Pigs On The Wing

No Entry Load

• Customers now don't have to bear the cost of purchasing a fund. They can negotiate a fee directly with the distributor.

Cap On Exit Load

• The charge levied when the investment is redeemed cannot exceed 1%. It has to be uniform for all investors. A minimum time limit (only if the investor exits within a year) may be imposed.

The Impact

• Good for investors, but price discovery will take time
• Big impact on the small distributors, expect a change
• Tough times ahead for the fund companies

Life Insurance

Caps On ULIP Charges

Fund management charges: below 1.35%

No Cap On

• Mortality, morbidity charges; costs of any riders; service tax

The Impact

• Marginally lower costs for the investor
• Margins for companies and agents will contract
• Companies will have to become more efficient in managing expenses

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It's ironic how even the most honourable of our intentions are thwarted by shoddy implementation. The market regulators’ decision to clean up unhealthy practices in the mutual fund and insurance industries has led to a fair amount of chaos and distress. Consumers are being told this is good for them—but no one quite understands how it all works. Brokers and agents are anxious about what it’s going to do to their livelihood. As for the companies, they are scrambling to make sense of what this will do to the bottomlines. It’s a mess.

More importantly, it’s a challenging time for consumers of financial services products. It will no longer do to be just a passive investor; regulators are stressing that investors must become active and informed participants in the decisions they are taking. The recent measures are geared towards greater transparency and accountability. At the same time, “investors will have to do more work. If they don’t understand the product, they have no business buying it,” argues Prithvi Haldea of Prime Database. Outlook dissects the implications of the changes in the two sectors.

Mutually Beneficial

Straight off, there’s no question lower costs (no entry loads and a cap on exit loads) should cheer mutual fund consumers. This is clearly a step in the right direction. In practice, it’s going to mean a drastic change in the way the industry operates. Thus far, investors bought into funds at the behest of distributors. More often than not, the product may not have been suitable or backed by research into past performance. But distributors earned their brokerages and companies sold their products—so everyone was happy. Apart from, of course, the consumer.

All this is going to change—but not without challenges. It’s all very well to assume distributors should impart more advice and service, but this is assuming distributors are qualified to do so and customers are willing to pay for it. Distributors say that now all their time and money will be spent chasing—rather than servicing—clients. The distributor will have to negotiate and collect two cheques (one towards the fund and the other to the distributor for services provided) from each of his clients. Also, they argue that where high net worth individuals were subsidising smaller ticket sizes, there won’t be enough reason to follow up with the smaller clients anymore.

Then there’s the larger issue of price discovery of the distributors’ commission. Consumers are not clear about how much to pay. If the distributor sees no incentive, the fear is that it will lead to a huge churn in the intermediary space. “Distributors are likely to get higher commissions from other related products—then they clearly won’t sell mutual funds,” warns UTI AMC’s U.K. Sinha. There is also a fear that alienating the intermediary will impact the penetration of mutual fund products. This will impact the companies—a large number of them are anyways unprofitable.

That’s why experts and financial advisors feel that while sebi’s move is beneficial, it should have been carried out in a phased manner with better preparation. Since August 1, many mutual fund distributors haven’t sold products—concentrating instead on nonconvertible debentures, IPOs and FDs. Pricing structures are still undecided. The larger brokerage houses or third-party distributors are working out deals that will ensure commissions with fixed costs to the client, while the smaller and medium players are still awaiting news on whether the fund houses will be paying them any brokerages or not. The net result in the short term is bound to be painful, till the dust settles.

Insurance Protection

It’s hard to tell what the real impact will be on the insurance industry. It is expected that the new cap on the much-sold (and mis-sold) ULIPS will force insurers to become more cost-efficient and manage expenses better. But there’s a divided view on the benefit to the consumer. It will mean a lowering of costs to some extent, but Life Insurance Council secretary general S.B. Mathur says that if viewed in totality—minus costs like service tax—the net impact will be marginal. Also, 50 per cent of the products already comply with the new cap, so consumers who’ve bought products that fall under that category actually gain nothing.

Companies’ margins will be restricted. Insurance companies say structures for expenses and managing insurance agents will have to be reworked—the latter will have to bear some of the burden of contracting margins. What this measure will do, however, is make the ULIP more standardised. So far, there’s been no real measure to evaluate or compare products since the costs differed greatly. Now, with this cap in place, that task will become simpler for the consumer. “Each company will have to take a call on balancing profitability and expenses to deal with this change,” says Puneet Nanda, executive vice president, ICICI Prudential Life Insurance.

But it’s clearly a double-edged sword for the industry and agents. This move could not have come at a worse time. New business premium collection has been hit thanks to the slowdown—agents will have to work out how to sell better to maintain their current earnings. With capital and business constraints, the next year is going to be one tough cookie to crack for the insurance players.

All told, these changes are clearly going to change the dynamics of the financial services market. It will eventually become customer-friendly, efficient and advisory rather than transaction-based. But it’s going to be a painful journey ahead. Companies will have to find innovative and cheaper ways to sell, distributors and agents will have to relearn the business and customers will have to work harder at understanding where their money is going. The big worry is: are customers ready for this brave new world?