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The Emerging Insurance sector of India.

EXECUTIVE SUMMARY :
Insurance sector in INDIA is booming up but not to level comparative with the developed economies such as Japan, Singapore etc. Also with the opening of the insurance sector to the private players have provided stiff competition resulting into quality products. Also there is a need to restructure the Indian Government owned “ Life insurance Corporation of India “ so as to maximize revenue and in turn profits. IRDA regulations and norms for the allocation of funds need to have a comprehensive look. In the phase of declining interest rates and rising inflation the funds need to be applied in productive areas so as to generate high returns. Also in terms of clients servicing areas such as premium payments, after sales service, policy dispatch, redressal of grievances has to be amended. In the current scenario, LIC has to provide flexible products suited to the customers requirements. Also a proper and systematic risk management strategy needs to be adopted. After the increase in terrorism and destructive events around the global world such as September 11 attack on World Trade Centre, US – Taliban war, US – Iraq war etc.. an alternative to reinsurance such as asset backed securities is emerging out in the developed economies. Catastrophe bonds is one of the alternatives for reinsurance. Finally some policies such as pure term and pension schemes needs to be addressed

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The Emerging Insurance sector of India.

massively at both the urban and the rural segment so as to generate high premium income which will help in the development and growth of the economy.

INDEX :
SR NO .
1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. INTRODUCTION INSURANCE SECTOR - A PREVIEW LIFE INSURANCE INDEX ( COUNTRYWISE ) WHY OPEN UP THE INSURANCE SECTOR ? GOVERNMENT / RBI REGULATIONS INDIAN PARTNER – FOREIGN TIE UP WHY LIBERALISE, WHAT MARKET STRUCTURE & ROLE FOR THE REGULATOR AN ALTERNATIVE TO REINSURANCE INVESTMENT AND CAPITAL NORMS ROLE OF THE PORTFOLIO MANAGER RESTRUCTURING OF LIC & GIC POINTERS FOR THE INDIAN POLICYMAKERS CURRENT SCENARIO BIBLIOGRAPHY 38 44 46 53 56 60 64 1 3 6 7 11 16 18

CONTENTS

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The Emerging Insurance sector of India.

INTRODUCTION :
Insurance may be described as a social device to reduce or eliminate risk of loss to life and property. Under the plan of insurance, a large number of people associate themselves by sharing risks attached to individuals. The risks which can be insured against include fire, the perils of sea, death and accidents and burglary. Any risk contingent upon these, may be insured against at a premium commensurate with the risk involved. Thus collective bearing of risk is insurance.

DEFINITION :
General definition: In the words of John Magee, “Insurance is a plan by which large number of people associate themselves and transfer to the shoulders of all, risks that attach to individuals.” Fundamental definition:

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S.      NLDIMSR 4 . Hansell. In the words of D. “ Insurance is a contract in which a sum of money is paid to the assured as consideration of insurer’s incurring the risk of paying a large sum upon a given contingency.” Contractual definition: In the words of justice Tindall. “Insurance may be defined as a social device providing financial compensation for the effects of misfortune.” Characteristics of insurance : Sharing of risks Cooperative device Evaluation of risk Payment on happening of a special event The amount of payment depends on the nature of losses incurred.The Emerging Insurance sector of India. the payment being made from the accumulated contributions of all parties participating in the scheme.

The General Insurance Corporation (GIC) in its present form was incorporated in NLDIMSR 5 . few other companies like Bombay Life Assurance Company. in 1850 were incorporated. 1972 was promulgated. in 1823 and Triton Insurance Company. Subsequently in 1973.The Emerging Insurance sector of India. INSURANCE SECTOR – A PREVIEW: The insurance sector in India dates back to 1818. The nationalisation of life insurance business took place in 1956 when 245 Indian and Foreign Insurance provident societies were first merged and then nationalized. It paved the way towards the establishment of Life Insurance Corporation (LIC) and since then it has enjoyed a monopoly over the life insurance business in India. when Oriental Life Insurance Company was incorporated at Calcutta. Insurance Act was passed in 1928 but it was subsequently reviewed and comprehensive legislation was enacted in 1938. for General Insurance. the insurance act was amended to allow for social control over the general insurance business. non-life insurance business was nationalised and the General Insurance Business (Nationalisation) Act. General Insurance followed suit and in 1968. Thereafter.

But now the parliament has given a nod to the Insurance Regulatory and Development Authority (IRDA) bill with some changes in the original structure. How big is the insurance market ? Insurance is a Rs. 1972 and maintains a very strong hold over the non-life insurance business in India.400 billion business in India. Yet more than three-fourths of India’s insurable NLDIMSR 6 . India also has the highest number of life insurance policies in force in the world. Gross premium collection is about 2% of GDP and has been growing by 15-20% per annum. and together with banking services adds about 7% to India’s GDP. Due to concerns of (a) Relatively low spread of insurance in the country.The Emerging Insurance sector of India. and called for private sector entry and restructuring of the LIC and GIC. (b) The efficient and quality functioning of the Public Sector insurance companies (c) The untapped potential for mobilizing long-term contractual savings funds for infrastructure the (Congress) government set up an Insurance Reforms committee in April 1993. recommended a phased program of liberalization. and total investible funds with the LIC are almost 8% of GDP. The Committee submitted its report in January 1994.

which checks on these tendencies. population has no life insurance or pension cover. and opening up the sector to private players. Insurance Regulatory Authority (IRA) is one such body. A statutory body needs to be made to regulate the market and promote a healthy market structure. Health insurance of any kind is negligible and other forms of non-life insurance are much below international standards.The Emerging Insurance sector of India. NLDIMSR 7 . To tap the vast insurance potential and to mobilize long-term savings we need reforms which include revitalizing and restructuring of the public sector companies.

7 35.2 112.The Emerging Insurance sector of India. 1994 COUNTRY Indonesia Philippines India Thailand Malaysia Hong Kong South Korea Taiwan Singapore Japan Source: NO. (Insurance in Asia: The financial times. OF POLICIES PER 100 PERSONS 2.5 69. quoted from Tillinghast study) NLDIMSR 8 . INDIVIDUAL LIFE INSURANCE COVERAGE INDEX.4 70.6 198.0 5.6 12.4 Charted Financial Analyst May 1999.5 75.4 14.

As per the latest estimates.31% in 199697 to 0. Unfortunately the concept of insurance is not popular in our country. Non-life business grew by 3. Different situations and different people require a different mix of risk-cost combinations. Opening of the sector to private firms will foster competition.20%. NLDIMSR 9 . WHY OPEN UP THE INSURANCE INDUSTRY? An insurance policy protects the buyer at some cost against the financial loss arising from a specified risk.34% in 1997-98.The Emerging Insurance sector of India. Insurance companies provide these by offering schemes of different kinds. In India insurance spending per capita was among the lowest in the world at $7. India’s market share in the life insurance business showed a real growth of 11% thereby outperforming the global average of 7.6 compared to $7 in the previous year. the total premium income generated by life and general insurance in India is estimated at around a meagre 1.95% of GDP.7%. Amongst the emerging economies. India is one of the least insured countries but the potential for further growth is phenomenal.1% against global average of 0. The nationalized insurance industry has not offered consumers a variety of products. as a significant portion of its population is in services and the life expectancy has also increased over the years. However India’s share of world insurance market has shown an increase of 10% from 0.

LIC operates at very low costs NLDIMSR 10 . Although the insurance sector is officially open to private players. Focus of insurance industry is changing towards providing a mix of both protection / risk over and long-term investment opportunities. they still need a license from the IRDA. Also there exists a strong correlation between insurance density and social indicators such as literacy. Some of the major international players in the insurance business. Standard Life. innovation. With social development. which is currently done. It would also generate greater awareness on the need for buying insurance as a service and not merely for tax exemption. are – Sun Life of Canada. insurance demand will grow. (1) The new entrants cannot compete with the state owned LIC on price alone. which might try to enter the Indian market. Future course of Insurance Business : One of the main differences between the developed economies and the emerging economies is that insurance products are bought in the former while these are sold in latter. and variety of products.The Emerging Insurance sector of India. Due to its size. On the demand side. and Allianz etc. a strong correlation between demand for insurance and per capita income level suggests that high economic growth can spur growth in demand for insurance. Prudential of the United Kingdom. Following might be the future strategies of insurance companies. which will announce its guidelines in May 2000.

For instance. and their premia on policies that offer pure protection are on a par with comparable schemes across the globe. (2) Consumers can also expect product innovations. New entrants have planned to offer universal life and variable life insurance products that allow the holder flexibility in deciding how his premia are split between protection and savings. (3) Apart from the basic term insurance. (5) Private insurers would compete furiously on the service platform. (4) LIC’s policies are not flexible according to the customer’s needs. This will put pressure on LIC to offer more attractive returns. at present. These would not only include faster claims settlement and other after-sales service but there agents would be trained in pre-sales interaction to usher in a customer-oriented NLDIMSR 11 . LIC provides cover for permanent disability and what the new companies could offer is temporary disability insurance as well. most insurance products worldwide are sold as long-term investment opportunities with the protection component being clearly spelt out in the scheme.The Emerging Insurance sector of India. New products would also enable product combinations that allow greater customisation. What the new insurance companies will probably offer is higher returns than the annualized 9-10% one can hope to earn from LIC’s policies.

NLDIMSR 12 .The Emerging Insurance sector of India. (8)Access to insurance too will probably become more widespread. LIC pays surrender value only after three years but private insurance companies are likely to offer sops by way of better and timely surrender value to clients. (6) Foreign companies would also use superior software (like APEX) that will give them an edge over the in-house LIC software. This technology will help private insurers in product development and customising products to suit individual needs. Role of intermediaries would decrease and sale of insurance through direct channels and banks would increase. Simple products like term insurance might be sold through the telephone or direct mail to high net worth clients. They would be better qualified in assisting clients in financial planning. (7)The foreign players will probably introduce a lot of innovation and competition on Surrender value. approach. (9)In reaction to foreign player’s strategies one might expect LIC to react and drop its premia and upgrade its services.

200 crores for reinsurance firms. The government might provide more autonomy to insurance companies by allowing them to invest 50 % of their funds as per their own discretions. LIC may invest the remaining 25% in private corporate sector.100 crores for life and general insurers and Rs. It says that non-performing assets (NPA) NLDIMSR 13 . which had dealt a severe blow to the plans of banks and financial institutions to enter the insurance sector. Section 27A of the Insurance Act stipulates that LIC is required to invest 75% of its accretions through a controlled fund in mandated government securities. Recently RBI has issued stiff guidelines. construction. the insurance companies will have very little leverage to earn more on their investments and they might not be able to offer as flexible products as offered abroad. a 26% cap on foreign equity and a minimum capital of Rs. and acquisition of immovable assets besides sanctioning of loans to policyholders. BOTTLENECKS – GOVERNMENT / RBI REGULATIONS : The IRDA bill proposes tough solvency margins for private insurance firms.The Emerging Insurance sector of India. If this inflexibility continues. These stipulations imposed on the insurance companies had resulted in lack of flexibility in the optimisation of risk and profit portfolio.

500 crores.The Emerging Insurance sector of India. and (c) that private and foreign firms would indulge in reckless profiteering and skim the ‘urban cream’ market. RBI has also stipulated that all prospective entrants need to have a net worth of Rs. The real reason behind the protests is that the dismantling of government monopoly would provide a benchmark to evaluate the government’s insurance services. Their objections are (a) that there is no major untapped potential in insurance business in India. and ignore the rural areas. RBI has taken too much caution to make sure that the new sector does not experience the kind of ups and downs that the non-bank financial sector has experienced in the recent past. Also banks and FI’s who are planning to enter the business cannot float subsidiaries for insurance. But all these fears are unfounded. They had to rethink about these guidelines if India’s strong banks and financial institutions have to enter the new business. These guidelines have made it virtually impossible for many banks to get into the insurance business. (b) that there would be massive retrenchment and job losses due to computerization and modernization. levels of the prospective players will have to be 1% point lower than the industry average (presently 7. The insurance employees’ union is offering stiff resistance to any private entry. NLDIMSR 14 .5%).

the Bombay Mutual Life Assurance Society. It Insured Indian lives at the normal rates instead of charging a premium of 15 to 20 percent as foreign insurers did. By 1921. opened offices in Calcutta in 1894. For two years. Fifty years ago. A plethora of insufficiently regulated NLDIMSR 15 . India had a bustling. many promoted by business houses like the Tatas and Dalmias. But it seems they have an endless wait before the sector is opened up. was set up in 1870 by six friends.. Prudential's first Asia office was opened In India in 1923. That's ironical: in 1947.758 crore in 1995-96). Indian Mercantile Insurance Company Ltd. BAT subsidiary Eagle Star. around 30 foreign insurers have eagerly explored the nationalized Indian insurance market. it was doing business with Brooke Bond and the Birlas. The year after Independence. if somewhat chaotic. for example. preparing to leap in when private participation is allowed.The Emerging Insurance sector of India. Foreign insurers had a large market share 40 per cent for general insurance but there were also plenty of Indian companies. 209 life Insurance companies were doing business worth Rs712. opened in Bombay in 1907. OPENING UP OF INSURANCE SECTOR : Indian History: Time to turn the clock back-and open up insurance. entirely private insurance industry.76 crore (which grew to an amazing Rs 295. The first Indian-owned life insurance company. many of these insurers were firmly established here. Its general insurance counterpart.

there is a tendency on the part of insurance companies in general to make illicit gains. 25 insurers went into liquidation and 25 transferred their business to other companies. The ordinance transferred control of 245 insurers to the government. The government resolved to first take over the management of life insurance companies by ordinance. The 1956 life insurance Nationalisation was a top-secret intrigue." After a 1951 inquiry. regulation remained Purshottamdas Thakurdas. General Insurance had its turn in 1972. but including mandatory investments ineffective. The Insurance Act. then their ownership. and giving loans regardless of security. NLDIMSR 16 . securities. This reckless record stoked the pro-nationalisation fires. players was a sure recipe for abuse. took over their ownership. the government was dismayed that companies had high expense and premium rates.The Emerging Insurance sector of India. LIC. No wonder that between 1945 and 1955. introduced state controls on insurance. for fear that unscrupulous insurers would siphon funds off if warned. when 107 insurers were amalgamated into four companies headquartered in the four metros. were speculating in shares. in approved In 1949. especially because there was no separation between business houses and the insurance companies they promoted. with GIC as a holding company. 1938. admitted: "We cannot deny that. chairman of the Oriental Assurance Company. Can we overlook the cutthroat competition for acquiring business? And still worse is the dishonest practice of adjusting of accounts. established eight months later. today.

The Emerging Insurance sector of India.956 crore in 199596. The frontier spirit of the early insurers has been lost. Today. 48 per cent Of LIC's new business is rural.222 crore in 1973 to Rs.5. Insurance companies have also been timid in managing their investment portfolios. NLDIMSR 17 . high-end business to a mass one. Yet. rigid controls hamper operational flexibility and initiative so both customers service and work culture today are dismal. Net premium income in general insurance grew from Rs. Nationalization brought some benefits. Competition between the four GIC subsidiaries remains illusory. Insurance spread from an urban-oriented.

Australia Zurich Insurance. WHO’S GOING WITH WHOM? Indian Company Kotak Mahindra Tata Group Sundram Finance Sanmar Group M A Chidambaram Bombay Dyeing DCM Shriram Dabur Group Godrej ITC S K Modi Group CK Birla Group Ranbaxy Alpic Finance 20th Century Finance Vyasa Bank Cholmandalam SBI HDFC ICICI IDBI Max India Foreign Partner Chubb. UK Eagle star. UK Prudential. UK Liberty Mutual Fund. US Winterthur. US AIG. UK Royal Sum Alliance. USA J. Rothschild. US Allianz. SWITZERLAND GIO of Australia MetLife General Accident.The Emerging Insurance sector of India. GERMANY Canada Life ING Guardian Royal Exchange. UK Alliance Capital Standard Life. Switzerland Cigna. UK Principal New York Life NLDIMSR 18 . UK Legal and General.

of LIC’s business. Hence pension business is expected to grow once the industry opens. or 98%. The demand for healthcare is growing due to population increase. people have to start planning their retirements.The Emerging Insurance sector of India. after comparing the work forces in India and the UK. The privatisation of the insurance sector would open up exciting new career options and new jobs would be created. At present. Now with increase in life expectancy rate. Healthcare insurance is more important for families with smaller savings because they would not be able to absorb the financial impact of adverse events without insurance cover. A few insurers estimated a figure of 1lakh. Pension comprises a mere 2%. life products comprise a big chunk. Managed Care integrates the financing and delivery of appropriate health care services to covered individuals. greater urban migration and alarming levels of pollution. NLDIMSR 19 . Foreign insurance companies like Aetna (world’s largest healthcare insurance provider) and Cigna have been providing Managed Care services across the globe.

what should be the appropriate market structure (many unregulated players or a few regulated players). These are the passage of the Insurance Regulatory Authority (IRA) Bill. whether banks and other financial institutions should be allowed to operate in the insurance business. WHAT MARKET STRUCTURE TO HAVE FINALLY. and amending the LIC and GIC Acts. we do not address many other related questions such as whether foreign (and not just private) players should be allowed. In particular. and finally.The Emerging Insurance sector of India. NLDIMSR 20 . which will end their respective monopolies. which will make IRA a statutory regulatory body. and so on. WHAT ROLE FOR REGULATOR? Introduction : The decision to allow private companies to sell insurance products in India rests with the lawmakers in Parliament. In 1994 the government appointed a committee on insurance sector reforms (which is known as the Malhotra Committee) which recommended that insurance business be opened up to private players and laid down several guidelines for orchestrating the transition. whether firms should be allowed to sell both life and -non-life insurance. WHY LIBERALIZE. The three questions that we address are (a) (b) Why should insurance be opened up to private players? If opened up. what cap should there be on foreign equity ownership.

An insurance contract is a "promise to pay" contingent on a specified event. The Life Insurance Corporation of India (LIC) was formed in 1956.The Emerging Insurance sector of India. (c) What is the role of the regulator in insurance business? Why allow entry to private players? The choice between public and private might amount to choosing between the lesser of two evils. smooth functioning of business depends heavily on the continuation of the trust and confidence that people place on the solvency of these financial institutions. under one nationalized monopoly corporation. Insurance products are of little value to consumers if they cannot trust the company to keep its promise. and not public provision of insurance. banking and insurance sectors are vulnerable to the "bank run" syndrome. Indeed in India. Furthermore. in the wake of several bankruptcies and malpractice’s'. This implies the need for a public regulator. when the Government of India brought together over two hundred odd private life insurers and provident societies. insurance was in the private sector for a long time prior to independence. In the case of insurance and banking. wherein even one insolvency can trigger panic among consumers leading to a widespread and complete breakdown. Another important justification for Nationalisation was to raise the much-needed funds for rapid industrialization and self- NLDIMSR 21 .

Meeting these concerns requires a strong regulatory body. (b) That without adequate regulation. telecom. If traditional infrastructure and "semi-public goods" industries such as banking. thus private players would concentrate on the lucrative mainly urban segment leaving the unprofitable segment to the incumbent LIC. continuing a state monopoly in provision of insurance is indefensible. such as infrastructure and public goods. reliance in heavy industries. the funds generated may not be deployed in sectors (which yield long-term social benefits). power. private sector presence. Insurance provided the means to mobilize household savings on a large scale. especially since the country had chosen the path of state planning for development. and even postal services (courier) have significant. LIC's stated mission was of mobilizing savings for the development of the country. private firms may renege on their social sector investment obligations. The non-life insurance business was nationalized in 1972 with the formation of General Insurance Corporation (GIC).The Emerging Insurance sector of India. This is not to deny that there are some valid grounds for being cautious about private sector entry. Another NLDIMSR 22 . airlines. similar without regulation. Thus the fact that insurance is a state monopoly in India is an artifact of recent history the rationale for which needs to be examined in the context of liberalization of the financial sector. Some of these concerns are: (a) That there would be a tendency of private companies to "skim" the markets.

Philippines opened up its insurance sector in 1992. there is sufficient evidence that suggests that introduction of private players in insurance can only lead to greater benefits to consumers. The former measure (premiums per unit) of GDP. over 81 per cent the households have insurance cover. In Singapore. and the latter. This can be seen from the fact that the spread in insurance in India is low compared to international benchmarks. commonly expressed fear is that there would be massive job losses in the industry as a whole due to computerization. as has been seen from the example of several other developing countries. rising literacy rates and increase of the service sector. Less than 7% of the population in India has life insurance cover. apart from consideration based on theoretical principles alone. around 45 per cent of the people are covered and in Japan. India has the biggest life insurance sector in the world if we go by the number of policies sold. the Korean market has grown three times faster than GDP and in Taiwan the rate of growth has been almost 4 times that of its GDP. but the number of policies sold per 10 persons is very low. opening up of the insurance sector is an integral part of the liberalization process being pursued by many developing countries. The two convention measures of the spread of insurance are penetration and density. After Korean and Taiwanese insurance sectors were liberalized. this is close to 100 per cent. This however does not seem to be corroborated by the countries' experience'. The demand for insurance is likely to increase with rising per-capita incomes.The Emerging Insurance sector of India. In the US. premiums per capita. In fact. Moreover. There are NLDIMSR 23 .

The Emerging Insurance sector of India.

several other factors that call for private sector presence. Firstly, a state monopoly has little incentive to innovate or offer a wider range of products. This can be seen by a lack of certain products from LlC's portfolio, and lack of extensive risk categorization in several GIC products, such as health insurance. In fact, it seems reasonable to conclude that many people buy life insurance just for the tax benefits, since almost 35 per cent of the life insurance business is in March, the month of financial closing. This suggests that insurance needs to be sold more vigorously. More competition in this business will spur firms to offer several new products, and more complex and extensive risk categorization. The system of selling insurance through commission agents needs a better incentive structure, which a state monopoly tends to stifle. For example LIC pays out only 5 per cent of its income as commissions, whereas this share in Singapore is 16 per cent, and in Malaysia it is close to 20 percent. Private sector presence will also mean that the current investment norms, which tie up almost 75 per cent of insurance funds in low yielding government securities, will have to go. This will result in more proactive and market oriented investment of funds. This needs to be tempered by prudential regulation to ensure solvency'. Of course, this also implies that cross-subsidizing across policyholders of different types that is seen both in life and non-life insurance will diminish. Since public sector firms are required to sell subsidized insurance to weaker sections of society, a separate subsidy mechanism will have to be designed. The India Infrastructure Report (GOI, 1996) estimates that

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the funds required in the next two decades are more than Rupees 4000 billion. Finally, private sector entry into insurance might be simply a fiscal necessity. Since large scale funds form long term contractual savings need to be mobilized, especially for investment in infrastructures the option of not having more (private) players in the insurance sector is too costly.

WHAT SHOULD BE THE MARKET STRUCTURE ?
Individuals buying an insurance contract pay a price (called the "premium") to the insurance company and the insurance company in turn provides compensation if a specified event occurs. By making such contractual arrangements with a large number of individuals and organizations the insurance company can spread the risk. This gives insurance its "social" character in the sense that it entails pooling of individual risks. The price of insurance i.e., the premium is based on average risk. This premium is too high for people who perceive themselves to be in a low risk category. If the insurer cannot accurately determine the risk category of every customer and prices insurance on the basis of average risk, he stands to lose all the low risk customers. This in turn increases the average risk, which means premia have to be revised upwards, which in turn drives away even more customers and so on. This is known as the problem of "adverse selection". Adverse selection problem arises when a seller of insurance cannot distinguish between the buyer's type i.e., whether

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the buyer is a low risk or a high type. In the extreme case, it may lead to the complete breakdown of insurance market. Another phenomenon, the problem of "moral hazard" in selling insurance, arises when the unobservable action of buyer aggravates the risk for which insurance is bought. For example, when an insured car driver exercises less caution in driving, compared to how he would have driven in the absence of insurance, it exemplifies moral hazard. Given these problems, unbridled competition among large number of firms is considered detrimental for the insurance industry. Furthermore, even the limited competition in insurance needs to be regulated. Insurance companies can differentiate among various risk types if there is a wide difference in risk profile of the buyers insuring against the strong insurers. It also called for keeping life insurance separate from the general insurance. It suggested the regulation of insurance intermediaries by IRA and the introduction of brokers for better ‘professionalisation'.

THE ROLE OF IRA :
(a) The protection of consumers’ interest, (b) To ensure financial soundness of the insurance industry and (c) To ensure healthy growth of the insurance market. These objectives must be achieved with minimum government involvement and cost. IRA’s functioning can be financed by levying a

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IRA can insist that for such products the prices also be standardized. ( a ) Protection of Customer Interests : IRA’s first brief is to protect consumer interests. They can be full of inscrutable jargon and escape clauses. The danger often is that prices may be too low and might take the insurer dangerously close to bankruptcy. those that involve common and well-known risks. Quick settlement without unnecessary litigation should be the norm. Consumers should not have to wake up to unpleasant surprises. finding that certain contingencies are not covered. in motor NLDIMSR 27 . An average consumer is likely to be confused by them.The Emerging Insurance sector of India. small fee on the premium income of the insurers thus putting zero cost on the government and giving itself autonomy. Furthermore. The IRA also has to ensure that prices of products stay reasonable and certain mandatory products are sold. keeping prices affordable but also insisting on some mandatory products. Ensuring proper disclosure is called Disclosure Regulation. This means ensuring proper disclosure. As for mandatory products. For example. The job of keeping prices reasonable is relatively easy. and most importantly making sure that consumers get paid by insurers. From the consumer’s point of view the most important function of IRA is ensuring claim settlement. Insurance contracts are basically contingency agreements. since competition among insurers will not allow any one company to charge exorbitant rates. certain standardization can be enforced. IRA must require insurers to frame transparent contracts.

it hides the fact that this settlement is plagued by long delays. arbitration and conciliation. It is especially here that IRA’s choice of being a bloodhound or a watchdog would have different implications. The decision of such a body would be binding on the insurers. We think that an initial tough stance should give way to a more forbearing and prudential approach in regulating insurance firms. If complainants are not satisfied. IRA must have severe penalties in NLDIMSR 28 . This system offers a first and quicker choice of settling out of court. The second area of IRA’s activity concerns monitoring insurer behavior to ensure fairness. but not on the complainant. vehicle insurance. some cooperation among the insurance companies could be considered desirable.The Emerging Insurance sector of India. This system can serve the function of adjudication. which reduce the value of settlement itself. Currently. This is especially in lines where claim experience of any one company is not sufficient to make accurate forecasts. However. Collusion among companies on information sharing and rate setting is considered “fair’. they can go to court. Some countries such as Singapore have such a system in place. LIC in India has a claims settlement ratio of 97%. When the industry has a few firms there is some chance of collusion. IRA can encourage the insurers to have such a grievance redressal mechanism. an impressive number by any standards. However. adopting no-fault principle can speed up many settlements. IRA must be alert to collusive tendencies and make sure that prices charged remain reasonable. If consumers have a complaint against an insurer they can go to a body formed by association of insurers.

Since insurance business involves managing trust money. i. a guarantee fund.e. This guarantee fund does not imply that firms can charge whatever they NLDIMSR 29 . Fourth is the creation of an industry financed guarantee fund to bail out firms hit by unexpectedly high liabilities. Entry restrictions of the IRA are implemented through a licensing requirement. There is however no magic number regarding the optimal number of firms. which ensure ongoing solvency. case of fraud or mismanagement. the entrants are continuously subjected to restrictions on reserves and investments.The Emerging Insurance sector of India. which involves capital adequacy among other things. ( b ) Ensuring Solvency of Insurers : There are basically four ways of ensuring enough solvencies. Second is the restriction on capital and reserves. on what kind of investments and speculative activities firms can make. First is the policy of a price floor. in some countries the appointment of senior managers and “key personnel” has to be approved by the insurance regulatory agency. Additionally. Restricting competition provides a scope for higher profits to the companies thereby strengthening their solvency position. which might be in financial trouble. created by mandatory contributions from all insurance companies is used to bail out any insurance company. After qualifying. Third is putting in place entry barriers to restrict the number of competitors.. Since there are economies of scale and scope in insurance operations it might be better to have only a few large firms.

rebating. fraudulent practices. If some of these ratios fall outside given limits the company is asked to take corrective action. Given their NLDIMSR 30 . brokers. Insurance intermediaries such as agents. This is because insolvency of any insurance company would entail a price. Peer review of accounts can also be institutionalized. Insolvency can also arise out of reinsures abandoning insurance companies in the lurch. which all the insurance companies would have to shoulder. consultants and surveyors are also under IRA’s jurisdiction. For example. in the USA there is an Insurance Regulatory Information System (IRIS) that regularly computes certain key financial ratios from financial statements of firms. Licensing of agents and brokers should be required to check against their indulging in activities such as twisting. IRA must evolve a set of operational guidelines to deal with reinsurance matters. IRA can also consider allowing banks to act as agents (as opposed to underwriters) of insurers in mass base types of products.The Emerging Insurance sector of India. Reinsurance is a bigger business dominated by large international reinsurers. IRA can have several ways for early detection of a potential insolvency. IRA has to evolve guidelines on the entry and functioning of such intermediaries. and misappropriation of funds. All insurance companies would have an incentive to monitor the activities of their rival peer firms. as witnessed in the USA in 1980’s. Such litigation between reinsurer and insurance companies involves cross boundary legalities and can drag on for years. wish to their consumers.

the banks can access this market for insurance products and also earn commission income. In the past. One only needs to look at the history of insurance to see how evolution of insurance helped trade flows along various trade routes. ( c ) Promoting Growth in the Insurance Industry : A society experiences many benefits from the spread of insurance business. and by making the insurance business a level playing field. An initial conservative approach (the bloodhound) is justified since there is no prior experience to fall back on. and it would be prudent to err by regulating more’ rather than less. As experience accumulates. wide network of branches and their customer base. IRA thus has to frame the rules. All this with virtually no relevant historical data makes the task very difficult. growth of trade has been facilitated by the development of insurance services. The incremental cost of providing such insurance products would be much lower. the IRA can relax its initial harsh stance and NLDIMSR 31 . which benefit society at large. These projects typically have positive externalities. Insurance contributes to economic growth by enabling people to undertake risky but productive activity. IRA can ensure growth of insurance business with better education and protection to consumers. They can also support Indian insurance companies in the international field. design procedures for enforcement and also make operational guidelines. which are utilized to fund big infrastructure projects. Promotion of insurance also provides for long-term funds.The Emerging Insurance sector of India.

IRA can also consider allowing banks to act as agents (as opposed to underwriters of insurers in mass base types of products. LIBERALISATION OF INSURANCE INDUSTRY : While no aspect of the reform process in India has gone smoothly since its inception in 1991. the banks can access this market for insurance products and also commission income. Such a move of allowing banks to operate insurance business and vice versa is consistent with a worldwide trend of greater integration of banking and insurance. the political debate that followed the submission of the report by the Malhotra Committee has presumably come to an end with the ratification of the Insurance NLDIMSR 32 . adopt a more accommodating stance (the watchdog). The incremental cost of providing such insurance products would be much lower. no individual initiative has stirred the proverbial hornets' nest as much as the proposal to liberalise the country's insurance industry. This range from comparative free markets of Hong Kong and Singapore to increasingly more liberal markets of South Korea and Taiwan to more densely regular insurance sectors of Thailand and Malaysia.The Emerging Insurance sector of India. The major insurance markets in South and East Asia are in varying degrees opposite. Given there wide network of branches their customer base. Regulation is always an evolutionary process and experience constantly has to feed into policy making. Care must be taken so that this process does not slow down and cause regulatory lags. However.

Regulatory Authority (IRA) Bill both by the central Cabinet and the standing committee on finance. and hence the viability of the insurance companies. The first sign of government concern about the state of the insurance industry was revealed in the early nineties. It continues to be dominated by the two giants.The Emerging Insurance sector of India. regulations have potential to adversely affect the pricing of risks. Life Insurance Corporation of India (LIC) and the General Insurance Corporation of India (GIC). Finally. In this context. It also provides a rationale for the increased autornatisation of insurance companies. and the increased emphasis on agent independent marketing strategies for their products. If politicized. Introduction : The insurance sector continues to defy and stall the course of financial reforms in India. especially in the non-life industry. This section traces the evolution of the life insurance companies in the US from firms underwriting plain vanilla insurance contracts to those selling sophisticated investment contracts bundled with insurance products. and is marked by the absence of a credible regulatory authority. when an expert committee was set up under the NLDIMSR 33 . it brings into focus the importance of portfolio management in the insurance business and the nature and impact of portfolio related regulations on the asset quality of the insurance companies. the backdrop of US experience provides some pointers for Indian policymakers.

made some far-reaching recommendations. and that the bone of contention was essentially the stake that foreign entities were NLDIMSR 34 . which. 100 crore. Subsequent to the submission of its report by the Malhotra Committee. subject to the conditions that a private insurer should have a minimum paid up capital of Rs. most importantly. which submitted its report in January 1994.N. The Committee urged the insurance companies to abstain from indiscriminate recruitment of agents. if implemented. The Malhotra Committee. and stressed on the desirability of better training facilities.Malhotra. and a closer link between the emolument of the agents and the management and the quantity and quality of business growth. there were several abortive attempts to introduce the Insurance Regulatory Authority (IRA) Bill in the Parliament. But. It is evident that there was broad support in favour of liberalisation of the industry. could change the structure of the insurance industry. chairmanship of late R. the Committee proposed that the liberalised insurance industry be regulated by an autonomous and financially independent regulatory authority like the Securities and Exchange Board of India (SEBI). and that the promoter's stake in the otherwise widely held company should not be less than 26 per cent and not more than 40 per cent. the Committee recommended that the insurance industry be opened up to private firms. Finally. It also emphasized the need for a more dynamic management of the portfolios of these companies.The Emerging Insurance sector of India. and proposed that a greater fraction of the funds available with the insurance companies be invested in non government securities.

For example. and its viability and strengths have far reaching consequences for not only its money and capital markets. and reinsurance and that the overall ceiling for foreign stakeholders in these companies be reduced to 26 per cent from the proposed 40 per cent. The committee has also recommended that the minimum paid up share capital of the new insurance companies be raised to Rs. if households are unable to NLDIMSR 35 . the central Cabinet approved the Bill which envisaged a ceiling of 40 per cent for Non Indian stakeholders: 26 per cent for Foreign collaborators of Indian promoters.The Emerging Insurance sector of India. and 14 per cent for Non resident Indians (NRI’s). Economic Rationale : The insurance industry is a key component of the financial infrastructure of an economy. However. The committee has since recommended at each private company be allowed to enter only one of the three areas of business life insurance.' but also for its real sector. Overseas corporate bodies (OCB’s) and Foreign institutional investors (FII’s). double the amount proposed by the Malhotra Committee. In November 1998. in view of the widespread resentment about the 40 per cent ceiling among political parties. to be allowed in the Indian insurance companies. the Bill was referred to he standing committee on finance. 200 crore. general or non life insurance.

and Lloyd’s companies. The former two are the dominant forms of organisational structures in the US insurance industry. the private investment would be adversely affected. It is not surprising. hedge their potential losses of wealth. mutual companies. might be negative. and certain potentially hazardous activities like mining and freight transfers might not attract any private investment. that economists have long argued that insurance facility is necessary to ensure the completeness of a market. the growth of demand for industrial products would be adversely affected. therefore. In such an event. A stock company is one that initially raises capital by issue NLDIMSR 36 . if firms are unable to hedge against "bad" events like fire and the job injury of a large number of labourers. many or all of them will have to save much more to provide for events that might occur in the future.The Emerging Insurance sector of India. the expected payoffs from a number of their projects. reciprocal exchanges. ORGANISATIONAL IMPLICATIONS : STRUCTURES AND THEIR Insurance companies can be broadly divided into four categories: stock companies. events that would be inimical to their interests. Similarly. after factoring in the expected losses on account such "bad" events. If a significant proportion of the households behave in such a fashion. assets and labour and non labour endowments with insurance contracts.

the objectives of the owners. managers and policyholders are significantly different. the shareholders. thereby paving the way for a take over. Hence. the managers. In principle. But whereas stockholders can exit a company easily by selling its shares in the secondary market. In other NLDIMSR 37 . namely. managers and the policyholders.The Emerging Insurance sector of India. In other words. like a bank or a non bank financial institution. giving rise to conflicts of interest. it is unlikely that in a company that the appetite of the owners and the managers will be similar. the policyholder cum part owners and the managers. and subsequently generates more funds for investment by selling insurance contracts to policyholders. However. and this provides the owners with a rationale to monitor the managers. the policyholder owners find it more difficult to exit because they then have to incur the informational cost of associating themselves with another (viable) company. in the event of an unfavorable outcome. there are three sets of stakeholders in a stock insurance company. on the other hand. namely. As in any organisation. raises funds only by selling policies such that the policyholders are also partners of the companies. both the shareholders in a stock company and the policyholder owners in a mutual company have it in their interest to monitor. A mutual company. of shares. a mutual company has only two groups of stakeholders. largely because the former have limited liability such that. Specifically. owners and managers are often more keen to undertake risky activities than are the policyholders. the policyholders will have to bear the lion's share of the loss.

words. Alternatively. the mutual insurance companies are likely to be more conservative with respect to risk taking than the stock companies. 3.The Emerging Insurance sector of India. Some insurance products not available in India : Associated Market Quest after a study of some of the international markets. is more credible for stock insurance companies than for mutual insurance companies. policyholder owners of mutual companies are likely to allow the managers of these companies less operational flexibility than the flexibility of the managers in stock insurance companies. As a consequence. and the associated threat of overhaul of the incumbent management by the owners. points out the following areas for new product development: 1. then it might be profitable for the company to adopt the mutual ownership structure and thereby eliminate the agency conflicts that can potentially arise between the owners and the policyholders. if an insurance company writes lines of business that do not require a significant amount of managerial discretion. Hence. Industry all risk policies Large projects risk cover Risk beyond a floor level NLDIMSR 38 . 2. the threat of exit by owners.

9. 10. 8.The Emerging Insurance sector of India. 4. 5. Alternative risk financing Disability insurance Antique insurance Mega show insurance Celebrity visits to the country. Extended public and product liability cover Broking and captivities. AN ALTERNATIVE TO REINSURANCE :- NLDIMSR 39 . 7. 6.

the reinsurer reimburses the private insurer any sum paid to the policyholders against the claims lodged. as it is not compelled to work on a profit motive. First the basket of insurance products is likely to expand once private insurers enter the market. But if the mancreated stock market is itself so difficult to predict. The corporation may enjoy a price advantage over the private insurers. Will the private insurer be able to transfer their risk to reinsurers? That is indeed. how can the insurance company predict with any reasonable degree of certainty the quantum of claims that could arise due to natural causes? This means private insurers need to maintain adequate contingency funds to honour such claims. The need for reinsurance assumes importance given the increasing uncertainty faced by individuals and businesses. Private insurers cannot resort to high levels of debt and equity to finance their business for the earnings uncertainty will dampen the returns. The rationale is this: at present General Insurance Corporation (GIC) offers products of a general nature. for two reasons. That is. Reinsurance is a process by which private insurers transfer some part of their risk to reinsurers. a moot point. Will the private insurers be in a position to honour claims of such magnitude? The answer is No. such as theft and accident insurance. the earthquake in Gujarat that has left millions homeless and damaged property worth crores of rupees. The reason? The policy premiums are priced by the insurers based on the probability of claims. Consider for instance. And second. it is unlikely that the NLDIMSR 40 .The Emerging Insurance sector of India. thanks to being a government arm.

The SPV can bundle the policies and sell them as securities to retail investors at attractive yields. This enables easy rating of the ABS. The benefits of the SPV are First. as the credit rating agency will be able to identify the underlying assets. the insurer removes the assets from its balance sheet. The reason? If a natural disaster occurs. by selling the policies to the SPV. This is because capital market is huge and can take on the risk that insurance companies run. The premium on the policies underlying the ABS can be invested by the SPV in low-risk. NLDIMSR 41 . reinsurance market will match the pace of the insurance market. Second.The Emerging Insurance sector of India. highly liquid instruments. This factor could inhibit the growth of reinsurers in the country. SO WHAT CAN THE PRIVATE INSURERS DO ? A variable risk transfer mechanism is the capital market. the SPV is a separate entity from the insurer. the losses suffered on account of the claims can cripple the reinsurers. The solution is Asset-backed securities (ABS). This means that the private insurer frees capital that can be used for further business and lastly. the SPV is not affected by the financial health of the insurer. The private insurer can float a Special-Purpose Vehicle (SPV) and sell the policies concerned to this entity. A private insurer can bundle off policies with similar maturity and quality and sell them as securities to retail investors.

Besides. debt market is not deep and liquid enough to receive products such as asset-backed securities. Finally the alternative risk transfer market will only develop once the need for such risk transfer assumes importance some time in the future. Moreover. will be those that stop interest payments and delay principal repayments of claims are honored. from the investors’ angle. therefore. regulatory restrictions. The retail investors. There can of course be many variants to the ABS. The most risky ABS. investors get attractive yields for taking the risk. such as high stamp duty and a not-so-efficient judicial system. In India. may act as deterrents. So when the policyholders (underlying the ABS) lodge the claims with the private insurer. the fund manager will do the needful. The SPV will stop paying interest on the ABS. This is because probability of claims from. on the other hand. say. The problem of adverse selection.The Emerging Insurance sector of India. the private insurer simply passes on the claims to the SPVs. If mutual funds invest in ABS. can be reduced if the ABS are creditenhanced by a third party and rated by a credit rating agency. CATASTROPHE BONDS : NLDIMSR 42 . bear a sizable portion of claims of the policyholders. in turn will liquidate its investments and meet the claims. The SPV. retail investors need not estimate the risk associated with the investment. Also buying ABS helps retail investors truly diversify their portfolio. a hurricane is largely unrelated to the economic factors or industry-specific factors that drive equity and bond values.

a predefined loss limit is set. proceeds that otherwise go to the bondholders are used to pay the claims.The Emerging Insurance sector of India. a special purpose vehicle acts as the reinsurer by issuing debt in the capital markets and providing a reinsurance policy to the ceding insurer. This loss limit. modeling the risks for the ceding insurer’s book of business is critical to the proper analysis of the CAT bond transaction. Catastrophe ( CAT ) bonds are one class of securities that provide reinsurers access to the capital markets. Besides structural and issuance-related concerns. NLDIMSR 43 . Should there be an event causing losses in excess of the attachment point. In a typical CAT bond. Catastrophe reinsurance bonds are gaining popularity as an alternative source of funding for property and casualty reinsurance. Generally. which functions like a deductible. is known as the attachment point. This results from the combination of population growth in areas subject to catastrophic perils and a consolidation of the global reinsurance industry that has put greater demands on viable funding sources. above which the reinsurer provides the coverage in the amount of the bond issuance.

89 years in 1961 to 62. over a period of time. NLDIMSR 44 . Subsequently in 1986. Recognizing this LIC has indicated in its corporate plan 1997-2007 that they hope to put in place a year to year revision of mortality rates in the calculation of premia. female life expectancy has improved from 40. the LIC uses the 1970-73 mortality tables for most of the premium calculations and for "without profit policies". the premium rates were reduced between 2 percent to 7 percent during the 1970's.80 years in recent times. However. Similarly. these instances are an inadequate response to the changes taking place in the market.55 years in 1961 to 64. those which are not eligible for bonuses). were also discontinued. affected price reduction. as empirically available in India. the premium rates were further reduced by 17% for such policies. LIC has. The problem faced by LIC in incorporating the trends in life expectancy in to their actuarial calculation has been partly technological and partly organizational. One of the most significant changes has been the improvement in Life Expectancy of individuals. Life Insurance premia are generally perceived as being too high while general insurance (especially motor insurance) is priced too low.20 years. such as charging extra premium on female insurance.The Emerging Insurance sector of India. For males this has improved from 41. the 1975-79 mortality rates are used. Practices. For instance on 'without profit policies' (that is. shows that pricing is not in consonance with market realities. Product pricing : Pricing of insurance products. Currently.

Those that fall under tariff regulations and controlled by Tariff Advisory Committee (TAC) 2. In the case of general insurance the issue of product pricing can be grouped into two categories. 1. Those that fall outside tariff regulations.The Emerging Insurance sector of India. NLDIMSR 45 .

These stipulations have resulted in the lack of flexibility in the optimization of its risk and profit portfolio. the manner in which LIC can deploy its funds is stated. loans to policyholders. it is proposed that the GIC will be subject to the following guidelines: CAPITAL NORMS FOR NEW INSURANCE COMPANIES : One of the contentious issues raised by foreign companies seeking an entry into the insurance sector in India is the minimum paid up capital requirements. The Malhotra committee (1994) recommended NLDIMSR 46 .The Emerging Insurance sector of India. the LIC is required to invest 75% of the accretions through a controlled fund in certain approved investments. Under the current guidelines. Similarly. It has been reported that the government is planning to offer greater autonomy to LIC through the following: It is proposed that the deployment of the balance of 50% of the funds will be left to discretion of LIC. Under sec 27A of the insurance act and its application in the LIC act. construction and acquisition of immovable assets. INVESTMENT OF INSURANCE FUNDS : Any reform of the insurance sector must necessarily consider aspects related to the investment of insurance funds. 25% of accretions may be invested by LIC for investments in private corporate sectors.

Restricted. 50 crore.The Emerging Insurance sector of India.27% p. through the operations of the two monopolies (LIC and GIC). naturally insurance companies see a vast potential. LIC predicts for itself that its business has potential to grow by 16. NLDIMSR 47 . The multilateral insurance working group (an industry forum representing most of the interested foreign and Indian companies seeking an entry into the insurance sector) has recommended Rs. in a decade 1997-2007 (LIC. The IRA is also reported to considering a graded pattern for capitalization of the companies keeping in mind the volume of business likely to be handled by them. If we take a look at insurance coverage index for the age group of 2059 years a considerable gap between India and other countries in Asia can be observed. The decade 1987-97 has witnessed a compounded growth rate of marginally more than 10% in life insurance business. as the market has been. is the vast potential for future business. Rs 100 crores as the norm. The Insurance Potential : The main reason why the leading insurance companies in the world and the leading corporate group in India have shown a keen interest in the insurance sector.a. it is generally felt that the sector can grow exponentially if it is opened up. 1997). In this scenario.

The Emerging Insurance sector of India. economic agents like households have increasingly viewed insurance contracts as a part of their investment portfolio. For example. Hence. and perhaps also moral hazard stemming from reinsurance facilities. asset liability management of property liability companies in the US has left much to be desired. it is easier to predict the approximate number of death claims. Although the role of an insurance policy is significantly different from that of investments. given a stable mortality table and other historical data. the perception about life insurance contracts has perhaps been irrevocably altered. As a consequence of such uncertainty. forcing them to move away from passive portfolio NLDIMSR 48 . the latter face the problem that their liabilities are far more unpredictable than the liabilities of the life insurance companies. However. a meaningful discussion about the changing nature and role of portfolio management for US's insurance companies is possible only in the context of the experience of its life insurance companies. and it has changed the nature of fund management of insurance companies significantly. However. than the approximate number of claims on account of car accidents and fire. which are still viewed as plain vanilla insurance contracts that can be used to hedge against unforeseen calamities. THE ROLE OF PORTFOLIO MANAGEMENT : Portfolio and asset liability management are important for both life and property liability insurance companies. This change in perception has not affected much the status of the property liability or non life insurance policies.

The insurance companies started offering universal life. when stock prices rose sharply in the US. management to active asset liability management. Hence it was in a (young) household's interest to opt for term insurance. and invest the difference between the whole life premium and term life premium in the equity market. the life insurance companies were forced to think about development of new products that could give the investors returns commensurate with the pins in the stock market. Some of the policies could also be forced into expiration if the afore mentioned inflow and experience fell below some critical minimum levels. Given the steep increase in the opportunity cost of funds. As a consequence. the premium for a term insurance policy is lower than the premium for a whole life policy. and allowed policy holders to choose the amount of their annual premium and/ or the nature of the portfolio into which the premium would be invested. variable life. These policies bundled insurance coverage with investment opportunities. The immediate impact of the financial volatility on portfolio or asset liability management came by way of a change in the design of the life insurance products. households shied away from whole life insurance products and opted for term life insurance policies! During the earlier part of a policyholder's life. The change in perception of the households became apparent during the 1950s. NLDIMSR 49 . but returns over and above that were determined by the inflow of premia and the subsequent investment experience. Most of these contracts carried guaranteed Minim urn death benefits.The Emerging Insurance sector of India. and flexible premium variable life products.

They have to. As a consequence of these changes. Further. and ensure that the risk return trade off of their portfolios remain at an acceptable level. the life insurance companies gradually reduced the duration of the fixed income securities in their portfolio. use value at risk modeling to ensure that their reserves are adequate to absorb market related shocks. which brought about a bundling of insurance and investment products. In other words. they also required active management of these portfolios in accordance with the changing liability structures and market conditions. thereby ensuring greater liquidity for their assets. They also moved away from long term and privately placed debt instruments and increasingly invested in exchange traded financial paper. policy loans were offered only at variable rates of interest. portfolio management of life insurance companies today is similar to that of a bank or non bank financial company. However. ensure that there is no mismatch of duration between their assets and liabilities. the policyholders were increasingly co-opted into sharing market and interest rate risks with the insurance companies. During the 1980s. while life insurance companies compete for market share by changing the nature and NLDIMSR 50 . Today. while the increased liquidity of their portfolios reduced their risk profiles. including mortgage backed securities. (i) (ii) (iii) (iv) look out for arbitrage opportunities in the market place both across markets and over time.The Emerging Insurance sector of India.

and its ability to minimise its cost of operations without compromising the quality of its service and risk management. In the US. depending on the line of business. As such. profitability and viability of a firm in the insurance industry significantly depends on its market share. These agents also benefit from the perception that. A significant part of these expenses accrue on account of the commissions paid to exclusive and/or independent agents. the US companies have found it more difficult to reduce their cost of marketing and distribution. IMPLICATIONS OF COST MANAGEMENT : As is the case with most competitive industries. structure of their products. the average cost of processing and underwriting an application has been estimated to be in excess of US $250." However. their viability is critically dependent on the quality of their portfolio and asset liability management. the usual rate of commission being 15 to 30 per cent. insurance companies have increasingly resorted to replacement of personnel by computer based "expert" systems which apply the vetting models used by the companies' (human) experts to a wide range of problems.The Emerging Insurance sector of India. As a consequence. independent agents have greater bargaining power than the exclusive agents because they "own" the insurance contracts held by the policyholders. Perhaps the easiest way to reduce cost is to reduce the cost of processing and underwriting policy applications. and can switch from one insurance company to another at will. as NLDIMSR 51 .

however. These actions might lead to significant reduction of cost of operations of insurance companies. Regulation of the former has typically emphasized asset quality. outsiders having bargaining power vis a vis the insurance companies.The Emerging Insurance sector of India. they will be able to ensure better service for the policyholders. The nature of regulation of life insurance companies. has differed significantly from the nature of regulation of property liability companies. In order to mitigate the cost related problem. but it is not obvious as yet as to how the small policyholders will fare in the absence of powerful intermediaries with bargaining power vis a vis the insurance companies. Direct marketing has gained popularity. the US experience indicates that the nature and extent of regulation too plays a key role in determining the viability of these companies. The insurance industry in the US has historically been one of the most regulated financial industries. insurance companies in the US are increasingly looking at alternative ways to market and distribute their products. as has marketing by way of selling insurance products through other financial organizations like banks and brokers. while the regulation of the latter has largely concerned itself with policyholder's "welfare. The Impact of Regulation : While portfolio and cost management are important determinants of the viability of insurance companies." The regulations had impact on the NLDIMSR 52 .

the US courts have retroactively granted citizen policyholders coverage against hazards. and the maximum provisioning of 5 per cent is required for Caa rated (or equivalent) and lower quality bonds. the relevant loss is adjusted against the MSVR account rather than against the company's surplus. the non life industry has suffered significantly as a consequence of changing legal ethos. The minimum provisioning. In the recent past. that were not factored into the actual insurance contract. the companies issuing the bonds have had enough earnings to meet debt obligations for the previous five years. Further. Further. The bond issuing companies are also required to have net earnings 25 per cent in excess of the annual fixed charges.The Emerging Insurance sector of India.1 per cent of par value. like those from use of asbestos. New York's insurance regulatory laws require that life insurance companies ensure that. and they should not be in default with respect to either principal or interest payments. According to this requirement. for all bonds purchased by them. regulations of all states are subject to the life insurance asset portfolios to the Mandatory Security Valuation Reserve (MSVR) requirement. for A rated and higher quality bonds. As a consequence. regulation of various states impose quantitative restrictions on the amount of "risky" bonds that can be purchased by the insurance companies. which came into effect in June 1990. life insurance companies are required to make mandatory provisions for all corporate securities. the NLDIMSR 53 . is 0. If the issuer of a bond goes into default. Finally. quality of bonds held by the life insurance companies.

The cyclical nature of the firms’ profitability requires that they be monitored/regulated such that they are not in default during the unfavorable phases of the cycle. The higher profits enable the companies to underwrite more policies at a lower price. the insurance market is believed to be "soft. premia actually earned by the property liability companies fell short of the "fair" prices of these contracts. and hence these companies had to bear huge losses on account of these policies. Once the higher prices restore the industry's profitability. in turn. while politics and changing ethos might together have dealt an unfair blow to the non life insurance companies. NLDIMSR 54 . During this phase. the importance of regulation cannot be overemphasized. Hard markets are characterized by higher prices and reduced volumes. and initiates the downturn in the cycle leading to the "hard" phase. The property liability cycle is typically initiated by an exogenous shock which increases the industry's profits.The Emerging Insurance sector of India. However. reduces the profitability of the companies. the market softens again and the cycle starts again." The decrease in price during the soft phase.

much more than a private company can hope to generate. has a kind of government backing which instills faith in all would-be policy holders. LIC and GIC will continue to command a very high market presence and in the long run it will take a very good market player to dislodge LIC and GIC from their prime positions. RESTRUCTURING OF LIC AND GIC : In the insurance sector as of today and in all probabilities for a long time to come. Firstly. In the short run atleast. they have been in business for a long time and therefore. LIC and GIC will form a very significant part. The reasons for these are many. the network of branches and agents is large. are in position to know business conditions better than any new entrant. Secondly. NLDIMSR 55 . deep and penetrating. which will take a long time for any other entrant to replicate. This also means that the reform in insurance sector will necessarily mean the reform of LIC and GIC.The Emerging Insurance sector of India. Thirdly. The envisaged private sector participation in the insurance sector is unlikely to take this advantage away from LIC and GIC. (especially the LIC).

Crore) (Rs.Crore) 7146.29 917.35 25478.24 8758.Crore) 1992-93 1993-94 1994-95 1995-96 1996-97 1997-98 1998-99 1999-00 2000-01 2001-02 178120 208619 254572 295758 344619 406583 459201 536450 645041 811011 NO OF POL.76 P.29 709.63 14499. (Lacs) 566.FUND (Rs.78 48963.50 20582.60 777.50 845. (Rs.Outside Tariff  Fire Insurance. Burglary and Housebreaking  Consequential Loss (fire policy) all Risk: Jewelry and Valuables  Marine.Television Insurance  Motor Vehicle Insurance. L.89 1131.11 1258.65 34207. Cargo and Hull insurance .INCOME INVEST.19 10384.Crore) (Rs.73 655. Baggage Insurance NLDIMSR 56 .26 1013.The Emerging Insurance sector of India.79 608.91 12093.60 20545 24631 45287 65254 85236 105000 120445 146364 175491 216883 21511 25455 48789 68542 95255 110255 127390 154040 186024 227008 GENERAL INSURANCE BUSINESS :  Under Tariff . THE PRESENT STATE OF AFFAIRS : YEAR S.A.32 30545.

Bhavishya Arogya  Carrier's Legal Liability  Public Liability Act Policy NLDIMSR 57 .  Personal Accident (Individuals and group up to 500 persons) Mediclaims  Personal Accident (Air travel).The Emerging Insurance sector of India. Overseas Mediclaims  Engineering Compensation Personal Accident (group over 500 people)  Bankers’ Indemnity Policy .

Herein lies the importance of the viability of insurance companies: insolvency/bankruptcy of an insurance company can be fast transformed into a systemic problem in two different ways. At the same time.The Emerging Insurance sector of India. they guaranty minimum payoffs to both individuals and companies by way of the put like insurance contracts. For example. However. POINTERS FOR INDIAN POLICYMAKERS: A significant part of the activities of the insurance industry of an economy entails mobilization of domestic savings and its subsequent disbursal to investors. The part of the systemic crisis that can be attributed to the quasi bank like function of a section of the insurance industry is easily understood. are perceived to lead to better outcomes for economies." The consequent insolvency of the company can affect a number of banks and other companies NLDIMSR 58 . these contracts can significantly affect behavior of economic agents and. the adverse impact of such default on the economy and the society at large can be quite devastating. in general. and merely reneges on its insurance obligations. however. it is not difficult to imagine the closure of a company that had not made provisions for damages on account of (say) product related liability because it had believed that it was protected from such damages by an insurance policy. even if an insurance company does not default on its credit and investment related obligations. As discussed above.

It is evident from the above discussion that decisions about what constitutes acceptable portfolio quality. but might pose a serious problem if liberalization leads to "price" competition among a large number of insurance companies It might be argued that if the insurance and pension fund industries are NLDIMSR 59 . Indeed.The Emerging Insurance sector of India. while a part of their portfolio might comprise of equity. liquid (and highly rated) mortgage backed securities. At the same time. the insurance industry in any country should be subjected to regulations that are at least as stringent as. In other words. absence of a market for liquid mortgage backed securities denies these companies the opportunity to enhance the yield on their investment without significantly adding to portfolio risk.the other hand. As the US experience suggests. mortgages and other relatively risky securities. much of their portfolio is made up of bonds and. This might not pose a problem in the absence of competition. especially if the government helps to increase the returns to the policyholders by way of tax breaks. and a systemic problem will be precipitated. insurance companies are usually subjected to stringent asset quality norms. is constrained by the fact that the market for fixed income securities is very illiquid such that only gilts and AAA and AA+ rated corporate bonds have liquid markets. on . and perhaps more stringent than those governing the activities of other financial organizations. adversely. An Indian insurance company. and the extent of price regulation hold the key to insurance regulation in a post liberalisation insurance market.

In view of these political and NLDIMSR 60 . however. Such increase in liquidity across the board would enable the fund managers to invest in investment grade bonds of lower rating and thereby add to the average yield of their investment without adding significantly to their portfolio risk. the Indian insurance industry might also be at the receiving end of regulations governing insurance prices / premia. be prudent for the policymakers to impose stringent capital and reserve norms on the insurance companies. is that till the imperfect character of the bond market is removed to a significant extent. The government might also be under pressure to "regulate" the prices of infrastructure related lines like freight and marine insurance. The problem. in order to ensure their viability in the short to medium run." Subsequent to liberalization. But if the reinsurers price the risks' accurately and the Indian insurance companies are forced to underprice the risks. the insurance companies might either have to operate with thinner margins or remain exposed to unacceptably high levels of liquidity risk. therefore. Specifically. In principle. It might. and if the fund managers of all these companies indulge in active portfolio management. there might be highly politicized interventions in the markets for workers' compensation and medical insurance. the margins of the insurance companies will be affected adversely. the risks associated with such liability insurance policies may be hedged by way of reinsurance. thereby reducing their long term viability.The Emerging Insurance sector of India. the liquidity of the bond market will increase significantly. liberalised.

competition in the insurance industry has to be tempered with appropriate prudential norms. insolvency of financial intermediaries calls for government action and usually affects the governments' budgetary positions adversely. other things remaining the same. it has to be realised that while competition enhances the efficiency of market participants.The Emerging Insurance sector of India. financial realities. while exit is perhaps the most efficient option for insolvent firms in many markets. it might be better to subsidies the policyholders of politically sensitive lines directly or indirectly through tax benefits. thereby making the robustness of the industry critically dependent on the efficiency of and regulatory powers accorded to the proposed Insurance Regulatory Authority. regular monitoring and other regulations." which ensures the sustenance and enhancement of efficiency. At the same time. the risk of insolvency is perhaps higher for insurance companies than for other financial intermediaries because of the option like nature of their liabilities. the process of "creative destruction. is not strictly applicable to the financial markets. if at all. Therefore. rather than distort the pricing of the risks themselves. Hence. NLDIMSR 61 . At the end of the day.

Though a large proportion of policies available in the country provides for returns. Some people do look for tax concessions. like public provident fund offers Secondly. other tax saving schemes.The Emerging Insurance sector of India. Companies offering General insurance products-like medical. whether life or non-life is to protect us from vagaries of life. but even that takes time. NLDIMSR 62 . So what does insurance offer. rather we invest in it for regrettable necessities. but nobody is looking for returns to the inflation rate. That’s because the agents of LIC push policies with the highest premium to pocket a higher premium. but lots of things have changed now. Life Insurance Corporation has nearly eighty products. concessions are still limited to a 20% tax shield. better returns. In India insurance is sold and not bought. due to poor claim performance. Same is the case with General insurance. Finally tax rates are not so high as they used to be. We do not invest in insurance for returns. THE CURRENT SCENARIO: EFFECTS ON POLICY HOLDERS : The primary reasons for buying an insurance policy. perhaps peace of mind. First. but investors know only about a handful.

General insurance sector will soon be opened up to private and foreign competition. Currently term policies constitute only1% of the total number of policies issued by LIC. and do not offer any returns. Endowment policies will change too. What does this mean for the consumer? Insurance companies will introduce more term policies. Instead of NLDIMSR 63 . But awareness is even lower than life insurance products. which offer better returns. Apart from the plain vanilla policies. new entrants will also offer consumers a choice of products with low premiums. which frees the capital for investment into other investment vehicles. The insurer. Change whether public sector companies like it or not change is the around the corner. in line with his precise risk appetite. It becomes obvious that GIC lacks the marketing results. These will cover simple requirements of the insurance for the investor. These policies provide protection for a specified time period. motor and industrial insurance. In effect term policies translates into low premium outgo. while the global average is 15-20 per cent. Indians as such have a high savings rate and bridging the existing gap points at immense potential. The potential for the new entrants is immense.The Emerging Insurance sector of India. where as the global average stands at 8%. life and non-life premiums add up to around 2% of the GDP.have more than 150 products to sell. housing. will be able to invest in a variety of indices or sector specific where in the returns would be higher.

indexed funds. At present some of the good policies offered to consumer with their respective benefits are. Disability policy Covers disability to a longer tenure to life time disability. like disability products. NLDIMSR 64 . immediate annuity or a deferred annuity. The general insurance industry is expected to grow at the rate of 25% per annum. The scope of new products is also immense in the non-life segment. workers compensation insurance. the accidental death of the spouse and legal expenses resulting from the divorce. renter’s coverage and employment practices liability insurance. Here the options offered could be indexed annuity. It covers disability from accidents. Companies would offer products for niche segment. Another opportunity is offered by a pension contract. or even real estate funds.The Emerging Insurance sector of India. First to die policy Beneficial for a couple and low premium outgo. PRODUCTS BENEFITS : Pure term insurance (pure life without insurance policy. current fixed returns schemes insurance companies will issue unit linked schemes.) Very low premiums and effective risk coverage. Scared of new entries in the insurance sector. Replacement policy Saves the customer the trouble of making claims and repurchasing the products. GIC has started offering new policies like Raj Rajeshwari.

silk worm policy etc. Despite this. Technology will also play a important role on the market. This indicates that a vast majority of rural population is not covered. RURAL AREAS : According to Malhotra committee report the penetration of insurance in India is around 22%. Facilities such as customer service center are already into 24-hour mode. new entrants are hopeful of covering the vast tracts of rural masses. Flexibility in Home insurance policy Policyholder has the flexibility of choosing one of the risk covers instead of the entire package. Effects of technologies are discussed in another section.The Emerging Insurance sector of India. Though GIC offers many products for this segment like. Enhanced marketing thus will be crucial. But due to poverty majority of the population cannot offered to get insured. NLDIMSR 65 . CHANNELS : Insurance companies will also get savvy in distribution. Already many companies have full operation capabilities over a 12-hour period. crop policy. These will provide services such as motor vehicle recovery.

28 February : Kit Development Report 1999-2000 (2) Insure for life: Navjit Gill 2000. Unit ICFAI ( Institute of Charter NLDIMSR 66 . (8) www. : : Economist Int.The Emerging Insurance sector of India. (3) Complete Guide to Business Risk Management Sadgrove (4) Risk Management Excellence (5) The Insurance Sector Financial Analyst of India. 2000 (7) Economic Times clippings.licindia.com : Business India. (6) Impossible guidelines editorials February 7-20. India : Business World. BIBLIOGRAPHY (1) Insurance : Ajit Ranade and Rajeev Ahuja.