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INTRODUCTION

The Committee on Reforms: In The Insurance Sector, popularly known as Malhotra Committee had recommended in 1994 that brokers, representing the customer, be brought in as another marketing and distribution channel, as prevalent in most of the developed and developing markets to protect the consumer interests, to raise the level of professional standards in risk management and underwriting and to speed up claims settlement. The Insurance sector in India governed by Insurance Act, 1938, the Life Insurance Corporation Act, 1956 and General Insurance Business (Nationalisation) Act, 1972, Insurance Regulatory and Development Authority (IRDA) Act, 1999 and other related Acts. With such a large population and the untapped market area of this population Insurance happens to be a very big opportunity in India. Today it stands as a business growing at the rate of 15-20 per cent annually. Together with banking services, it adds about 7 per cent to the countrys GDP .In spite of all this growth the statistics of the penetration of the insurance in the country is very poor. Nearly 80% of Indian populations are without Life insurance cover and the Health insurance. This is an indicator that growth potential for the insurance sector is immense in India. It was due to this immense growth that the regulations were introduced in the insurance sector and in continuation Malhotra Committee was constituted by the government in 1993 to examine the various aspects of the industry. The key element of the reform process was Participation of overseas insurance companies with 26% capital. Creating a more efficient and competitive financial system suitable for the requirements of the economy was the main idea behind this reform. Since then the insurance industry has gone through many sea changes .The competition LIC started facing from these companies were threatening to the existence of LIC .since the liberalization of the industry the insurance industry has never looked back and today stand as the one of the most competitive and exploring industry in India. The entry of the private players and the increased use of the

new distribution are in the limelight today. The use of new distribution techniques and the IT tools has increased the scope of the industry in the longer run. Insurance sector in India is one of the booming sectors of the economy and is growing at the rate of 15-20 per cent annum. Together with banking services, it contributes to about 7 per cent to the country's GDP. Insurance is a federal subject in India and Insurance industry in India is governed by Insurance Act, 1938, the Life Insurance Corporation Act, 1956 and General Insurance Business (Nationalisation) Act, 1972, Insurance Regulatory and Development Authority (IRDA) Act, 1999 and other related Acts. The origin of life insurance in India can be traced back to 1818 with the establishment of the Oriental Life Insurance Company in Calcutta. It was conceived as a means to provide for English Widows. In those days a higher premium was charged for Indian lives than the non-Indian lives as Indian lives were considered riskier for coverage. The Bombay Mutual Life Insurance Society that started its business in 1870 was the first company to charge same premium for both Indian and non-Indian lives. In 1912, insurance regulation formally began with the passing of Life Insurance Companies Act and the Provident Fund Act. By 1938, there were 176 insurance companies in India. But a number of frauds during 1920s and 1930s tainted the image of insurance industry in India. In 1938, the first comprehensive legislation regarding insurance was introduced with the passing of Insurance Act of 1938 that provided strict State Control over insurance business. Insurance sector in India grew at a faster pace after independence. In 1956, Government of India brought together 245 Indian and foreign insurers and provident societies under one nationalised monopoly corporation and formed Life Insurance Corporation (LIC) by an Act of Parliament, viz. LIC Act, 1956, with a capital contribution of Rs.5 crore. The (non-life) insurance business/general insurance remained with the private sector till 1972. There were 107 private companies involved in the business of general operations and their operations were restricted to organised trade and industry in large cities. The General Insurance Business (Nationalisation) Act, 1972 nationalised the general insurance business in India with effect from January 1, 1973. The 107 private insurance
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companies were amalgamated and grouped into four companies: National Insurance Company, New India Assurance Company, Oriental Insurance Company and United India Insurance Company. These were subsidiaries of the General Insurance Company (GIC).
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REFORMS IN INSURANCE The insurance sector in India have come a full circle from being an open competitive market to nationalization and back to a liberalized market again. Tracing the developments in the Indian insurance sector reveals the 360- degree turn witnessed over a period of almost two centuries. The business of life insurance in India in its existing form started in India in the year 1818 with the establishment of the Oriental Life Insurance Company in Calcutta. The General insurance business in India, on the other hand, can trace its roots to the Triton Insurance Company Ltd., the first general insurance company established in the year 1850 in Calcutta by the British. The main objective of this section is to review the insurance sector at broader aspects and to outline the main findings of important studies relating to insurance sector to use the analysis as a background, for delineating the area of the present work. In 1993, Malhotra Committee, headed by former Finance Secretary and RBI Governor R.N. Malhotra, was formed to evaluate the Indian insurance industry and recommend its future direction. The Malhotra committee was set up with the objective of complementing the reforms initiated in the financial sector. The reforms were aimed at creating a more efficient and competitive financial system suitable for the requirements of the economy keeping in mind the structural changes then underway and recognizing that insurance was an important part of the overall financial system where it was necessary to address the need for similar reforms. In 1994, the committee submitted the report and recommendations.

The committee emphasized that in order to improve the customer services and increase the coverage of insurance policies, industry should be opened up to competitions. But at the same time, the committee felt the need to exercise caution as any failure on the part of new players could ruin the public confidence in the industry. Hence, it was decided to allow competition in a limited way by stipulating the minimum capital requirement of Rs.100 crores. The committee felt the need to provide greater autonomy to insurance companies in order to improve their performance and enable them to act as independent companies with economic motives. For this purpose, it had proposed setting up an independent regulatory body- The Insurance Regulatory and Development Authority. Reforms in the Insurance sector were initiated with the passage of the IRDA Bill in Parliament in December 1999. The IRDA since its incorporation as a statutory body in April 2000 has fastidiously stuck to its schedule of framing regulations and registering the private sector insurance companies. Since being set up as an independent statutory body the IRDA has put in a framework of globally compatible regulations. The other decision taken simultaneously to provide the supporting systems to the insurance sector and in particular the life insurance companies was the launch of the IRDA online service for issue and renewal of licenses to agents. The approval of institutions for imparting training to agents has also ensured that the insurance companies would have a trained workforce of insurance agents in place to sell their products.

THE COMMITTEE ON REFORMS IN THE INSURANCE SECTOR

THE GOVERNMENT appointed the committee on reforms in the insurance sector (1994) in april 1993 headed R.N.MALHOTRA,the former Governor of the Reserve Bank of India.The terms of reference of the said Committee were:

(1) to examine the structure of the insurance industry as it has evolved within the existing

framework and to assess its strength and weaknesses in terms of the objective of creative an efficient and viable insurance industry providing a wide reach of insurance services and a variety of insurance products wit a high quality of service to the public and serving as an effective instrument for mobilization of financial resources for development.

(2) to make recommendations for changes in the structure of the insurance industry, as well as the general framework of policy, as may be appropriate for the pursuit of the above objectives keeping in mind the structural changes currently underway in other parts of the financial system and in the economy.

(3) to make specific suggestions regarding the LIC and the GIC, which would help to improve the functioning of these organizations in the changing economic environment (4) to review the present structure of regulation and supervision of the insurance sector and to make recommendations for strengthening and modernizing the regulatory system in the tune with changing requirements.

(5) to review and make recommendations on the role and functioning of the surveyors, intermediaries and other ancillaries of the insurance sector.

(6) to make recommendations o such other matters as the Committee considers relevant for the health and long-term development of the insurance sector.

In under a year. the Committee submitted its Report, which was approved in principle by the government. The major thrust of the recommendations was towards the opening up of the insurance sector,for which initiative had to come from the government.

LIBERALISATION OF THE INSURANCE INDUSTRY


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 farreaching 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 emphasised 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 promoters 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. While several political parties were against the very idea of allowing private firms to enter the insurance industry, others were unsure about the extent of the stake that foreign investors/firms should be allowed to have in the post-liberalisation insurance companies. However, it was 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 was 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
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14 per cent for nonresident Indians (NRIs), overseas corporate bodies (OCBs) and foreign institutional investors (FIIs). However, in view of the widespread resentment about the 40 per cent ceiling among political parties, the Bill was referred to the standing committee on finance. The committee has since recommended that each private company be allowed to enter only one of the three areas of businesslife insurance, general or non-life insurance, and reinsurance and that the overall ceiling for foreign stakeholders in these companies be lowered 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. The redrafted Bill, which was scheduled to be introduced in the Parliament during the budget session of 1999, is yet to see the light of the day. The liberalisation of the insurance industry in India has thus emerged as the litmus test for the ability and the willingness of a central government to push through market friendly economic reforms. At the same time, the governments action in this sphere of economic activity is being viewed by some others as the indicator of the extent to which the government is willing to accommodate the dictates of the International Monetary Fund and the United States. The consequence has been politicisation of the reform of the insurance sector, and analyses of possible post-liberalisation scenarios have given way to jingoism and doublespeak. 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,1 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, thereby reining in industrial and GDP growth. Similarly, if firms are unable to hedge against bad events like fire and onthe-

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 of 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. However, while insurance companies provide hedging opportunities to households and the corporate sector by selling them de facto Americanput options that can be exercised in the event of a calamity, they themselves remain vulnerable to risks that are associated with risk management. Further, owing to changes in the nature of their products, they are increasingly becoming vulnerable to the risk that is usually associated with banks and non-bank financial intermediaries, namely, mismatch of assets and liabilities. While not a significant amount has been written about the experiences of the emerging markets, the US experience suggests that even in a developed financial markets with provisions for supervision, insurance companies can become insolvent and/or face runs. Since the viability of insurance companies is a necessary condition for the emergence of a robust insurance industry, it would be imprudent to ignore the impact that market forces might have on the aforesaid viability.

MALHOTRA COMMITTEE
In 1993, the Government set up a committee under the chairmanship of RN Malhotra, former Governor of RBI, to propose recommendations for reforms in the insurance sector.The objective was to complement the reforms initiated in the financial sector. The committee submitted its report in 1994 wherein , among other things, it recommended that the private sector be permitted to enter the insurance industry. They stated that foreign companies be allowed to enter by floating Indian companies, preferably a joint venture with Indian partners.

Following the recommendations of the Malhotra Committee report, in 1999, the Insurance Regulatory and Development Authority (IRDA) was constituted as an autonomous body to regulate and develop the insurance industry. The IRDA was incorporated as a statutory body in April, 2000. The key objectives of the IRDA include promotion of competition so as to enhance customer satisfaction through increased consumer choice and lower premiums, while ensuring the financial security of the insurance market.

With the Insurance Regulatory and Development Authority Act, 1999 coming into force, the insurance industry has been opened up for the private sector. The Act provides for the establishment of a statutory IRDA to protect the interests of insurance policy holders and to regulate, promote and ensure orderly growth of the insurance industry. The IRDA was formed by an Act of Parliament on April 19, 2000. Under the IRDA Act, an Indian insurance company will be allowed to conduct insurance business provided it satisfies the following conditions: It must be formed and registered under the Companies Act, 1956;
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The aggregate holdings of equity shares by a foreign company, either by itself or through its subsidiary companies or its nominees, should not exceed 26% paid up equity capital of the Indian insurance company; Its sole purpose must be to carry on the life insurance business or general insurance business or reinsurance business. 2 To operate the insurance business in India, the Indian insurance company has to obtain a certificate of registration from IRDA.

It has also been provided in the IRDA Act that on or after the commencement of the IRDA Act, no insurer will be allowed to carry on the life and general insurance business in India, unless it has a paid up equity capital of Rs. 1 billion. For carrying on the reinsurance business, the minimum paid up equity capital has been prescribed as Rs. 2 billion. The Reserve Bank of India (RBI) has also issued guidelines for banks entry into the insurance business. For banks, prior approval of the RBI is required to enter into the insurance business. The RBI would give permission to banks on a case-by-case basis, keeping in view all relevant factors. Banks having a minimum net worth of Rs. 5 billion and satisfying other criteria in respect of capital adequacy, profitability, non-performing asset (NPA) level and track record of existing subsidiaries can undertake insurance business through joint ventures, subject to certain safeguards. However, banks need not obtain prior approval of the RBI for engaging in insurance agency business or referral arrangement without any risk participation, subject to certain conditions.

In December, 2000, the subsidiaries of the General Insurance Corporation of India were restructured as independent companies and at the same time GIC was converted into a national re-insurer. Today there are 24 general insurance companies including the ECGC and Agriculture Insurance Corporation of India and 23 life insurance companies operating in the country.
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The insurance sector is a colossal one and is growing at a speedy rate of 15-20%. Together with banking services, insurance services add about 7% to the countrys GDP. A well-developed and evolved insurance sector is a boon for economic development as it provides long- term funds for infrastructure development at the same time strengthening the risk taking ability of the country. 1994, the committee submitted the report and some of the key recommendations included:

i)

Structure

Government stake in the insurance Companies to be brought down to 50%. Government should take over the holdings of GIC and its subsidiaries so that these subsidiaries can act as independent corporations. All the insurance companies should be given greater freedom to operate.

ii)

Competition

Private Companies with a minimum paid up capital of Rs.1bn should be allowed to enter the sector. No Company should deal in both Life and General Insurance through a single entity. Foreign companies may be allowed to enter the industry in collaboration with the domestic companies.

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Postal Life Insurance should be allowed to operate in the rural market. Only one State Level Life Insurance Company should be allowed to operate in each state.

iii)

Regulatory Body

The Insurance Act should be changed. An Insurance Regulatory body should be set up. Controller of Insurance- a part of the Finance Ministry- should be made independent

iv)

Investments

Mandatory Investments of LIC Life Fund in government securities to be reduced from 75% to 50%. GIC and its subsidiaries are not to hold more than 5% in any company (there current holdings to be brought down to this level over a period of time)

v)

Customer Service

LIC should pay interest on delays in payments beyond 30 days. Insurance companies must be encouraged to set up unit linked pension plans. Computerisation of operations and updating of technology to be carried out in the insurance industry The committee emphasized that in order to improve the customer services and increase the coverage of insurance policies, industry should be opened up to competition. But at the same

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time, the committee felt the need to exercise caution as any failure on the part of new players could ruin the public confidence in the industry. Hence, it was decided to allow competition in a limited way by stipulating the minimum capital requirement of Rs.100 crores.

How big is the insurance market ? Insurance is a Rs.400 billion business in India, and together with banking services adds about 7% to Indias GDP. Gross premium collection is about 2% of GDP and has been growing by 15-20% per annum. India also has the highest number of life insurance policies in force in the world, and total investible funds with the LIC are almost8% of GDP.

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.

Insurance 20-20: 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, Following might be the future strategies of insurance companies.

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(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 premier on policies that offer pure protection are on a par with comparable schemes across the globe. What the new insurance companies will probably offer is higher returns than the annualized 9-10% one can hope to earn from LICs policies. This will put pressure on LIC to offer more attractive returns. (2)Consumers can also expect product innovations. For instance, at present, LIC provides cover for permanent disability and what the new companies could offer is temporary disability insurance as well. (3)Apart from the basic term insurance, most insurance products worldwide are sold as longterm investment opportunities with the protection component being clearly spelt out in the scheme. (6) Foreign companies would also use superior software (like APEX) that will give them an edge over the in-house LICsoftware. This technology will help private insurers in product development and customizing products to suit individual needs. (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.

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

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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 notpublic provision of insurance. Indeed in India, insurance was in the private sector for a long time prior to independence India is poised to experience major changes in its insurance markets as insurers operate in an increasingly deregulated and liberalized environment. However, despite the liberalization in the insurance sector, public sector insurance companies are expected to maintain their dominant positions, at least in the foreseeable future. Nevertheless, given the enormous potential of the Indian market, it is expected that there will be enough business for new entrants. For consumers, opening up of the insurance sector will mean new products, better packaging, and improved customer service. Product innovation and channel diversification would gain momentum, in line with the global trend of financial services convergence. For government, insurance, especially life insurance, can substitute for State security programmes. It can thus relieve pressure on social welfare systems and allow individuals to tailor their security programmes to their own preferences. This substitution role is especially valuable, given the growing demand for social security and the increased financial challenges faced by the Indian social insurance system.

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RECOMMENDATIONS
The Committee has made its recommendations on the Terms of Reference as under. A. Detariffing: 1. To take immediate and urgent steps to move towards detariffing the entire general insurance market that includes the profitable segments like the fire and engineering and the unprofitable business segments like motor. It is strongly recommended that this issue should be addressed on a priority basis and a free market without tariffs and price controls should be organized. IRDA, TAC and the General Insurance Council of the Insurance Association of India should collaborate with each other to ensure a smooth changeover to the non tariff system not later than 1st April 2006. 2. A road map should be drawn up for this purpose. IRDA, TAC and the General Insurance Council should encourage, assist and guide individual insurers to build up statistical bases for their own risk acceptances on all businesses currently under tariffs, category-wise, as is now prevalent in the respective tariffs. This will enable them to be ready for a Pure Risk rate regime (wherein the rates will not include any administration and /or procurement costs or profit margins) proposed by the Committee to operate at least with effect from 1st April 2006. This will thus prepare the insurers for a completely detariffed market two years later. Involvement of consulting actuaries of insurers in this exercise should be considered. Insurers should gross up the designated Pure Risk rates to cover for their administration and procurement expenses and profit margins according to their best underwriting judgment. To this extent the market should have floating rates in which the underwriting skills and cost and profit considerations will have a primacy from 1st April 2006. 3. The effect and fall out of the introduction of Pure Risk rate regime in the interim may have an adverse impact on the rates in the short run on profitable segments whereas the rates may go up in the hitherto unprofitable segments. To avoid or mitigate unhealthy competition in pricing, until the market stabilizes, the Pure Risk rates (which will not include any administration and / or procurement costs or profit margins) should be regarded as the minimum benchmark subject to strict discipline and inspection as an
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intermediate step. Insurers should be alerted on the need to control expenses to achieve appropriate balances in their results. During such regime of Pure Risk rates, the standard terms and conditions of the tariff wordings should be preserved. The roadmap envisaged must thoroughly dwell on this aspect. The TAC should be entrusted with the responsibility to prepare Pure Risk rates to be regarded as the minimum for two years commencing from 1st April 2006 or even earlier if possible and such rates should have the status of tariff rates. The TAC should monitor the breaches of Pure Risk rates. Punishment for breaches should be hefty enough to discourage deliberate breaches. 4. Since there is an industry tariff structure currently in force on most portfolios, the Committee is of the view, that there has been very little incentive for individual insurers to build up their individual risk category acceptances and experiences to be able to price risks on claims cost plus basis. Absence of statistical data would compel an insurer to price risks on assumptions either with a conservative element built into it or force it to follow the rates of any of its aggressive competitor. In a strongly developed broker market, the pressure on underwriters will be intense; and the current competition is still young, just three years old. The Indian insurance market is yet to mature in terms of underwriting skills to be able to face tougher competitive conditions likely to emerge in future. Underwriting and pricing of risks should, therefore, be based on statistical data to back up the intended pricing structure both at the level of the individual insurer and of the market as a whole. It is time for individual insurers to start building up their statistical data on sound lines to avoid a chaotic situation and price wars later. The IRDA, TAC and the General Insurance Council should guide and assist individual insurers to adjust to the transformation that a free market situation will impose on their business practices, mindset and procedures. The changeover has to be as smooth as possible and with full awareness of its consequences.
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5. Customers do need price competition to experience the full benefits of liberalization. Insurers need to practice underwriting skills and risk management techniques to evaluate risks and price products to fit in with global trends and practices. They should be enabled to learn from international trends and developments. Brokers and agents need to display their professional wares and expertise.

B. Special discount, Intermediary Remuneration, Special dispensation to PSUs and Paid-up Capital norms. 1. To continue with the 5% Special discount (that has been in usage for over 25 years) in the interim for certain Corporate bodies both in the private and public sector on fire and engineering insurances only- till detariffing of rates by 1st April 2006 or earlier as the case may be. There is no justifiable reason demonstrated to the Committee for its sudden withdrawal. 2. Since the Rs 10 lakh paid-up capital norm for corporate bodies, as defined below, fixed earlier for qualifying for special discount of 5% is very low under the present economic trends, the Committee recommends that the eligibility limit for the special discount of 5% should now be raised to a minimum paid-up capital of Rs 1 crore and above for corporate bodies. The special discount of 5% should be further restricted to such corporate bodies for only fire and engineering insurances. This will widen the access of corporate client base, below paid-up capital of Rs 1 crore, both to the agents and brokers to display their professional expertise. There should be no special discount of 5% allowed on any tariff cover either to individuals or corporate bodies whose paid-up capital is below Rs 1 crore. IRDA/TAC may issue suitable instructions in this regard. Where special discount 5% is not applicable, the agency commission for insurances of individuals and corporate bodies with a paid up capital below Rs 1 crore should be restricted to a maximum of 10% for agents. The brokerage should be a maximum of 12.5% on tariff covers.

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Although not related to the paid-up capital issue, it is recommended that for statutory covers both the agents and brokers should be eligible to a maximum of 10% remuneration, as no special expertise is required to sell and service these covers and further there shall be no special discount payable on this. For non-tariff covers the brokers should be eligible to a maximum remuneration of 17.5% and the agents to a maximum of 15% as currently specified. 3. The Corporate bodies, whether private limited companies or public limited companies or public sector undertakings or statutory bodies having a paidup capital of Rs 1 crore and above and up to Rs 25 crores should be allowed to have a choice of availing either a 5% special discount and place fire and engineering businesses directly with an insurer or seek the services of a broker/agent when they will become ineligible for the 5% special discount. The remuneration to brokers in such an event should be limited to a maximum of 7.5%. The agency commission should be restricted to a maximum 6.25 %. 4. The Corporate bodies, whether private limited companies or public limited companies or public sector undertakings or statutory bodies having a paid up capital of above Rs 25 crores should be allowed to have a choice of availing either a 5% special discount and place the fire and engineering business directly with an insurer or seek the services of a broker/ agent, when they will become ineligible for the 5% special discount. The remuneration to brokers in such an event should be limited to a maximum of 6.25%. The agency commission should be restricted to a maximum of 5%. In suggesting the above norms and remuneration, the Committee would like to record that these remuneration packages should be regarded only as interim measures pending the detariffing of the market with the introduction of Pure Risk rate regime not later than 1st April 2006. The brokers/agents should be enabled in the interim to get integrated into the system for their future potential gains and the more important professional roles they will be expected to play. 5. The present brokerage/commission structure as it exists in the present regulations on tariff covers, does in the view of the Committee, encourage rebating and malpractices to

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flourish. It has happened in the past, despite numerous measures discouraging their proliferation by way of social control of insurance and nationalization. The Regulator at this initial stage of liberalization of markets should be wary of such substantial remuneration to be paid on tariff covers, wherein the professional input is limited, whether it is the broker or the agent. Inducing competition in the market, while controlling prices and product features for most covers will inevitably encourage unhealthy practices to flourish. Hence the Committee has suggested detariffing the market by the introduction of Pure Risk rate regime not later than by 1st April 2006 as the logical step to create an environment where competition is fair and there is a level playing field. 6. As regards the impact of brokerage and commission on procurement costs of insurers on tariff covers, it is observed that the cost of transacting insurance business in India has remained high at over 30% of the earned premiums generated for both the public and the private players. Additional costs if imposed suddenly would further burden them. Insurers have neither actively adopted nor taken any serious measures to reduce costs nor have they any strategies in place to do so that will result in lower premiums to consumers at least in future. Insurers have combined ratios (claims cost plus expenses) in excess of 114% on earned premiums for the year 2002/3 resulting in huge underwriting losses. The Boards of Directors of these insurers should actively encourage drawing up of plans to reduce management costs in order to lower their combined ratios that will ultimately benefit consumers. The Committee is also of the view that in a tariff market the brokerage and commission structure as recommended above is in keeping with the services that can be rendered by them. Detariffing should, however, be completed not later than 1st April 2006 in order to allow the Pure Risk rate regime and market forces to decide on prices and intermediation expenses and allow consumers to experience the benefits of liberalization.

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C. Remuneration of agents and brokers: 1. There should be a differential maintained between the Agents and Brokers in their remuneration packages. The latter has more onerous responsibilities and functions to discharge. As such the maximum brokerage payable should be a little higher than the agency commission. 2. Agency commission for tariff covers should be revised to a maximum of 10% to maintain a differential of 2.5% in the remuneration structure between brokers and agents / corporate agents. 3. For statutory covers, however, 10% remuneration should be maintained for both of them, as no special expert advice is required in providing or servicing such covers. 4. On non-tariff covers, the maximum remuneration for brokers should remain at 17.5% and that of agents at 15%.

D. Government/Public Sector Undertakings: 1. The Committee recommends that all corporate bodies be treated alike and for intermediation purposes treated under the Special Discount recommendation as mentioned in B - 2 to 4 above. This is irrespective of whether they are in the private sector or public sector. As such, public sector undertakings should be permitted to exercise their choice for intermediary access with stipulations on paid-up capital norms, remuneration and discounts as mentioned under in B - 2 to 4 above. 2. Fairness and equity requires that IRDA should not take a selective view in organizing the market or in limiting the freedom of choice to any sector on its own.

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CONCLUSION
A committee was set up in 1993 under the chairmanship of R.N. Malhotra, former Governor of the Reserve Bank of India, to make recommendations for reforms in the insurance sector. The Malhotra Committee recommended introduction of a concept of professionalisation in the insurance sector to make out a strong case for paving the way for foreign capital. In its report submitted in 1994, the committee recommended, among other things, that: Private players be included in the insurance sector. Foreign companies be allowed to enter the insurance sector, preferably through joint ventures with Indian partners. The Insurance Regulatory and Development Authority (IRDA) be constituted as an autonomous body to regulate and develop the insurance sector. The key objectives of the IRDA would include promotion of competition so as to enhance customer satisfaction through increased consumer choice and lower premiums while ensuring the financial security of the insurance market. Brokers representing the customer be brought in as another marketing and distribution channel, a practice prevalent in most developed markets Raise the level of professional standards in risk management and underwriting and speed up settlement of claims. Following the recommendations, the IRDA was constituted as an autonomous body in 1999 and incorporated as a statutory body in April 2000. With the coming into force of the IRDA Act, 1999, the insurance industry was opened up to the private sector.

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REFERENCES
Babbel, D. F. and A. M. Santomero, (1996) Risk Management by Insurers: An Analysis of the Process, Financial Institutions Center working paper no. 96-16, Wharton School, University of Pennsylvania. Babbel, D. F. and C. Merrill, (1997) Economic Valuation Models for Insurers, Financial Institutions Center working paper no. 97-44, Wharton School, University of Pennsylvania. Brewer, E. III, T. S. Mondschean and P. E. Strahan, (1996) The Role of Monitoring in Reducing the Moral Hazard Problem Associated with Government Guarantees: Evidence from the Life Insurance Industry, Financial Institutions Center working paper no. 96-15, Wharton School, University of Pennsylvania. Briys, E. and F. de Varenne, (1996) On the Risk of Life Insurance Liabilities: Debunking Some Common Pitfalls, Financial Institutions Center working paper no. 9629, Wharton School, University of Pennsylvania. Cork, D. O. and J. D. Cummins, (1996) Productivity and Efficiency in Insurance: An Overview of the Issues, Financial Institutions Center working paper no. 97-57, Wharton School, University of Pennsylvania. Cummins, J. D. and M. A. Weiss, (1991) The Structure, Conduct, and Regulation of the Property-Liability Insurance Industry, (in) R. E. Randall and R. W. Kopcke (eds.) The Financial Condition and Regulation of Insurance Companies, Federal Reserve Bank of Boston. Cummins, J. D. and P. M. Danzon, (1997) Price, Financial Quality and Capital Flows in Insurance Markets, Journal of Financial Intermediation, 6:3-38. Fama, E. and M. Jensen, (1983) Separation of Ownership and Control, Journal of Law and Economics, 26: 327-349. Gardner, L. A. and M. F. Grace, (1995) Efficiency Comparisons between Mutual and Stock Life Insurance Companies, Working Paper no. 95-1, Georgia State University. Garven, J. R. and M. Guillen, (1995) Ownership Structure and Distribution Systems in

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Property-Liability Insurance: A Bivariate Probit Approach, Working Paper, University of Texas at Austin. Government of India, (1994) Report of the Committee on Reforms in the Insurance Sector, New Delhi: Ministry of Finance. Grace, M. F. and M. M. Barth, (undated) The Regulation and Structure of Non-Life Insurance in the United States, Mimeo, Financial Sector Development Department, The World Bank. Jensen, M. C. and W. H. Meckling, (1976) Theory of the Firm: Managerial Behavior, Agency Costs, and Ownership Structure, Journal of Financial Economics, 3: 305-360. Kopcke, R. Q. and R. E. Randall, (1991) Insurance Companies as Financial Intermediaries: Risk and Return, (in) R. E. Randall and R. W. Kopcke (eds.) Op cit, Federal Reserve Bank of Boston. Lee, S-J and M. L. Smith, (1995) Property Casualty Insurance Guaranty Funds and Insurer Vulnerability to Misfortune, Working Paper, Ohio State University. Myers, D. and C. W. Smith Jr., (1981) Contractual Provisions, Organizational Structure, and Conflict Control in Insurance Markets, Journal of Business, 54: 407-434. Wright, K. M., (1991) The Structure, Conduct, and Regulation of the Life Insurance Industry, (in) R. E. Randall and R. W. Kopcke (eds.) Op cit, Federal Reserve Bank of Boston.

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