(Emergence of Insurance Sector of India)

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The Emerging Insurance sector of India.

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

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

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The Emerging Insurance sector of India.

OVERVIEW OF THE INSURANCE SECTOR

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.
(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.

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The Emerging Insurance sector of India.
How big is the insurance market ?
Insurance is a Rs.400 billion business in India, and together with banking services
adds about 7% to India’s 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 India’s insurable population has no life insurance or
pension cover. 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.

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The Emerging Insurance sector of India.

INDIVIDUAL LIFE INSURANCE COVERAGE INDEX, 1994
COUNTRY NO. OF POLICIES PER 100 PERSONS
Indonesia

2.0

Philippines

5.6

India

12.4

Thailand

14.7

Malaysia

35.5

Hong Kong

69.4

South Korea

70.5

Taiwan

75.2

Singapore

112.6

Japan

198.4

Source:

Charted Financial Analyst May 1999. (Insurance in Asia: The financial

times, quoted from Tillinghast study)

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The Emerging Insurance sector of India.

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 India’s share of world insurance market has shown an increase of 10% from
0.31% in 1996-97 to 0.34% in 1997-98. India’s market share in the life insurance
business showed a real growth of 11% thereby outperforming the global 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.

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The Emerging Insurance sector of India.
Future course of Insurance Business
One of the main differences between the developed economies and the emerging
economies is that insurance products are bought in the former while these are sold in
latter.
Focus of insurance industry is changing towards providing a mix of both 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 premium 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 LIC’s 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.

(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)

LIC’s policies are not flexible according to the customer’s 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
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The Emerging Insurance sector of India.
protection and savings. New products would also enable product combinations
that allow greater customization.

(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 customeroriented 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 customising products to suit

individual needs.
(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 player’s strategies one might expect LIC to react

and drop its premia and upgrade its services.

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The Emerging Insurance sector of India.

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 inflexibility continues,
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-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 FI’s 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
India’s strong banks and financial institutions have to enter the new business.

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The Emerging Insurance sector of India.
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 firms 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 provide a benchmark to evaluate the
government’s insurance services.

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The Emerging Insurance sector of India.
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 firmly established 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 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.

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The Emerging Insurance sector of India.
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 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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The Emerging Insurance sector of India.

WHO’S GOING WITH WHOM?
Indian Company
Kotak Mahindra

Foreign Partner
Chubb, US

Tata Group

AIG, US

Sundram Finance

Winterthur, SWITZERLAND

Sanmar Group

GIO of Australia

M A Chidambaram

MetLife

Bombay Dyeing

General Accident, UK

DCM 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

ICICI

Prudential, UK

IDBI

Principal

Max India

New York Life

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The Emerging Insurance sector of India.
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 LIC’s
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 (world’s 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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The Emerging 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) players should 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?
(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?

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The Emerging Insurance sector of India.
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 Insurance Corporation of India (LIC) was formed in 1956, when the
Government of India brought together over two hundred odd private life insurers and
provident societies, under one nationalized monopoly corporation, in the wake of
several bankruptcies and malpractice’s'.
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.

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The Emerging Insurance sector of India.
This is not to deny that there are some valid grounds for being cautious about private
sector entry. Some of these concerns are:
(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 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.

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The Emerging Insurance sector of India.
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 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 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.

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The Emerging Insurance sector of India.

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

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The Emerging Insurance sector of India.
from the general insurance. It suggested the regulation of insurance intermediaries by
IRA and the introduction of brokers for better ‘professionalisation'.

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The Emerging Insurance sector of India.
THE ROLE OF IRA
(a)

The protection of consumers’ interest,

(b) To ensure financial soundness of the insurance industry and
(c)

To ensure healthy growth of the insurance market.

These objectives must be achieved with minimum government involvement and cost.
IRA’s functioning can be financed by levying a 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
IRA’s 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 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 wellknown risks, certain standardization can be enforced. Furthermore, IRA can insist that
for such products the prices also be standardized. From the consumer’s 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.
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The Emerging Insurance sector of India.

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 adjudication, arbitration and conciliation. The
second area of IRA’s activity concerns monitoring insurer behavior to ensure fairness.
It is especially here that IRA’s 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.
1. The policy of a price floor.
2. The restriction on capital and reserves, i.e., on what kind of investments and
speculative activities firms can make.
3. Putting in place entry barriers to restrict the number of competitors.
4. The creation of an industry financed guarantee fund to bail out firms hit by
unexpectedly high liabilities.

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The Emerging Insurance sector of India.
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 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 1980’s.
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 IRA’s jurisdiction. IRA has to evolve guidelines on the entry and functioning of
such intermediaries. Licensing of agents and brokers should be required to check

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The Emerging Insurance sector of India.
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 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 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

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The Emerging Insurance sector of India.
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.
Liberalisation Of Insurance Industry
While no aspect of the reform process in India has gone smoothly since its inception
in 1991, no individual initiative has stirred 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 potential to adversely affect the pricing of risks,
especially in the non-life industry, and hence the viability of the insurance companies.

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The Emerging Insurance sector of India.
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 of government 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 management of the portfolios of these
companies, and proposed that 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.

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The Emerging Insurance sector of India.
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 (NRI’s), Overseas
corporate bodies (OCB’s) and Foreign institutional investors (FII’s).
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 infrastructure 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
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.

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The Emerging Insurance sector of India.
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 investment 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 Lloyd’s 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 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.
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The Emerging Insurance sector of India.

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 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.

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The Emerging Insurance sector of India.

SOME INSURANCE PRODUCTS NOT AVAILABLE IN INDIA
Associated Market Quest after a study of some of the international markets, 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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The Emerging Insurance sector of India.

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 policyholders against 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 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?

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The Emerging Insurance sector of India.
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 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 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

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The Emerging Insurance sector of India.
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 assetbacked 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 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
insurer’s 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. Life Insurance premia are generally perceived

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The Emerging Insurance sector of India.
as being too high while general insurance (especially motor insurance) is priced too
low. 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. 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
Advisory Committee (TAC)
2. Those that fall outside tariff regulations.

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The Emerging Insurance sector of India.

INVESTMENT OF INSURANCE FUNDS
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. These stipulations 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 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
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The Emerging Insurance sector of India.
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).
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.

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The Emerging Insurance sector of India.

THE ROLE OF PORTFOLIO MANAGER
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 car accidents 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 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!

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The Emerging Insurance sector of India.
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
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,
(i)

look out for arbitrage opportunities in the market place both across
markets and over time,

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The Emerging Insurance sector of India.
(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
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 have
increasingly resorted to replacement of personnel by computer based "expert" systems
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The Emerging Insurance sector of India.
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 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 the nature of regulation of property liability companies. Regulation

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The Emerging Insurance sector of India.
of the former has typically emphasized asset quality, while the 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.
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
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The Emerging Insurance sector of India.
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 industry's profitability, the market softens again and the cycle
starts again.

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The Emerging Insurance sector of India.
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 than a private company can hope to generate.
The envisaged private sector participation in the insurance sector is unlikely to take
this 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.

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The Emerging Insurance sector of India.

GENERAL INSURANCE BUSINESS
 Under Tariff ,Outside Tariff
 Fire Insurance, Burglary and Housebreaking
 Consequential Loss (fire policy) all Risk: Jewelry and Valuables
 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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The Emerging 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 the viability 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 obligations, the adverse impact of such default on the
economy and the 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

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The Emerging Insurance sector of India.
insurance regulation in a post liberalisation insurance market. As the US experience
suggests, insurance companies are usually subjected to stringent asset quality norms.
Indeed, while a part of their portfolio might comprise of equity, mortgages and other
relatively risky securities, much of their portfolio is made up of bonds and. liquid (and
highly rated) mortgage backed securities. An Indian insurance company, on ,the other
hand, is constrained by the fact that the market for fixed income securities is very
illiquid such that only gilts and AAA and AA+ rated corporate bonds have liquid
markets.
At the same time, absence of a market for liquid mortgage backed securities denies
these companies the opportunity to enhance the yield on their investment without
significantly adding to portfolio risk. This might not pose a problem in the absence of
competition, especially if the government helps to increase the returns to the
policyholders by way of tax breaks, but might pose a serious problem if liberalization
leads to "price" competition among a large number of insurance companies
It might be argued that if the insurance and pension fund industries are liberalised,
and if the fund managers of all these companies indulge in active portfolio
management, the liquidity of the bond market will increase significantly.
Such increase in liquidity across the board would enable the fund managers to invest
in investment grade bonds of lower rating and thereby add to the average yield of
their investment without adding significantly to their portfolio risk.
The problem, however, is that till the imperfect character of the bond market is
removed to a significant extent, the insurance companies might either have to operate
with thinner margins or remain exposed to unacceptably high levels of liquidity risk.
It might, therefore, be prudent for the policymakers to impose stringent capital and
reserve norms on the insurance companies, in order to ensure their viability in the
short to medium run." Subsequent to liberalization, the Indian insurance industry
might also be at the receiving end of regulations governing insurance prices / premia.

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The Emerging Insurance sector of India.
Specifically, there might be highly politicized interventions in the markets for
workers' compensation and medical insurance. The government might also be under
pressure to "regulate" the prices of infrastructure related lines like freight and marine
insurance. In principle, the risks associated with such liability insurance policies may
be hedged by way of reinsurance.
But if the reinsurers price the risks' accurately and the Indian insurance companies are
forced to underprice the risks, the margins of the insurance companies will be affected
adversely, thereby reducing their long term viability.
In view of these political and financial realities, it might be better to subsidies the
policyholders of politically sensitive lines directly or indirectly through tax benefits, if
at all, rather than distort the pricing of the risks themselves.
At the end of the day, it has to be realised that while competition enhances the
efficiency of market participants, the process of "creative destruction," which ensures
the sustenance and enhancement of efficiency, is not strictly applicable to the financial
markets
. Hence, while exit is perhaps the most efficient option for insolvent firms in many
markets, insolvency of financial intermediaries calls for government action and
usually affects the governments' budgetary positions adversely.
At the same time, other things remaining the same, the risk of insolvency is perhaps
higher for insurance companies than for other financial intermediaries because of the
option like nature of their liabilities.
Therefore, competition in the insurance industry has to be tempered with appropriate
prudential norms, regular monitoring and other regulations, thereby making the
robustness of the industry critically dependent on the efficiency of and regulatory
powers accorded to the proposed Insurance Regulatory Authority.

Page | 46

The Emerging Insurance sector of India.

THE CURRENT SCENARIO
EFFECTS ON POLICY HOLDERS
The primary reasons for buying an insurance policy, whether life or non-life is to
protect us from vagaries of life. We do not invest in insurance for returns; rather we
invest in it for regrettable necessities.
Though a large proportion of policies available in the country provides for returns, but
nobody is looking for returns to the inflation rate. Some people do look for tax
concessions, but lots of things have changed now.
First,

tax rates are not so high as they used to be.

Secondly,

concessions are still limited to a 20% tax shield.

Finally other tax saving schemes, like public provident fund offers better returns.
So what does insurance offer, perhaps peace of mind, but even that takes time, due to
poor claim performance. In India insurance is sold and not bought. Life Insurance
Corporation has nearly eighty products, but investors know only about a handful.
That’s because the agents of LIC push policies with the highest premium to pocket a
higher premium. Same is the case with General insurance.
Companies offering General insurance products-like medical, housing, motor and
industrial insurance- have more than 150 products to sell. But awareness is even lower
than life insurance products.

Page | 47

The Emerging Insurance sector of India.
It becomes obvious that GIC lacks the marketing results. Change whether public
sector companies like it or not change is the around the corner. General insurance
sector will soon be opened up to private and foreign competition.
The potential for the new entrants is immense; life and non-life premiums add up to
around 2% of the GDP, where as the global average stands at 8%. Indians as such
have a high savings rate and bridging the existing gap points at immense potential.
What does this mean for the consumer?
Insurance companies will introduce more term policies. These policies provide
protection for a specified time period, and do not offer any returns. These will cover
simple requirements of the insurance for the investor. In effect term policies translates
into low premium outgo, which frees the capital for investment into other investment
vehicles, which offer better returns.
Currently term policies constitute only1% of the total number of policies issued by
LIC, while the global average is 15-20 per cent. Apart from the plain vanilla policies,
new entrants will also offer consumers a choice of products with low premiums.
Endowment policies will change too.
The insurer, in line with his precise risk appetite, will be able to invest in a variety of
indices or sector specific where in the returns would be higher. Instead of current
fixed returns schemes insurance companies will issue unit linked schemes, indexed
funds, or even real estate funds. Another opportunity is offered by a pension contract.
Here the options offered could be indexed annuity, immediate annuity or a deferred
annuity.
The scope of new products is also immense in the non-life segment. Companies
would offer products for niche segment, like disability products, workers
compensation insurance, renter’s coverage and employment practices liability
insurance.

Page | 48

The Emerging Insurance sector of India.
The general insurance industry is expected to grow at the rate of 25% per annum.
Scared of new entries in the insurance sector, GIC has started offering new policies
like Raj Rajeshwari. It covers disability from accidents, the accidental death of the
spouse and legal expenses resulting from the divorce.
At present some of the good policies offered to consumer with their respective
benefits are.
Products Benefits
Pure term insurance (pure life without insurance policy.) Very low premiums and
effective risk coverage.
Disability policy Covers disability to a longer tenure to life time disability. First to
die policy Beneficial for a couple and low premium outgo.
Replacement policy Saves the customer the trouble of making claims and
repurchasing the products.
Flexibility in Home insurance policy Policyholder has the flexibility of choosing one
of the risk covers instead of the entire package.
Channels
Insurance companies will also get savvy in distribution. Enhanced marketing thus will
be crucial. Already many companies have full operation capabilities over a 12-hour
period. Facilities such as customer service center are already into 24-hour mode.
These will provide services such as motor vehicle recovery. Technology will also play
a important role on the market. Effects of technologies are discussed in another
section.

Rural Areas
According to Malhotra committee report the penetration of insurance in India is
around 22%. This indicates that a vast majority of rural population is not covered.
Though GIC offers many products for this segment like, crop policy, silk worm policy
etc, But due to poverty majority of the population cannot offered to get insured.
Despite this, new entrants are hopeful of covering the vast tracts of rural masses.
Page | 49

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