Regulators hand out more tools to customers for decoding financial products

Sebi's new risk-o-meter and Irdai's proposed colour coding of health insurance plans will enable buyers to make more informed choices

Two regulators—the Securities Board of India (Sebi) and the Insurance Regulatory and Development Authority of India (Irdai)—have announced initiatives that are expected to make it easier for customers to understand better the financial products they are purchasing. While Sebi’s new risk-o-meter will come into force from January 1, 2021, the document on colour coding of health insurance products issued by Irdai is an exposure draft seeking feedback from stakeholders.

The new risk-o-meter

How is it different? One change Sebi has made in the new risk-o-meter is that it has introduced one more risk category—‘very high’. The earlier risk-o-meter only went up to the ‘high’ risk category. The new risk-o-meter will thus have six grades instead of five.

The other, more significant change, is that in the earlier risk-o-meter a fund’s risk level was defined primarily on the basis of the category it belonged to. “In the new risk-o-meter, a fund’s risk level will be calculated using well-defined parameters and will depend on the securities it holds in its portfolio. The new approach is much more granular,” says Kaustubh Belapurkar, director-manager research, Morningstar Investment Adviser India. Sebi has prescribed a detailed methodology for arriving at a fund’s risk score. The process will become standardised with little left to the discretion of fund houses.

In the case of debt funds, a fund’s risk score will be arrived at based on the credit, interest-rate, and liquidity risk of the securities it holds. “Within the same category, different funds can carry different levels of risk. The new risk-o-meter will capture that,” says Arun Kumar, head of research, Fundsindia.com.  Ultra-short duration funds, for instance, take low interest-rate risk and are generally perceived by investors to be safe. But investors have, in the recent past, been unpleasantly surprised to find that such funds held papers with low credit ratings. It will be harder for fund houses to get away with such shenanigans in the future as holding such papers will push its risk score up.

The methodology for calculating the final risk score gives a lot of weight to liquidity (remember, it was liquidity risk that led to the closure of Franklin Templeton’s debt funds). The credit, interest-rate and liquidity risk scores of a fund will be averaged to arrive at the final risk score. However, if a fund’s liquidity risk score is higher than the average score, then the former will become the final score.   

Keep a close eye on the risk level: When selecting a fund, investors generally go by past returns. By looking at the new risk-o-meter, however, they will be able to tell if the fund manager took a lot of risk to generate those returns.

If a fund’s risk grade rises, it could serve as an early warning to existing investors. “If a fund moves to a higher risk grade, investors must ask their advisors or find out for themselves where the risk is emanating from—which parameter is causing the level to rise?” says Belapurkar. The new risk-o-meter, say experts, will be useful in both pre- and post-purchase decision making. “If a fund’s risk rises above the level acceptable to an investor, he can exit it,” says Deepesh Raghaw, founder, PersonalFinancePlan, a Securities and Exchange Board of India-registered investment advisor.    

While the new risk-o-meter is an effective tool that the regulator has handed to investors, they will still need to do a lot of due diligence when either selecting or holding a fund. In case of debt funds, especially, investors will still need to examine the fund’s portfolio. “Suppose that a fund holds 97 per cent AAA paper and 3 per cent below investment grade paper. Its overall risk level may not be high. But a default in the 3 per cent holding could still cause problems to the investor,” says Kumar. An aggregate score can only give you an overall picture. Investors, or their advisors, will still have to do the hard work of examining the portfolio for finer nuances. Those buying a debt fund, for instance, will need to look at quality of the non-AAA portfolio, the fund’s yield to maturity (a level much higher than that of peers should be a red flag) whether the expense ratio is reasonable, and so on.

Colour coding of health insurance plans

Irdai has proposed to introduce a system of colour coding that will indicate the level of complexity of health insurance plans. Green will signify that the product is simple and easy to comprehend; orange will indicate it is moderately complex; and red will indicate it is more complex than its green and orange peers. “With more than 500 health insurance products available in the market, choosing the right one can be difficult. Colour coding will make buyers’ task easier. It will also bridge the trust deficit that exists at present due to lack of understanding of products,” says S. Prakash, managing director (MD), Star Health and Allied Insurance.

In India, insurance remains a push product. Customers often buy the product that is sold to them by the agent. “A layman will be able to get a hint of product complexity at a glance. It will hopefully instigate customers to ask more questions and seek more information, which is a good thing,” says Indraneel Chatterjee, co-founder and principal officer, Renewbuy.com.

Colour coding will reflect complexity and not the quality of the product. A red colour will not necessarily mean that the product is bad. “Red won’t mean that you should not buy the product. It will only mean that you should dig deeper and understand it better,” says Prakash. Adds Raghaw: “A complex plan may be so because it offers the customer a number of options. Investors should opt for the ones they need and avoid those they don’t. But a complex plan could still be a good one because, say, it charges a lower premium,” says Raghaw.  

Even after the introduction of a colour coding scheme, buyers will need to do a lot of due diligence. “When you set out to buy a health insurance product, you need to pay attention to three things—product features, the insurer’s claim settlement ratio, and price. Colour coding will focus on the first element, but buyers will still need to figure out the other two by themselves,” says Kapil Mehta, co-founder and managing director, Secure Now Insurance Broker.

Experts say buyers must compare, read about products, and then make an informed choice since health insurance is a long-term purchase. “Pay attention to whether the product comes with a sub-limit on room rent; whether it has a co-payment requirement; the exclusions; and the length of waiting period for pre-existing diseases,” says Amit Chhabra, head of health business, Policybazaar.com.  

Seven criteria that will be used for deciding a health plan’s colour code

• How many optional covers does the plan offer?
• How much is the copay percentage the customer has to pay out of his own pocket?
• How many months will the customer have to wait before he gets coverage for a pre-existing disease?
• How many procedures are there to which a sub-limit is applicable?
• How much is the deductible?
• How many permanent exclusions does the product have?
• How simple are the terms and conditions?