CHAPTER - II

LIFE INSURANCE - BASICS AND GLOBAL TRENDS

2.1 DEFINITION OF RISK

Insurance essentially is an arrangement where many, who are exposed to similar

risk, share the losses experienced by a few. Insurance is a device for risk sharing and

risk transfer. When someone states that there is a risk in a particular situation, it means

that in the given situation there is an uncertainty about the outcome and the possibility

exists that the outcome will be unfavourable also. This loose intuitive notion of risk,

which implies a lack of knowledge about the future and the possibility of some adverse

consequence, is satisfactory for conventional usage, according to Vaughan, (2003). If

the outcome of an event can be predicted with certainty then there is no risk and the

existence of risk means that there are at least two possible outcomes of which one is

undesirable.

The term risk is variously defined as 1) the chance of loss 2) the possibility of

loss 3) uncertainty 4) the dispersion of actual from the expected results and 5) the

probability of any outcome different from the one expected. Vaughan, (2003) has defined

risk as a condition in which there is a possibility of an adverse deviation from a desired

outcome that is expected or hoped for. According to Rejda, (2004) risk is defined as

uncertainty concerning occurrence of a loss.

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According to NIA Pune (Online learning), risk is said to exist if there is a

possibility of getting an outcome other than the one desired for and

a. It is a combination of circumstances in the external environment over which a

person has very little control.

b. The probability is between zero and one.

c. The extent of adverse outcome may not be measurable before risk takes place.

Although the terms peril and hazard are used interchangeably with each other

and also with risk, each of them is distinct. Peril is a cause of a loss. Fire and Hurricane

are classic examples of peril. On the other hand hazard is a condition that may create or

increase the probability of loss that arises out of a peril. Hazard can be classified as

Physical hazard, and Moral hazard Physical hazard arises out of physical properties

that increase the chances of loss. For example storage of highly inflammable fluid

increases the probability of loss due to fire in a work place. Moral hazard refers to the

increase in loss arising out of dishonest behaviour or nondisclosure on the part of an

insured individual. Moral hazard is present in all forms of insurance including life

insurance.

2.2 RISK CLASSIFICATION

Risk can be classified into several categories but considering the relevance to

insurance, it can be classified into

• Fundamental and particular risk

• Pure and speculative risk

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2.2.1 FUNDAMENTAL AND PARTICULAR RISK:

Fundamental risks are those that affect the entire economy or large numbers of

persons or groups within the economy (Rejda, 2004). Fundamental risks involve losses

that are impersonal in origin and consequence. The risk of natural disaster arising out of

hurricanes, earthquakes and floods is a fine example of fundamental risk that involves

losses to large groups. On the other hand, particular risks involve losses that arise out of

individual events and are felt by Individuals only. Particular risk is a risk that affects only

the individual and not the entire community. Risk arising out of car theft or fire in a

dwelling unit is an example of particular risk.

2.2.2 PURE AND SPECULATIVE RISK:

The term pure risk is used to designate those situations that involve only the

chance of loss or no loss. In a pure risk the possible outcomes are loss or no loss. A

person buying a car has the risk of damage due to accident, fire or theft, where the

probable outcome of the risk is loss or no loss. Speculative risk describes a situation

where there is not only a possibility of loss but also a possibility of gain. Gambling is a

good example of speculative risk. The distinction between pure and speculative risks is

an important one, because normally only pure risks are insurable. Speculative risk is

voluntarily accepted because of its two dimensional nature, which includes the possibility

of gain. (Vaughan, 2003)

Not all pure risks are insurable, and a further distinction between insurable and

uninsurable pure risks may be also made. An uninsurable pure risk may also exist.

"War-risk exclusion" inserted by Life Insurance companies in times of war, exclusion of

terrorist attack cover to airlines after 9/11 are fine examples of uninsurable pure risks.

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Pure risk that exists for individuals and business firms can be classified as

personal risk, property risk, liability risk and risks arising from failure of others. Personal

risks are risks that directly affect an individual or his dependants. It consists of the

possibility of loss of income or reduction in financial assets as a result of the loss of the

ability to earn income. Premature death, dependent old age, sickness or disability and

unemployment/loss of employment are perils associated with personal risk. Personal

risk is the subject matter in life insurance business. The risk of having the property

damaged or lost from several causes leads to property risks for a property owner.

Liability risks arise out of unintentional injury to other persons or damage to their

property through negligence or carelessness. When a person’s failure to meet his

obligation may result in a financial loss for an individual and this risk arising out of the

person’s failure can be termed as risk arising from failure of others. (Rejda, 2004).

Risk causes financial loss to an individual or to the society at large or to both.

The financial loss can be a direct loss or a consequential loss. It is always prudent to

take appropriate steps or manage risk to reduce the impact of the risk or reduce or limit

the loss arising out of a risk.

2.3 RISK MANAGEMENT

According to Vaughan, (2003) risk management is a scientific approach to

dealing with pure risks by anticipating possible accidental losses and designing and

implementing procedures that minimize the occurrence of loss or the financial impact of

the losses that do occur.

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Risk can be managed by the following ways:

• Risk avoidance

• Risk retention

• Risk reduction

• Risk transfer

Risk avoidance has been described as a method of managing risk, which

involves ceasing to undertake the activity, which creates the risk, or performing it in

another way or at some other place (Insurance Institute of India). In risk retention, the

individual or business retains or owns all or part of the risk and has voluntarily or willingly

subjected himself or herself to the loss arising out of the risk. Risk reduction covers all

methods employed to reduce either the probability of loss producing events occurring or

the potential size of losses that do occur. Risk transfer can take the shape of physical

transfer, wherein the activity, which creates the risks, may be outsourced or contracted

out through a specialist. This method is called as non-insurance transfers or transfer of

risk by contract. Secondly through a contract the financial loss arising out of risk can be

transferred. Insurance is the most preferred way of transferring the impact of risk.

Purchasing an insurance contract is a primary approach to risk transfer.

2.4 INSURANCE

Insurance is a complicate and intricate risk transfer mechanism and it has two

fundamental characteristics.

a) Transferring or shifting risk from individual to a group

b) Sharing losses, on some equitable basis, by all members of the group

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Insurance as a risk management tool is available only for pure risk. From the

point of view of the insurer, there are certain requirements to be fulfilled before the

insurance is provided and these requirements are normally known as elements of

insurability of risk

2.4.1 ELEMENTS OF INSURABLE RISK

Vaughan, (2003), lists the following as elements of insurable risk.

• Presence of large number of exposure units

• Loss produced must be definite and measurable

• Loss must be accidental

• Loss must not be catastrophic

There must be a sufficiently large number of homogeneous exposure units to

make the losses reasonably predictable. A large number of similar units exposed to the

risk help the insurer in estimating the probable loss in financial terms. The purpose of

this requirement is to enable the insurer to predict the loss on the law of large numbers.

The loss produced by the risk must be definite and measurable and it means that

the loss should be definite as to cause, time, place and amount. Life insurance in most

cases meets this requirement easily.

The loss must be fortuitous or accidental and unintentional. The loss should be

beyond the insured’s control. Loss must be the result of a contingency, that is, it must be

some thing that may or may not happen. There are two main reasons as to why the loss

must be accidental. Firstly if intentional losses were to be paid, moral hazard would

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substantially increase as a result of which premium would rise. Secondly the loss

should be accidental because the law of large numbers is based on the random

occurrence of events. A deliberately caused loss is not a random event. This leads to

prediction of future experience highly inaccurate.

Rejda (2004) mentions that for insurance to work successfully the loss must not

be catastrophic and it means that a large proportion of the exposure units should not

incur losses at the same time. Pooling is the essence of insurance. If most or all the

exposure units in a certain class simultaneously incur a loss, then the pooling technique

breaks down and becomes unworkable.

Personal risks relate to the loss of ability to earn income and include premature

death, dependant old age, sickness or disability and unemployment. A well-designed risk

management program for an individual must take care of the biggest risk for self and

family that is the loss of income. The principal objective of managing personal risks is to

avoid the deprivation of the individual and those dependent on him or her in the event of

a loss that causes the termination of income. Achieving this objective generally means

making arrangements to replace the income that would be lost as a result of death,

retirement, disability or unemployment. Insurance is a common approach to replacing

such income.

2.5 DEFINITION OF INSURANCE – DIFFERENT PERSPECTIVES

Insurance, defined from the individual’s point of view, is an economic device

whereby the individual substitutes a small certain cost (the premium) for a large

uncertain financial loss (the contingency insured against) that would exist if it were not

for the insurance.

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INSURANCE – ECONOMIC AND LEGAL PERSPECTIVE

According to Life Insurance Underwriting (Online learning of NIA, Pune)

Insurance can be defined under two different perspectives, economic and legal.

Economic Perspective – Insurance is a financial intermediation function by

which individuals exposed to a specified contingency each contribute to a pool from

which covered events suffered by participating individuals are paid. Individuals

purchase the right to collect from the pool if the insured contingency occurs. Insurance

then is a contingent claim contract on the pool’s assets.

Legal Perspective – Insurance is an agreement (the insurance policy or the

insurance contract), by which one party, like policy owner, pays stipulated consideration,

called premium, to the other party called Insurer in return for which the insurer agrees to

pay a defined amount of money or provide a defined service if a covered event occurs

during the policy term.

The term, insurance has also been defined as the device in which a sum of

money as a premium is paid as consideration of the insurer’s incurring the risk of paying

a large sum upon a particular eventuality. Insurance is a contract between one party i.e.

the insurer or the insurance company and the other party. I.e. Insured

2.6 LIFE INSURANCE

Life insurance is a plan by which a group of people can pool their money to share

risks. It is a protective measure, and it can be a way to build savings. Premiums are paid

to an insurance company. The policy states what the company will do and when, and

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tells how much money the company will pay the policyholder or the beneficiaries under

various conditions (Stephenson J, 2000).

In most lines of insurance, an attempt is made to put the individual back in

exactly the same financial position after a loss as before the loss. This is called law of

indemnity. This principle of indemnity is not possible in life insurance business for

obvious reason that we cannot place a value on a human life nor we can get a dead man

alive. What a life insurance product aims to achieve is to put the family back on a similar

financial position.

In India, Life Insurance Business is defined under Section 2(11) of Insurance Act

1938, which reads as follows:

“Life insurance business” means the business of effecting contracts of insurance

upon human life, including any contract whereby the payment of money is assured on

death (except death by accident only) or the happening of any contingency dependent

on human life and any contract which is subject to payment of premium for a term

dependent on human life and shall be deemed to include - the granting of

a) Disability and double or triple indemnity accident benefits, if so provided in the

contract of insurance;

b) Annuities upon human life; and

c) Superannuation allowances and annuities payable out of any fund applicable

solely to the relief and maintenance of persons engaged or who have been

engaged in any particular profession, trade or employment or of the

dependents of such persons.

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2.7 PRINCIPLES UNDERLYING LIFE INSURANCE

The specific or unique principles that are of paramount significance to life

insurance contract, as per Life Insurance Underwriting, NIA Pune are

• Law of Large Numbers

• Principle of Indemnity

• Principle of Insurable Interest

• Principle of Utmost good faith

2.7.1 LAW OF LARGE NUMBERS

Insurance and more particularly Life Insurance relies on the law of large numbers

to minimize the losses and make it viable. The law of large numbers, shows that, in

insurance the greater the number of similar exposures to a peril, the less observed loss

experience will deviate from the expected loss experience. The Law of Large Numbers

does not suggest that the losses to particular individual will become more predictable.

Rather it suggests that the larger the group (of people) insured, the more predictable will

be the loss experience of the entire group, other things being similar.

2.7.2 PRINCIPLE OF INDEMNITY

Insurance contracts provide compensation for an insured’s loss. Indemnity

means the insured should be in the same financial position after as before the insured

loss. But life insurance is an exception to this rule, as the economic value of a human

life cannot be measured precisely. One could not be put precisely in the same financial

position occupied before the loss. Nevertheless, life insurance underwriting takes care

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not to overinsure by preventing insures from acquiring more life insurance than their

financial position justifies.

2.7.3 PRINCIPLE OF INSURANCE INTEREST

It is the interest that the owner of the insurance has on the continuance of the life

insured. If the person does not have any interest in the life that is insured, it becomes

gambling. Insurable Interest can also be termed as the financial loss that the insured’s

dependent will suffer in case of the death of the life insured. This insurable interest

should exist at the time of purchase of the life insurance policy. People are presumed to

have unlimited insurable interest in their own lives. A husband and wife have unlimited

insurable interest on each other’s lives. Similarly, insurable interest can be present in

close family relationships such as parents – children. Beyond such close relationships,

insurable interest exists in financial relationship. For example creditors have insurable

interest on the lives of debtors to the extent of the debt outstanding. Partners have

insurable interest on the basis of each other, employers on the lives of key employees.

2.7.4 PRINCIPLE OF UTMOST GOOD FAITH

A person buying life insurance is deemed to have the highest standard of

honesty in dealing with the insurer. The insurance contract depends upon various facts

about the life to be insured which are known only to the insured and not the insurer.

Hence contracts of insurance are termed as contracts of Utmost Good Faith. The

penalty for lesser level of truthfulness is the insurer’s right to void the contract.

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2.8 RISK EVALUATION CONCEPTS IN LIFE INSURANCE

There are two main approaches to evaluate the risk of premature death as per

Life Insurance Underwriting (Online learning, NIA Pune), which are,

1. HUMAN LIFE VALUE

2. NEED ANALYSIS

Human life value concept deals with human capital, which is a person’s income

potential. Human life value concept goes beyond the numbers and into considering the

entire impact caused by the loss of a human being.

Dr. S.S. Huebner, a distinguished professor of insurance at the Wharton School,

University of Pennsylvania, and Chairman of the Department of Insurance, regarded as

the father of insurance education in the United Sates, had the following concerning the

obligation to insure:

“From the family stand point, life insurance is a necessary business proposition

which may be expected by every person with dependents as a matter of course, just like

any other necessary business transaction which ordinary decency requires him to

meet. The care of his family is man’s first and most important business. The family

should be established and run on a sound business basis. It should be protected

against needless bankruptcy. The death or disability of the head of this business should

not involve its impairment or dissolution any more than the death of the head of a bank,

railroad or store. Every corporation and firm represents capitalized earning capacity and

goodwill. Why then, when men and women are about to organize the business called

family should there not be capitalization in the form of life insurance policy of the only

real value and goodwill behind the business? Why is it not fully as reasonable to have a

life insurance policy accompany a marriage certificate, as it is to have a marine

insurance certificate invariably attached to a foreign bill of exchange? The voyage in the

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first instance is, on the average, much longer, subject to much greater risk and in case of

wreck, the loss is of infinitely greater consequence”. (NIA Pune)

The growth of life insurance implies an increasing development of the sense of

responsibility. The idea of providing only for the present must give way to recognition of

the fact that a person’s responsibility to his family is not limited to the years of survival.

Emphasis should be laid on the “crime of not insuring” and the finger of scorn should be

pointed at any man, who although he has provided well while he was alive, has not seen

fit to discount the uncertain future for the benefit of a dependent household. Life

Insurance is a sure means of changing the uncertainty into certainty and the opposite of

gambling. He who does not insure gambles with the greatest of all chances and if he

loses makes those dearest to him pay for forfeit.

2.8.1 THE HUMAN LIFE VALUE CONCEPT

The Human Life Value (HLV) concept is a part of the general theory of human

capital. While Human Capital is the production potential of an individual, HLV is a

measure of the actual future earnings or values of services of an individual – that is, the

capitalized value of an individual’s future net earnings after subtracting self maintenance

cost such as food, clothing and shelter. From the standpoints of one’s dependents, an

individual HLV is the measure of the value of benefits that the dependents can expect

from their breadwinner or supporter. Similarly from the viewpoint of an organization, the

HLV of an employee is the value of his/her services to the firm. Thus there is not

necessarily one single HLV. A given HLV is a function of its purpose and value to

others.

The insurable value of an individual’s economic possibilities is the monetary

worth of the following qualitative forces in that individual: (i) ethical behaviour (ii) good

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health (iii) willingness to work (iv) willingness to make an investment in the mind and (v)

creative ability and judgment.

The HLV may be defined, quantitatively as the present value of the expected net

earnings of an individual. The appraisal of an individual’s potential earnings involves

taking the present value of future projected earnings.

The following are the limitations of Human Life value approach in measuring the

correct amount of life insurance cover. (Rejda, 2004). Firstly, HLV does not take into

account other sources of income other than salary. Secondly, in a simple HLV

approach, the earnings and expenses are assumed to remain constant. Thirdly the

amount of income allocatable to the family is a critical factor in determining the value.

This amount is subjected to several factors like birth or death in the family, divorce etc.

Fourthly, the appropriate discount value assumption is critical. The amount of provision

can change significantly, only by the change in discount value used, even though all the

other key family specific factors are kept constant. Finally HLV ignores the effect of

inflation on earnings and expenses.

2.8.2 NEEDS ANALYSIS

Needs analysis focuses on the income and cash needs that must be met

following an individual’s premature death and compares those needs to resources

already available. According to Stephenson J (2000) families usually purchase life

insurance for financial protection. If an insured wage earner dies, the insurance money

can provide financial security for the surviving family members. When both husband and

wife are wage earners, life insurance may be needed for both. If there are young

children to be cared for, a fulltime homemaker may consider life insurance. There is

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seldom, if ever, a good reason to purchase life insurance on children. First consideration

should be given to a policy that protects the family against possible loss of income.

Building savings for future needs should come after buying this loss-of -income

protection for the family.

Stephenson J (2000) also mentions that the type and amount of financial

protection a family needs from life insurance will be largely determined by:

• Family income

• Other resources available

• Family plans and objectives

• Size and composition of the family, and

• Stage in the family life cycle

Life insurance needs change with time. A typical family's needs begin when the

first child is conceived and reaches a maximum amount when the last child is conceived.

The insurance need drops to zero several years before the expected retirement age. An

insurance policy should provide this lifetime pattern of insurance coverage. That is, it

should provide a maximum amount of protection while the family is growing and taper

off, as the family gets older and smaller.

2.9 LIFE STAGES ANALYSIS

The life insurance needs vary for different individuals and it is depended interalia

on the income, number of dependants and current life style. An individual will

necessarily travel through various stages of life (Figure 2.1) and the time of incidence of

which may be different for different individuals. Similarly the nature of insurance also

changes as the individual travels through different stages in life. In the initial years of

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married life, he needs life insurance cover that graduates into long-term savings related

products and culminates to pension and annuities.

Figure 2.1: Life stages of an individual

Source: ICFA Program guide, CII, London Figure 2.2: Trends of needs and resources for family

Source: Mary J Stephenson (2000)

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Figure 2.2 describes the need for insurance, security / insurance provision for an

individual. The need for dependency for insurance decreases as the individual starts

savings and makes investments and the need is the highest at the time of birth of

children and when the children grow old and become independent, the quantum of life

insurance cover reduces significantly.

2.10 IMPACT OF LIFE INSURANCE ON AN INDIVIDUAL

Life insurance products have manifold impact on the economic well being of the

customer and his family. The benefits to an individual can be classified into the following:

(Bodla, et al 2003)

• Risk cover

• Compulsory savings

• Credit protection

• Savings for a need

• Tax relief

Any life insurance product is aimed at addressing two most important risks in

human life i.e. risk of early death and the risk of living longer. Life risk cover provided by

a life insurance policy ensures that the insurance company pays the full sum assured to

the dependants of life assured. The availability of a corpus helps the dependants to

continue to maintain their life style.

Life insurance contracts are normally taken for longer term with a commitment

from the individual that he is agreeable to pay the premium every year. This condition

brings in a compulsion and ensures that the individual pays the premium or does the

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savings year after year. Non-payment of premium leads to cessation of the policy and

cessation deprives the most valuable life protection.

Life insurance can be taken to cover the exposure of credits or borrowings. In the

event of death of the borrower, the life insurance policy benefit payout can settle the

outstanding borrowing and can save the family from a potential bankruptcy.

Being of long term in nature, life insurance can be used for accumulating savings

for specific long-term needs like money for higher education, marriage and retirement

planning. In addition, in a few countries like India, premium paid also entails an

individual to certain tax benefits under the Income tax regulations.

2.11 IMPACT OF LIFE INSURANCE ON THE ECONOMY

Life insurance has a significant impact on the macro economy of a country. The

impact can be classified into the following (Bodla, et al 2003)

• Savings and insurance

• Capital formation

• Insurance as a financial intermediary

• Economic development

2.11.1 SAVINGS AND INSURANCE

The internal savings of a country flows from three sectors (Table 2.1).

• Household sector

• Private corporate sector and

• Public sector

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The savings from the household sector constitutes a significant proportion of the

total savings in the country (Bodla, et al 2003). Household savings comprises of physical

savings and financial savings. Physical savings refers to savings by household to

purchase physical assets like gold, land, buildings etc. Financial savings means savings

in financial instruments like deposits, bonds, shares, mutual fund, insurance and small

savings. 46.7 percent of household financial savings are made in bank deposit. (Table

2.2)

Indian economy continues to have high savings rate and from the table given

below (2.3), it can be observed that GDS has always been higher than 24 percent since

2000-01. Life insurance constitutes one of the most important components in the

financial savings for households and it is above 13 percent of the household financial

savings. (Figure 2.3).

Table 2.1: Sectorwise Domestic Savings (at current prices) Sectorwise Domestic Savings (at current prices) (Rs in Crores)

Household Sector

Financial Savings

Physical Savings Total

Private Corporate

Sector Public Sector

Gross Domestic Savings

Net Domestic Savings

1999-00 206602 210124 416726 87234 -16659 487301 300652

2000-01 215219 231098 446317 87017 -37062 496272 293540

2001-02 247476 255198 502674 81669 -46377 537966 316805

2002-03 253256 312152 565408 99767 -16181 648994 413392

2003-04P 316444 332190 648634 120852 28026 797512 540942

2004-05E 320777 366302 687079 150947 69390 907416 612658 Source: IRDA Reports P- Provisional, E-Estimates

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Table 2.2: Composition of Gross Financial Assets of the household sector (in percentages)

2005-06# 2004-05P 2003-04P 2002-03P 2001-02P 2000-01

Currency 8.8 8.5 11.2 8.9 9.7 6.3

Bank Deposits 46.7 36.4 37.4 38.3 36.8 38.1

Non-banking Deposits 0.8 0.8 1 2.7 2.6 2.9

Life Insurance Funds 14.2 16 13.7 16.1 14.2 13.6 Provident and Pension Funds 10 12.9 13.6 15 16.1 19.3

Claims on Government 14.7 24.4 23 17.4 17.9 15.7

Shares and Debentures 4.9 1.1 0.1 1.7 2.7 4.1

Total 100 100 100 100 100 100 Source: ICRA Report, May 2003.IRDA ANNUAL REPORTS P- Provisional, #-estimates

Table 2.3: Percentage contribution of components of Gross Domestic Savings

1999-00 2000-01 2001-02 2002-03 2003-04P 2004-05E

GDS as a % of GDP 25 24 24 27 29 29

Household sector savings as a % of GDS 86 90 93 87 81 76

Financial Assets as a % of Household savings 50 48 49 45 49 47

Life Insurance Fund as a % of Financial assets of Household

12 14 14 16 14 16

Source: RBI Reports, P- Provisional, E-Estimates

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Figure 2.3: Life insurance premium as a percentage of household savings

Source: RBI Report P- Provisional, #-estimates

2.11.2 CAPITAL FORMATION

Capital formation envisages three essential steps, which are

1. Real savings

2. Mobilisation and channelising of savings through financial intermediaries

to be placed at the disposal of investors

3. The act of investment.

Contribution of insurance in the process of capital formation appears at all these

stages. Insurance services act as a tool to mobilize savings and function as financial

intermediary.

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2.11.3 INSURANCE AS A FINANCIAL INTERMEDIARY

Financial intermediaries carry out the function of mobilization of savings and

placing them at the disposal of investors. In a large economy, act of savings is

performed by a very large number of entities/ individuals scattered across the country.

Insurance as an intermediary helps in mobilizing such small savings and direct them to

appropriate investment avenues.

2.11.4 ECONOMIC DEVELOPMENT

In life insurance, since the time horizons for investments are long-term, the

savings can be tied up for a long time and hence can be made available for capital

expenditures. These savings can be made available to the private sector or to the

government for the purposes of infrastructures, which are essentially long term in nature.

The capital investment decisions by the private and the government, lead to

increase in the level of employment and increase in the standard of living across the

economy. Increase in the productive base of the economy results in rise of exports

leading to improving the balance of payment.

As the percentage of savings by household increases, then by definition they will

be consuming less. This reduced consumption will help to lower the inflationary

pressures that might exist within the economy. This inflation reducing benefit will clearly

be greater within an economy where consumption is tending to squeeze out potential

capital expenditure. With the increase in domestic savings, the dependency on foreign

investment comes down.

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The figure 2.4 gives a graphical representation of the role that life insurance

companies play in the mobilization of savings, investment of the savings in the capital

market and the resulting impact on the wider macro economy.

Figure 2.4: Economic contribution of life insurance industry

Source: Dickinson, 2000

Life insurance policies bought by customers

Life Insurance companies

Capital Market

Capital investment by the owners of the life insurance company

Higher employment

GDP of the economy increases

Government Private Sector

Increase in exports, balance of payment

More potential of increase in domestic consumption

Premium

Capital Subscribed

Dividends Claims payments

Investment in capital market

Finance available for Increase in the number of companies listed in the market and increase in market prices

Encourages savings and life insurance in particular by household and insurance

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2.12 GLOBAL INSURANCE TRENDS Global experience shows that life insurance markets tend to take time to develop,

often developing later than banks and non-life insurance companies. According to

Dickinson (2000), long term savings across the population as a whole increases as

standards of living rise and as standards of living rise, longevity also increases.

The pattern of the growth of national life insurance markets tends to follow an ‘S’

shaped curve pattern, depicted in the figure 2.5. As the GDP per head within an

economy remains low, spending on life insurance remains low, often growing at a rate

less than the growth of GDP. But when the GDP per head increases beyond a certain

threshold, spending on life insurance begins to accelerate. At very high level of GDP per

head, the rate of acceleration tends to slow, partly due to the fact that the wealthier

economies tend to have older populations who begin to draw down their savings during

retirement.

There is a strong correlation among economic, political, cultural and commercial

factors at work which vary from country to country, which affect the life insurance market

and life insurance products (Dickenson, 2000). The products purchased by the

customers in any life insurance market also keep changing with the economic and

demographic development of the country. Life insurance markets start slowly, due to

lower consumer awareness and individual income constraints.

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Figure 2.5: Growth of life insurance markets

Source: Dickinson, 2000

Figure 2.6: Life insurance product development & economic development

Source: Dickinson, 2000

Firstly, as the economy grows, the life insurance products tend to move from

having a primary emphasis on insurance protection towards a greater savings role,

especially saving for retirement purposes. Secondly, there is a move away from simple

products sold either on an individual and group basis to a more complex products sold

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mainly on individual basis. This relation between emergence of different products and

the level of economic development is presented in figure 2.6.

2.13 INDICATORS OF INSURANCE DEVELOPMENT

Two indicators, which help to distinguish the current and potential states of an

insurance market, are insurance density and insurance penetration (percentage of

insurance premiums in GDP.

Insurance density is measured as the ratio between total premium income and

population. Insurance density indicates the current state of the market, which is highest

in industrialized nations. For example, both the United States (US) and Japan, the

world’s most industrialized countries, have the highest premium density ranking, with

over $800 per capita. China and India, in contrast, are represented by single-digit

figures. The high insurance density implies that the insurance market is fully actualized

and therefore has less room to grow. (Beck et al 2002)

Insurance penetration, on the other hand, can be used as a rough indicator of

growth potential. Insurance penetration can be computed as

The numerator of the right hand side of the equation, insurance premiums/capita, can be

described as the insurance expenditure per household. The denominator of the right

hand side of the equation, GDP/capita, can be described as the production per

household. When combining the two parts, insurance penetration can be viewed as the

relationship between insurance expenditures and economic production per household. In

contrast to the relatively flat rate of growth exhibited at the low and high ends of the GDP

37

spectrum, the demand for insurance grows significantly faster than wealth in transitional

markets (South Korea, Taiwan, Singapore and Hong Kong). When income rises above

the minimal level, people begin to accumulate personal assets and an awareness of the

value of insurance develops. Insurance consumption then rises rapidly to fill gaps of

need. Transitional markets thus demonstrate highest growth potential.

The adjoining figure 2.7 compares the penetration of life insurance with the

economic development. It can be observed that in general the emerging markets or the

developing economies figure in the growth phase of the trend line and as the economy

matures to become a developed or industrialized country the growth tapers off.

Developing economies like India, China, Brazil and Russia are in the nascent lower end

of the trend line and developed economies like Japan, US, Switzerland are in the upper

end of the trend line. United Kingdom has the maximum life penetration percentage

amongst the developed economies.

It can also be observed from figure 2.7 that there is a positive relationship

between wealth (measured as gross national income per capita in purchasing power

parities) and a country’s insurance penetration. Higher wealth tends to result in a rising

penetration in Life as well as in Non-Life (i.e. the insurance market is growing faster than

the overall economy). In general, the increase is stronger in emerging markets than in

industrialized countries.

Existing deviations of individual countries from the “Global trend line” shown in

the graph are due to differences in Life insurance market environments across countries

(e.g. degree of old-age pension systems being based on social security), and wealth

alone does not explain the state of a country’s Life insurance market.

38

Figure 2.7: Relation between wealth and life insurance penetration in global economies in 2002

Source: Reiche, 2004.

Figure 2.8: Share of each continent in the worldwide life premium income

Asia29%

Europe40%

America28%

Africa2%

Oceania1%

Source: CEA report 2005

39

2.14 GLOBAL LIFE INSURANCE MARKET

According to the Swiss Re analysis (Sigma No.5/2006), in 2005 the worldwide

life business generated a total premium income of US$1999bn, an increase of 5.1%

compared to 2004. With more than 40% of this amount and a growth rate above 10%,

the European market is the world’s leading market in terms of premium income and

growth (Figure 2.8). Just behind Europe, the American market represents 28% of the

world life business and experienced a negative growth of 3.3% in real terms. This

slowdown, essentially due to the US market, is related to lower sales in individual life

and annuity products, which suffered from “low return rates and increased competition

from bank savings products” (Swiss Re – Sigma No 5/2006). North America has the

highest insurance density in the world and it stood at US $1686.3 during 2005 (Table

2.4)

The Asian market represents 29% of world business and has shown a positive

growth of 5.1 percent, which actually conceals different developments across the

continent. On the one hand, with almost US$380bn, Japan is the largest Asian life

insurance market but recorded a moderate growth of 2.3 percent, essentially due to the

success of annuity products. On the other side, the South and East Asian life insurance

market has grown by 11.6 percent in 2005 (9.1 percent in 2004), reflecting the economic

boom in the region. This success is driven by participating universal life products and

also by annuity products, which are supported by governments in order to supplement

state pension schemes. Behind these three leading continents, Africa and Oceania each

represent less than 1.5% of the world business and recorded growth rates of 6.5% and -

4.9% respectively and these economies also have low insurance density. (Table 2.4)

40

Table 2.4: Continentwise insurance density and insurance penetration

Insurance Density (US $) Insurance Penetration (% )

2002 2003 2004 2005 2002 2003 2004 2005

North America 1563.8 1565.7 1617.2 1686.3 4.48 4.25 4.12 4.05

Latin American & Caribbean

29.1 30.0 37.2 42.0 0.92 0.94 1.01 0.93

Europe 620.4 726.9 848.1 911.8 4.83 4.64 4.68 4.69

Asia 128.1 140.1 147.2 149.6 5.81 5.74 5.58 5.16

Africa 21.5 26.1 30.3 30.7 3.28 2.93 3.41 3.33

Oceania 668.7 750.7 851 885 4.48 3.99 3.75 3.16

World 247.3 267.1 291.5 299.5 4.76 4.59 4.55 4.34

Source: IRDA reports 2.15 LIFE INSURANCE IN ASIA The premium distribution and maturity of Asian insurance markets vary

considerably by country. According to Chu, (2001), broadly, Asian insurance markets

can be stratified into three levels: fully mature, transitional, and incipient. Japan is the

only fully mature market, accounting for over 75% of the insurance premiums in Asia.

Transitional markets include countries like South Korea, Taiwan, Singapore, and Hong

Kong and the two major incipient markets are China and India, which are the world’s two

most populated countries.

Fully mature. (Japan) - The life insurance industry is characterized by the

sophisticated liability insurance for protection of personal wealth and advanced risk

management structure for large commercial firms. Japan’s well-developed economy can

sustain the full range of modern insurance products. Japan has an insurance density of

US $ 2956.3 during 2005 and is the highest among all Asian economies (Table 2.5)

41

Transitional. (South Korea, Taiwan, Hong Kong, and Singapore) - Customers in

these developing economies are becoming aware of the importance of protecting

personal wealth, but may not have the full appreciation to warrant an ultra-sophisticated

approach. Incidentally Taiwan with 11.17% has the highest insurance penetration among

its Asian neighbours.

Incipient. (China, India, Vietnam) - Customers in countries like India and China

are mainly concerned with preserving what they have acquired through hard work.

Insurance policies with a savings mechanism will attract people by offering an

accumulation of wealth rather than expenditure.

Table 2.5: Comparison of Asian economies on insurance density and insurance penetration

Insurance Density (US $) Insurance Penetration (% )

2002 2003 2004 2005 2002 2003 2004 2005

Japan 2783.9 3002.9 3044.0 2956.3 8.64 8.61 8.26 8.32

South Korea 821.9 873.6 1006.8 1210.6 8.23 6.77 6.75 7.27

India 11.7 12.9 15.7 18.3 2.59 2.26 2.53 2.53

China 19.5 25.1 27.3 30.5 2.03 2.30 2.21 1.78

Malaysia 118.7 139.8 167.3 188.0 2.94 3.29 3.52 3.60

Indonesia 5.2 6.4 7.5 10.5 0.66 0.66 0.63 0.82

Taiwan 925.1 1050.1 1494.6 1699.1 7.35 8.28 11.06 11.17

Pakistan 1.0 1.1 1.5 1.9 0.24 0.24 0.28 0.27

Sri Lanka 4.5 5.3 6.2 6.9 0.55 0.55 0.60 0.62

Asia 128.1 140.1 147.2 149.6 5.81 5.74 5.58 5.16

Source: IRDA Annual Reports

42

2.16 JAPAN – LIFE INSURANCE MARKET

Japan continues to suffer from sluggish economic growth and as a result

Japanese life insurance companies are being forced to take various initiatives (Ryotaro

2004). As of the end of March 2001, statistics measuring the scale of the life insurance

market in Japan, including postal life and Japanese Agricultural Mutual Society’s

business, are as follow:

1. Life insurance in force is around 378 million policies and amounts to ¥2,298

trillion (roughly US$17.7 trillion)

2. Annual premium income amounts to ¥47.6 trillion (more than US$366 billion)

3. Total assets exceed ¥350 trillion (which is around US$2.7 trillion)

According to Ryotaro (2004), Japan accounts for about 26% of the world’s total

life insurance premium income and as such ranks among the top tier of countries with

major life insurance markets. Annual life insurance premium income per capita is No.1 in

the world. As measured by the above, the diffusion of life insurance in Japan is pretty

high as measured on a global basis, although the life insurance industry currently

operates in a very severe economic and business environment.

The first challenge facing the life insurance industry is demographic change.

According to the estimates by the National Institute of Population and Social Security

Research, Japan, the Japanese population should have reached a peak by 2006 before

it begins to decline. In 2015, 26 % of Japanese will be 65 years old or over. The aging of

society and the drop in the birth rate are progressing rapidly. Demographic change such

as this will of course affect the population’s ultimate demand for life insurance, but it is

important to also understand that this trend will change the kind of products needed as

well. In the past, protection products featuring large amounts of coverage accounted for

a large percentage of total products sold. However, the rapidly changing demographics

have recently been encouraging demand for medical and nursing care products as well

43

as retirement related products. A sustained high growth rate in annuity related products

can be observed as against negative or single digit growth in life premiums. (Table 2.6).

Table 2.6: Life insurance business in Japan Fiscal year 2002 2003 2004 2005 Life companies' premium (JPY bn) 25,434 25,911 26,957 28,284 Life premium growth (%) -2.5 1.9 4 4.9 Life companies' individual annuity premium (JPY bn) 3,021 4,638 6,293 7,585

Annuity Premium growth (%) 41.5 53.5 35.7 20.5 Individual annuity market share within life companies (%) 11.9 17.9 23.3 26.8

Life companies' share of the insurance market (%) 73.9 74.6 75.4 77.4

Source: www.limra.com

The second challenge facing the industry is the severe economic environment.

The Japanese economy is still struggling to fully recover from the recession that began

following the bursting of what is called as the “bubble economy”. The recession is

keeping household budgets under pressure, and as a result, private life insurance

companies’ new business and business in force in the individual sector declined for 5

consecutive years from 1997 to 2001. Additionally, years of historically low interest rates

have generated a negative yield gap between the assumed interest rate on older policies

and actual investment return. Because of this, life insurance companies, particularly

those that are longer established, are suffering from this spread. Due to the adverse

nature of the economic environment, 7 Japanese life insurers have unfortunately failed

since 1997 and not only many of those failed, but also now a few other Japanese life

offices were bought by the foreign companies. The involvement of Kampo (the Postal

Life insurance system) and the co-operative movement (especially the many small

unregistered and unregulated co-operatives - Kyosai) in life and annuity business has

significantly reduced the market that has been available to the traditional insurance

44

companies. The life premium income of Kampo and the regulated co-operatives

combined is approximately 90% of the individual business of the traditional private life

companies.

2.16.1 DISTRIBUTION CHANNELS IN JAPAN

In Japan, since the end of the World War II, life insurers have used female sales

agents as their main sales channel as a part of the revitalization process of life insurance

business and these female sales agents showed vigorous power under the debit system

which was extensively introduced in late 1940’s according to (Ryotaro, 2004). Currently

some Japanese life insurance companies, including many of the foreign-based life

companies are heavily relying on male sales agents. The position of the sales agents as

the main channel is expected to remain. However, sales through independent agencies

and banks, as well as mass marketing such as direct mailing and sales through Internet

will play a more important role than ever. Furthermore, the cross selling of life and non-

life insurance products and cross selling of life and banking or securities products should

gradually increase in the market. Meanwhile, due to the increase in the variety and

flexibility of insurance products, career sales agents, the main channel of life insurance

sales, are currently being required to learn more advanced techniques so as to improve

their sales abilities as consultants. As a result, to improve sales and after service, sales

agents’ usage of notebook computers with advanced software is increasing.

45

2.17 KOREA LIFE INSURANCE MARKET

The Asian economic crisis, which reached Korea in late 1997, provided the

landscape for restructuring that allowed some Korean companies to excel while forcing

others to close down (Hong, 2004). Strong growth in exports, due in part to the

depreciation of the Korean currency, resulted in a remarkable recovery in the Korean

economy. The government has accumulated significant foreign currency reserves and

paid off International Monetary Fund (IMF) bailout loans in advance according to

Milliman Global Insurance report of September 2001.

As stated earlier, the Asian economic crisis gave the impetus for restructuring the

Korean life insurance industry. In 1995, there were 33 Korean life insurance companies

and there were 23 in 1999, with the prospect of fewer companies by the end of 2001.

The following table 2.7 gives the details of the life insurance premium income of the

Korean market. From the table it can also be observed that female agents dominate the

distribution of life insurance products.

Table 2.7: Life insurance premium and number of agents in Korea

Fiscal year Life company premium (KRW bn )

Number of solicitors (Agents) % of female solicitors

2005 61,472.20 123,702 83.7

2004 53,750.60 136,947 84.7

2003 50,392.50 143,498 86.7

2002 49,066.70 151,064 88.2

2001 47,364.30 171,505 91

2000 51,791.40 214,793 -

1999 46,757.60 241,429 - Source.www.limra.com

Milliman Global Report of March 2004 states that about one-third of Korean

domestic life insurers declared bankruptcy due to the financial crisis, which swept major

part of Asia, in 1997. While some were successfully merged into or acquired by other

46

insurers, some were eventually merged into a life insurer under the custody of the

government. Any joint venture partnerships between failed local companies and foreign

insurers were dissolved. They are now under a single ownership or management. Korea

also saw the entry of multinational insurance companies entering the country by either

buying out the troubled local life insurance company or setting up their own subsidiaries.

There are currently 23 life insurance companies, of which 10 are multinational life

insurance companies with a recorded business (Face Amount) as of September 2003

amounting to 139,905 billions of Won (Korean currency). It is worth noticing the

strengthened position of the foreign insurers in the market. They will play an important

role in future market development, becoming market makers rather than market

followers, by introducing advanced and innovative products to the market.

2.17.1 MARKET TRENDS

Most Korean life insurers have shifted their leading life products from savings

type to protection-type products, as demonstrated in Table 2.8.

Table 2.8: Shifts in new business products in Korea Face Amount (in %) Premium Income (in %)

New Business Existing Business New Business

Year Savings Protection Savings Protection Savings Protection

1999 30 70 35 65 73 27

2000 34 66 32 68 29 71

2001 14 86 25 75 55 45

2002 15 85 22 78 49 51

2003(2Q) 12 88 20 80 46 54

Source: Hong, 2004

Among the protection-type products, a significant increase in sales is due to

whole life policies. The proven success of whole life policies by foreign insurers has

47

motivated domestic insurers to sell the policies through their female tied-agency forces

and newly established professional sales forces.

2.17.2 ALTERNATIVE DISTRIBUTION CHANNELS

Table 2.9: Life insurance companies and alternate channels of distribution in Korea

DISTRIBUTION CHANNEL LEADING INSURANCE COMPANIES

Independent Brokerage Kyobo, PCA

Independent financial adviser Samsung

Direct marketing AIG

Telemarketing LINA, AIG, Shinhan, MetLife

Cyber marketing All companies for lead

Worksite/affinity marketing Samsung, Kyobo

Bancassurance AIG, ING, Tongyang, Shinhan, Samsung, PCA

Source: Hong, 2004

While the tied agency system, from female solicitors to professional sales force,

is well established in the market, insurance companies have made a limited commitment

to developing alternative distribution channels. Currently, available distribution channels

and channels in development along with the names of the insurance companies focusing

on the channels are listed in table 2.9. According to market observers of Korean life

insurance industry, only a few companies are actively developing new channels. Most

small to medium sized domestic companies are currently focusing on developing

professional sales forces rather than developing alternative distribution channels.

48

2.18 TAIWAN

The Taiwan life insurance market has experienced tremendous growth since the

market was opened in 1987 (Sun, et al 2004). As would be expected, the foreign

companies and other new entrants have grown at a more rapid pace than the general

market. Foreign companies reported large statutory losses in 1999 mainly due to their

high growth, the conservative accounting on certain items in Taiwan and the low interest

rate environment, although each particular company’s situation may be different. Current

issues facing the industry are lower interest rates (and therefore lower spreads),

expansion to Mainland China, appointed actuary regulations and risk based capital rules.

2.18.1 Growth Potential

Since the Taiwan government opened the market in 1987, the Taiwan life

insurance industry has seen significant growth, whether measured in terms of total

assets, total premiums or new business premiums. Historically, for cultural reasons, life

insurance had been a taboo subject with the Taiwanese. However, Table 2.10 shows the

growing acceptance of the life insurance concept over the period 1986 – 1999. This

table (2.10) shows the ratio of the number of life insurance policies in force to the total

population. The Taiwanese population is now very receptive to the idea of buying life

insurance as a result of the life insurance industry’s relentless education and promotion.

Total premium in Taiwan stands at US $ 41.26 billion during 2006. (Table 2.11)

Table 2.10: Ratio of number of in-force policies to total population in Taiwan

Year 1986 1991 1995 1999

% ratio of number of policies to population 16 36 62 99

Source: Sun and Affleck (2004)

49

Table 2.11: Life insurance premium in Taiwan Year 2002 2003 2004 2005 2006

Premium Income (US $ billions) 20.71 27.46 33.2 38.79 41.26

Source: www.limra.com

Table 2.12: Growth in life insurance industry assets and premiums in Taiwan Values in NT$ billions Annualised Growth Rates (in

Percentage) 1986 1991 1995 1999 1986-96 1991-93 1995-99

Assets 141 520 1127 2171 30 21 18

Total Premiums 62 168 310 558 22 16 16

New Premiums 21 47 77 128 17 13 14

Source: Sun and Affleck (2004)

In spite of this rapid recent growth (Table 2.12), steady premium growth of 10

percent to 15 percent per annum is expected to continue. Three factors, which will fuel

future growth of life insurance market in Taiwan, are economic growth, life insurance

products and insurance density. First, the overall Taiwan economy has been growing at

6-8% in recent years. Second, the products in the Taiwan life market are heavily

concentrated on savings type products. As the economy grows, the Taiwanese

population will have more disposable income to be invested in life insurance products.

Thirdly, the ratio of life insurance premium to total GDP was about 6.7% in Taiwan in

1999. Compared with the 9 to11% in Korea and Japan, it is believed that there is still

room for further penetration because both the general culture and life insurance practice

in Taiwan are very similar to those in Korea and Japan.

50

2.19 CHINA

The Chinese government has agreed to open up the insurance market gradually

upon accession to the WTO, which was formally approved on 11 December 2001. There

will be no fixed quota on insurance licenses. Foreign life insurers are currently

technically permitted to provide services in Shanghai, Guangzhou, Dalian, Shenzhen

and Foshan. Within 2 years, foreign life insurance companies were permitted to expand

to Beijing, Chengdu, Chongqing, Fuzhou, Fuzhou, Xiamen, Ningbo, Shenyang, Wuhan

and Tianjin. All geographical restrictions require to be lifted on foreign-invested life

insurers over a period of time. In fact, in 2002 Sun Life Everbright and AIA commenced

business in Tianjin and Beijing respectively, which demonstrates some flexibility to

negotiate on a case-by-case basis.

2.19.1 MARKET POTENTIAL

Table 2.13: Life insurance premium income in China Year 2001 2002 2003 2004 2005

Premium Income (US $ billions)

15.67 25.14 32.76 34.37 39.6

Growth Rate (%) 60 30 5 15 Source: www.limra.com

The China life insurance industry achieved tremendous growth over the past

decade, with a cumulative annual growth rate (CAGR) over 23% since 1997 (Paul et al

2002). Total insurance premiums are projected to grow at 12% per annum for the next

five years, and life insurance premium growth is expected to be in the range 15% - 20%

per annum in this period. In 2005, the total life insurance premium income was over US$

39.6 billion (Table 2.13) and despite the impressive growth rates, by international

standards, the Chinese insurance market remains relatively under-developed and hence

still represents a great potential opportunity. In terms of insurance density, measured by

51

insurance premiums as a percentage of GDP, the ratio for China is only 1.8% compared

to around 6% in Taiwan, 9% in Japan and 10% in South Korea. Besides the low

penetration rate, there are other drivers for this significant growth. The savings rate in

China is very high, over 40%, compared to approximately 30% in Japan and less than

20% in the United States. One reason for this phenomenon is the lack of investment

vehicles in China. Most people in China keep their money in bank deposits. Even a small

portion of the country’s total savings could generate a considerable volume of funds

flowing into the life insurance market and with bank deposit rates so low, competition for

bank savings is intense. Furthermore, increasing affluence, financial education and

awareness of insurance contribute to the continuing growth in life insurance premiums.

While life insurance is still a minor part of household assets, bank deposits

continue to be the largest component of household savings amounting to almost 64% of

household savings according to BCG report of 2004 on China. The percentage of life

insurance in the household savings has increased from 2% in the year 1996 to 4% in the

year 2002 (Figure 2.9)

Figure 2.9: Composition of household savings in China

8264

1228

2

44

4

0%

20%

40%

60%

80%

100%

1996 2002

Bank deposits Life insurance Bonds Stocks and Other holdings

Source: Boston consulting Group Report 2004

52

China has started the process of licensing life insurance companies for every

province. It means that if a life insurance company is licensed for a province, it is

permitted to do business only in the territory for which license has been accorded. Life

insurance companies looked at provinces providing opportunities for growth. Shanghai

and Guangzhou are currently the two most competitive cities for foreign-invested

companies.

As and when other cities open, foreign insurers entering China need to select the

location of their new ventures carefully based on economic and industry specific factors

as well as company specific business strategies. It is clear from Table 2.14 that

Shanghai is still the first choice city for foreign entrants, although Manulife, ING, and

AXA will soon open their 2nd branches in Guangzhou, which will reinforce it as the

number two city for foreign life insurers. .

Table 2.14: Foreign joint venture life insurance companies in China Foreign Insurer Year of set up Chinese Partner Industry Sector Location

Manulife 1996 Sino-chem Import/Export trade Shanghai

Allianz 1998 Dazhong Non-Life Insurance Shanghai

ING Aetna 1998 China Pacific Life Insurance Shanghai

AXA 1999 Minmetal Import/Export Trade Shanghai

CMG 2000 China Life Life Insurance Shanghai

Prudential UK 2000 CITIC Financial Guangzhou

John Hancock 2001 Tian an Non-Life Insurance Shanghai

Sun Life 2002 Everbright Financial Tianjin

Generali 2002 China National Petroleum Energy Guangzhou

CGNU N/A COFCO Import/Export Trade Guangzhou

New York Life N/A Haier Manufacturer Shanghai

ING N/A Beijing Capital Group Financial Dalian

Aegon N/A CNOOC Energy Shanghai Source: Paul, 2002, Note: N/A –Not available

53

It can be observed in Table 2.15 that even for the more developed cities in

China, there is a significant variation in economic activity and the level of insurance

competition. Most companies are expected to adopt a geographic roll-out strategy

starting in the more developed cities with higher wealth levels before expanding into less

developed areas. However, Table 2.15 shows that despite the lack of foreign

participation in life insurance industry, Beijing stands at second place in terms of

premium income during 2001.

Table 2.15: Number of registration of life insurance companies in major Chinese cities -2001

City/Province GDP Number of Life Insurers Premium Income

Shanghai 60 12 1.7

Beijing 34 5 1.2

Guangzhou 32 7 0.7

Shenzhen 24 4 0.3

Tianjin 22 5 0.3

Source: Paul, 2002 2.19.2 DISTRIBUTION CHANNELS

Tied agency remains the dominant distribution channel for individual life

insurance business in China (Paul et al 2002). Several new entrants in Shanghai have

experienced problems in developing a successful agency force due to high turnover and

poaching of agents and the lack of well-trained, quality agents in the marketplace. Since

2000 bancassurance channel has emerged involving exclusive distribution agreements

between insurers and individual bank branches. Each branch of a particular bank is free

to tie up with a different insurance company. Nevertheless, this resulted in significant

sales growth in 2001, and for some companies bancassurance business comprises

more than 10% of their total premiums. This channel is likely to grow further, particularly

54

as new entrants such as Taiping Life aggressively expand and the market share of

agency business can be expected to decline in time as other channels including broker/

independent financial advisors (IFA) emerge.

2.20 EUROPEAN MARKET

Europe is the leading market in the world for life insurance, with market share

accounting for 40% of global business. With a total premium income of € 616bn and a

growth rate of 9.5% in 2005, life insurance remains by far the most important insurance

line of business in terms of turnover in Europe. More importantly the distribution of these

new premiums continues to show a predominance of financial institutions

(Bancassurance, saving banks, post offices) as major distribution channels in many

European countries (CEA Report 2007).

This growth rate of 9.5% in 2005 is the highest level recorded within the last five

years but is still below the exceptional rate observed for the year 2000 at 16.9%. This

new increase in premium income after the negative market shock experienced in 2001,

confirms the recovery of the insurance sector from this financial crisis, demonstrates the

popularity of life insurance products in the opinion of consumers and proves the ability of

insurers to develop products conforming to the needs of policyholders. The recent

evolution of the life insurance market is characterised by an increase in the share of unit-

link products from 22.2% to 24.2%, which is largely explained by the strong growth of the

stock market observed during the three last years.

55

2.20.1 Life insurance in Europe

The European life insurance market is dominated by the four main countries

(United Kingdom, France, Germany and Italy) which taken together represent 72% of the

European market. (Figure 2.10) The United Kingdom is the leading country with a

market share of 27.4% in 2005 and this market share level has shown a decrease of 10

points compared to the highest level observed in 2000. This leading position is closely

linked to the UK’s market size and to the pension scheme, which relies much more on

the private insurance sector than in most other countries (CEA Report, 2007)

Just behind the UK, France has consolidated its second place with a rise of 0.5

points to reach 19.8%. The growing share of the French market since 2000 reflects the

strong growth rate recorded in recent years. Stable at 12.1%, Italy takes third position

ahead of Germany (11.9%) where the growth and the penetration are below the

European average. All other markets have a market share below 5% individually. In

terms of Insurance density, UK continues to be the leader with 8.9% as against EUs

average of 4.69. Insurance density of other EU countries, other than the top 4 countries,

is lower than 4. (Table 2.16)

Table 2.16: Insurance density and insurance penetration in European market Insurance Density (US $) Insurance Penetration

2002 2003 2004 2005 2002 2003 2004 2005

Europe 620.4 726.9 848.1 911.8 4.83 4.64 4.68 4.69 United Kingdom 2679.4 2617.1 3190.4 3287.1 10.19 8.62 8.92 8.9

France 1349.5 1767.9 2150.2 2474.6 5.61 6.81 6.89 7.33

German 736.7 930.4 1021.3 1042.1 3.06 3.17 5.15 5.19

Italy 904.9 1238.3 1417.2 1449.8 4.39 4.82 4.86 4.86

Source: IRDA reports

56

Figure 2.10: European markets – Share of total life premium

Source: CEA Report 2007

2.20.2 DISTRIBUTION

Figure 2.11: Channelwise distribution of life insurance in Europe

Source: CEA Report 2007

57

According to a sample of 10 countries, financial institutions (including banks, post

offices and savings banks) form the leading channel in the distribution of new individual

premiums (CEA Report 2007). The market share of this channel is above 50% in more

than half of the countries and even exceeds 80% in Portugal and Italy. On the supply

side, this dominance of the financial institutions is related to the willingness of banks to

offer a larger range of saving products, to increase their assets under management and

to diversify their income sources. This trend over the last decade has given birth to large

financial conglomerates offering insurance as well as bank products. On the consumer

side, the reflex leading them to consult the bank in relation to investing or saving money

is very strong. The difference between insurance and bank products is therefore not

always obvious to the consumer. Moreover, the wide variety of saving products offered

by financial institutions and the central location of all financial services can be seen as

an advantage and partly explains the success of this channel. On the other markets,

brokers or agents dominate the distribution of new individual contracts with market

shares amounting to up to 70% for brokers in United Kingdom or up to 75% for agents in

Slovakia.

Employees do not constitute the main selling channel on any market but continue

to be an important channel in countries like Estonia (39%) or Belgium (22%). Direct

selling which has long been seen as a potential threat to traditional channels has not

greatly changed consumer habits except slightly in the Netherlands where this channel

grew to 14%.

58

2.21 LIFE INSURANCE IN AMERICA Most of the American families depend on life insurance to provide economic

protection for self and their dependents. According to the Federal Reserve’s analysis of

its Survey of Consumer Finances, sixty-nine percent owned some type of life insurance

in 2001. Americans purchased $3.0 trillion of new life insurance coverage in 2005, 4

percent more than in 2004. By the end of 2005, total life insurance coverage in the

United States reached $18.4 trillion, an increase of 5 percent from 2004. Three types of

life insurance policies are predominant in the market. Individual insurance is

underwritten separately for each individual who seeks insurance protection. Group

insurance is underwritten on a group as a whole, such as the employees of a company

or the members of an organization. Credit insurance guarantees payment of some debt,

such as a mortgage or other loan, in the event the insured person dies, and can be

bought on either an individual or a group basis. (ACLI, 2005)

Table 2.17: Insurance density and insurance penetration in American market Insurance Density (US $) Insurance Penetration (%)

2002 2003 2004 2005 2002 2003 2004 2005 North America 1563.8 1565.7 1617.2 1686.3 4.48 4.25 4.12 4.05

United States 1662.6 1657.5 1692.5 1753.2 4.60 4.38 4.22 4.14

Canada 657.3 722.9 926.1 1071.9 2.81 2.63 2.97 3.05 Source: Facts & Statistics of life insurance, Insurance Information Institute USA, 2006 2.21.1 INDIVIDUAL LIFE INSURANCE Individual life policies offered in the American market are of two basic types,

which are in the nature of protection cover for a specified term and permanent cover on

one’s whole life. Insurance density for USA stands at US $ 1753.2 and insurance

penetration is at 4.14% in the year 2005. (Table 2.17) Individual life is the most widely

used form of life insurance protection and accounts for about 54 percent of all life

59

insurance in force in the United States at year-end 2005. Total individual life insurance

protection in the United States totaled $10 trillion at the end of 2005 and has grown at an

average annual rate of 6 percent since 1995, when $6.4 trillion was in force. (Table 2.18)

The size of newly purchased individual life policies also grew in 2005. During the same

period the average, new individual life policy increased 14 percent to $158,000 while the

number of individual policies purchased fell 1 percent.

Table 2.18: Individual life insurance business in United States of America

New Business 1995 2005

Face amount ($ Millions) 1057233 1796384

No of policies (in thousands) 13835 11407

Total Inforce 1995 2005

Face amount ($ Millions) 6448758 9969899

No of policies (in thousands) 169000 166118 Source: Facts & Statistics of life insurance, Insurance Information Institute USA, 2006 Most life insurers are organized as either stock or mutual companies. Stock life

insurance companies issue stock and are owned by their stockholders (ACLI, 2005).

Mutual companies are legally owned by their policyholders and consequently do not

issue stock. At the end of 2005, 1,119 life insurance companies were in business in the

United States. (Table 2.19) The number of active companies has fallen steadily since

peaking in 1988, mostly due to mergers and consolidations. This streamlining helped to

reduce operating costs and general overhead significantly. Since 1990 the number of

agents and brokers in the life insurance industry in United States has got stabilized

(Table 2.20) Besides consolidation, another recent trend in the life insurance industry is

demutualization and the formation of mutual holding companies—a structure that allows

easier and less expensive access to capital.

60

Table 2.19: Nature and number of life insurance companies in USA Nature of life insurance

companies 2004 2005

Stock 903 864

Mutual 139 135

Fraternal* 108 102

Other 29 18

Total 1179 1119 *Fraternal refers to companies owned by fraternal benefit societies Source: Facts & Statistics of life insurance, Insurance Information Institute USA, 2006

2.21.2 DISTRIBUTION CHANNELS

Table 2.20: Number of agents, brokers in United States of America

Year 1980 1990 2000 2001 2002 2003 2004 2005

Agents & Brokers ( in ‘000s) 1687.9 2125.5 2220.5 2233.7 2233.2 2266 2258.7 2255.4

Source: Facts & Statistics of life insurance, Insurance Information Institute USA, 2006

Life insurance was once sold primarily by career life agents, captive agents who

represent a single insurance company and by independent agents who represent

several insurers (III.org, 2006). Table 2.20 gives the details of Agents & Brokers

employed by the life Insurance Industry in the United States. Currently life insurance

company products are also sold by direct mail, telephone, and the Internet, directly to

the public. In addition, in the 1980s, insurers began to market annuities and term life

insurance through banks and financial advisors, professional organizations and

workplaces. Large portions of variable annuities, which are based on stock market

performance, and a small portion of fixed annuities, are sold by stockbrokers. Figure

2.12 gives the details of the percentage contribution of each of the channels of

distribution in the US market. It can be observed individual agents (Career agents,

61

Independent agents) dominate the distribution and bancassurance is yet to develop into

a significant channel for distribution of life insurance products.

Figure 2.12: Channelwise distribution of life insurance in United States of America

(2001)

2%

1%

22%

43%32%

Career agents Financial InstitutionsDirect response Personal Producing General AgentsIndependent Agent

Source: Facts & Statistics of life insurance, Insurance Information Institute USA, 2006

2.22 LIFE INSURANCE IN BRAZIL

Table 2.21: New premium income in Brazil

Year 2002 2003 2004 2005 2006

New Premium (US $ millions) 2385 3921 5580 7557 10565

Source: www.limra.com,

Life insurance represents a relatively small proportion of total insurance activity in

Brazil (18%) compared to developed countries such as the USA (30%) and Japan (40%)

(Interfund Research, 2004). This proportion has grown from 12% in 1993. Premiums per

capita were $12 in Brazil in 1999, compared to $450 in the USA and this comparison of

life insurance premiums per capita shows the underdevelopment of the life insurance

62

sector in Brazil. Similarly, as a percentage of the country’s economy, life insurance in

Brazil represented only 0.4% of GDP in 1999, compared to 1.5% in the US. (Interfund

Research, 2001). New life insurance premium during 2006 was at US $ 10,565 millions

(Table2.21) and it has been growing consistently.

Distribution of life insurance tends to be predominantly through brokers, although

the sale of life insurance through banks is also increasing. The top ten players in the

sector are responsible for 58% of total life insurance sales. The main catalysts for

growth have been the fall in inflation since 1994, and the deregulation of the industry.

With the fall in inflation, financial products have become much more attractive, as the

preoccupation with inflation has also declined. Added to this, a wider distribution of

income and a previously low insurance penetration among the Brazilian population has

led to growth.

The Brazilian life sector is dominated by term (temporarily) life insurance, the

majority of which is sold through group life policies, usually to cover employees of

businesses. However, in 1998 long-term life insurance policies, including endowment

policies and some whole life policies began to appear in the market. Life insurance

industry shows potential for continued growth, mainly because of its very low penetration

within the Brazilian market place, and the very high latent demand for savings products.

2.22.1 DISTRIBUTION IN BRAZIL

Brokers remain the main distribution channels for insurance in Brazil, accounting

for some 70% of sales. The remaining 30% of sales are accounted for by the sale of

insurance through bank branches (25%), and through direct marketing methods (5%).

The involvement of brokers in a direct or indirect form is mandatory in Brazil. The figure

63

of an 'agent' (a salesman working purely on behalf of the insurance company) does not

formally exist, although brokers often have an ambiguous role - officially earning their

income independently from customers, but concentrating on (and supported by) just one

or two insurance companies. . There is also scope for a more effective use of customer

profiling and targeting, to make direct marketing a more effective means of distributing

personal insurance.

Insurers are experimenting with new methods of distribution, particularly in their

attempts to reach a wider market place (for example, among middle and lower income

customers who have not bought insurance in the past). Firms are keenly exploring both

broker and non-broker distribution channels. Insurers are selling products through

banks, supermarkets, gas stations, motor accessory shops and subway stations. They

are also looking at the use of affinity groups, direct marketing, and alliances with firms

such as credit card operators, and are beginning to explore the use of the Internet as an

interface for both the client and suppliers such as brokers.

Globally countries, which are in different stages of economic development, have

varying insurance density and insurance penetration levels. Each country has evolved

their principal distribution channel for life products. A summary of insurance climate for

select economies has been captured in Table 2.22.

64

Dom

inan

t di

strib

utio

n C

hann

el

Bro

ker

Age

ncy

Fina

ncia

l In

stitu

tions

(B

anca

ssur

ance

)

Tied

Age

ncy

Tied

Age

ncy-

W

omen

Age

ncy

Car

eer L

ife

Age

nts

IFA

s / B

roke

rs

Insu

ranc

e Pe

netr

atio

n (%

)

0.99

1.95

8.63

2.53

7.62

7.35

4.35

9.97

Insu

ranc

e D

ensi

ty ($

)

56.5

6

34

3164

18.3

1255

.22

2614

.56

1817

.23

3931

.73

Mar

ket s

ize

(U

S $

Bill

ion)

12.5

39.6

176.

2

18.8

60

256.

6

416.

5

247.

9

Stat

us o

f ec

onom

ic

deve

lopm

ent

Em

ergi

ng

Eco

nom

y

Em

ergi

ng

Eco

nom

y

Dev

elop

ed

Eco

nom

y

Em

ergi

ng

Eco

nom

y

Dev

elop

ing

Eco

nom

y

Dev

elop

ed

Eco

nom

y

Dev

elop

ed

Eco

nom

y

Dev

elop

ed

Eco

nom

y

Tabl

e 2.

22: L

ife in

sura

nce

mar

ket -

Glo

bal p

ersp

ectiv

e

Cou

ntry

Bra

zil

Chi

na

Fran

ce

Indi

a

Kor

ea

Japa

n

Uni

te d

Sta

tes

of A

mer

ica

Uni

ted

Kin

gdom

Source: www.limra.com

65

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66

20 Reiche, Edward, “The Development of Life Insurance Companies in Emerging

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