Life insurance and mutual funds are different kettle of fish; here's why parity of treatment is not possible

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Deepak Parekh, arguably the doyen of the Indian financial sector who founded the HDFC group and brought the idea of home finance companies into the Indian consciousness, has urged the insurance regulator to emulate the SEBI and prescribe Total Expenses Ratio (TER) and forget the minutiae of micromanagement of investment of life insurer’s funds.

The SEBI in April 2020 ushered in regime of TER pursuant to which a mutual fund scheme’s chargeable expenses are restricted on a tapering scale. To wit, on the first Rs 500 crore of the average daily net assets managed, 2.25 percent can be the maximum expenses that can be loaded on the unit holders and so on till only 1.05 percent is allowed on the remaining Rs 50,000 crore or more of average net assets. In return for this adherence to fiscal discipline, SEBI has allowed the mutual fund houses freehand in investing their funds the way they like.

Obviously, HDFC Life is chafing at the way IRDA has straightjacketed the investment of life insurance funds. The lion’s share must be kept invested in safe securities as per the IRDA norms. What Parekh is canvassing for is parity of treatment in the matter of investments between mutual funds and life insurers. This is clearly comparing apples with oranges.

Mutual fund investments are subject to market risks. This is more than a clichéd expression. Though through diversification, mutual funds try to mitigate the risks inherent in a direct interface with the market, the element of market risks cannot be wished away. And the existence of this risk is constantly dinned into the minds of the investors. Therefore, mutual fund investors are expected to take losses in their strides in the manner of taking the rough with the smooth. The fund managers’ hands would be tied if the regulator at every stage snaps at their heels by micromanaging their investments.

But what is good for mutual funds stakeholders need not be good for life insurance stakeholders as well. One insures his life not as a matter of investment. Indeed management schools constantly din this message into the minds of students—-don’t approach life insurance with an investment mindset. That is why insurance experts and advisors set store by pure term plans under which the premium paid is solely for covering one’s life during the prescribed period of time.

To wit, a one-time premium of say Rs 2,500 for a guaranteed payment to the nominee of Rs 1 lakh in the unfortunate event of the death of the insured within say ten years. In such a plan, the premium goes waste in hindsight if one happily survives the term of the plan. There is no element of investment in such plans. Whatever the plan, the truth is life insurance is not investment though as pointed out later, LIC had been promoting this notion to create insurance awareness.

Since life expectancy is in the realm of informed speculation (though actuarial calculations are fairly rational) at best, a large part of the premium has to be carried into reserves and invested in safe securities. Inevitably, therefore a large part of life insurer’s funds gets locked up in long-term securities; thus incidentally making them ideal candidates for investment in long-term infrastructure bonds. While insurers definitely would like to break free of the stifling restrictions on investments, the regulator simply cannot afford to humor them because what is at stake is the commitment to the insured—-life cover being handed over to the next of kin.

LIC has been making most of the life insurance business taking advantage of its first-mover role. Indeed, till two decades or so ago, LIC was the byword for insurance in India. True, it is governed by the LIC Act of 1956 and not by the law applicable to the private players. But it is also bound by some stifling restrictions, the chief among them being 95 percent of its reserves enure for the policyholders and only 5 percent for the government. The government had, till allowing private participation, viewed and promoted life insurance as a saving plan in addition of course to securing life cover. That is why it has had to take the policyholders along.

LIC still looms large in the life insurance sphere and government is grappling with a tough call—-how to provide a level playing field before making the IPO? The point is, so long as it is perceived as the greater protector of the insured, people will be swayed by its overarching presence. Therefore, HDFC Life and other private life insurers have to grin and bear both– in deference to the looming presence of LIC as well as in deference to the interest of the insured the stifling restrictions on investments. To pine for parity with mutual funds is irrational. Mutual fund investors empathize with risks, life insurance takers don’t. Period.