India’s fierce battle for control of Ulips

It was the kind of thing rarely seen in Indian bureaucracy. Two normally restrained financial industry regulators engaged in such a fierce public battle that the matter went to court.

The combatants were the Securities and Exchange Board of India, the capital markets regulator, and the Insurance Regulatory and Development Authority, the insurance watchdog. The fight was over who should have jurisdiction over one of India’s most common investment products – unit-linked insurance products. Sebi argued insurers were selling mutual funds dressed up as insurance with high fees. Irda rejected the argument.

In June, the finance ministry stepped in. It gave Irda control over Ulips – policies that offer life insurance cover as well as the upside from investments in underlying stocks or bonds – but on the condition that the terms of the products were tightened up to reduce fees.

“Life insurance business shall include any unit linked insurance policy or scripts or any such instruments. This would set at rest issues regarding Ulips between two financial regulators,” the finance ministry said in a statement.

The battle has been one of the most closely watched in the financial industry for years. Insurers generate more than half of their premium collections from the sale of new Ulips. According to the Life Insurance Council, India’s life insurance industry is valued at $41bn (£27bn, €33bn). More importantly for foreign investors, it is growing at a rate of 32-34 per cent a year.

The confrontation between the regulators has its roots in a move by Sebi in August last year to abolish “entry load” on mutual funds – fees paid by equity funds to their distributors.

Formerly, mutual funds would charge investors up to 2.25 per cent entry load. The asset management company would also pay an additional 50-100 basis points to distributors as a form of commission.

These distributors include banks as well as thousands of individual agents who go door to door selling funds. Sebi said it was abolishing the entry load on the basis that distributors should earn their fees directly from investors in return for advice. This left distributors looking for other sources of income.

For many, Ulips provided a viable alternative. Insurers were charging upfront fees of up to 40 per cent on first-year premiums for Ulips, a significant portion of which would be passed on to the distributors, often 10-12 percentage points.

But in January, Sebi moved to bring Ulips under its control by sending a notice to all life insurance companies asking them to explain why they had not sought its approval before selling Ulips. Sebi argued that the structure of Ulips, with their underlying investments in equities and bonds, resembled an investment product more than an insurance product and therefore should come under its jurisdiction as the stock market watchdog.

In April, Sebi escalated the confrontation by issuing a notice banning 14 life insurance firms from offering new Ulip schemes.

Irda told the life insurers to ignore the Sebi order. The issue went to the courts until the finance ministry intervened on the side of Irda.

Although Sebi was not able to wrest regulatory control of Ulips from the insurance regulator, since the Sebi notice in April, Irda has introduced a succession of regulatory changes to Ulips, most of which are aimed at enlarging the policies’ insurance components. The most recent was introduced by Irda last month [on June 28] following the finance ministry’s ordinance.

Among the changes, Irda has capped commissions to distributors at 4 per cent in the first year from September 1, increased the lock-in period for Ulips from three to five years and required minimum annualised returns of 4.5 per cent. The minimum sum insured must be 10 times the premium compared with five times earlier.

Like Sebi’s abolition of entry load on mutual funds in August last year, the new regulations have upset the insurance industry. They say the lower commissions mean distributors will have no incentive to sell Ulips with annual premiums of below Rs20,000 (£281, $426, €339) a year. These represent about half the market and mean lower income earners will not have access to the product.

“This is going to really be a huge hit for the industry,” Kamesh Goyal, chief executive of joint venture Bajaj Allianz Life Insurance Company said on Indian television.

Brokerages have already begun downgrading the targets for listed insurance firms. “We cut volumes to flat in financial year 2011 (from 10-15 per cent) due to new norms, and cut valuations by 5-10 per cent for insurance companies,” said UBS in a research note.

Mutual fund managers are naturally pleased with the changes. They argued that before the new norms, the playing field had been tilted in the favour of Ulips and the insurance companies. The new regulations favoured investors.

“The measures introduced over the past few months should result in an increase in the insurance component of Ulips and lower costs, making them more investor friendly,” says Vivek Kudva, managing director, India and Ceemea (central and eastern Europe, Middle East and Africa), Franklin Templeton Investments. Insurers, however, are not giving up. V. Srinivasan, chief financial officer with Bharti Axa Life, says the industry plans to lobby Irda further.

“We’ve been running this regime of 40 per cent upfront commission for the last 10 years and on that basis we have built a huge workforce across the country. We can’t just undo this in two months time,” Mr Srinivasan says.