What is mis-selling and how to safeguard yourself from it

Mis-selling of financial products is becoming more and more rampant. While insurance policies may lead the pack in terms of wealth lost, there are many instances of mis-selling in mutual funds and even products like corporate bonds. 

Data from the insurance regulator IRDAI shows that over 60,000 complaints of unfair business practices were filed in FY23. Further, another report by 1Finance shows that 43% of benefits paid by the top 10 life insurers were for surrender, withdrawal, discontinuation and lapse of policies. Persistency ratio (a measure of how many policyholders continue paying renewal premiums) is at 50% after 5 years, which implies that only 50% of policyholders continue the policy beyond 5 years. All this translates to a big capital loss for policyholders given that they would get only 50% (or lesser if surrendered earlier) of the premiums paid back. 

Mutual Fund NFOs (new fund offers) too tend to be promoted widely and switches from existing funds are suggested for better returns. In the alternate investment space, investments like fractional property, invoice discounting, P2P lending and even corporate bonds are sold only on the basis of returns without explaining the risks involved. 

While regulators are continuously putting restrictions in place to stop mis-selling, ultimately investors need to be responsible for their own financial wellbeing. Here are a few steps investors should take to not fall into the mis-selling trap. 

1. →Do not engage with agents/advisors/bank employees who pursue pressure tactics and push products as being available for a limited period or for a few people only. 

2. →Research the product thoroughly and read the fine print carefully. The first check is if the product is regulated. Understand the working of the product and how returns are generated. The XIRR ( extended internal rate of return, which is used to calculate the annual rate of return on investments with multiple cash flows occurring at irregular intervals) is the right metric to assess returns, not point to point returns.  Investors tend to fall for false promises of high returns without questioning if such returns are possible or calculating the XIRR that the promised returns can translate to. 

3. →Even if the promised returns are possible, investors need to question the level of risk that needs to be taken. There are corporate bonds giving 11-14% return but are low rated, which means high risk of default. Agents routinely talk about 10% guaranteed income from insurance plans. Read the fine print to check if the returns can actually be guaranteed. 

4. →Evaluate the liquidity in the product and the penalties for early withdrawal. Products which carry high lock-in and early withdrawal penalties are a strict no. 

5. →Recommendation for switches from FD to insurance plans  or from existing funds to NFOs should be looked at with utmost caution (and suspicion) and returns should be the last consideration to make the switch.  

6. →Check for alternatives which might be simpler, lower cost and more transparent, even though with lesser returns. New age products like invoice discounting, P2P, fractional property promise high returns but come with multiple hidden risks, which investors cannot fathom. Best to stay away. 

For better transparency and to help investors, regulators can consider having a customer information sheet for every product with key details including regulation. Specifically for insurance products, the customer information sheet can also mention the XIRR assuming various rates of return and the commission payout, so that customers can take informed decisions. 

Mis-selling doesn’t just hurt individuals—it undermines confidence, misallocates capital, and weakens the very financial system a nation depends on. Every stakeholder needs to take this head on.