Jun 30, 2009

Investor Reforms - What’s New in 2009? (# 1)

Of late, every regulator be it RBI, SEBI, PFRDA or IRDA is trying to do his bit for the benefit of the common investor /consumer.

Following is the list of investor / consumer friendly reform measures announced by various regulators of financial services industry during the first half of 2009:

1. New Pension Scheme (NPS)—Better retirement planning (PFRDA)
2. Scrapping of Entry Loads in mutual funds —Lower transaction costs (SEBI)
3. Saving Bank Accounts—More interest earnings (RBI)
4. Health Mediclaim Insurance— Better renewal terms (IRDA)
5. Senior Citizen Health Insurance—Cheap and easy availability (IRDA)

New Pension Scheme (NPS)
New pension scheme (NPS) regulated by PFRDA is in existence since 2004 but was available only for government employees. Now, with effect from 1st May 2009, this scheme has been thrown open for all.

As ULIPs are considered better than the traditional insurance plans, similarly NPS (a defined contribution pension scheme) is an improvement over existing options for retirement planning such as pension plans of insurance companies, Employees’ Provident Fund scheme, Employees’ Pension Scheme, and Public Provident Fund (PPF).

What is the USP (Unique Selling Proposition) of the scheme? Potential to earn better returns (OPTION to invest in equities) at low cost AND truly long term since it is meant strictly for retirement planning.

Unlike your existing EPF, which is a mandatory, this one is optional and also not linked to your employer. So anybody can join in. Similar to ULIPs where various fund options exist, NPS offers you default option called auto choice life cycle fund, in addition to various other fund options.

However, the major drawback of the scheme is taxation of returns. Unlike, EPF or PPF, in case of NPS the amount at maturity is taxable. Let’s hope that this major irritant will also be removed as PFRDA is trying to convince the government to remove it. Just wait for the upcoming budget.

No more Entry Loads in Mutual Funds
SEBI has been tightening its hold on the mutual funds since last 2-3 years during which time it has made substantial regulations in the interest of retail investors. Last year (1st Jan’08) it announced zero entry loads for direct investments (i.e., direct applications to AMC) in mutual fund schemes.

Now, a few days back, sebi has decided to completely scrap entry loads in new as well as current mutual fund schemes (Note: Decision already taken in Sebi board meeting held on 18th June, 2009 but yet to be notified). As per the existing practice, around 2.25% is deducted towards distributor commission and marketing expenses and balance 97.75% of the amount gets invested in the fund.

Investors would now have to pay the mutual fund distributors commission / fee directly based on negotiation and mutual understanding. Sebi is also making it mandatory for distributors to disclose the commission––trailing or any other––to the investor.

Getting rid of entry loads: Consequences

Effectively, now there will be:

1. Variable Upfront fee instead of fixed percentage
2. Competition among distributors
3. Direct negotiation between investor and distributor
4. More awareness & direct control of investor
5. More emphasis on existing schemes
6. End of unethical practice of rebating
7. Unbiased advice

AND it will result in following benefits to mutual fund investors:

1. More Transparency (Investor will know the exact cost of investing)
2. Lower transaction costs
3. Better quality of service
4. Curb on mis-selling of NFOs
5. Lower churning of portfolio
6. Emergence of fee based financial planning

Initially, this investor friendly reform may give an edge to life insurance industry as the gap between commission structure of life insurance products and mutual funds schemes will widen and might result in more pushing and mis-selling of ULIPs. However, let’s hope that better sense prevails over IRDA and it learns some lessons from SEBI about regulating Life Insurance Industry, so that there’s a level playing field.

UPDATE (July 1, 2009): To implement the above measures, SEBI has issued a circular (SEBI/IMD/CIR No. 4/ 168230/09) on 30 June, 2009 vide which the above provision becomes effective from August 1, 2009.

It shall be applicable to investment in all existing mutual fund schemes (including additional purchases and switch-in to a scheme from other schemes) as well as new mutual fund schemes launched on and after August 1, 2009.

In fact, the circular goes beyond that and introduces one other innovative measure regarding exit load /CDSC (Contingent Deferred Sales Charge). The circular states that AMCs can no longer retain more than 1% of exit loads/CDSCs to meet various marketing and selling commission (including payment of commission to distributors). Any amount over and above one per cent of the redemption proceeds will have to be credited to the mutual fund scheme immediately. This provision has also been made applicable to all redemptions from mutual fund schemes (including switch-out from other schemes) with effect from 1st August, 2009.

This will discourage AMCs from charging exorbitant exit loads/ CDSCs. And, if they do so it will be for the benefit of existing investors only.

Interest on Savings Bank Accounts
At present, banks calculate interest on savings bank account at the rate of 3.5 per cent per annum calculated on monthly basis (though credited to saving bank accounts on quarterly basis) on the minimum balance lying in your saving deposits account from the 10th to the last date of each month. Put simply, while withdrawals are deducted, fresh deposits after 10th are not considered for interest calculation. Does it make any sense?

As per the circular no. RBI/2008-09/452 dated April 24, 2009 to be effective from April 1, 2010, RBI has instructed all scheduled commercial banks to calculate interest on saving bank accounts on a daily product basis. Perhaps, RBI has become wiser and started thinking in the interests of investors / customers.

Effectively, this will increase your interest earnings from savings bank account by almost hundred per cent. For example, if you used to earn a interest income of, say, Rs 2,500 annually; from financial year 2010-11 onwards it will work out to be roughly Rs 5,000 i.e. double the present amount.

Although, it won’t make much difference in your finances but don’t forget every penny counts.

Next part: Health Mediclaim Insurance – Latest IRDA Guidelines

Also see:

1. 6 Myths about Mutual Funds
2. 10 Practical Tips about PPF Investment
3. Section 80C Tax Planning – 10 Smart Tips

4. Health Mediclaim Policy - IRDA Guidelines 2009
5. Budget 2009 - Review of Tax Proposals Impacting Individuals
6. 10 Principles of Mutual Fund Investing

7. Investor Reforms (#3): Cap on ULIP Charges

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