The sad reality of financial services is that good financial products like term insurance are sold the least, and horrible products like endowment policies and ULIPs are sold the most. There’s an old saying, “there’s no product a high commission can’t sell.” The one or two stories of mis-selling out of the hundreds that get attention are a reminder of this.
The latest story of mis-selling involved Bherulal, a daily labourer. He was not only mis-sold an insurance policy instead of a fixed deposit but his fixed deposit was also used to renew the policy without his consent.
Mis-selling is a problem across financial services, and the reason is simple—flawed incentives. Salespeople in financial services often have unreasonable sales targets, which push them to sell products by any means. It doesn’t matter what the product is—if it has a high commission, it will be sold.
It’s not just people who aren’t financially savvy; even senior executives of financial services companies regularly get mis-sold. Since we keep hearing about these incidents from our users, I’ll just cover a few very basic pointers without complicated terms or numbers that may help you avoid getting mis-sold.
The ugly truth of the financial services industry is that the elderly are the biggest victims of mis-selling. Since senior citizens would’ve accumulated money for their retirement, they are lucrative targets. As long as a product has a decent commission, most relationship managers and agents will do whatever it takes to close a sale, and unfortunately, senior citizens tend to be easy targets.
Even the elderly with cognitive impairments or intellectual disabilities aren’t spared. There have been countless cases where the elderly with mental health issues have been mis-sold insurance policies that were even renewed without their consent with forged signatures.
About 24-25% of Indian household assets are in insurance policies. So the odds are pretty high that your parents also would’ve been mis-sold some useless insurance policies. Talk to your parents and see if they’ve ever bought a financial product. If they’ve been mis-sold, file a complaint and get rid of those policies. If not, ensure that they never buy toxic products like endowment policies, ULIPs, cashback policies, or other fancy structured products from banks and other intermediaries.
The more I think about it, the more I realise that the best way to avoid being mis-sold is to always say no without any exceptions. Good products are rarely hard-sold. If someone is trying to hard-sell you something, the odds are the product is terrible. Just in case a product might be good, still, say no. You can say yes, once you have analysed the product carefully. People often fall for sales pitches without looking closely and regret it later.
Financial products are more complex than ever. The more complex things are, the more time you should take when deciding to buy or sell something. You should always carefully analyse the pros and cons of a product or a service. Make a choice only when you are 100% sure there are no hidden charges or commissions. Most importantly, buy something only if you need it. Investors typically buy shiny objects based on deceptive and misleading marketing, FOMO and peer pressure.
Banks are for banking
Given their sheer scale and reach, banks are the biggest distributors of financial products in India. Bank employees have sales targets to sell products like insurance, credit cards, mutual funds etc. It’s unfair to paint everyone with the same brush, but unfortunately, some of these relationship managers push the envelope a little too far to sell these products.
“Show me the incentive and I will show you the outcome.”
— Charlie Munger
Unreasonable sales targets are the root cause of most mis-selling because they create a perverse incentive to use aggressive sales tactics to sell products. Investors aren’t blameless in all this—mis-buying is as big a problem as mis-selling. Even educated investors don’t bother to verify what they are buying, and they end up investing in horrible insurance products with ridiculous commissions and high surrender charges.
The only things you should use banks are for deposits, withdrawals and loans, assuming that you have read all the terms and conditions of the loan clearly. But when it comes to investing, insurance, advisory and pretty much anything else, there are far more transparent and cost-efficient alternatives. Banks are distributors, their incentive is to sell products with the highest commissions, not products that are right for you.
Bundling products is a common way financial products are mis-sold. For example, ULIPs and endowment policies are typically sold along with home and personal loans. Since the insurance premiums would typically be a few thousand a month and a home loan is large, people buy these products without thinking twice. The salespeople also cleverly pitch it by saying if you pay Rs X thousand a month, you will get Rs Y lakhs after 10-15 years.
But if you look closely, these products will typically have ridiculous commissions, hidden charges and huge surrender penalties. Since investors get nothing if they surrender these policies early, they end up continuing to invest in them.
If it’s bundled with something, always say no.
It doesn’t matter if it’s a bank, an insurance agent or an RIA, everybody mis-sells—some more than the other.
Never ever go by titles and marketing. Just because someone calls themselves an “advisor” doesn’t make them one. At the same time, just because you choose to hire an advisor doesn’t mean that you bury your head in the sand. Always ensure you do appropriate due diligence on the advisor. Jason Zweig had a nice post with 19 questions you should ask an advisor when you’re hiring them.
By now, you should have realised that no matter how you choose to manage your personal finances—by yourself or an advisor—having a basic understanding of personal finance is important. Being financially literate is a life skill in the 21st century. The reason why a lot of people get mis-sold is that they assume they don’t need to know anything since they can outsource their personal finances.
In an effort to educate investors, we’ve created an entire module on the basics of personal finance on Varsity.
Never mix insurance and investments
The biggest mistake that people make is mixing investments and insurance. This is because of a fundamental misunderstanding of what insurance is. Here’s the definition:
An arrangement by which a company or the state undertakes to provide a guarantee of compensation for specified loss, damage, illness, or death in return for payment of a specified premium.
The purpose of insurance is to help you protect yourself against specific risks and financial losses. For example, when you buy a life insurance policy, you are buying protection for your family or nominees in the case of your death. In case, you meet with an untimely death, your nominees get the sum assured. You don’t buy life insurance to create wealth. On the other hand, you invest in stocks and mutual funds to create wealth over the long term. As simple as this sounds, people still confuse the two.
It’s partly because we’re all loss averse—we hate losing money. Paying premiums in a pure life insurance policy (term insurance) feels like losing money because the policy doesn’t pay anything back, it just offers protection. So, people naturally look for options where they can get both insurance and investments. The insurance companies realized this, and they created products like endowment policies and ULIPs to take advantage of this.
In a typical endowment policy, you invest every month for X years, and at the end of the term, you get a lump sum payout and an insurance cover. A unit-linked insurance plan (ULIP) is like a mutual fund plus life insurance—it promises stock market returns plus an insurance cover. Both these products sound nice in theory, but in reality, most of them are horrible products and offer the worst of both worlds.
A lot of endowment policies have about 20-30% of the first-year premiums and up to 5% from the second year as commissions. Then there are all the assumptions about bonuses etc. When you finally run the numbers, most of these policies barely return about 3-4% (IRR). That’s less than a liquid fund, fixed deposit or a Govt bond. Not to mention the fact that the insurance cover you get in these policies is highly inadequate. A life cover of 20-30 lakhs is as good as nothing in the unfortunate event of your demise.
But the insurance companies are clever. The advertisements don’t mention the returns in percentage terms, they just say, invest X and get Y. Since people don’t think in percentages, they think the maturity value is huge, and they fall for it. There’s also the issue of agents using misleading numbers and downright lies to mis-sell these policies. Here’s one such hilarious example.
It’s the same with most ULIPs. They are similar to mutual funds in structure, but with multiple layers of costs. In a mutual fund, you just have one expense ratio which covers all costs. You don’t pay anything over and above the expense ratio. But in a ULIP, there are multiple charges like premium allocation charges, mortality charges, fund administration charges, withdrawal charges etc. To be fair, ULIPs have become much more transparent compared to the first generation products, but they still don’t make sense. As for the performance of ULIPs, less than 30% of them beat a simple index fund. So a ULIP is like a horrible mutual fund with high commissions.
Keep your insurance and investments separate
Mixing insurance and investments is a guaranteed way to make yourself poor and the insurance salesmen rich. Always keep them separate. For long term wealth creation, stick to mutual funds and direct equities if you have the ability to pick stocks.
As for insurance, get a term insurance policy (life insurance) and a health insurance policy separately. You can get a 1 crore term policy for just ~8000 a year, not that 1 crore is adequate for everyone, It’s just an example to illustrate the cost. A term policy pays out only in the case of your death. By combing mutual funds and a term policy, you not only save commissions and earn better returns, but most importantly, since they are transparent, you get peace of mind.
We recently asked people what part of their personal finances they struggle with the most, and insurance was by far the most common answer.
What part of personal finance (saving, investing, insurance etc.) do you struggle with the most?
— Coin by Zerodha (@CoinByZerodha) April 19, 2022
It makes perfect sense. Insurance products are incredibly complex, opaque and heavily mis-sold. It’s a nightmare for people to find the right life and health insurance policies. I personally struggled with it until I could get the right help. This is why we are working with ditto to make insurance easier so that you can protect yourself and your loved ones without getting ripped off.
- Avoid all endowment, cashback, money-back policies and ULIPs—no ifs and buts. Most of them are unequivocally and completely toxic! Even if there were some good products, there’s an ocean of horrible insurance products, so the odds of you finding that one good product is worse than a prayer.
- Keep investments and insurance separate. You not only save commissions, but you can also get adequate insurance cover so that in the worst-case scenario, your loved ones are protected financially.
- Avoid buying financial products from banks. If a bank manager wants to talk to you, decline politely and walk away.
- Don’t say yes just because someone pesters you or makes an emotional sales pitch. Every emotional sales pitch comes with a 20-40% commission. It’s your hard-earned money.
- Most Indian parents will have multiple useless and toxic insurance policies. Make sure you talk to your parents and get rid of these policies.
- For investing in mutual funds, stick to Coin. We offer commission-free direct mutual funds.
- If you want to invest in ETFs and stocks, you can do so on Kite. We don’t charge any brokerage.
- For life and health insurance, check out ditto by Finshots. We are working with them to make insurance simple and transparent.