Costs 4 100 85 Lock-in 7 36 50 Optimal holding period 12 62 86

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
• utflows
• 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
• paque 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

• 60.00
• 40.00
• 20.00

0.00 20.00 40.00 60.00 80.00 100.00

Annul Sensex return in % % of 1st year Ulip premium % of 1st year Traditional premium September 2010 Ulip rules changed

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