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Commentary

Misaligned Incentives for Agents

The incentives provided to Mutual fund and Insurance agents are all warped, and actually hurt the industry more than anything else.

Agents get a commission immediately after selling a product. This is charged to the customer as either an entry load or a premium allocation chart. While agents get “trailing commissions” – or a part of the total money every year – this is very little money and therefore the agents don’t really care about it in comparison with the upfront loads.

Which means it incentivises agents into doing stupid and potentially fraudulent things.

Like, Lying to investors. Many agents routinely misinform investors about schemes – saying that their money is guaranteed when it is no, telling them that a certain % return is “definite” and hiding information about loads and commissions.

Agents also refuse to compare products. For insurance agents this is understandable as they can only sell one company’s products. Mutual fund agents don’t have this problem, but they either refuse to compare, or simply provide non-verifiable parameters to sell the products of their choice. Like – Sir, this fund is good because I heard it will give dividend very soon.

Many agents also confuse investors into listening to them. I don’t blame them for not educating investors – if people get educated they can ditch the agents completely, the system is that easy. But I do blame them for confusing them – and the underlying companies help. By providing options like “SIP, SWP, STP, Dividend, Growth, Bonus, Quarterly something, Annuity based something else” etc. The agents then latch on to inconsistencies in literature and hard sell a product – for instance, many agents sold LIC’s market plus as a product that guaranteed 25% returns every year, when some silly bloke had made only an illustration of how the product would grow if it should return 25% a year.

The incentives therefore need to be changed. I suggest zero upfront commissions (and therefore, loads). This is possible right now with “direct” investments in mutual funds – but not with insurance products.

And then commissions should be back-loaded. Maximum commissions for a 20 year insurance product should be in the 20th year (or a prior exit). For mutual funds, pay commissions at the end of a year of investment (for equity).

In the end we should all be able to buy these products online or by direct investments. Agents should be able to charge a fee, billed separately from investment, so that people know what they are paying and demand appropriate service. It may not happen in my lifetime, but I think we are slowly starting to get there – in a few years, we’ll revisit and see if something radical has happened.

But remember – in the end, it’s about how we, as investors, choose to educate ourselves. Regardless of what some agent tells you, if you go and buy a product that takes 70% upfront commissions, you are stupid, period. Can’t go around blaming the brokers for this – you have to take responsibility. But we have to change the incentive model, or live with biases, lies and frauds forever.

  • Gunjan (gunjan.fwd@gmail.com) says:

    >Hi,

    Really very nice perspective to see the MF industry. Some discrete thoughts:

    (a) There are very large number of people in our country who have got gun before the skills to fire it! They earn lot of money before knowing how money works. Take polished professionals from IT only; they earn in 5 figure packets but do not know difference between insurance and investment. Thats where agents mis-sale.
    (b) Highest concern for mis-sale goes to fund houses. If they are good to investors, investors would keep coming to them even if they are not the top performer. Most of the time, people know that they are taking some amount of risk by investing in equities/MFs; so they would be happy to keep/put their money in trustworthy hands. Building trustworthiness is no different from building a brand, and that responsibility ultimately is with fund house.
    (c) If fund houses puts some money and efforts to educate people in right manner, people would be able to make out difference between apples and oranges. Issue here is, out of so many fund houses who would start first? If I start first, what if it would impact my AUM?
    Ultimately, whatever time and money spent on educating people is going to benefit industry as a whole. People have money to put, they just need trustees who can manage their money with due responsibility.
    (d) Fund houses should treat their agents not just as commission-agents but as their own extensions. They represent fund house, brand in the end.

    Some thoughts on incentive schemes
    (1) Reducing rate commission
    Just like LIC agents gets reducing rate commission throughout the tenure of active policy, fund houses could keep giving commissions to the agent for full length of investment. Mainly useful in schemes with lock-in period.

    (2) Commission based on funds performance
    Some agents might think “If fund performs good, investors would get their benefits, what would I get?”. Thats where fund houses can introduce funds performance based annual incentives for agents. Ultimately they are the one who bring investments.

    (3) Portfolio based
    If an agent is able to sale good mix of ELSS, Diversified, Balanced, Debt etc funds from the same fund house, he should be given some special incentive.

    (4) Stock option?
    Not exactly that way, but after achieving certain targets, fund house can offer some number of units of some mutual fund to agents. They also want to invest somewhere!

    Gunjan

  • Deepak Shenoy says:

    >gunjan: agreed on all your points. In fact with some funds keeping 40% in cash today it’s ridiculous that they still take 2.5% of assets as management related fees!

    I agree, education is the future, at least for fund houses. But they don’t want to – and I dont’ think it’s possible for anyone else to either, as there is no business model there.

    btw, agents do get trailing commissions for MF sales too, like LIC. Performance based is only allowable if SEBI and AMFI mend the rules…and I’m all for it too.

    Eventually cash is king but the idea is not to increase incentives (even that is ok in the right measure) but to make the incentive motivate the right behaviour.

  • Guruprasad says:

    >From ethical point of view this article is good. But reality point of view, this is different. If you run your own Insurance Company would dare to write about this? please be honest.

  • Sakshar says:

    >There needs to be more accountability from agents and companies. Inappropriate selling of products needs to be punishable with revocation of license (they should be required to have reneweable licenses) to sell insurance / mfs. Taking signatures on blank forms also needs to be a punishable offence. Selling by unqulaified people (essentially quacks) needs to be punishable.
    This wont stop malpractices, but will help in control.

  • Deepak Shenoy says:

    >Guruprasad: I’m not sure I understand. It’s a totally hypothetical question and my answer will neither be convincing nor valid because I may change with the situation. No point taking a “yes” or “no”. Having said that I eventually want to be in the money management business, and I already denounce a lot of accepted practices there.

    Sakshar: The offenses you talk about are indeed dire, but the problem is also that buyers don’t get themselves informed, despite all the information being publicly available.

  • Ninad Kunder says:

    >Hi

    There are two sides to this story. At one level I completely agree with the points that you have put across and I think SEBI is doing whatever it can at its end to mitigate this malpractice. I cant say the same about IRDA.

    But the flip side to that is “Caveat Emptor”. People will spend hours on buying a 20k TV comparing features, checking with friends etc but wont dont do that with investments. One doesnt buy a Tv bcos the salesman says its good.

    So at one level if a individual is a reasonably educated person, then the onus lies on him.

    If you chose to not put in the effort to educate oneself then you bear the consequences.

    Ninad

  • Siddharth says:

    >Lesson learnt hard way will make sure that it wont be repeated for wise one’s.
    Although onus is on individual to self educate, research the matter, the resources and variations in the information are a great hurdle.

    I was reading somewhere, one NRI investor wanted to invest and was seeking guidance on tax and all related matters, but his problem was he was getting different views from different sources even when he was willing to be within the legal frame.

    So many rules, regulations, restrictions, policies,small font t’s and c’s which you cant even read properly. Bottomline is CONFUSION.
    I believe for financial matters most people tend to rely on agents/firms in good faith that the knowledgable’s(!) will look after their investments.

    At the end of the day its like swimming in unknown waters infested with sharks, IMHO.

  • Arthi Madhusudhan says:

    >I do agree with a number of points that you have put forth such as how the system motivates the agents/ financial advisors to do stupid and fraudulent things. One more thing to add to your list is how unaware these agents are sometimes. They don’t keep themselves updated and sometimes the investor is the one who knows more about products than the agents. I am constantly baffled about how less they know about the products they themselves recommend.

    What I don’t agree with is the change you suggest in the incentive system. As much as I have met some deplorable agents, there are some very good and honest ones out there too. I am not sure the system you are suggesting will motivate them to continue in the field. Instead, why not a system where the commission is the same across products (at least for mutual funds)? That way agents will be motivated to recommend based on the requirements of the investor than their own.

    Arthi Madhusudhan
    personalfinanceandyou.blogspot.com

  • Anonymous says:

    >dear all.
    welcome to the board.thanks for this service.life insurance companies in india yes sir knowingly encourages all their agents, UNIT MANAGERS, B.D.MS etc to cheat very very innocent but rich people by showing printed articles in favour of their products.dear all life insurance companies advt. have you not seen!