Insurance in India: ‘Hope for deliverance’ or are we ‘waiting for Godot’?

Insurance is not only one of many routes through which household savings can be efficiently allocated to meet the equity and debt needs of private sector but also a vehicle that provides financial security to a large section of our population, hitherto excluded from the benefits of modern financial services, Anumeha Iyer stresses

August 22, 2012 3:43 IST | India Infoline News Service

As the Beatles once reminisced, it’s been a ‘long and winding road’ for the insurance industry in India.  The journey began in 1818 where the largely unregulated sector comprised few domestic players transacting insurance business amidst stiff competition from their overseas counterparts. Despite its focus on life business, the Indian Life Assurance Companies Act, 1912 was the first statutory enactment seeking to rein in the hitherto wayward industry, followed closely by the more comprehensive Insurance Act, 1938 that set about consolidating and amending earlier legislation and introducing blanket provisions for the insurance sector as a whole.

A game of monopoly

In January 1956, nearly 10 years after India attained independence, approximately 245 life insurers and provident societies were nationalised and, in their place, the Life Insurance Corporation of India (LIC) was set up under the Life Insurance Corporation Act, 1956. The general insurance industry was nationalised in January 1973 by the General Insurance Business (Nationalisation) Act, 1972 under the purview of which the state-owned General Insurance Corporation (GIC) absorbed over 100 players in this segment and began operations through four subsidiaries—the United India Insurance Company, the National Insurance Company, the Oriental Insurance Company and the New India Assurance Company. In addition to being the point-man for the general insurance industry, GIC also arranged its subsidiaries’ reinsurance programs either by having them cede reinsurance business to each other or through the industry pooling mechanism. 

In a span of nearly 150 years, the Indian insurance industry transitioned from being a largely unregulated and open sector to a state-owned nationalised industry. From 1972 to 1999, state monopolies dominated the sector with the government barring private participation or foreign investment (direct or indirect) in the insurance market or in respect of Indian risks, except in case of reinsurance or retrocession. The Tariff Advisory Committee, a statutory body created under the Insurance Act, 1938, determined the rates, terms and conditions that insurers could offer for their products. This tariff regime meant that premiums were fixed at the same rate for all insurers, products were plain vanilla and undifferentiated, and coverage was limited in almost every line of business.

Liberalisation begins

The insurance industry continued to remain under the wrap of the government until the New Economic Policy of the early 1990s—a precursor to deregulation and liberalisation of the industry. The RN Malhotra Committee was established in 1993 to re-work the institutional structure of the insurance industry with a view to complement reforms underway in the financial services sector. The Committee’s report came out a year later and, as part of its recommendations, suggested opening up of the markets to private sector competition and ultimately, foreign participation, primarily through the joint venture route. Further, the Committee’s proposal to set up an independent regulatory and supervisory authority for the insurance sector was widely supported in several forums.

Its intent evident in the title, the Insurance Regulatory and Development Authority Act, 1999 went about laying the groundwork for establishing “an Authority to protect the interests of holders of insurance policies, to regulate, promote and ensure orderly growth of the insurance industry” and specifically:

  • Revoke the GIC monopoly and the stronghold of the state-run life insurer, LIC

  • Re-nominate GIC as the national reinsurer with mandatory 20% cessions by the country’s direct insurers

  • Raise the ban on domestic private companies from operating in the market

  • Re-open the markets and level the playing field for foreign entrants albeit with considerable limitations

In terms of the Foreign Direct Investment Policy announced by the Indian Government in 1999, foreign investment was permitted in the insurance sector subject to a cap of 26% under the automatic route wherein neither the foreign investor nor the Indian company required approval from the Reserve Bank of India or the Government of India for the investment. Companies bringing in FDI also had to obtain necessary license from the IRDA for writing insurance business. Shortly thereafter, the Insurance Regulatory and Development Authority (Insurance Brokers) Regulations, 2002 allowed insurance brokers to foray into the recently liberalised markets subject once again to a sectoral cap of 26%.

Challenges to further market liberalisation

Despite the onset of liberalisation wave, there remain impediments to an open and competitive market including limitations on FDI, compulsory tariffs and mandatory reinsurance cessions.

Sectoral cap on FDI

With the Parliamentary Panel rejecting the proposal to raise FDI in insurance to 49% from 26% and the FDI Policy 2012 throwing no surprises on this front, the biggest challenge to the growth in this industry remains the removal of the sectoral cap on FDI.

Insurance is a capital intensive business not meant for short-term players. A recent spate of regulatory moves, such as monitoring of insurers’ management expenses, guidelines on outsourcing and distance marketing guidelines, have required players to change operating plans and business models to remain compliant with the legal and regulatory framework. In the wake of wider compliance and reporting requirements, industry players are now facing tremendous strain on capital, particularly life insurers.

A less than enticing increase in contributions to the motor pool was partly offset by permissible increases in third party liability premiums, which may go a long way to address the cause of potential deficit in the pool. However, the two largest lines of business for general insurers—health and motor—are proving to be the proverbial ‘white elephants’ and while there has been a burgeoning growth in business, the underwriting is far from lucrative. Insurance companies need more capital to grow and meet their solvency needs in accordance with the prudential norms. IRDA has estimated capital requirement of approximately Rs. 612 billion over the next five years. While Indian promoters have invested around Rs. 210 billion over the last decade, capital raising initiatives for another Rs. 612 billion from the domestic market may prove to be a tall order.

Further, the recent initial public offer (IPO) guidelines notified by IRDA to raise capital failed to drum up any excitement amongst the life insurance companies given the poor sentiment in the capital market and uncertainties on the possibility of getting good valuations. On the contrary, insurers eligible for the IPO would rather dilute their stake in favour of their foreign joint-venture partners which could help insurers raise additional capital, increase resources and bring in fresh managerial talent.

Compulsory tariff

The IRDA is yet to roll-out and approve the phased dismantling of the prevalent tariff system and usher in market-based pricing. The challenge in this endeavour will be to develop a database of reliable premium and claims information to which insurance pricing can be pegged. While India’s insurance market has historically lacked such a database, the Tariff Advisory Committee has painstakingly compiled this information which will help insurers and reinsurers with their rate-making decisions in the long run.

Mandatory reinsurance cessions

The purpose of compulsory cessions has been to maximise retentions within the country while the market was in the process of restructuring. Nevertheless, this is a restrictive practice and permits limited flexibility in the reinsurance portfolio of domestic entities. IRDA’s reinsurance advisory committee proposed a gradual reduction of 5% on a year on year (YoY) basis; however, the IRDA is yet to undertake concrete steps to enforce the committee’s recommendations.

Outsourcing guidelines

The IRDA released outsourcing guidelines for all insurers operating in India in February 2011. The guidelines were the direct fallout of an increase in outsourcing of core activities to third party firms by insurers and concerns that such outsourcing could lead to a dilution of insurers’ internal controls, business conduct and reputation. In light of such developments, insurers were compelled to review their outsourcing arrangements to ensure compliance with the guidelines and to terminate all contracts in contravention of the guidelines before 31 June 2011. 

In terms of the mandate, insurers were specifically prohibited from outsourcing all core activities (including underwriting, product design, investment, compliance with anti-money laundering, know your client issues). Policy servicing was identified as a core activity and outsourcing of this function was generally prohibited, except for specified components contained in the guidelines. Outsourcing of supporting and non-core activities was permitted subject to compliance with risk management principles and reporting requirements.

Dark ages to the age of reforms

In spite of considerable strait-jacketing, the insurance sector has witnessed a 15%-20% YoY growth since liberalisation. India now has 47 players in the life and non-life segment though still one reinsurer, 29 third-party administrators, over 300 brokers and an army of corporate agents and insurance agents.

In addition to vetting and licensing the entities transacting insurance business in the marketplace, and maintaining a watchful eye over product development and distribution, IRDA has been busy introducing a spate of reforms in the recent years with a view to introduce and implement regulatory structure in areas as wide-ranging as the delivery and distribution framework for policies and products, insurance advertisements and disclosures, licensing of agents, obligations to the rural and social sector, valuation of assets solvency margins and outsourcing insurance-related activities to third parties.

The IRDA has published and finalised the exposure draft on mergers and acquisitions in the non-life sector. The IRDA (Scheme of Amalgamation and Transfer of General Insurance Business) Regulations, 2011 prescribes the procedure to be undertaken prior to implementation of any arrangement effecting a merger or acquisition including a two-step approval from the IRDA. The process involves:

  1. Notice of intention

  2. In-principle approval by IRDA

  3. Approval from other regulatory authorities and courts

  4. Final approvals from IRDA

Despite the scope of applicability of these Regulations being limited to the non-life domain, the industry is waiting in eager anticipation for similar regulations in respect of companies engaged in the life business. In any event, the Regulations are definitely a step toward liberalisation and consolidation of the insurance sector in India without compromising on the interests of policyholders.

Crop insurance scheme

Innovative insurance products such as crop insurance and its modified offshoot—weather-based crop insurance—have come up as important tools for risk mitigation for small and marginal farmer households. National Agricultural Insurance Scheme is the principal crop insurance scheme which presently encompasses subsidy to the farming community with expense on the subsidy being equally shared between central and state governments.

Despite an aggregate sum insured of Rs. 255 billion and a large number of farmers (11.4 million in kharif 2010) subscribing to this programme, the fact remains that not enough farmers are availing of this scheme. Therefore the market to develop and distribute location and need specific insurance solutions remains largely untapped and would significantly benefit from driving investment in infrastructure and a favourable regulatory environment for the various insurance delivery institutional mechanisms. While 24 million families have been covered and over 8,600 health care providers enrolled in selected districts under Rashtriya Swasthya Bima Yojana—a health insurance scheme available to the poor and other identified target groups—the scope of public private partnership has not been fully explored in the health sector.

The Approach Paper on the Twelfth Five Year Plan reports that since more than two-third of the investment in the economy is by private sector (households & corporate), it is necessary to ensure that the financial system is able to translate the otherwise favourable macroeconomic investment-savings balances into effective financing of the private sector investment needed for 9% GDP growth. Insurance is not only one of the many routes through which household savings can be mobilised and efficiently allocated to meet the equity and debt needs of the fast expanding private corporate sector but also a vehicle that provides financial security to a large section of our population, hitherto excluded from the benefits of modern financial services.

Despite the slowdown in growth in the current year, GDP growth target of 9% for the Twelfth Plan is feasible from a macro-economic perspective. However, the Paper acknowledges that this is not a foregone outcome but one that is contingent on wide ranging policy changes including insurance reforms which have been pending and need to be undertaken on a fast-track basis.

The various regulatory changes and proposals to amend the insurance law is primarily an enabling measure. The point is that the real power of this sector lies in the economies of scale which may be tapped through creation of viable business entities, innovative, inclusive products & solutions, and efficient delivery & servicing models. In addition, there is an increasing awareness of risk and insurance amongst Indian consumers. When this knowledge is viewed in the light of the low penetration levels of insurance and reinsurance in this country, the potential opportunities in this industry are immense.

The author works as an associate at Advaya Legal, a commercial law firm in Mumbai.

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