Life insurers must reveal commission on policies

28 Apr 2010 IRDA

 

MUMBAI/NEW DELHI: Life insurance firms will now have to spell out to customers the commission they pay to agents on each policy.

 

The insurance regulator has told insurers to disclose explicitly the commission in the `benefit illustration’, a document that contains the benefits due to a policyholder upon maturity of an insurance policy.

 

A signed copy of the illustration along with the proposal form is mandatory for issuing a policy. In a circular to all life companies, the Insurance Regulatory and Development Authority (Irda) said companies will have to disclose the commission paid to agents with effect from July 1, 2010.

 

The regulator said this will bring about enhanced transparency by providing prospective policyholders the exact amount of commission/brokerage paid by insurers.

 

The circular is seen by life insurers as a fallout of the tussle between capital market regulator Sebi and Irda over regulating unit-linked insurance plans (Ulips), which have emerged as the hottest investment product in recent years.

 

Most insurers feel that Sebi has attempted to regulate Ulips after mutual funds complained that the bar on agent commission put them at a disadvantage to companies offering products similar to mutual funds. Irda’s latest directive could strengthen the case for life firms when the dispute reaches the courts.

 

The Irda move comes seven months after Sebi’s ban on entry loads on mutual funds took effect. Entry loads essentially arise out of commissions paid by mutual funds and the ban on loads effectively stopped them from recovering the commission money from investors. The decision also comes less than five months after the Reserve Bank of India (RBI) asked banks to disclose the commission on policies sold by them.

 

Insurance companies have resisted this move all along. However, in November `09, RBI forced banks to disclose the commission they receive for policies sold by them. “If you buy soap, the shopkeeper does not disclose what he earns on the sale. Why should it be any different for life policies,” said the CEO of a life company when questioned on disclosures.

 

However, of late, a section of the industry has come around to the view that such disclosures would be inevitable, particularly after the Irda-Sebi spat over Ulips and lobbying by mutual funds over high commissions paid on these products. “We welcome this move and look forward to working with Irda on disclosures. We also feel that the time is ripe for legalising rebates,” said a spokesperson for Bajaj Allianz Life Insurance.

 

“We are maturing as an industry and this will further help establish insurance products as a viable long-term investment option,” said Rajesh Relan, managing director, MetLife India Insurance Company.

 

Life insurance companies said the immediate impact of the disclosure would drive many insurance agents to rebate commissions. Although rebating commissions, giving back a slice of the money to policy buyers, is illegal, a large section of agents has been passing on commissions collected under traditional policies.

 

But after the life industry shifted to Ulips, rebating of commissions had come down as policyholders were given the impression that most of the premium was going into their account.

 

Internationally, rebates of commission are allowed and in many countries an agent can claim tax relief if he uses part of his commission to pay premium on behalf of his client. In India it is not possible for the regulator to allow commissions as this would require an amendment to insurance laws.

IRDA SEBI standoff FM intervenes

For the time being, investors as well as insurance companies can breath easy. Thanks to Finance Minister Pranab Mukherjee‘s mediation, status quo has been restored as far as the popular unit-linked insurance products (ULIPs) are concerned.

 

“Status quo ante has been restored on ULIPs,” Mukherjee was quoted as saying to the reporters in New Delhi after holding a meeting with the chairpersons of SEBI and IRDA.

 

Both the regulators, who are fighting tooth and nail with each other over ULIPs, would now jointly approach court to resolve the impasse for them. Insurance companies can continue to sell ULIPs till the court delivers its legally binding verdict on the contentious issue.

 

“To resolve any ambiguities and to ensure smooth functioning in the markets, the two regulators have agreed that they will jointly seek a binding legal mandate from an appropriate court,” Mukherjee is believed to have said.

 

Earlier today, SEBI chairman C.B. Bhave and IRDA chairman J. Hari Narayan met Finance Secretary Ashok Chawla and other Finance Ministry officials separately to present their case on the matter.

 

“Existing policy holders are completely safe, their claims and products are safe… there is no cause for anxiety at all,” IRDA Chairman, Harinarayan reportedly told media persons in the capital.

 

Though the two regulators have had differences for a while over the issue of who should regulate ULIPs, the same reached a flashpoint last weekend.

 

SEBI on Friday announced a ban on sales of ULIPs by 14 private insurance companies, saying they needed to register with the capital markets regulator before selling these products. Reports suggested that SEBI may impose a similar ban on nine other insurance companies, including LIC.

 

The IRDA on Saturday issued an order asking all insurance companies to continue selling ULIPs.

 

ULIPs are similar to mutual funds with an added life cover.

SEBI bans 14 insurance cos from selling ULIPs

The original SEBI order passed on 09/04/2010 is as follows

WTM/ PS /IMD/06/APR/2010
BEFORE THE SECURITIES AND EXCHANGE BOARD OF INDIA
CORAM: PRASHANT SARAN, WHOLE TIME MEMBER
ORDER
DIRECTIONS UNDER SECTIONS 11 and 11B OF THE SECURITIES AND
EXCHANGE BOARD OF INDIA ACT, 1992 READ WITH SECTION 12(1B)
THEREOF.
1. It has been noticed that the following entities have launched several Unit Linked
Insurance Products (ULIPs) :-
a. Aegon Religare Life Insurance Company Limited
b. Aviva Life Insurance Company India Limited
c. Bajaj Allianz Life Insurance Company Limited
d. Bharti AXA Life Insurance Company Limited
e. Birla Sun Life Insurance Company Limited
f. HDFC Standard Life Insurance Company Limited
g. ICICI Prudential Life Insurance Company Limited
h. ING Vyasa Life Insurance Company Limited
i. Kotak Mahindra Old Mutual Life Insurance Limited
j. Max New York Life Insurance Co. Limited
k. Metlife India Insurance Company Limited
l. Reliance Life Insurance Company Limited
m. SBI Life Insurance Company Limited
n. TATA AIG Life Insurance Company Limited
2. Since, the ULIPs launched by the abovesaid entities were prima facie found to be
akin to the mutual fund schemes and were launched without obtaining registration
from the Securities and Exchange Board of India (hereinafter referred to as “SEBI”)
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under the Securities and Exchange Board of India Act, 1992 (hereinafter referred to
as “the SEBI Act”) and the regulations made thereunder, notices were issued to these
entities on January 15, 2010 (except in case of HDFC Standard Life Insurance
Company Limited where the notice was issued on December 14, 2009). SEBI had
sought replies from the said entities as to how the ULIPs were launched without
obtaining the requisite certificate of registration from SEBI and why appropriate
action should not be taken against them under the provisions of the SEBI Act.
3. The entities replied to the aforementioned notices, inter alia, stating that:
a. sub-section (2) and (3) of section 11AA of the SEBI Act provide for conditions
for any scheme or arrangement to be classified as collective investment schemes
and exceptions to the sub-section (2) of section 11AA of the SEBI Act, 1992
respectively.
b. section 11AA (3) excludes contracts of insurance under the Insurance Act, 1938
from the purview of collective investment schemes.
c. ULIP is a life insurance product and not covered under the definition of
“securities” under the Securities Contracts (Regulation) Act, 1956.
d. the predominant feature of a ULIP is insurance cover which is dependent on
human life and the mere existence of an additional investment feature cannot
convert a ULIP into a mutual fund.
e. ULIPs have a mandatory insurance cover which forms a vital and inseparable part
of every ULIP.
f. unlike mutual fund schemes, the linked products are interlinked with the life of
the policy holder.
g. under a ULIP units are only notionally allocated and not physically issued and the
units are created for the purpose of determining the benefits payable under the
policy and are not owned by the policyholder.
h. under a ULIP only the risk on the investment portion lies with the policyholder
while the risk on the life insurance portion vests with the insurer.
i. mutual fund units can be transferred or traded freely whereas the rights and
benefits under ULIPs are transferable or assignable only for limited purpose.
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j. Unlike a mutual fund, a ULIP is not established in the form of a trust. The fund is
held by the insurance company itself as required under the Insurance Act.
Ancillary features such as fund management, fund management charges etc., are
alone not sufficient to convert a life insurance product into a mutual fund scheme.
k. A ULIP is an insurance contract falling within the ambit of life insurance
business. “Life Insurance business” is defined under Section 2(11) of the
Insurance Act, 1938 inter alia to mean the ‘business of effecting contracts of
insurance upon human life’ or ‘the happening of any contingency dependent on
human life’. The said definition indicates that the policy is dependent on the
happening or the non-happening of an event linked to human life.
l. ULIPs fall under the definition of Life Insurance products. Unit Linked Life
Insurance Business is defined in IRDA (Investment) Regulations, 2000.
Regulation 3(3) states “every insurer shall invest and at all times keep invested
his segregated fund of units linked life insurance business as per pattern of
investment offered to and approved by the policy holders….”
m. “Linked business” is defined in IRDA (Registration of Companies) Regulations,
2000 which means life insurance contracts or health insurance contracts under
which benefits are wholly or partly to be determined by reference to the
underlying assets or any approved index.
n. the product was launched after following appropriate procedures and obtaining
unique identification number from IRDA, which is the regulator in case of life
insurance products. Thus, there was no need to obtain requisite certificate of
registration from SEBI.
4. Before considering the issues involved in the matter, I refer to the relevant provision
of the SEBI Act. Section 12(1B) of the SEBI Act provides as under:
“No person shall sponsor or cause to be sponsored or carry on or caused to be
carried on any venture capital funds or collective investment schemes including
mutual funds, unless he obtains a certificate of registration from the Board in
accordance with the regulations.”
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5. I have carefully considered the replies of each of the entities, product brochures of
various ULIPs offered by them and the relevant material available on record. Since
the subject matter in the notices issued to the entities is identical and their replies are
substantially similar, I proceed to deal with issues involved in the matter by way of a
common order. Some of the entities have also sought an opportunity of personal
hearing. I note that each entity has been served with separate notices and each of them
has availed of the opportunity of making its written submissions. Therefore, under
facts and circumstances of the case, I do not consider necessary to give an
opportunity of personal hearing to the entities in the matter.
6. The question that arises for my consideration is whether ULIPs offered by the said
entities are a combination of investment and insurance and if so whether the
investment components are in the nature of mutual funds which can only be
offered/launched after obtaining registration from SEBI under section 12(1B) of the
SEBI Act?
7. From the examination of the product documents of such ULIPs, it is noted that in
addition to the insurance component, the ULIPs also have inter alia the following
characteristics –
a. the product is unit linked and money is raised from public through sale of units
to them.
b. the investment risk in chosen investment portfolio is borne by investors.
c. upon untimely death before the expiration date of the policy the policy holder
will be paid either the NAV (Unitized Fund Value) or the sum assured
whichever is higher.
d. upon survival at the maturity of the policy, the policy holder will be paid the
NAV (Unitized Fund value) of the investments.
e. premium will be used to allocate units in the fund chosen by the investor.
f. the product has characteristics such as fund management, fund management
charges, switch and partial withdrawal options.
4
8. It is observed that the various ULIPs launched/offered by these entities offer
investment options with varying degrees of exposure to equity and debt. It is also
noted that in their product brochure for ULIPs, the entities have under the heading
“risks of investments”, inter alia, disclosed and declared that:
a. unit linked life insurance products are different from traditional insurance
products and are subject to risk factors.
b. the premium paid in unit linked life insurance policies are subject to investment
risks associated with capital markets and the unit price of the units may go up or
down based on the performance of the fund and factors influencing the capital
market and the insured/policyholder is responsible for his/her decisions.
9. From the above, I find that the attributes of the ULIPs launched/offered by these
entities are different from the traditional insurance products and they are a
combination of insurance and investment. The attributes of the investment component
of ULIPs launched by these entities are akin to the characteristics of mutual funds
which issue units to the investors and provide exit at net asset value of the underlying
portfolio. The investment component of ULIPs is subject to investment risks
associated with securities markets which are entirely borne by the investors. I also
find that the entities by their own admission have stated that there are two
components of ULIPs – an insurance component where the risk on the life insurance
portion vests with the insurer and the investment component where the risk lies with
the investor. This establishes conclusively that ULIPs are a combination product and
the investment component need to be registered with and regulated by SEBI.
10. Now I proceed to deal with the specific contentions raised by the aforesaid entities.
11. Some of the entities have pleaded that the regulations issued by IRDA are special
laws for ULIPs and SEBI cannot apply the general laws applicable to tradeable
securities such as collective investment schemes or mutual funds to ULIPs. In this
regard, I find that in terms of section 11(1) of the SEBI Act one of the duties of SEBI
is to protect the interests of the investors in securities and to promote the development
5
of, and to regulate, the securities market by such measures as it thinks fit. Section
11(2) of the SEBI Act enumerates certain illustrative measures which can be taken by
SEBI without prejudice to the provision of sub-section (1). One such measure is
registering and regulating the working of collective investment schemes including
mutual funds. To carry out the purposes of sections 11 and 12(1B), SEBI has framed
various regulations including the Securities and Exchange Board of India (Mutual
Funds) Regulations, 1996 and the Securities and Exchange Board of India (Collective
Investment Scheme) Regulations, 1999. The SEBI Act and the regulations made
thereunder are also special laws made/laid before the Parliament and any investment
product or investment contract having any characteristic of securities or exposing
investors to securities market risks is under the jurisdiction of SEBI under the SEBI
Act.
12. It is also contended that a mutual fund is a fund established in the form of a trust for
raising money through the sale of units through the public and established under one
or more schemes for investing in securities. I find that in terms of section 12(1B) of
the SEBI Act “no person” can sponsor or cause to be sponsored a collective
investment scheme including a mutual fund unless he has been registered with SEBI
under the SEBI Act. I note that the emphasis is on the prior registration with SEBI
under the SEBI Act, notwithstanding who that person is. Therefore, an entity which is
not established in the form of a trust cannot launch or offer an investment product in
the nature of mutual fund without being registered with SEBI. The structure of the
entity is immaterial for compliance of section 12(1B) of the SEBI Act. For seeking
registration such person has to establish a trust for launching mutual fund schemes.
Thus, the “trust” structure is not a condition for compliance of section 12(1B) of the
SEBI Act though it is a requirement for getting registered as a mutual fund.
13. It is also contended by the said entities that ULIPs are predominantly life insurance
products having an investment component. In my opinion, if in a combination product
there is an investment component, in any proportion, exposing investors to risks of
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securities market products, it can be issued only after obtaining registration from
SEBI and compliance of the applicable laws with respect to such component.
14. The entities have contended that the predominant feature of a ULIP is insurance cover
which is dependent on human life and the mere existence of an additional investment
feature cannot convert a ULIP into a mutual fund. Further, it has been said that ULIPs
have a mandatory insurance cover which forms a vital and inseparable part of every
ULIP. In this regard I note from one of the products offered by one of the entities that
for a sum assured of Rs. 15,00,000/- an annual premium of Rs. 1,50,000/- is collected
for 10 years. The premium allocated for insurance out of this is Rs. 7500/- in the first
year and Rs. 3000/- in subsequent years. (The annual premium for a term plan for 10
years for an identical sum assured for an identical life assured by the same company
is Rs. 3,342/-) Here, the insurance component is 2% of the premium paid. The
products offered by other entities also follow a broadly similar pattern. Thus, the
argument that insurance is both predominant and inseparable in a ULIP fails.
15. Some of the entities have contended that even if the ULIP is construed to be a mutual
fund the existing mutual fund regulations lay down terms and conditions which
cannot be complied with by life insurance companies while issuing ULIPs. Further, if
SEBI can regulate ULIPs, the SEBI Regulations as they currently stand cannot be
applied to the unique features of ULIP and since SEBI has not provided any guidance
for insurance companies, they cannot be penalized for any non compliance. I find it
unacceptable and untenable that having admitted ULIP as combination product with
an investment component, the issuers expect that they be allowed not to comply with
the existing Mutual Fund Regulations. The substance and spirit of SEBI Act and
regulations framed thereunder makes an over arching emphasis on investor
protection. It is imperative and incumbent upon every entity to comply with the
regulations. In my view, such products attract the SEBI Regulations and the entities
must seek registration from SEBI for launching such products. The existing
regulations have detailed scheme and procedure for registration and regulation of
7
mutual funds. Framing of special regulations for ULIPs under section 12 (1B) is not a
pre-requisite for compliance of said section.
16. It is noted that in some of its ULIPs, the entities offer the investors the guarantee to
encash the units at maturity at the highest unit price achieved by the fund over the
term of the policy. This reinforces that the ULIPs launched/offered by these entities
are a combination of insurance and investment. From the examination of the product
documents of the ULIPs and the investment options offered therein by the entities it is
noted that:
a. the contributions or payments made by the investor are pooled;
b. the contributions or payments are made to such ULIPs by the investor with a view
to receive profits, income;
c. the investment made by the investor in the ULIPs is managed on behalf of the
investor;
d. the investor do not have day to day control over the management and operation of
the ULIPs.
The aforementioned attributes are those of a collective investment scheme and also of
the mutual funds.
17. It is contended that section 11AA (3) of the SEBI Act excludes ‘contracts of
insurance’ from the purview of a collective investment scheme as enumerated under
section 11AA (2) of the SEBI Act. From the perusal of the product brochures of the
ULIPs it is noted that the said products are combination of investment and insurance.
The investor chooses between the options and decides as to how much be allocated
toward buying insurance and how much be allocated towards investment. The ULIPs
have a component of investment product and carry with themselves securities market
risk which is borne by the investors. I find that the ULIPs launched/offered by the
said entities are not purely in the category of “contracts of insurance” but have
components of investment products.
8
18. It is also contended that the contracts of insurance are exempt from the purview of a
collective investment scheme under section 11AA (3) of the SEBI Act. Here, it is
necessary to clearly understand the nature of collective investment schemes as
referred to in the section 11AA of SEBI Act. Collective investment schemes have
characteristics defined in Section 11AA (2); viz. pooled investments, investors not
participating in day to day control of investments etc. However, in terms of Section
11AA (3), collective investment schemes exclude all types of schemes/arrangements
which have financial bearing. viz. deposits taken by non-banking financial
companies, contracts of insurance, pension schemes and also mutual funds. Thus the
argument that Section 11AA (3) exempts insurance contracts from the purview of
collective investment schemes does not in any way exempt ULIPs which are a
combination of insurance and investment from Mutual Fund Regulations.
19. The entities have contended that ULIPs are an insurance contract falling within the
ambit of life insurance business and have quoted Section 2(11) of Insurance Act in
this regard. It has been established in the preceding paragraphs that ULIPs are a
combination of insurance and investment. Therefore, in my opinion, they must be
regulated under relevant/applicable Acts and Regulations. The investment component
should be registered with and regulated by SEBI.
20. It has been contended that ULIPs are a life insurance product and life insurance
products are not covered under Securities Contracts (Regulations) Act, 1956. Units of
ULIPS have the characteristics of units of mutual funds. Units of mutual funds are
“securities” as defined under Section 2 (h) of Securities Contracts (Regulations) Act,
1956. Merely because they are named as units of ULIPs, such units cannot be ousted
from the ambit of definition of “securities”.
21. The entities have also contended that units issued under ULIPs are not freely
transferable or have transferability for limited purpose, therefore, they are not units of
mutual funds. I find that not all the units of mutual funds are transferable, e.g., in the
case of open ended schemes of mutual fund the investor subscribes to and redeems
9
from the mutual fund directly. The units of an open ended mutual fund scheme are,
therefore, not transferable. Further, not in all cases are the units of mutual fund
schemes issued physically. I note that it is common among mutual funds to issue
statements of accounts. Therefore, the contentions in these regards are misconceived.
22. I find that the attributes of ULIPs launched/offered by the aforesaid entities have
components of mutual fund schemes. As discussed above, in spirit and substance, the
ULIPs have characteristics of mutual fund schemes and the arguments forwarded by
the entities have no merit. It is, therefore, necessary from the point of view of
protecting the interest of investors that such products should be offered/launched after
obtaining requisite certificate of registration from SEBI under the SEBI Act.
23. The entities have contended that their policies were launched after following
appropriate procedures and obtaining requisite permission from IRDA, which is the
regulator in case of life insurance products. The approval/registration from one
regulatory authority does not exempt the entity from complying with other applicable
laws administered by relevant regulators.
24. In view of the above, I conclude that ULIPs offered by the said entities are a
combination of investment and insurance and, therefore, the investment components
are in the nature of mutual funds which can only be offered/launched after obtaining
registration from SEBI under section 12(1B) of the SEBI Act.
25. However, the said entities have not obtained any certificate of registration from SEBI
though the ULIPs launched by them had an investment component in the nature of
mutual funds, as mandated by section 12(1B) of the SEBI Act. It is, therefore,
necessary to restrain the entities mentioned in para 1 of this order from raising further
monies/subscription, new and/or additional, from the investors for any product
(including ULIPs) having an investment component in the nature of mutual funds till
they obtain registration from SEBI.
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26. Accordingly, in exercise of the powers conferred upon me by virtue of section 19 of
the SEBI Act read with sections 11, 11B and 12(1B) thereof, I hereby direct the
entities mentioned in para 1 of this order not to issue any offer document,
advertisement, brochure soliciting money from investors or raise money from
investors by way of new and/or additional subscription for any product (including
ULIPs) having an investment component in the nature of mutual funds, till they
obtain the requisite certificate of registration from SEBI. This order is without
prejudice to any action that might be taken by SEBI in respect of offer documents or
advertisements issued by these entities for products (including ULIPs) having an
investment component in the nature of mutual funds launched so far.
27. This order will not affect soliciting money/subscription from public with respect to
any pure contract of insurance or the insurance component of a combination product.
28. This order shall come into force with immediate effect.
DATE: April 9, 2010 PRASHANT SARAN
PLACE: MUMBAI WHOLE TIME MEMBER
SECURITIES AND EXCHANGE BOARD OF INDIA
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