Insurance

INSURANCE Indian Insurance Industry The insurance business in India can be broadly sub-divided into two categories: • Life Insurance • General Insurance In January 1956, the management of life insurance business of 245 insurance players at the time was taken over by the Government of India (GoI). In September 1956, the business was nationalized and the Life Insurance Corporation of India (LIC) set up, which took over this ownership. LIC was formed in September 1956 by an Act of Parliament (LIC Act, 1956), with a capital contribution of Rs. 50 million from the GoI. Since nationalization, LIC developed a vast network of branches and expanded its business. Up to the initial reforms initiated during 1993 (refer below), LIC built up a life fund to the extent of Rs. 410 billion by end – FY 1993. New business increased from Rs. 3.3 billion under 0.95 million policies during 1956-57 to Rs. 360 billion under 10 million policies on individual lives during FY 1993; business in force increased from 13.8 billion (5.4 million policies) to Rs. 1,773 billion (56.6 million policies). General Insurance The first General Insurance Company in India – Triton Insurance Company Limited – was set up in 1850 with dominant British control. Its first Indian counterpart, the Indian Mercantile Insurance Company Limited, launched its operations in Bombay in 1907. Although the general insurance business was not nationalized along with life insurance, a code of conduct for fair and sound business practices was framed in 1957 by the General Insurance Council (a wing of the Insurance Association of India). In 1968, the Insurance Act was amended to provide for greater social control over the general insurance business. In 1971, the management of non-life insurers was taken over by the GoI. The general insurance business was nationalized in 1973 by the General Insurance Business (Nationalisation) Act, 1972. As a result, 107 insurers (including both Indian and foreign companies) were amalgamated and grouped into four companies – National

Insurance Company Limited (NIC), New India Assurance Company Limited (NIACL), Oriental Insurance Company Limited (OIC) and United Indian Insurance Company Limited (UIIC) – with the General Insurance Corporation of India (GIC) as the holding company. The GIC was incorporated as a company in November 1972 and it commenced business on January 1, 1973. GIC has been acting as the Indian reinsurer since then. The GoI subscribed to the capital of GIC while GIC subscribed to the capital of the four companies. In November 2000, the GoI restructured the general insurance industry by notifying GIC as the ‘Indian Reinsurer’. The notification followed the request of the Insurance Regulatory and Development Authority (IRDA) for bifurcation of the reinsurance business from the general insurance business of GIC. The General Insurance Business (Nationalisation) Amendment Act, 2002 was passed by both Houses of Parliament and assented to by the President of India on August 7, 2002. Consequently, GIC now

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undertakes only reinsurance business, while the four public sector undertakings (PSUs) – NIC, NIACL, OIC and UIIC – continue to handle the general insurance business. Following the notification, the administrative link that existed between the four nationalized companies and the GIC ended. The four PSUs are now broadly run as board managed companies. Further, GIC has now ceased to do any direct business in India, except for crop insurance. It has also diversified into acceptance of life reinsurance business. As the sole reinsurer in the domestic reinsurance market, GIC provides reinsurance to the direct general insurance companies in the Indian market. It leads many of the domestic companies’ treat programmes and facultative placements. Deregulation of the Industry While effecting reforms in the banking sector and capital markets during the 1990s, the GoI also recognized the importance of insurance as an important part of the overall financial system where it was necessary to undertake similar reform measures. In April

1993, the GoI appointed a Committee on Reforms in the Insurance Sector (the Malhotra Committee). The Committee, which submitted its report in January 1994, recommended that the insurance business in India be opened up to private players, and laid down several guidelines for managing the transition. The decision to allow private companies to sell insurance products in India rests with Indian Parliament. Opening up the insurance sector required crossing at least two legislative hurdles. These were the passage of the Insurance Regulatory Authority (IRA) Bill, which would make IRA a statutory regulatory body, and amendment of the LIC and GIC Acts, which would end their respective monopolies. Subsequently, in pursuance to the announcement made by the Union Finance Minister in his Budget Speech of 1998-99, the Insurance Regulatory & Development Authority (IRDA) Bill, 1999, was passed by both Houses of Parliament. The Bill was assented to by the President and notified on December 29, 1999. With the Insurance Regulatory and Development Authority Act, 1999 coming into force, the insurance industry has been opened up for the private sector. The Act provides for the establishment of a statutory IRDA to protect the interests of insurance policy holders and to regulate, promote and ensure orderly growth of the insurance industry. The IRDA was formed by an Act of Parliament on April 19, 2000. Under the IRDA Act, an ‘Indian insurance company’ will be allowed to conduct insurance business provided it satisfies the following conditions: • It must be formed and registered under the Companies Act, 1956; • The aggregate holdings of equity shares by a foreign company, either by itself or through its subsidiary companies or its nominees, should not exceed 26% paid up equity capital of the Indian insurance company; In the last budget, though the Government has proposed an enhancement in the FDI limit from 26% to 49% but this is yet to be notified in the Insurance Regulatory & Development Act (IRDA). • Its sole purpose must be to carry on the life insurance business or general insurance business or reinsurance business.

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• To operate the insurance business in India, the Indian insurance company has to obtain a certificate of registration from IRDA. It has also been provided in the IRDA Act that on or after the commencement of the IRDA Act, no insurer will be allowed to carry on the life and general insurance business in India, unless it has a paid up equity capital of Rs. 1 billion. For carrying on the reinsurance business, the minimum paid up equity capital has been prescribed as Rs. 2 billion. The Reserve Bank of India (RBI) has also issued guidelines for banks’ entry into the insurance business. For banks, prior approval of the RBI is required to enter into the insurance business. The RBI would give permission to banks on a case-bycase basis, keeping in view all relevant factors. Banks having a minimum net worth of Rs. 5 billion and satisfying other criteria in respect of capital adequacy, profitability, nonperforming asset (NPA) level and track record of existing subsidiaries can undertake insurance business through joint ventures, subject to certain safeguards. However, banks need not obtain prior approval of the RBI for engaging in insurance agency business or referral arrangement without any risk participation, subject to certain conditions. Establishment of Liaison Offices in India by Foreign Insurance Companies The Government has since decided to grant general permission to establish liaison offices in India to insurance companies incorporated outside India, which have obtained prior approval from IRDA to establish liaison offices in India subject to the necessary terms and conditions as mentioned in the circular No. 39 dated 25th of April, 2005 and the other conditions that may be stipulated by the IRDA from time to time. Market Structure following Deregulation Following the passage of the IRDA Act, private players were allowed into the insurance business in 2000. At present, the life insurance business in India is conducted by 14 companies – one public sector company (LIC) and 13 private sector players. The general insurance business in India is carried out by 14 companies – six PSUs (including

the old four PSUs, and recent entrants such as AICIL and Export Credit Guarantee Corporation of India Ltd. Or ECGC), and eight registered companies in the private sector. Although private insurance companies have commenced operations since FY 2001, the nationalized insurance companies are expected to dominate the market in the near future, especially in long-term savings products such as life insurance. During FY 2003, the premium income of private sector life insurance companies was only Rs. 1,096 million, as companied with Rs. 546,285 million for LIC. In the general insurance business, the gross direct premium income (GDPI) in India of private sector companies was Rs. 13,416 million during FY 2003, as compared with Rs. 129,311 million for the five PSUs (excluding AICIL). During FY 2003, the private sector players had a market share of 2% (in terms of premium income) in life insurance, and a market share of 9.4% (in terms of GDPI in India) in general insurance. The limiting factor for prospective private insurers will be the extensive and costly distribution structure required. Building and servicing a distribution network large enough to generate economies of scale are likely to be critical. At least during the next few years, the new entrants cannot expect to replicate the extensive distribution network of the nationalized insurance companies. Building a distribution network is expensive and time consuming. Private insurers are expected to follow a strategy similar to that of the

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foreign banks i.e. starting from the affluent segment and gradually building up the distribution network to reach out to the middle-income (even if urban) segment. In villages and semi-urban areas, insurance companies have introduced a number of innovative schemes to strengthen their distribution channels and expand operations. Players are also tapping the extensive banking network in the country. Subsequent to the enabling legislative framework being put in place by IRDA allowing Bancassurance, insurers have started offering products through this strategic channel. Indian Industry – Key Issues and Outlook

Deregulation and Competition The Indian insurance market has witnessed considerable deregulation over the past few years. This has facilitated an increase in the levels of competition, entry of reputed international insurers, expansion of the market, and adoption of more innovative approaches to distribution and product development. Significantly, however, despite the entry of large global players, the Indian market continues to be dominated by the incumbent public sector companies. Despite the low penetration of insurance in the country, the monopolization of the insurance sector by the public sector companies had till recently prevented the Indian insurance market from achieving its full growth potential. Deregulation has gained widespread acceptance in Asia. Countries like China, Malaysia, Indonesia and Thailand, which opened their insurance markets to foreign players, displayed significant increases in growth rates. The rank of South Korea, which opened its insurance sector in 1971, in global premium mobilization improved from 30th in 1971 to 7th in 2003. The scenario in India is also likely to change following the deregulation of the Indian insurance industry, which has resulted in global majors such as the Allianz Group, ING, Prudential, AIG Group, Aviva, MetLife, Chubb, Royal Sun Alliance and Lombard setting up operations in India in association with established domestic business houses. The newer players are expected to contribute towards the development of newer products and delivery systems, and focus on creating a greater awareness about insurance as a protection and risk management device. These efforts are expected to result in an expansion of the market over a period of time, and increased competition for public sector companies. While public sector players are likely to lose market share, the would continue to hold a strong market position on account of their well-established brand equity and distribution network. However, at the same time, it must be noted that major public sector banks such as State Bank of India, Bank of Baroda, Punjab National Bank and other large

public-sector banks also have established brand equity and distribution strength. Bancassurance is likely to catch on in India, the same way it has done globally. Growth Despite India’s vast population; low incomes, rural poverty, low levels of education, and lack of awareness about insurance products have constrained the growth and penetration of insurance products in the past. India, which accounted for around 6.6% of Asia’s GDP in 2003, accounted for only 2.5% of the region’s insurance business, which in fact points to a large untapped business potential.

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The Indian insurance industry undoubtedly displays great potential. The country’s high savings rate (with gross domestic savings at 24.2% of GDP in FY 2003), customary lack of social security nets, and a tradition of frugality are expected to be key growth drivers. The liberalization of the market is also likely to improve penetration through a broader scope of products. Banc-assurance is another development that is expected to drive the growth in the insurance business in India. As the increased tie-ups of banks and insurance companies indicate, banks view selling insurance products as an opportunity to leverage their extensive branch network, and broaden their income base to include more fee-based business. Insurers equally see Banc-assurance as a low-cost option to expand their distribution network and penetrate into previously inaccessible segments of the market. A key point to note that although the high level household savings and product innovations in the insurance business are likely to drive the growth in insurance business, the channelisation of household savings into insurance products is dependent on developments in other financial products for household savings. The availability of mutual funds, equities and other money market instruments has proliferated along with yield-driven investments. Mutual funds have had growing success through the early 1990s, particularly after the sector was opened to competition from the private sector. However, they have also experienced considerable volatility in fund mobilization in

recent years. These alternative avenues could compete with insurance products for attracting financial assets of the household sector. In buoyant stock market conditions, life insurance products could become less attractive investment vehicles visà-vis equity investments and mutual funds, mainly owing to the comparatively low interest rate paid on life insurance funds. This is largely because of portfolio allocation constraints. Even if the Indian insurance industry achieves the per capita premium level of China (US$ 36 during 2003), the industry turnover will increase to US$ 38 billion at the 2003 levels of population. In case the Indian market can reach the insurance density of a developing country like Brazil (US$ 83 per capita in 2003) the domestic industry turnover will reach almost US$ 87 billion. As discussed, the expansion of the market is likely to come from both increased promotional efforts by private sector players, and the introduction of products that cover new kinds of risks and cater for a wider range of hitherto untapped needs. An example of the latter is creditor insurance, which covers the risk of not being able to meet loan payments because of illness, accidents or loss of employment. Similarly, only a minute fraction of consumer durables purchased in India is insured. Structural reasons account for the small size of some key insurance segments in India. A prime example is health insurance where government’s role has not been so extensive. The public health investment in the country, over the years, has not only been comparatively low, but also continuously on the decline (as a percentage of GDP). The investment, which was 1.3% in 1990, has now declined to 0.9%. Increase in penetration of health insurance was one of the main objectives of opening up the insurance sector to private players. Since then, health insurance premiums have increased from Rs. 5.19 billion in FY 2001 to Rs. 10.02 billion in FY 2003. Health insurance business contributed an estimated Rs. 12.74 billion in premium income during FY 2004, accounting for 7.9% of the premium income of the general insurance industry in India. The presence of

private players is likely to result in increased awareness of health insurance products (on

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account of more aggressive promotion), and more aggressive tackling of structural bottlenecks that have impeded the growth of this segment. Insurance penetration in India is also expected to improve with increased life expectancy. Improved nutrition and medical standards have improved the life expectancy, suggesting that retirees are likely to live long after retirement. As per the 2001 Census, the expectation of life at birth has increased from 57.7 years for male and 58.7 years for female in 1991 to 62.3 and 65.3 respectively in 2001. The expectation of life at 60 years has also increased from 14.5 years in 1991 to 17 years in 2001. India’s life expectancy (at birth) is expected to increase from 64 years during 2000-05 to 72 years during 202530. As the table below shows, over the next few decades, the growth rate of the older population (60+ years) is expected to outstrip the growth rate of population, indicating greater demand for old age financial security. There are an estimated 80 million people over 60 years in India, and a majority of them have to rely on income support, mainly from their children. The number of people over 60 years is expected to increase to 169 million 2025. India’s population structure, in 2050, is likely to be similar to that presently found in the major industrial countries – the US, France, Italy and Germany. Years Population (million) % of total 2000 2025 2050 2000 2025 2050 0-14 338 314 309 33.5 23.2 19.7 15-59 594 869 939 58.9 64.3 59.7 60-69 48 100 170 4.7 7.4 10.8 70-79 23 51 106 2.3 3.8 6.7 >80 6 17 48 0.6 1.3 3.1 Total 1,009 1,352 1,572 100 100 100 60+ 77 169 324 7.6 12.5 20.6 (Source: United Nations)

With increased life expectancy, the demand for insurance to cover the risks of old age is expected to increase. A contributory factor likely to drive demand is the expected

reduced support from children, given the gradual dissolution of the traditional joint family structure. The present social security system in India is inadequate. Out of an estimated 402 million workers in the country, only 11-12% are covered by some form of social security, mostly in the organized sector. The present social security system in India is largely confined to the organized sector. For the rest, a job is the best guarantee of social security. Even in the organized sector, social security measures such as pension funds are expected to be increasingly inadequate in providing retirees with a comfortable standard of living. Employers, who are mainly government and public sector, have severe financial limitation. There is increased fiscal pressure on the Government to reduce its role in the provision of old age insurance. The pension liability of the Central Government employees has risen from 0.6% of the GDP (at constant prices) in FY 1994 to 1.6% in FY 2003. Over the same period, actual outgo has increased from Rs. 52 billion to Rs. 220 billion. Total pension liability as a percentage of net tax revenue has increased from 9.7% to 12.7%. For Central Government employees, the dependency

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ratio (the ratio of pensioners to active employees) is 0.85. With rising longevity and live expectancy, the pension liability is expected to increase further. In the unorganized sector, there are a large number of self-employed persons with reasonable levels of income, but without access to any mechanism for earning a risk-free and reasonable return on their savings for retirement. Thus, there is significant potential for insurance products in the unorganized sector, where persons in the unorganized sector can save in insurance products during their active working life. The GoI, realizing the need for increased old age income security, constituted the interim Pension Fund Regulatory Development Authority (PFRDA) in October 2003. The PFRDA has been entrusted the task of regulating and developing the pension market in

India, and also developing privately-managed pensions in India. In such a scenario, the insurance industry is expected to play a key role as the GoI shifts the future burden of some of its retirement provision obligations. Favorable Regulatory Environment The development of the insurance industry in India, as in other international markets, is likely to be critically dependent on the nature and quality of regulation. The role of the regulator in most markets is to ensure efficiency, transparency and fair play, while at the same time protecting the interests of the consumer. The IRDA Act 2000 has laid down the broad regulatory framework within which insurance companies are expected to operate in India. The provisions of this Act address issues related to ownership, solvency, investment portfolio construction, commission structures, reporting formats and accounting standards. The minimum paid-up equity capital requirement has been set at Rs. 1 billion. The insurance business is capital intensive, and international experience suggests that, on an average, general insurance companies require four to five years to break even. In the interim, these companies would require regular capital infusion for funding expected losses and meeting solvency requirements. In this context, given the existing regulatory constraints of foreign direct investment by the overseas partner, a substantial part of the funding would have to be done by the Indian partner, whose financial strength is likely to influence the credit strength of the joint venture. Given the evolutionary stage of the Indian insurance industry, one of the focal points for the regulator has been to ensure stability and solvency of the industry. The IRDA Act specifies that all insurance companies must maintain an excess of asset over liabilities, to the extent not less than Rs. 0.5 billion, or a sum equivalent based on the prescribed formula, not exceeding 5% of the mathematical reserves, and a percentage exceeding 1% of the sum at risk for the policies on which the sum at risk is not negative, whichever is the highest. A general insurance company would at any point in time need to maintain

a minimum solvency capital of Rs. 500 million, or a sum equivalent to 30% of the net incurred claims, whichever is the highest. The Act also lays down broad guidelines for the construction of the investment portfolios of life insurance companies. These norms have been designed to ensure that an insurer does not make on unsustainable risks in deploying funds collected by way of premium. Overall, the regulatory environment is favorable and one which ensures that players maintain prudent underwriting standards, and reserve valuation and investment practices. The primary objective for the current regulations is to ensure stability and fair play in the market place. Distribution

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The effectiveness and cost of different distribution strategies of different players is likely to be crucial in ensuring the success for players in the insurance business, particularly in the retail lines of business. The low differentiation among retail insurance products suggests the criticality of distribution reach and efficiency for success in this business. The most attractive segment for the private insurance players in the life segment will be the Indian middle-class. Life insurance in India has been distributed through an elaborate network of agents. The limiting factor for prospective insurers will be the extensive and costly distribution structure equipped for reaching this segment. The new entrants cannot expect to replicate the extensive distribution network of the nationalized insurance companies. Building a distribution network is expensive and time consuming. As a result, private insurers have largely followed a strategy similar to that of the foreign banks i.e. starting from the affluent segment and gradually building up the distribution network to reach out to the middle-income (even if urban) segment. In general insurance, the target group of customers targeted are the corporates, who have sizeable insurance business that is compulsorily insurable. By comparison, personal insurances of affluent individuals in urban and semi-urban areas, retail segments like to shopkeepers, etc. and

insurance for rural population are mostly voluntary and optional in nature. The private sector companies are expected to leverage on the existing distribution franchise of their Indian promoters to access this potentially large retail insurance market. The importance of distribution is particularly important in life insurance and the retail segment of non-life insurance. By contrast, the marketing of insurance products aimed at corporate customers would continue to involve a fair amount of direct customer interface, and insurance companies are expected to develop customized product packages and offer allied risk management services as a differentiation strategy. The strong relationships that the public sector companies have with their existing corporate clients are likely to enable them to sustain their market position in this segment. However, the private sector players are likely to leverage the business relationships of their parents and their service quality to gain strategic entry into large corporate accounts. Private players are exploring several alternatives to reduce the costs of replicating the distribution network of the public sector insurance companies. One potential channel is marketing through corporate employers, that is, the employers purchase the product on behalf of the employees or at least co-operate in the marketing effort. While third-party distribution, as in fast moving consumer goods, is a possibility, the complexity of insurance products, especially given the low awareness levels, would necessitate direct selling. However, some products, once they receive a high level of penetration and awareness, can become commodities and be sold through more impersonal channels. Technological advances are expected to enable new distribution channels, while recent regulatory changes (bank’s entry into insurance) are expected to allow crossselling between financial services companies. The use of the Internet to distribute life insurance products has only emerged recently and has not made a significant impact so far, partly because of the substantial advisory component of most life insurance products. However, Banc-assurance is expected to gain considerable popularity.

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CONCLUSION India is poised to experience major changes in its insurance markets as insurers operate in an increasingly deregulated and liberalized environment. However, despite the liberalization in the insurance sector, public sector insurance companies are expected to maintain their dominant positions, at least in the foreseeable future. Nevertheless, given the enormous potential of the Indian market, it is expected that there will be enough business for new entrants. For consumers, opening up of the insurance sector will mean new products, better packaging, and improved customer service. Product innovation and channel diversification would gain momentum, in line with the global trend of financial services convergence. For government, insurance, especially life insurance, can substitute for State security programmes. It can thus relieve pressure on social welfare systems and allow individuals to tailor their security programmes to their own preferences. This substitution role is especially valuable, given the growing demand for social security and the increased financial challenges faced by the Indian social insurance system.

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