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7/29/2019 Insurance Sector of India
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PROJECT ON
insurance sector in India
Bachelor of Commerce-
Banking & Insurance
Semester VI
(2012-2013)
Submitted By
GEETA MEDI
Roll no- 19
GURU NANAK COLLEGE OFARTS,SCIENCE, AND
COMMERCE
G.T.B nagar sion (E), Mumbai -400037
7/29/2019 Insurance Sector of India
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Insurance sector of India.
PROJECT ON
insurance sector in India
Bachelor of Commerce-
Banking & Insurance
Semester VI
(2012-2013)
Submitted By
GEETA MEDI
Roll no- 19
GURU NANAK COLLEGE OFARTS,SCIENCE, AND
COMMERCE
G.T.B nagar sion (E), Mumbai -400037
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Insurance sector of India.
C E R T I F I C A T E
This is to certify that Miss. GEETA MEDI of B.Com -
Banking & Insurance Semester VI (2012-2013) has
successfully completed the project on INSURANCE
SECTOR IN INDIA
under the guidance of SUDHA MAM
Project guide
Principal
Course Co-ordinator:
Internal Examiner:
External Examiner:
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Insurance sector of India.
Declaration
I GEETA MEDI student of B.Com Banking & Insurance Semester
VI (2012-2013) hereby declare that I have completed the Project on
INSURANCE SECTOR IN INDIA The information submitted
is true and original to the best if my knowledge.
Signature of the student
Name of the student
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ACKNOWLEDGEMENT
I would like to thank a lot of people without whom this
project would not have been complete. First prof. SUDHA
MAM she was of utmost help in guiding me structures this
project. She helped me throughout and was always present
to help me whenever I had a doubt.
A research can never be over without access to a good
library and in this case I was blessed as our college library,
is very well stocked with books. And the lending policy
made life a lot easier. And not to forget the unconditional
support provided by my parents and friends.
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Insurance sector of India.
EXECUTIVE SUMMARY:
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Insurance sector of India.
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. A catastrophe
bond is one of the alternatives for reinsurance. Finally some policies
such as pure term and pension schemes needs to be addressed
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.
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Insurance sector of India.
INDEX :
SR CONTENTS PAGE
NO.
NO .
1. INTRODUCTION
1
2. INSURANCE SECTOR - A PREVIEW3
3. LIFE INSURANCE INDEX ( COUNTRYWISE )
6
4. WHY OPEN UP THE INSURANCE SECTOR ?
7
5. GOVERNMENT / RBI REGULATIONS
11
6. INDIAN PARTNER FOREIGN TIE UP
16
7. WHY LIBERALISE, WHAT MARKET STRUCTURE
18
& ROLE FOR THE REGULATOR
8. AN ALTERNATIVE TO REINSURANCE
38
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Insurance sector of India.
9. INVESTMENT AND CAPITAL NORMS
44 10. ROLE OF THE PORTFOLIO
MANAGER 46
11. RESTRUCTURING OF LIC & GIC
53
12. POINTERS FOR THE INDIAN POLICYMAKERS
56
13. CURRENT SCENARIO
60
14. BIBLIOGRAPHY
64
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
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Insurance sector of India.
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:
In the words of D.S. Hansell, Insurance may be defined as a
social device providing financial compensation for the effects of
misfortune,
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Insurance sector of India.
the payment being made from the accumulated contributions of
all parties participating in the scheme.
Contractual definition:
In the words of justice Tindall, Insurance is a contract in which a
sum of money is paid to the assured as consideration of insurers
incurring the risk of paying a large sum upon a given
contingency.
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.
INSURANCE SECTOR A PREVIEW :
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Insurance sector of India.
The insurance sector in India dates back to 1818, when
Oriental Life Insurance Company was incorporated at Calcutta.
Thereafter, few other companies like Bombay Life Assurance
Company, in 1823 and Triton Insurance Company, for General
Insurance, in 1850 were incorporated. Insurance Act was passed
in 1928 but it was subsequently reviewed and comprehensive
legislation was enacted in 1938. 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. General
Insurance followed suit and in 1968, the insurance act was
amended to allow for social control over the general insurance
business. Subsequently in 1973, non-life insurance business was
nationalised and the General Insurance Business
(Nationalisation) Act, 1972 was promulgated. The General
Insurance Corporation (GIC) in its present form was incorporated
in 1972 and maintains a very strong hold over the non-life
insurance business in India. Due to concerns of
(a) Relatively low spread of insurance in the country.
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Insurance sector of India.
(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.
The Committee submitted its report in January 1994,
recommended a phased program of liberalization, and called for
private sector entry and restructuring of the LIC and GIC. 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 an Rs.400 billion business in India, and together with
banking services adds about 7% to Indias GDP. Gross premium
collection is about 2% of GDP and has been growing by 15-20%
per annum. India also has the highest number of life insurance
policies in force in the world, and total investible funds with the
LIC are almost 8% of GDP. Yet more than three-fourths of Indias
insurable population has no life insurance or pension cover.
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Insurance sector of India.
Health insurance of any kind is negligible and other forms of non-
life insurance are much below international standards. 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, and opening up the sector to private
players. A statutory body needs to be made to regulate the
market and promote a healthy market structure. Insurance
Regulatory Authority (IRA) is one such body, which checks on
these tendencies.
INDIVIDUAL LIFE INSURANCE COVERAGE INDEX,
1994
COUNTRY NO. OF POLICIES PER 100
PERSONS
Indonesia 2.0Philippines 5.6
India 12.4
Thailand 14.7
Malaysia 35.5
Hong Kong 69.4
South Korea 70.5
Taiwan 75.2
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Insurance sector of India.
Singapore 112.6
Japan 198.4
Source: Charted Financial Analyst May 1999. (Insurance in
Asia: The financial times, quoted from Tillinghast study)
WHY OPEN UP THE INSURANCE INDUSTRY ?
An insurance policy protects the buyer at some cost against
the financial loss arising from a specified risk. Different situations
and different people require a different mix of risk-cost
combinations. Insurance companies provide these by offering
schemes of different kinds. Unfortunately the concept of
insurance is not popular in our country. As per the latest
estimates, the total premium income generated by life and
general insurance in India is estimated at around a meagre
1.95% of GDP. However Indias share of world insurance market
has shown an increase of 10% from 0.31% in 1996-97 to 0.34%
in 1997-98. Indias market share in the life insurance business
showed a real growth of 11% thereby outperforming the global
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average of 7.7%. Non-life business grew by 3.1% against global
average of 0.20%. In India insurance spending per capita was
among the lowest in the world at $7.6 compared to $7 in the
previous year. Amongst the emerging economies, India is one of
the least insured countries but the potential for further growth is
phenomenal, as a significant portion of its population is in
services and the life expectancy has also increased over the
years. The nationalized insurance industry has not offered
consumers a variety of products. Opening of the sector to private
firms will foster competition, innovation, and variety of products. It
would also generate greater awareness on the need for buying
insurance as a service and not merely for tax exemption, which is
currently done. On the demand side, a strong correlation between
demand for insurance and per capita income level suggests that
high economic growth can spur growth in demand for insurance.
Also there exists a strong correlation between insurance density
and social indicators such as literacy. With social development,
insurance demand will grow.
Future course of Insurance Business:
One of the main differences between the developed economies
and the emerging economies is that insurance products arebought in the former while these are sold in latter. Focus of
insurance industry is changing towards providing a mix of
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protection / risk over and long-term investment opportunities.
Some of the major international players in the insurance
business, which might try to enter the Indian market, are Sun
Life of Canada, Prudential of the United Kingdom, Standard Life,
and Allianz etc. Although the insurance sector is officially open to
private players, they still need a license from the IRDA, which will
announce its guidelines in May 2000. Following might be the
future strategies of insurance companies.
(1) The new entrants cannot compete with the state owned
LIC on price alone. Due to its size, LIC operates at very
low costs and their premia on policies that offer pure
protection are on a par with comparable schemes across
the globe. What the new
insurance companies will probably offer is higher returns
than the annualized 9-10% one can hope to earn from LICs
policies. This will put pressure on LIC to offer more
attractive returns.
(2) Consumers can also expect product innovations. For
instance,
at present, LIC provides cover for permanent disability and
what the new companies could offer is temporary disability
insurance as well.
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(3) Apart from the basic term insurance, most insurance
products worldwide are sold as long-term investment
opportunities with the protection component being clearly
spelt out in the scheme.
(4) LICs policies are not flexible according to the customers
needs. 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. New products would also enable
product combinations that allow greater customisation.
(5) Private insurers would compete furiously on the service
platform. 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 approach. They would be better
qualified in assisting clients in financial planning.
(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 customizing products to suit
individual needs.
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(7)The foreign players will probably introduce a lot of
innovation and competition on Surrender value. 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.
(8)Access to insurance too will probably become more
widespread. 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.
(9) In reaction to foreign players strategies one might expect
LIC to react and drop its premia and upgrade its services.
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Insurance sector of India.
BOTTLENECKS GOVERNMENT / RBI
REGULATIONS:
The IRDA bill proposes tough solvency margins for
private insurance firms, a 26% cap on foreign equity and a
minimum capital of Rs.100 crores for life and general
insurers and Rs. 200 crores for reinsurance firms. 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. LIC may invest the
remaining 25% in private corporate sector, construction, and
acquisition of immovable assets besides sanctioning of
loans to policyholders. These stipulations imposed on the
insurance companies had resulted in lack of flexibility in the
optimisation of risk and profit portfolio. If this inflexibilitycontinues, 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.
The government might provide more autonomy to insurance
companies by allowing them to invest 50 % of their funds as per
their own discretions. Recently RBI has issued stiff guidelines,
which had dealt a severe blow to the plans of banks and financial
institutions to enter the insurance sector. It says that non-
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performing assets (NPA) levels of the prospective players will
have to be 1% point lower than the industry average (presently
7.5%). RBI has also stipulated that all prospective entrants need
to have a net worth of Rs. 500 crores. These guidelines have
made it virtually impossible for many banks to get into the
insurance business. Also banks and FIs who are planning to
enter the business cannot float subsidiaries for insurance. 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. They had to
rethink about these guidelines if Indias strong banks and
financial institutions have to enter the new business. The
insurance employees union is offering stiff resistance to any
private entry. Their objections are
(a) that there is no major untapped potential in insurance
business in India;
(b) that there would be massive retrenchment and job
losses due to computerization and modernization;
and
(c) that private and foreign firm would indulge in reckless
profiteering and skim the urban cream market, and
ignore the rural areas.
But all these fears are unfounded. The real reason behind the
protests is that the dismantling of government monopoly would
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provide a benchmark to evaluate the governments insurance
services.
OPENING UP OF INSURANCE SECTOR :
Indian History: Time to turn the clock back-and open up
insurance. For two years, around 30 foreign insurers have
eagerly explored the nationalized Indian insurance market,
preparing to leap in when private participation is allowed. But it
seems they have an endless wait before the sector is opened up.
That's ironical: in 1947, many of these insurers were firmlyestablished here. BAT subsidiary Eagle Star, for example,
opened offices in Calcutta in 1894. By 1921, it was doing
business with Brooke Bond and the Birlas. Prudential's first Asia
office was opened In India in 1923. Fifty years ago, India had a
bustling, if somewhat chaotic, entirely private insurance industry.
The year after Independence, 209 life Insurance companies were
doing business worth Rs712.76 crore (which grew to an amazing
Rs 295,758 crore in 1995-96). Foreign insurers had a large
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market share 40 per cent for general insurance but there were
also plenty of Indian companies, many promoted by business
houses like the Tatas and Dalmias. The first Indian-owned life
insurance company, the Bombay Mutual Life Assurance Society,
was set up in 1870 by six friends. It Insured Indian lives at the
normal rates instead of charging a premium of 15 to 20 percent
as foreign insurers did. Its general insurance counterpart, Indian
Mercantile Insurance Company Ltd., opened in Bombay in 1907.
A plethora of insufficiently regulated
players was a sure recipe for abuse, especially because there
was no separation between business houses and the insurance
companies they promoted. The Insurance Act, 1938, introduced
state controls on insurance, including mandatory investments in
approved securities, but regulation remained ineffective. In 1949,
Purshottamdas Thakurdas, chairman of the Oriental Assurance
Company, admitted: "We cannot deny that, today, there is a
tendency on the part of insurance companies in general to make
illicit gains.
Can we overlook the cutthroat competition for acquiring
business?And still worse is the dishonest practice of adjusting
of accounts." After a 1951 inquiry, the government was dismayed
that companies had high expense and premium rates, were
speculating in shares, and giving loans regardless of security. No
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wonder that between 1945 and 1955, 25 insurers went into
liquidation and 25 transferred their business to other companies.
This reckless record stoked the pro-nationalisation fires. The
1956 life insurance Nationalisation was a top-secret intrigue; for
fear that unscrupulous insurers would siphon funds off if warned.
The government resolved to first take over the management of
life insurance companies by ordinance, then their ownership.
The ordinance transferred control of 245 insurers to the
government. LIC, established eight months later, took over their
ownership. General Insurance had its turn in 1972, when 107
insurers were amalgamated into four companies headquartered
in the four metros, with GIC as a holding company.
Nationalization brought some benefits. Insurance spread from an
urban-oriented, high-end business to a mass one. Today, 48 per
cent Of LIC's new business is rural. Net premium income in
general insurance grew from Rs.222 crore in 1973 to Rs.5,956
crore in 1995- 96. Yet, rigid controls hamper operational flexibility
and initiative so both customers service and work culture today
are dismal. The frontier spirit of the early insurers has been lost.
Insurance companies have also been timid in managing their
investment portfolios. Competition between the four GIC
subsidiaries remains illusory.
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Insurance sector of India.
WHOS GOING WITH WHOM?
Indian Company Foreign PartnerKotak Mahindra Chubb, US
Tata Group AIG, US
Sundram Finance Winterthur, SWITZERLAND
Sanmar Group GIO of Australia
M A Chidambaram MetLife
Bombay Dyeing General Accident, UKDCM Shriram Royal Sum Alliance, UK
Dabur Group Liberty Mutual Fund, USA
Godrej J. Rothschild, UK
ITC Eagle star, UK
S K Modi Group Legal and General, Australia
CK Birla Group Zurich Insurance, Switzerland
Ranbaxy Cigna, US
Alpic Finance Allianz, GERMANY
20th Century Finance Canada Life
Vyasa Bank ING
Cholmandalam Guardian Royal Exchange, UK
SBI Alliance Capital
HDFC Standard Life, UK
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Insurance sector of India.
ICICI Prudential, UK
IDBI Principal
Max India New York Life
The privatisation of the insurance sector would open up exciting
new career options and new jobs would be created. A few
insurers estimated a figure of 1lakh, after comparing the work
forces in India and the UK. At present, life products comprise a
big chunk, or 98%, of LICs business. Pension comprises a mere
2%. Now with increase in life expectancy rate, people have to
start planning their retirements. Hence pension business is
expected to grow once the industry opens. The demand for
healthcare is growing due to population increase, greater urban
migration and alarming levels of pollution. 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. Foreign insurance companies
like Aetna (worlds largest healthcare insurance provider) and
Cigna have been providing Managed Care services across the
globe. Managed Care integrates the financing and delivery of
appropriate health care services to covered individuals.
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Insurance sector of India.
WHY LIBERALIZE, WHAT MARKET STRUCTURE TO
HAVE FINALLY, WHAT ROLE FOR REGULATOR?
Introduction:
The decision to allow private companies to sell insurance
products in India rests with the lawmakers in Parliament. These
are the passage of the Insurance Regulatory Authority (IRA) Bill,
which will make IRA a statutory regulatory body, and amending
the LIC and GIC Acts, which will end their respective monopolies.
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. In particular, we do not address many other related
questions such as whether foreign (and not just private) playersshould be allowed, what cap should there be on foreign equity
ownership, whether banks and other financial institutions should
be allowed to operate in the insurance business, whether firms
should be allowed to sell both life and -non-life insurance, and so
on.
The three questions that we address are
(a) Why should insurance be opened up to private players?
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(b) If opened up, what should be the appropriate market
structure?
(many unregulated players or a few regulated players); and
finally,
(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. An insurance contract is a
"promise to pay" contingent on a specified event. In the case of
insurance and banking, smooth functioning of business depends
heavily on the continuation of the trust and confidence that
people place on the solvency of these financial institutions.
Insurance products are of little value to consumers if they cannot
trust the company to keep its promise. Furthermore, banking and
insurance sectors are vulnerable to the "bank run" syndrome,
wherein even one insolvency can trigger panic among consumers
leading to a widespread and complete breakdown. This implies
the need for a public regulator, and not public provision of
insurance. Indeed in India, insurance was in the private sector for
a long time prior to independence. The Life InsuranceCorporation of India (LIC) was formed in 1956, when the
Government of India brought together over two hundred odd
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Insurance sector of India.
private life insurers and provident societies, under one
nationalized monopoly corporation, in the wake of several
bankruptcies and malpractices'. Another important justification for
Nationalisation was to raise the much-needed funds for rapid
industrialization and self-
reliance in heavy industries, especially since the country had
chosen the path of state planning for development. Insurance
provided the means to mobilize household savings on a large
scale. LIC's stated mission was of mobilizing savings for the
development of the country.
The non-life insurance business was nationalized in 1972
with the formation of General Insurance Corporation (GIC).
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. If traditional infrastructure and
"semi-public goods" industries such as banking, airlines, telecom,
power, and even postal services (courier) have significant, private
sector presence, continuing a state monopoly in provision of
insurance is indefensible. This is not to deny that there are some
valid grounds for being cautious about private sector entry. Some
of these concerns are:
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Insurance sector of India.
(a) That there would be a tendency of private companies to
"skim" the markets; thus private players would concentrate on the
lucrative mainly urban segment leaving the unprofitable segment
to the incumbent LIC.
(b) That without adequate regulation, the funds generated may
not be deployed in sectors (which yield long-term social benefits),
such as infrastructure and public goods; similar without
regulation, private firms may renege on their social sector
investment obligations. Meeting these concerns requires a strong
regulatory body. Another
commonly expressed fear is that there would be massive job
losses in the industry as a whole due to computerization. This
however does
not seem to be corroborated by the countries' experience'.
Moreover, apart from consideration based on theoretical
principles alone, there is sufficient evidence that suggests that
introduction of private players in insurance can only lead to
greater benefits to consumers. This can be seen from the fact
that the spread in insurance in India is low compared to
international benchmarks. The two convention measures of the
spread of insurance are penetration and density. The former
measure (premiums per unit) of GDP, and the latter, premiums
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Insurance sector of India.
per capita. Less than 7% of the population in India has life
insurance cover. In Singapore, around 45 per cent of the people
are covered and in Japan, this is close to 100 per cent. In the US,
over 81 per cent the households have insurance cover. India has
the biggest life insurance sector in the world if we go by the
number of policies sold, but the number of policies sold per 10
persons is very low. The demand for insurance is likely to
increase with rising per-capita incomes, rising literacy rates and
increase of the service sector, as has been seen from the
example of several other developing countries. In fact, opening
up of the insurance sector is an integral part of the liberalization
process being pursued by many developing countries. After
Korean and Taiwanese insurance sectors were liberalized, 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. Philippines opened up its insurance sector in 1992. There
are
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
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Insurance sector of India.
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
the funds required in the next two decades are more than Rupees
4000 billion. Finally, private sector entry into insurance might be
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Insurance sector of India.
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 eventoccurs. 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
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insurance cannot distinguish between the buyer's type i.e.,
whether
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,
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(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. IRAs functioning can be financed by
levying a
small fee on the premium income of the insurers thus putting zero
cost on the government and giving itself autonomy.
( a ) Protection of Customer Interests :
IRAs first brief is to protect consumer interests. This
means ensuring proper disclosure, keeping prices affordable but
also insisting on some mandatory products, and most importantly
making sure that consumers get paid by insurers. Ensuring
proper disclosure is called Disclosure Regulation. Insurance
contracts are basically contingency agreements. They can be full
of inscrutable jargon and escape clauses. An average consumer
is likely to be confused by them. IRA must require insurers to
frame transparent contracts. Consumers should not have to wake
up to unpleasant surprises, finding that certain contingencies are
not covered. The IRA also has to ensure that prices of products
stay reasonable and certain mandatory products are sold. The
job of keeping prices reasonable is relatively easy, since
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competition among insurers will not allow any one company to
charge exorbitant rates. The danger often is that prices may be
too low and might take the insurer dangerously close to
bankruptcy. As for mandatory products, those that involve
common and well-known risks, certain standardization can be
enforced. Furthermore, IRA can insist that for such products the
prices also be standardized. From the consumers point of view
the most important function of IRA is ensuring claim settlement.
Quick settlement without unnecessary litigation should be the
norm. For example, in motor
vehicle insurance, adopting no-fault principle can speed up many
settlements. Currently, LIC in India has a claims settlement ratio
of 97%, an impressive number by any standards. However, it
hides the fact that this settlement is plagued by long delays,
which reduce the value of settlement itself. If consumers have a
complaint against an insurer they can go to a body formed by
association of insurers. The decision of such a body would be
binding on the insurers, but not on the complainant. If
complainants are not satisfied, they can go to court. Some
countries such as Singapore have such a system in place. This
system offers a first and quicker choice of settling out of court.
IRA can encourage the insurers to have such a grievance
redressal mechanism. This system can serve the function of
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adjudication, arbitration and conciliation. The second area of
IRAs activity concerns monitoring insurer behavior to ensure
fairness. It is especially here that IRAs choice of being a
bloodhound or a watchdog would have different implications. We
think that an initial tough stance should give way to a more
forbearing and prudential approach in regulating insurance firms.
When the industry has a few firms there is some chance of
collusion. IRA must be alert to collusive tendencies and make
sure that prices charged remain reasonable. However, some
cooperation among the insurance companies could be
considered desirable. This is especially in lines where claim
experience of any one company is not sufficient to make accurate
forecasts. Collusion among companies on information sharing
and rate setting is considered fair. IRA must have severe
penalties in
case of fraud or mismanagement. Since insurance business
involves managing trust money, in some countries the
appointment of senior managers and key personnel has to be
approved by the insurance regulatory agency.
( b ) Ensuring Solvency of Insurers :
There are basically four ways of ensuring enough
solvencies.
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First is the policy of a price floor.
Second is the restriction on capital and reserves, i.e., on what
kind of investments and speculative activities firms can make.
Third is putting in place entry barriers to restrict the number of
competitors.
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,
which involves
capital adequacy among other things. Since there are economies
of scale and scope in insurance operations it might be better to
have only a few large firms. There is however no magic number
regarding the optimal number of firms. Restricting competition
provides a scope for higher profits to the companies thereby
strengthening their solvency position. After qualifying, the
entrants are continuously subjected to restrictions on reserves
and investments, which ensure ongoing solvency. Additionally, a
guarantee fund, created by mandatory contributions from all
insurance companies is used to bail out any insurance company,
which might be in financial trouble. This guarantee fund does not
imply that firms can charge whatever they wish to their
consumers. All insurance companies would have an incentive to
monitor the activities of their rival peer firms. This is because
insolvency of any insurance company would entail a price, which
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all the insurance companies would have to shoulder. Peer review
of accounts can also be institutionalized.
IRA can have several ways for early detection of a potential
insolvency. 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. If
some of these ratios fall outside given limits the company is
asked to take corrective action. Insolvency can also arise out of
reinsures abandoning insurance companies in the lurch, as
witnessed in the USA in 1980s. Reinsurance is a bigger business
dominated by large international reinsurers. Such litigation
between reinsurer and insurance companies involves cross
boundary legalities and can drag on for years. IRA must evolve a
set of operational guidelines to deal with reinsurance matters.
Insurance intermediaries such as agents, brokers,
consultants and surveyors are also under IRAs jurisdiction. IRA
has to evolve guidelines on the entry and functioning of such
intermediaries. Licensing of agents and brokers should be
required to check against their indulging in activities such as
twisting, rebating, fraudulent practices, and misappropriation of
funds. IRA can also consider allowing banks to act as agents
(as opposed to underwriters) of insurers in mass base types of
products. Given their
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wide network of branches and their customer base, the banks
can access this market for insurance products and also earn
commission income. The incremental cost of providing such
insurance products would be much lower.
( c ) Promoting Growth in the Insurance Industry :
A society experiences many benefits from the spread of
insurance business. Insurance contributes to economic growth by
enabling people to undertake risky but productive activity. In the
past,
growth of trade has been facilitated by the development of
insurance services. One only needs to look at the history of
insurance to see how evolution of insurance helped trade flows
along various trade routes. Promotion of insurance also provides
for long-term funds, which are utilized to fund big infrastructure
projects. These projects typically have positive externalities,
which benefit society at large. IRA can ensure growth of
insurance business with better education and protection to
consumers, and by making the insurance business a level playing
field. They can also support Indian insurance companies in the
international field. IRA thus has to frame the rules, design
procedures for enforcement and also make operational
guidelines. All this with virtually no relevant historical data makes
the task very difficult. An initial conservative approach (the
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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, the IRA can relax its initial
harsh stance and
adopt a more accommodating stance (the watchdog). 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. IRA can
also consider allowing banks to act as agents (as opposed to
underwriters of insurers in mass base types of products. Given
there wide network of branches their customer base, the banks
can access this market for insurance products and also
commission income. The incremental cost of providing such
insurance products would be much lower. 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 major insurance markets in South and East
Asia are in varying degrees opposite. 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.
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LIBERALISATION OF INSURANCE INDUSTRY :
While no aspect of the reform process in India has gone
smoothly since its inception in 1991, no individual initiative hasstirred the proverbial hornets' nest as much as the proposal to
liberalise the country's insurance industry. However, 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
Regulatory Authority (IRA) Bill both by the central Cabinet and
the standing committee on finance. 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. In this context, 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. 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, regulations
have potentialto adversely affect the pricing of risks, especially in the non-life
industry, and hence the viability of the insurance companies.
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Finally, the backdrop of US experience provides some pointers
for Indian policymakers.
Introduction :
The insurance sector continues to defy and stall the course of
financial reforms in India. It continues to be dominated by the two
giants, Life Insurance Corporation of India (LIC) and the General
Insurance Corporation of India (GIC), and is marked by the
absence of a credible regulatory authority. The first sign ofgovernment concern about the state of the insurance industry
was revealed in the early nineties, when an expert committee
was set up under the
chairmanship of late R.N.Malhotra. The Malhotra Committee,
which submitted its report in January 1994, made some far--
reaching recommendations, which, if implemented, could change
the structure of the insurance industry. The Committee urged the
insurance companies to abstain from indiscriminate recruitment
of agents, and stressed on the desirability of better training
facilities, and a closer link between the emolument of the agents
and the management and the quantity and quality of business
growth. It also emphasized the need for a more dynamic man-
agement of the portfolios of these companies, and proposed that
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a greater fraction of the funds available with the insurance
companies be invested in non government securities. But, most
importantly, the Committee recommended that the insurance
industry be opened up to private firms, subject to the conditions
that a private insurer should have a minimum paid up capital of
Rs. 100 crore, 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. Finally, 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). Subsequent to the
submission of its report by the Malhotra Committee, there were
several abortive attempts to introduce the Insurance Regulatory
Authority (IRA) Bill in the Parliament. It is evident that there was
broad support in favour of liberalisation of the industry, and that
the bone of contention was essentially the stake that foreign
entities were
to be allowed in the Indian insurance companies. In November
1998, 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, and 14
per cent for Non resident Indians (NRIs), Overseas
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corporate bodies (OCBs) and Foreign institutional investors
(FIIs).
However, in view of the widespread resentment about the
40 per cent ceiling among political parties, the Bill was referred to
he standing committee on finance. The committee has since
recommended at each private company be allowed to enter only
one of the three areas of business life insurance, general or non
life insurance, 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. 200 crore, double the
amount proposed by the Malhotra Committee.
Economic Rationale :
The insurance industry is a key component of the financial infra-
structure of an economy, and its viability and strengths have far
reaching consequences for not only its money and capital
markets,' but also for its real sector. For example, if households
are unable to
hedge their potential losses of wealth, assets and labour and non
labour endowments with insurance contracts, many or all of them
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will have to save much more to provide for events that might
occur in the future, events that would be inimical to their interests.
If a significant proportion of the households behave in such a
fashion, the growth of demand for industrial products would be
adversely affected. Similarly, if firms are unable to hedge against
"bad" events like fire and the job injury of a large number of
labourers, the expected payoffs from a number of their projects,
after factoring in the expected losses on account such "bad"
events, might be negative. In such an event, the private invest-
ment would be adversely affected, and certain potentially
hazardous activities like mining and freight transfers might not
attract any private investment. It is not surprising; therefore, that
economists have long argued that insurance facility is necessary
to ensure the completeness of a market.
ORGANISATIONAL STRUCTURES AND THEIR
IMPLICATIONS :
Insurance companies can be broadly divided into four
categories: stock companies, mutual companies, reciprocal
exchanges, and Lloyds companies. The former two are the
dominant forms of organisational structures in the US insurance
industry. A stock company is one that initially raises capital by
issue
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of shares, like a bank or a non bank financial institution, and
subsequently generates more funds for investment by selling
insurance contracts to policyholders. In other words, there are
three sets of stakeholders in a stock insurance company, namely,
the shareholders, managers and the policyholders. A mutual
company, on the other hand, raises funds only by selling policies
such that the policyholders are also partners of the companies.
Hence, a mutual company has only two groups of stakeholders,
namely, the policyholder cum part owners and the managers. As
in any organisation, the objectives of the owners, managers and
policyholders are significantly different, giving rise to conflicts of
interest. Specifically, owners and managers are often more keen
to undertake risky activities than are the policyholders, largely
because the former have limited liability such that, in the event of
an unfavorable outcome, the policyholders will have to bear the
lion's share of the loss. However, it is unlikely that in a company
that the appetite of the owners and the managers will be similar,
and this provides the owners with a rationale to monitor the
managers. In principle, both the shareholders in a stock company
and the policyholder owners in a mutual company have it in their
interest to monitor, the managers. But whereas stockholders can
exit a company easily by selling its shares in the secondary
market, thereby paving the way for a take over, the policyholder
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owners find it more difficult to exit because they then have to
incur the informational cost of associating themselves with
another (viable) company. In other
words, the threat of exit by owners, and the associated threat of
overhaul of the incumbent management by the owners, is more
credible for stock insurance companies than for mutual insurance
companies. Hence, 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, the mutual insurance companies
are likely to be more conservative with respect to risk taking than
the stock companies. Alternatively, if an insurance company
writes lines of business that do not require a significant amount of
managerial discretion, 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.
Some insurance products not available in India :
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Associated Market Quest after a study of some of the
international markets, points out the following areas for new
product development: 1. Industry all risk policies
2. Large projects risk cover
3. Risk beyond a floor level
4. Extended public and product liability cover
5. Broking and captivities.
6. Alternative risk financing
7. Disability insurance
8. Antique insurance
9. Mega show insurance
10. Celebrity visits to the country.
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AN ALTERNATIVE TO REINSURANCE :-
Reinsurance is a process by which private insurers
transfer some part of their risk to reinsurers. That is, the reinsurer
reimburses the private insurer any sum paid to the policyholdersagainst the claims lodged. The need for reinsurance assumes
importance given the increasing uncertainty faced by individuals
and businesses. Consider for instance, the earthquake in Gujarat
that has left millions homeless and damaged property worth
crores of rupees. Will the private insurers be in a position to
honour claims of such magnitude?
The answer is No. The reason? The policy premiums are
priced by the insurers based on the probability of claims. But if
the man-created stock market is itself so difficult to predict, 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. Private insurers cannot
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resort to high levels of debt and equity to finance their business
for the earnings uncertainty will dampen the returns. Will the
private insurer be able to transfer their risk to reinsurers? That is
indeed, a moot point, for two reasons. First the basket of
insurance products is likely to expand once private insurers enter
the market. The rationale is this: at present General Insurance
Corporation (GIC) offers products of a general nature, such as
theft and accident insurance. The corporation may enjoy a price
advantage over the private
insurers, as it is not compelled to work on a profit motive, thanks
to being a government arm. And second, it is unlikely that the
reinsurance market will match the pace of the insurance market.
The reason? If a natural disaster occurs, the losses suffered on
account of the claims can cripple the reinsurers. 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. This is
because capital market is huge and can take on the risk that
insurance companies run. The solution is Asset-backed
securities (ABS). A private insurer can bundle off policies with
similar maturity and quality and sell them as securities to retail
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investors. The private insurer can float a Special-Purpose
Vehicle(SPV) and sell the policies concerned to this entity. The
SPV can bundle the policies and sell them as securities to retail
investors at attractive yields. The premium on the policies
underlying the ABS can be invested by the SPV in low-risk, highly
liquid instruments. The benefits of the SPV are First; the SPV is
a separate entity from the insurer. This enables easy rating of the
ABS, as the credit rating agency will be able to identify the
underlying assets. Second, by selling the policies to the SPV, the
insurer removes the assets from its balance sheet. 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.
So when the policyholders (underlying the ABS) lodge the
claims with the private insurer, the private insurer simply passes
on the claims to the SPVs. The SPV, in turn will liquidate its
investments and meet the claims. The SPV will stop paying
interest on the ABS. The retail investors, therefore, bear a sizable
portion of claims of the policyholders. There can of course be
many variants to the ABS. The most risky ABS, from the
investors angle, will be those that stop interest payments and
delay principal repayments of claims are honored. Also buying
ABS helps retail investors truly diversify their portfolio. This is
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because probability of claims from, say, a hurricane is largely
unrelated to the economic factors or industry-specific factors that
drive equity and bond values. Besides, investors get attractive
yields for taking the risk. If mutual funds invest in ABS, retail
investors need not estimate the risk associated with the
investment, the fund manager will do the needful. The problem of
adverse selection, on the other hand, can be reduced if the ABS
are credit-enhanced by a third party and rated by a credit rating
agency.
In India, debt market is not deep and liquid enough to
receive products such as asset-backed securities. Moreover,
regulatory restrictions, such as high stamp duty and a not-so-
efficient judicial system, may act as deterrents. Finally the
alternative risk transfer market will only develop once the need for
such risk transfer assumes importance some time in the future.
CATASTROPHE BONDS :
Catastrophe ( CAT ) bonds are one class of securities that
provide reinsurers access to the capital markets. In a typical CAT
bond, a special purpose vehicle acts as the reinsurer by issuing
debt in the capital markets and providing a reinsurance policy to
the ceding insurer. Generally, a predefined loss limit is set, above
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which the reinsurer provides the coverage in the amount of the
bond issuance. This loss limit, which functions like a deductible,
is known as the attachment point. Should there be an event
causing losses in excess of the attachment point, proceeds that
otherwise go to the bondholders are used to pay the claims.
Besides structural and issuance-related concerns, modeling the
risks for the ceding insurers book of business is critical to the
proper analysis of the CAT bond transaction. Catastrophe
reinsurance bonds are gaining popularity as an alternative source
of funding for property and casualty reinsurance. 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.
Product pricing :
Pricing of insurance products, as empirically available in India,
shows that pricing is not in consonance with market realities. LifeInsurance premia are generally perceived as being too high while
general insurance (especially motor insurance) is priced too low.
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LIC has, over a period of time, affected price reduction. For
instance on 'without profit policies' (that is, those which are not
eligible for bonuses), the premium rates were reduced between 2
percent to 7 percent during the 1970's. Subsequently in 1986, the
premium rates were further reduced by 17% for such policies.
Practices, such as charging extra premium on female insurance,
were also discontinued. However, these instances are an
inadequate response to the changes taking place in the market.
One of the most significant changes has been the improvement in
Life Expectancy of individuals. For males this has improved from
41.89 years in 1961 to 62.80 years
in recent times. Similarly, female life expectancy has improved
from 40.55 years in 1961 to 64.20 years. The problem faced by
LIC in incorporating the trends in life expectancy in to their
actuarial calculation has been partly technological and partly
organizational. 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. Currently,
the LIC uses the 1970-73 mortality tables for most of the premium
calculations and for "without profit policies", the 1975-79 mortality
rates are used.
In the case of general insurance the issue of product pricing
can be grouped into two categories.
1. Those that fall under tariff regulations and controlled by Tariff
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Advisory Committee (TAC)
2. Those that fall outside tariff regulations.
INVESTMENT OF INSURANCE FUNDS :
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Any reform of the insurance sector must necessarily
consider aspects related to the investment of insurance funds.
Under sec 27A of the insurance act and its application in the LIC
act, the manner in which LIC can deploy its funds is stated. Under
the current guidelines, the LIC is required to invest 75% of the
accretions through a controlled fund in certain approved
investments. 25% of accretions may be invested by LIC for
investments in private corporate sectors, loans to policyholders,
construction and acquisition of immovable assets. Thesestipulations have resulted in the lack of flexibility in the
optimization of its risk and profit portfolio.
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. Similarly, 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
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paid up capital requirements. The Malhotra committee (1994)
recommended
Rs 100 crores as the norm. 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. 50 crore. 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.
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, is the vast potential for
future business. Restricted, as the market has been, through the
operations of the two monopolies (LIC and GIC), it is generally
felt that the sector can grow exponentially if it is opened up. The
decade 1987-97 has witnessed a compounded growth rate of
marginally more than 10% in life insurance business. LIC predicts
for itself that its business has potential to grow by 16.27% p.a. in
a decade 1997-2007 (LIC, 1997).
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If we take a look at insurance coverage index for the age group of
20-59 years a considerable gap between India and other
countries in Asia can be observed. In this scenario, naturally
insurance companies see a vast potential.
THE ROLE OF PORTFOLIO MANAGEMENT :
Portfolio and asset liability management are important for
both life and property liability insurance companies. However, the
latter face the problem that their liabilities are far more
unpredictable than the liabilities of the life insurance companies.
For example, given a stable mortality table and other historical
data, it is easier to predict the approximate number of death
claims, than the approximate number of claims on account of caraccidents and fire. As a consequence of such uncertainty, 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. Hence, 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. Although the role of
an insurance policy is significantly different from that of
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investments, economic agents like households have increasingly
viewed insurance contracts as a part of their investment portfolio.
This change in perception has not affected much the status of the
property liability or non life insurance policies, which are still
viewed as plain vanilla insurance contracts that can be used to
hedge against unforeseen calamities. However, the perception
about life insurance contracts has perhaps been irrevocably
altered, and it has changed the nature of fund management of
insurance companies significantly, forcing them to move away
from passive portfolio
management to active asset liability management. The change in
perception of the households became apparent during the 1950s,
when stock prices rose sharply in the US. Given the steep
increase in the opportunity cost of funds, 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 premium for a term insurance policy is lower than the
premium for a whole life policy. 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. As a consequence, the life insurance
companies were forced to think about development of new
products that could give the investors returns commensurate with
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the pins in the stock market. 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.
The insurance companies started offering universal life, variable
life, and flexible premium variable life products. These policies
bundled insurance coverage with investment opportunities, 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. Most of these contracts carried
guaranteed Minim urn death benefits, but returns over and above
that were determined by the inflow of premia and the subsequent
investment experience. Some of the policies could also be forced
into expiration if the afore mentioned inflow and experience fell
below some critical minimum levels.
Further, policy loans were offered only at variable rates of
interest. In other words, the policyholders were increasingly co-
opted into sharing market and interest rate risks with the
insurance companies. As a consequence of these changes,
which brought about a bundling of insurance and investment
products, portfolio management of life insurance companies
today is similar to that of a bank or non bank financial company.
They have to,
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(i) look out for arbitrage opportunities in the market place
both across markets and over time,
(ii) use value at risk modeling to ensure that their reserves
are adequate to absorb market related shocks,
(iii) ensure that there is no mismatch of duration between
their assets and liabilities, and
(iv) ensure that the risk return trade off of their portfolios
remain at an acceptable level.
During the 1980s, the life insurance companies gradually reduced
the duration of the fixed income securities in their portfolio,
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, including mortgage backed securities. However,
while the increased liquidity of their portfolios reduced their risk
profiles, they also required active management of these portfolios
in accordance with the changing liability structures and market
conditions. Today, while life insurance companies compete for
market share by changing the nature and
structure of their products, their viability is critically dependent on
the quality of their portfolio and asset liability management.
IMPLICATIONS OF COST MANAGEMENT :
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As is the case with most competitive industries, profitability
and viability of a firm in the insurance industry significantly
depends on its market share, and its ability to minimise its cost of
operations without compromising the quality of its service and risk
management. Perhaps the easiest way to reduce cost is to
reduce the cost of processing and underwriting policy
applications. In the US, the average cost of processing and
underwriting an application has been estimated to be in excess of
US $250. As a consequence, insurance companies haveincreasingly 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."
However, the US companies have found it more difficult to
reduce their cost of marketing and distribution. A significant part
of these expenses accrue on account of the commissions paid to
exclusive and/or independent agents, the usual rate of
commission being 15 to 30 per cent, depending on the line of
business. As such, independent agents have greater bargaining
power than the exclusive agents because they "own" the
insurance contracts held by the policyholders, and can switch
from one insurance company to another at will. These agents
also benefit from the perception that, as
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outsiders having bargaining power vis a vis the insurance
companies, they will be able to ensure better service for the
policyholders. In order to mitigate the cost related problem,
insurance companies in the US are increasingly looking at
alternative ways to market and distribute their products. Direct
marketing has gained popularity, as has marketing by way of
selling insurance products through other financial organizations
like banks and brokers. These actions might lead to significant
reduction of cost of operations of insurance companies, 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.
The Impact of Regulation :
While portfolio and cost management are important determinants
of the viability of insurance companies, 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. The nature of regulation of life
insurance companies, however, has differed significantly from thenature of regulation of property liability companies. Regulation of
the former has typically emphasized asset quality, while the
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regulation of the latter has largely concerned itself with
policyholder's "welfare." The regulations had impact on the
quality of bonds held by the life insurance companies. New York's
insurance regulatory laws require that life insurance companies
ensure that, for all bonds purchased by them, the companies
issuing the bonds have had enough earnings to meet debt
obligations for the previous five years. The bond issuing
companies are also required to have net earnings 25 per cent in
excess of the annual fixed charges, and they should not be in
default with respect to either principal or interest payments.
Further, regulation of various states impose quantitative
restrictions on the amount of "risky" bonds that can be purchased
by the insurance companies. Finally, regulations of all states are
subject to the life insurance asset portfolios to the Mandatory
Security Valuation Reserve (MSVR) requirement. According to
this requirement, which came into effect in June 1990, life
insurance companies are required to make mandatory provisions
for all corporate securities. The minimum provisioning, for A rated
and higher quality bonds, is 0.1 per cent of par value, and the
maximum provisioning of 5 per cent is required for Caa rated (or
equivalent) and lower quality bonds. If the issuer of a bond goes
into default, the relevant loss is adjusted against the MSVR
account rather than against the company's surplus.
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Further, the non life industry has suffered significantly as a
consequence of changing legal ethos. In the recent past, the US
courts have retroactively granted citizen policyholders coverage
against hazards, like those from use of asbestos, that were not
factored into the actual insurance contract. As a consequence,
the
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.
However, while politics and changing ethos might together have
dealt an unfair blow to the non life insurance companies, the
importance of regulation cannot be overemphasized. 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 property liability cycle is
typically initiated by an exogenous shock which increases the
industry's profits. The higher profits enable the companies to
underwrite more policies at a lower price. During this phase, the
insurance market is believed to be "soft." The decrease in price
during the soft phase, in turn, reduces the profitability of the
companies, and initiates the downturn in the cycle leading to the
"hard" phase. Hard markets are characterized by higher prices
and reduced volumes. Once the higher prices restore the
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industry's profitability, the market softens again and the cycle
starts again.
RESTRUCTURING OF LIC AND GIC :
In the insurance sector as of today and in all probabilities for a
long time to come, LIC and GIC will form a very significant part.
The reasons for these are many.
Firstly, they have been in business for a long time and therefore,
are in position to know business conditions better than any new
entrant. Secondly, the network of branches and agents is large,
deep and penetrating, which will take a long time for any other
entrant to replicate.
Thirdly, (especially the LIC), has a kind of government backing
which instills faith in all would-be policy holders, much more thana private company can hope to generate. The envisaged private
sector participation in the insurance sector is unlikely to take this
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advantage away from LIC and GIC. In the short run atleast. 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. This also means
that the reform in insurance sector will necessarily mean the
reform of LIC and GIC.
THE PRESENT STATE OF AFFAIRS :
YEAR S.A. NO OF POL. P.INCOME INVEST.
L.FUND
(Rs.Crore) (Lacs) (Rs.Crore) (Rs.Crore)
(Rs.Crore)
1992-93 178120 566.79 7146.24 20545
21511
1993-94 208619 608.73 8758.19 24631
25455
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1994-95 254572 655.29 10384.91 45287
48789
1995-96 295758 709.60 12093.63 65254
68542
1996-97 344619 777.50 14499.50 85236
95255
1997-98 406583 845.29 20582.35 105000
110255
1998-99 459201 917.26 25478.32 120445
127390
1999-00 536450 1013.89 30545.65 146364
154040
2000-01 645041 1131.11 34207.78 175491
186024
2001-02 811011 1258.76 48963.60 216883
227008
GENERAL INSURANCE BUSINESS :
Under Tariff ,Outside Tariff
Fire Insurance, Burglary and Housebreaking
Consequential Loss (fire policy) all Risk: Jewelry andValuables
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Marine, Cargo and Hull insurance ,Television Insurance
Motor Vehicle Insurance, Baggage Insurance
Personal Accident (Individuals and group up to 500
persons) Mediclaims
Personal Accident (Air travel), Overseas Mediclaims
Engineering Compensation Personal Accident (group over
500 people)
Bankers Indemnity Policy - Bhavishya Arogya
Carrier's Legal Liability
Public Liability Act Policy
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Insurance sector of India.
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. At the same time, however,
they guaranty minimum payoffs to both individuals and
companies by way of the put like insurance contracts. As
discussed above, these contracts can significantly affect behavior
of economic agents and, in general, are perceived to lead to
better outcomes for economies. Herein lies the importance of theviability of insurance companies: insolvency/bankruptcy of an
insurance company can be fast transformed into a systemic
problem in two different ways. 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. However, even if an
insurance company does not default on its credit and investment
related obligations, and merely reneges on its insurance obliga-
tions, the adverse impact of such default on the economy and the
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society at large can be quite devastating. For example, 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." The consequent insolvency of
the company can affect a number of banks and other companies
adversely, and a systemic problem will be precipitated. In other
words, the insurance industry in any country should be subjected
to
regulations that are at least as stringent as, and perhaps more
stringent than those governing the activities of other financial
organizations.
It is evident from the above discussion that decisions about
what constitutes acceptable portfolio quality, and the extent of
price regulation hold the key to insurance regulation in a post
liberalisation insurance market. As the US experience suggests,
insura