The capital market regulator, SEBI, recently banned mutual fund houses from bundling different mutual fund products along with insurance. SEBI informed the Association of Mutual Funds of India(AMFI) to ensure that no AMCs issue any fresh bundled products and all the existing bundled products be withdrawn with immediate effect.
So, what are these bundled products offered by mutual funds and how does the ban impact retail investors? Here’s everything you need to know.
How do SIP insurance plans work?
Many mutual fund houses were offering bundled products known as SIP insurance plans. Under these, the fund houses offer a free life insurance cover along with SIP investments. The insurance cover is set at a multiple of the SIP amount.
So, if an investor opts for a monthly SIP of Rs. 10,000, the attached insurance cover will be of Rs. 10 lakhs. In case of death of the SIP investor, the SIP insurance proceeds allow the SIP to continue without any interruption and thereby benefit the family of the investor.
What were the flaws of bundled products?
One-sided benefit to fund houses
In the hope of attracting more investors, mutual fund houses had been bundling SIPs with insurance policies for more than a decade. Many SIPs in equity and hybrid mutual funds were eligible for insurance benefits. This resulted in increased popularity of such schemes and benefits to mutual fund houses.
Precondition of continued SIPs
The insurance cover in these plans was about 100 to 120 times the SIP amount, however, the availability of cover was subject to continued instalment payments till a specified time. Hence, investors who opted for these bundled products had to mandatorily pay SIPs for a pre-specified time, even if the scheme was underperforming or not giving good returns.
Insufficient insurance cover
Many new investors were tempted with the SIP+Insurance combination, especially those who wanted the convenience of free insurance with investment. However, investment experts are of the opinion that mutual fund schemes are meant for investment, therefore, insurance should always be kept aside from it and should be treated as a distinct product. This is because, Insurance with SIPs may lend investors in a situation where they are underinsured, especially if an investor does not have any other insurance cover. On an average, people opt for monthly SIPs of Rs. 3,500. Thus, an attached insurance cover will automatically decrease and be insufficient for an investor.
Higher expense ratios
While mutual fund investors were made to believe that the insurance cover was a free attachment with SIPs, on the face of it, many plans charged higher expense ratios to compensate for the cover. New investors often do not look at the scheme’s expense ratios and get tempted with the free offerings, only to realise about the larger loss in the long run.
What happens to existing bundled schemes?
With the official communication from SEBI, many fund houses have proactively discontinued bundling of insurance with mutual fund investments. However, there are chances that the regulator may allow fund houses to continue with their existing commitments to investors. This is because, as per mutual fund norms set by the regulator, a scheme originator cannot go back on a commitment made to investors.
ULIPs vs bundled schemes
ULIPs (unit-linked insurance policies) have been in existence for a long time and appeal to many investors due to the attached life cover. Additionally, investors also get an opportunity to profit from equity market participation.
In ULIPs, an investor pays a fixed premium amount to get a certain insurance cover. Some portion of this premium payment does towards buying an insurance cover and the remaining is invested in equity or debt, as per investor preference. Fund managers manage the investment on behalf of investors, however, the fund performance depends on the market performance and exposure of the scheme. These schemes come with a lock-in period of 5 years.
ULIPs therefore offer a three-fold benefit of insurance cover, investment for financial goals and tax benefits through deduction of up to Rs. 1.5 lakhs under Section 80C of the Income tax act. Against these, bundled schemes only had insurance with investment with higher expense ratios and risk of loss due to underperformance of scheme.
Considering the SEBI ban, investors who have already invested in bundled schemes must check with the AMC about the near-term impact on their investment. Investors who have not invested in them must stay away from any new offerings, since these have been banned by SEBI.