Why insurance agents should be done away with and insurance sold on a non-commission basis

I recently came across the following from a CLSA report which I thought was quite informative in terms of putting exact numbers to what I always have suspected – that majority of Life Insurance agents work more for their own benefit (sell products with highest commissions) rather than trying to genuinely meet needs of clients. Consider these (Italicised from CLSA report):
1) Equities account for only 10% of total household assets in India

2) Life insurance in India has seen AUM grow 5 times in 5 years (as compared to only 4 times in 5 years in case of Mutual funds). Higher growth in Insurance is attributed to perception of ‘greater safety’.
A perception arising from fact that Insurance agents constantly belittle direct investment in equities or even Mutual funds for that matter. They have helped spread the idea among lesser aware clients that equities is risky but Insurance is not. Never mind that Insurance industry is one of the largest Institutional force that invests in equities – so where is the risk argument coming from?

3) Only 70,000 agents sell mutual funds, versus 2.5 Million (yes – MILLION) life-insurance agents. The main reason is that life-insurance agents earn higher commissions.
4) Unit-linked insurance plans (ULIPs) account for 90% of the new business of private life-insurance companies.
Because ULIPs often have commissions of as little as 30% and in some instances they have been more than 100%!!!!

Kudos to SEBI

SEBI’s move to remove entry load charges (which go straight into the distributor’s pocket) from Mutual Funds (MFs) is a welcome move for consumers. MF distributors have been notorious (but not half as much as insurance sales persons) in mis-selling MF products to consumers and also churning MF portfolios of individuals in order to earn extra-commission.

For example, Mr. A who is a MF distributor once told me how he had sold an ELSS fund to a client. The client was looking for a tax-planning MF and was very keen on HDFC’s MF. HDFC had two MFs under ELSS - one which had a 2% commission and another which had a 4% commission. Mr. A did not tell the unknowing customer about existence of two funds. Rather than discussing which of the two fund’s portfolio comprised what, Mr. A simply told the client that HDFC’s 4% fund was ‘good’. And therefore invested client money in the 4% fund.
It is a shame that these distributors like to call themselves “investment advisors’. Ask them why a fund is good and most of them will not go into fundamental reasons why a particular MF is suited to that client. Their reasons will typically range from ‘everyone is investing in this, ‘good fund’, ‘popular fund’ etc. Some of the smarter ones will take out their laptops and rattle out numbers like ‘five star rating’, ‘Sharpe ratio’ out of a software that pulls all data from valueresearch. None, will ever go into the portfolio composition, defensive/aggressive portfolio or sectoral allocation of the fund.

During the bull run, a cousin of mine had invested some of his money in 5 different MFs through a distributor. Ever quarter, he would find his portfolio allocation of 5 MFs changing because the distributor would ‘churn’ the portfolio as if it were a portfolio of stocks. With each churn, the distributor would earn the entry load on the new fund that he had switched the money into. So even with a 2% entry load, with a quarterly switch, that is at least 8% commission earned per MF invested. But since it was the bull run and practically all MFs did well, no one minded.

Insurance agents are notorious for promising unrealistic returns verbally. Rather than selling ‘insurance’ for the sake of insurance, they sell insurance as investment products (the insurance cum investment products make maximum commission for them). One only hopes that the proposed measures to curtail commissions in the insurance sector are implemented soon.