The insurance industry's structural defence

Insurance defenders miss the point about systematic problems that go beyond individual bad actors

The response to my note from last week about organising insurance buyers was both predictable and revealing. Alongside the flood of supportive messages from people who had been deceived by insurance sellers, there came the inevitable pushback from industry representatives and agents. Their argument followed a familiar script: yes, there might be a few bad apples, but most insurance professionals are honest people trying to help their customers make sound financial decisions.

This defence, while possibly sincere, fundamentally misunderstands the nature of the problem. It's not about individual character or the moral qualities of insurance agents and company executives. It's about a business model that has become structurally hostile to customer interests, creating perverse incentives that make poor outcomes for customers almost inevitable, regardless of anyone's good intentions.

The most glaring example of this structural problem is how the insurance industry has quietly transformed itself into an investment management business. Through ULIPs and traditional endowment policies, insurance companies are essentially running mutual fund operations under the guise of providing insurance coverage. Unlike India's actual mutual fund industry, which operates under stringent regulations designed to protect investor interests, these insurance-wrapped investment products are opaque, expensive, inflexible, and deliver consistently poor returns.

Consider the regulatory framework that governs mutual funds in India. Fund houses must disclose their holdings monthly, publish detailed fact sheets, maintain independent trustees, and operate under expense ratio caps that limit how much they can charge investors. The entire structure is designed around transparency and accountability. Investors can see exactly what they own, how much it costs, and how it's performing. They can exit their investments freely, mostly without any charges, after a brief initial period.

Contrast this with a ULIP or traditional insurance policy. The underlying investments are largely hidden from the policyholder. The charges are complex, numerous, and often undisclosed in any meaningful way. Exit is either impossible or prohibitively expensive for years or even decades. Performance information is presented in ways that make comparison with other investment options nearly impossible. The entire structure is designed around opacity and customer lock-in.

The irony is that many of these insurance companies are owned by the same financial conglomerates (mostly banks) that run transparent, well-regulated mutual fund businesses. They know perfectly well how to operate investment products in a customer-friendly manner because they do exactly that in their mutual fund arms. Yet when they sell investments through their insurance divisions, they abandon every principle of good investment management that they follow elsewhere.

This isn't an accident or an oversight. It's a deliberate business strategy that exploits the regulatory arbitrage between insurance and investment products. Insurance regulations, designed for a different era when insurance products actually provided insurance, have not kept pace with the industry's transformation into an investment business. This regulatory lag creates opportunities for practices that would be illegal or impossible in the mutual fund industry.

The structural nature of these problems means that individual good intentions, while admirable, are largely irrelevant. An insurance agent who genuinely wants to help a customer faces a product range that consists mainly of expensive, inflexible investment products masquerading as insurance. Even if this agent correctly identifies that the customer needs term insurance – the only product that actually provides pure insurance coverage – the commission structure makes selling such products financially unattractive.

Meanwhile, the products that generate meaningful commissions are precisely those that serve customers poorly. This isn't a conspiracy; it's simply how the business model works. This is why the usual remedies – better training for agents, more disclosure, enhanced consumer awareness – have failed to solve the problem despite decades of implementation. These approaches assume that the issue is primarily about information asymmetry or individual bad behaviour. But when the business model itself is structured around exploiting customers, cosmetic reforms cannot address the fundamental dysfunction.

The insurance industry's transformation into a high-cost, opaque investment management business represents perhaps the most successful regulatory arbitrage in Indian financial services. By wrapping inferior investment products in insurance clothing, companies have managed to avoid the consumer protections that apply to proper investment products while charging fees that would be scandalous in the mutual fund industry. Until regulators recognise this, the structural problems will persist.

For more columns by Dhirendra Kumar, click here.

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