The Indian general insurance industry has been growing in excess of 20% over the last two years. Increasing ownership of assets like automobiles and higher healthcare costs have driven higher penetration of general insurance products like auto insurance and health insurance. Yet penetration is still at a low 0.7% of the GDP (2011) and the potential for growth is immense.
It is a well documented fact that the Indian industry went through a difficult time in the immediate wake of detarriffing, wherein premium rates fell precipitously as individual companies chased market share. As an example, the total sum insured for fire had gone up nine times from 2009-10 to 2011-12, while the fire gross direct premium increased only by 1.6 times during the same period. Such aggressive pricing strategy did not yield the anticipated pay-offs, and the entire industry was affected adversely by increasing losses. In addition to the impact of de-tariffication, the industry had to bear the brunt of enhanced provisioning required by the regulator for the commercial vehicle third party (CV TP) pool which severely impacted the profitability and solvency margins of the industry at a time when availability of capital has been impacted post the 2008 crisis.
This hard reality makes it imperative for the domestic general insurance companies to adjust its approach. The domestic insurance companies face the twin “optimisation problems” of increasing the business basket and remaining profitable. This can be achieved only through proper selection of the business lines the companies wish to pursue, and the appropriate pricing thereof. We believe that each company has to migrate to risk-based pricing of insurance services. At the same time, the Indian industry, in general, has to tighten its internal underwriting and risk management practices, so that risks do not spiral and consume precious capital. This transformation is absolutely essential for profitability and sustainable growth of the industry. Failure to do so will send the companies into a cycle of underwriting losses, resulting in lack of investment in service architecture leading to poor servicing and low penetration.
In general, since liberalisation of pricing, the industry has made some progress on parameters pertaining to risk management and servicing. However, the pricing levels continue to be a cause of concern. This is leading to waste of insurance capacity and lower realisations overall. Insurance rates have to rise in certain segments. For instance, property insurance rates (while they have increased somewhat this year) are still lesser than a fair, scientific price. The increasing industry loss ratio for this segment, as seen in the chart below, is indicative of the same. On the health insurance front, while we have seen some degree of improvement on the loss ratios front, it is very clear from the accompanying chart that there is a significant degree of pricing correction still required.
Source: IRDA Handbook on Insurance Statistics 2010-11
For motor insurance, pricing is adequate only in certain geographies, but not everywhere. This brings us to the point that we as an industry have to move away from the existing one-size-fits-all solutions and look at micro-segmentation of individual risks, as well as build the underwriting and actuarial capacity to arrive at appropriate pricing. Product lines should be segregated into low frequency-high severity and high frequency-low severity, and separate pricing approach should be established.
One of the first stumbling blocks individual companies face is the lack of long term data points to make correct pricing decisions. The industry and the regulator should work together on industry wide data sharing to ensure availability of greater volumes of data and experience to all the players in the industry, so that they can take a principled view of risk irrespective of their scale. IRDA has set up the India Insurance Bureau with this objective and access has been provided to individual companies. Once the data quality issues are eliminated, it will lead to more active usage of this information. Under the aegis of IRDA or the General Insurance Council, insurance companies are taking the initiative of standardising data formats and issuing quality guidelines. This will ensure that over time, data of consistent quality will become available to insurance company actuaries to arrive at a fair price for risk underwritten.
In certain lines, while there is data availability, there is a need to enhance the richness of the same. For example, in the motor own damage business line, significant data has accumulated with companies over the past years. However only vehicle related attributes are captured and no driver related attributes are available. Internationally, attributes of the driver (like age, gender, driving history, etc.) are significant determinants of claim frequency. While steps have been taken by few players in the market to capture this information by offering pricing inducement, systematic effort needs to be undertaken to deepen data capture and overcome customer resistance.
Once clean data sets are available, the domestic companies should adopt appropriate techniques of actuarial modeling. At the very least, pricing should reflect the position of a risk on the frequency-severity matrix. This modeling is also imperative from the capital-provisioning point of view. For instance, low frequency, high severity business lines would require higher capital provisioning compared to the high frequency, low severity lines. Hence the pricing of large commercial property lines should also reflect the additional capital strain they would entail. Such an approach would also lead to a more measured approach to underwriting large risks where typically the Indian retentions are low and much of the risk is reinsured overseas.
Another important aspect, both from pricing and risk management prospective is adequacy of reserving. It has been observed globally that inadequate reserving is one of the major risks of insurance business, and is the primary cause of failure of insurance companies. The recent increase in provisioning for the CV TP Pool, wherein reserving had to be increased for the last five years, brings the same lesson closer home. Further, inadequate reserving inflates profitability giving a false sense of comfort with regard to pricing adequacy, creating a vicious cycle of inadequate reserving and underpricing that can spin out of control. Here again, appropriate actuarial approach needs to be taken to ensure adequate reserving.
Finally, beyond data, models and analysis, what becomes most critical for this shift to occur is the mindset of the companies, its management and shareholders. Given the paucity of capital, most shareholders would be interested in this shift so that they receive adequate returns on their invested capital. Hence, the primary responsibility of making this transition rests with the management. There is a need for an alignment of incentives for staff with the objective of healthy underwriting practices, and not topline growth alone. Only if the management fails to, either due to lack of intent or lack of ability, should the shareholders step in and influence the same through proper corporate governance processes. Insurance companies should also be encouraged to go public, as a wider public shareholding, and corresponding analyst scrutiny, would provide the desired momentum towards a balanced and sustainable approach.
Finally, the regulator, who has addressed a number of issues to ensure sustainable development of the industry, could consider some steps to encourage the industry’s migration to risk based pricing. IRDA has initiated work on Economic Capital reporting and Financial Condition Assessment Report. We need to set ourselves a roadmap to risk based capital or Solvency II so that the industry takes appropriate steps to ready itself for the transition. While this would be a long-term solution, an immediate step could be to introduce dis-incentives for high risk behavior of companies. This could be a two step process wherein initially companies with high combined ratio are required to hold more capital through higher solvency margin reflecting their greater chance of insolvency. If the combined ratio is not reduced within certain period of time, then the company could be restricted from writing specific lines which contribute to the high loss ratios. It should be recognised that large players running high combined ratio books of business can distort the market and reduce profitability for all the players, hence correcting that is a prerequisite to correcting overall market behavior.
To summarise, a general insurance penetration of 0.7% makes India one of the most attractive potential growth market in the world. But the onus on capitalising on this opportunity lies squarely with the Indian companies. Some inefficiencies have crept into the system, largely due to historical reasons. The Indian industry is relatively nascent as total detarriffing was effected only four years ago. It is now time for the Indian industry to get on with the task of capacity building, particularly in the areas of underwriting, risk management and actuarial science. A vibrant local industry requires that all risks are priced appropriately, in line with the underwriting capacity and risk appetite of the insurer. Towards that objective, the Indian industry has to migrate towards the scientific determination of risks and appropriate pricing models. Indian insurers need to provide customised insurance solutions at different price points for different sets of our population. It is therefore imperative that the Indian general insurance industry migrate each and every product to risk-based premium pricing and learn how to manage these risks better on its own balance sheet.
The author is the MD & CEO of ICICI Lombard General Insurance Company Ltd. This article first appeared in the souvenir published by CII (Confederation of Indian Industry) during the 15th Insurance Summit on 6 August 2012 and is reproduced here with the kind permission of CII.
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