As per Sec. 12(1B) of the SEBI Act, “No person shall… carry on… collective investment schemes including mutual funds, unless he obtains a certificate of registration from SEBI.'' What is meant by collective investment? Will unit linked insurance (ULIP) come under this classification? On answers to these questions depends the outcome of the dispute between SEBI (Securities and Exchange Board of India) and IRDA (Insurance Regulatory and Development Authority).
To understand the meaning of ‘collective investment', consider a group of a few hundred women, belonging to financially weaker sections in a village, brought together by a self help group (SHG) to start an investment scheme. Under the scheme, each member contributes a prescribed amount each month and the amounts so collected are deposited in a bank and then used to give loans at reasonable rates of interest to members in need. Most of the services rendered are voluntary in nature and so the expenses are minimal. The profit emerging at the end of the year is distributed equitably among members and credited to their individual accounts. This is what is meant by a ‘collective investment scheme'. The role of the SHG is that of a mentor and, there is no room in such an arrangement for an external agency driven by profit motive.
Now consider the case of mutual insurance companies in which all the policyholders, and only the policyholders, are shareholders and the actuarial surplus (net of tax and provisions) emerging at the end of each year is divided equitably among the policyholders. This is another example of collective investment. But mutual insurance companies in India are not allowed by IRDA to operate.
Next, take the case of a mutual fund. It sells a product called units, charges a fee for managing the assets and meeting marketing expenses, but gives no guarantee on the return on investments. The unit holders are not the shareholders, do not get any share of the profits and have no say in the asset management strategy. Surprisingly, such an arrangement is considered a collective investment scheme, perhaps because of the misleading adjective ‘mutual'.
Unit linked insurance does not have this misleading adjective, but is similar in structure to mutual funds. One thing is common between the two. Since the NAV (net asset value) keeps changing, the number of units allotted for a given amount of premium can differ, depending on the time of payment of premium, When units are surrendered, a few days' difference in the time of surrender may mean a significant difference in the amount of surrender value received. Paying premiums when the NAV is low and encashing units when the NAV is high is considered a good strategy. So, while one person, with good knowledge of the market, may make high profits from investments in units, another person, without such knowledge, may suffer a loss. This, surprisingly, is considered to be an example of collective investment.
Consider next the investment in traditional insurance. At the time a policy is purchased, the premium payable and the benefits receivable are clearly indicated and guaranteed. As a result of better than expected experience in respect of claims, return on investments and allowing for the impact of inflation on expenses, a surplus arises at the end of each year and is estimated by actuarial techniques. Five to ten per cent of this surplus is given to shareholders and the balance distributed among policyholders, in an equitable manner, in the form of reversionary bonus.
Increase in market values of assets is not recognised unless the appreciation is actually booked (encashed), thus ensuring minimum volatility in asset values. When a policy matures for payment, any shortfall in the total amount payable (including bonus) as compared to the policy's estimated share in the assets, determined by actuarial methods, is given as ‘final additional bonus'. An expert in market operations and a person not having any knowledge of these operations, will both get treated alike — a real case of collective investment, but, ironically, not considered to be so.
So the standard adopted for determining whether or not an investment scheme is collective or not, appears to be quite simple. If it is a case of “each for each and none for all'' it is collective. If it is a case of “all for each and each for all'' it is not collective, a remarkable standard indeed.
Without wasting the time of the country's apex court, the Finance Ministry by itself should try to resolve the dispute. It can seek the advice of eminent personalities outside SEBI and IRDA before arriving at a fair decision, and then enforce the same. At the same time, it should also address the concerns being expressed by SEBI from time to time regarding the way in which ULIP is being marketed. The IRDA too appears to be alive to these issues, as is evident from the instructions issued by it recently. .
Let us hope that ‘All's well that ends well'.
(Actuary)
