INSURANCE

Indian Insurance Industry

The insurance business in India can be broadly sub-divided into two
categories:
• Life Insurance
• General Insurance
In January 1956, the management of life insurance business of 245 insurance
players at
the time was taken over by the Government of India (GoI). In September
1956, the
business was nationalized and the Life Insurance Corporation of India (LIC)
set up,
which took over this ownership. LIC was formed in September 1956 by an Act
of
Parliament (LIC Act, 1956), with a capital contribution of Rs. 50 million from
the GoI.
Since nationalization, LIC developed a vast network of branches and
expanded its
business. Up to the initial reforms initiated during 1993 (refer below), LIC built
up a life
fund to the extent of Rs. 410 billion by end – FY 1993. New business
increased from Rs.
3.3 billion under 0.95 million policies during 1956-57 to Rs. 360 billion under
10 million
policies on individual lives during FY 1993; business in force increased from
13.8 billion
(5.4 million policies) to Rs. 1,773 billion (56.6 million policies).
General Insurance
The first General Insurance Company in India – Triton Insurance Company
Limited –
was set up in 1850 with dominant British control. Its first Indian counterpart,
the Indian
Mercantile Insurance Company Limited, launched its operations in Bombay in
1907.
Although the general insurance business was not nationalized along with life
insurance,
a code of conduct for fair and sound business practices was framed in 1957
by the
General Insurance Council (a wing of the Insurance Association of India). In
1968, the
Insurance Act was amended to provide for greater social control over the
general
insurance business. In 1971, the management of non-life insurers was taken
over by the
GoI. The general insurance business was nationalized in 1973 by the General
Insurance
Business (Nationalisation) Act, 1972. As a result, 107 insurers (including both
Indian and
foreign companies) were amalgamated and grouped into four companies –
National
Insurance Company Limited (NIC), New India Assurance Company Limited
(NIACL),
Oriental Insurance Company Limited (OIC) and United Indian Insurance
Company
Limited (UIIC) – with the General Insurance Corporation of India (GIC) as the
holding
company. The GIC was incorporated as a company in November 1972 and it
commenced business on January 1, 1973. GIC has been acting as the Indian
reinsurer
since then. The GoI subscribed to the capital of GIC while GIC subscribed to
the capital
of the four companies.
In November 2000, the GoI restructured the general insurance industry by
notifying GIC
as the ‘Indian Reinsurer’. The notification followed the request of the
Insurance
Regulatory and Development Authority (IRDA) for bifurcation of the
reinsurance
business from the general insurance business of GIC. The General Insurance
Business
(Nationalisation) Amendment Act, 2002 was passed by both Houses of
Parliament and
assented to by the President of India on August 7, 2002. Consequently, GIC
now
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undertakes only reinsurance business, while the four public sector
undertakings (PSUs)
– NIC, NIACL, OIC and UIIC – continue to handle the general insurance
business.
Following the notification, the administrative link that existed between the
four
nationalized companies and the GIC ended. The four PSUs are now broadly
run as
board managed companies. Further, GIC has now ceased to do any direct
business in
India, except for crop insurance. It has also diversified into acceptance of life
reinsurance business. As the sole reinsurer in the domestic reinsurance
market, GIC
provides reinsurance to the direct general insurance companies in the Indian
market. It
leads many of the domestic companies’ treat programmes and facultative
placements.
Deregulation of the Industry
While effecting reforms in the banking sector and capital markets during the
1990s, the
GoI also recognized the importance of insurance as an important part of the
overall
financial system where it was necessary to undertake similar reform
measures. In April
1993, the GoI appointed a Committee on Reforms in the Insurance Sector
(the Malhotra
Committee). The Committee, which submitted its report in January 1994,
recommended
that the insurance business in India be opened up to private players, and laid
down
several guidelines for managing the transition.
The decision to allow private companies to sell insurance products in India
rests with
Indian Parliament. Opening up the insurance sector required crossing at least
two
legislative hurdles. These were the passage of the Insurance Regulatory
Authority (IRA)
Bill, which would make IRA a statutory regulatory body, and amendment of
the LIC and
GIC Acts, which would end their respective monopolies.
Subsequently, in pursuance to the announcement made by the Union Finance
Minister
in his Budget Speech of 1998-99, the Insurance Regulatory & Development
Authority
(IRDA) Bill, 1999, was passed by both Houses of Parliament. The Bill was
assented to
by the President and notified on December 29, 1999. 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;
• 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;
In the last budget, though the Government has proposed an enhancement in
the FDI
limit from 26% to 49% but this is yet to be notified in the Insurance
Regulatory &
Development Act (IRDA).
• Its sole purpose must be to carry on the life insurance business or general
insurance
business or reinsurance business.
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• 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.
Establishment of Liaison Offices in India by Foreign Insurance
Companies
The Government has since decided to grant general permission to establish
liaison
offices in India to insurance companies incorporated outside India, which
have obtained
prior approval from IRDA to establish liaison offices in India subject to the
necessary
terms and conditions as mentioned in the circular No. 39 dated 25th of April,
2005 and
the other conditions that may be stipulated by the IRDA from time to time.
Market Structure following Deregulation
Following the passage of the IRDA Act, private players were allowed into the
insurance
business in 2000. At present, the life insurance business in India is conducted
by 14
companies – one public sector company (LIC) and 13 private sector players.
The
general insurance business in India is carried out by 14 companies – six PSUs
(including
the old four PSUs, and recent entrants such as AICIL and Export Credit
Guarantee
Corporation of India Ltd. Or ECGC), and eight registered companies in the
private sector.
Although private insurance companies have commenced operations since FY
2001, the
nationalized insurance companies are expected to dominate the market in
the near
future, especially in long-term savings products such as life insurance. During
FY 2003,
the premium income of private sector life insurance companies was only Rs.
1,096
million, as companied with Rs. 546,285 million for LIC. In the general
insurance business,
the gross direct premium income (GDPI) in India of private sector companies
was Rs.
13,416 million during FY 2003, as compared with Rs. 129,311 million for the
five PSUs
(excluding AICIL). During FY 2003, the private sector players had a market
share of 2%
(in terms of premium income) in life insurance, and a market share of 9.4%
(in terms of
GDPI in India) in general insurance.
The limiting factor for prospective private insurers will be the extensive and
costly
distribution structure required. Building and servicing a distribution network
large enough
to generate economies of scale are likely to be critical. At least during the
next few years,
the new entrants cannot expect to replicate the extensive distribution
network of the
nationalized insurance companies. Building a distribution network is
expensive and time
consuming. Private insurers are expected to follow a strategy similar to that
of the
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foreign banks i.e. starting from the affluent segment and gradually building
up the
distribution network to reach out to the middle-income (even if urban)
segment. In
villages and semi-urban areas, insurance companies have introduced a
number of
innovative schemes to strengthen their distribution channels and expand
operations.
Players are also tapping the extensive banking network in the country.
Subsequent to
the enabling legislative framework being put in place by IRDA allowing Banc-
assurance,
insurers have started offering products through this strategic channel.
Indian Industry – Key Issues and Outlook
Deregulation and Competition
The Indian insurance market has witnessed considerable deregulation over
the past few
years. This has facilitated an increase in the levels of competition, entry of
reputed
international insurers, expansion of the market, and adoption of more
innovative
approaches to distribution and product development. Significantly, however,
despite the
entry of large global players, the Indian market continues to be dominated by
the
incumbent public sector companies.
Despite the low penetration of insurance in the country, the monopolization
of the
insurance sector by the public sector companies had till recently prevented
the Indian
insurance market from achieving its full growth potential. Deregulation has
gained
widespread acceptance in Asia. Countries like China, Malaysia, Indonesia and
Thailand,
which opened their insurance markets to foreign players, displayed
significant increases
in growth rates. The rank of South Korea, which opened its insurance sector
in 1971, in
global premium mobilization improved from 30th in 1971 to 7th in 2003.
The scenario in India is also likely to change following the deregulation of the
Indian
insurance industry, which has resulted in global majors such as the Allianz
Group, ING,
Prudential, AIG Group, Aviva, MetLife, Chubb, Royal Sun Alliance and Lombard
setting
up operations in India in association with established domestic business
houses. The
newer players are expected to contribute towards the development of newer
products
and delivery systems, and focus on creating a greater awareness about
insurance as a
protection and risk management device. These efforts are expected to result
in an
expansion of the market over a period of time, and increased competition for
public
sector companies.
While public sector players are likely to lose market share, the would continue
to hold a
strong market position on account of their well-established brand equity and
distribution
network. However, at the same time, it must be noted that major public
sector banks
such as State Bank of India, Bank of Baroda, Punjab National Bank and other
large
public-sector banks also have established brand equity and distribution
strength. Bancassurance
is likely to catch on in India, the same way it has done globally.
Growth
Despite India’s vast population; low incomes, rural poverty, low levels of
education, and
lack of awareness about insurance products have constrained the growth and
penetration of insurance products in the past. India, which accounted for
around 6.6% of
Asia’s GDP in 2003, accounted for only 2.5% of the region’s insurance
business, which
in fact points to a large untapped business potential.
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The Indian insurance industry undoubtedly displays great potential. The
country’s high
savings rate (with gross domestic savings at 24.2% of GDP in FY 2003),
customary lack
of social security nets, and a tradition of frugality are expected to be key
growth drivers.
The liberalization of the market is also likely to improve penetration through a
broader
scope of products. Banc-assurance is another development that is expected
to drive the
growth in the insurance business in India. As the increased tie-ups of banks
and
insurance companies indicate, banks view selling insurance products as an
opportunity
to leverage their extensive branch network, and broaden their income base
to include
more fee-based business. Insurers equally see Banc-assurance as a low-cost
option to
expand their distribution network and penetrate into previously inaccessible
segments of
the market.
A key point to note that although the high level household savings and
product
innovations in the insurance business are likely to drive the growth in
insurance business,
the channelisation of household savings into insurance products is dependent
on
developments in other financial products for household savings. The
availability of
mutual funds, equities and other money market instruments has proliferated
along with
yield-driven investments. Mutual funds have had growing success through
the early
1990s, particularly after the sector was opened to competition from the
private sector.
However, they have also experienced considerable volatility in fund
mobilization in
recent years. These alternative avenues could compete with insurance
products for
attracting financial assets of the household sector. In buoyant stock market
conditions,
life insurance products could become less attractive investment vehicles vis-
à-vis equity
investments and mutual funds, mainly owing to the comparatively low
interest rate paid
on life insurance funds. This is largely because of portfolio allocation
constraints.
Even if the Indian insurance industry achieves the per capita premium level
of China
(US$ 36 during 2003), the industry turnover will increase to US$ 38 billion at
the 2003
levels of population. In case the Indian market can reach the insurance
density of a
developing country like Brazil (US$ 83 per capita in 2003) the domestic
industry turnover
will reach almost US$ 87 billion.
As discussed, the expansion of the market is likely to come from both
increased
promotional efforts by private sector players, and the introduction of products
that cover
new kinds of risks and cater for a wider range of hitherto untapped needs. An
example of
the latter is creditor insurance, which covers the risk of not being able to
meet loan
payments because of illness, accidents or loss of employment. Similarly, only
a minute
fraction of consumer durables purchased in India is insured.
Structural reasons account for the small size of some key insurance segments
in India.
A prime example is health insurance where government’s role has not been
so extensive.
The public health investment in the country, over the years, has not only
been
comparatively low, but also continuously on the decline (as a percentage of
GDP). The
investment, which was 1.3% in 1990, has now declined to 0.9%. Increase in
penetration
of health insurance was one of the main objectives of opening up the
insurance sector to
private players. Since then, health insurance premiums have increased from
Rs. 5.19
billion in FY 2001 to Rs. 10.02 billion in FY 2003. Health insurance business
contributed
an estimated Rs. 12.74 billion in premium income during FY 2004, accounting
for 7.9%
of the premium income of the general insurance industry in India. The
presence of
private players is likely to result in increased awareness of health insurance
products (on
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account of more aggressive promotion), and more aggressive tackling of
structural
bottlenecks that have impeded the growth of this segment.
Insurance penetration in India is also expected to improve with increased life
expectancy.
Improved nutrition and medical standards have improved the life expectancy,
suggesting
that retirees are likely to live long after retirement. As per the 2001 Census,
the
expectation of life at birth has increased from 57.7 years for male and 58.7
years for
female in 1991 to 62.3 and 65.3 respectively in 2001. The expectation of life
at 60 years
has also increased from 14.5 years in 1991 to 17 years in 2001. India’s life
expectancy
(at birth) is expected to increase from 64 years during 2000-05 to 72 years
during 2025-
30.
As the table below shows, over the next few decades, the growth rate of the
older
population (60+ years) is expected to outstrip the growth rate of population,
indicating
greater demand for old age financial security. There are an estimated 80
million people
over 60 years in India, and a majority of them have to rely on income
support, mainly
from their children. The number of people over 60 years is expected to
increase to 169
million 2025. India’s population structure, in 2050, is likely to be similar to
that presently
found in the major industrial countries – the US, France, Italy and Germany.
Years Population
(million)
% of total
2000 2025 2050 2000 2025 2050
0-14 338 314 309 33.5 23.2 19.7
15-59 594 869 939 58.9 64.3 59.7
60-69 48 100 170 4.7 7.4 10.8
70-79 23 51 106 2.3 3.8 6.7
>80 6 17 48 0.6 1.3 3.1
Total 1,009 1,352 1,572 100 100 100
60+ 77 169 324 7.6 12.5 20.6
(Source: United Nations)
With increased life expectancy, the demand for insurance to cover the risks of
old age is
expected to increase. A contributory factor likely to drive demand is the
expected
reduced support from children, given the gradual dissolution of the traditional
joint family
structure.
The present social security system in India is inadequate. Out of an estimated
402
million workers in the country, only 11-12% are covered by some form of
social security,
mostly in the organized sector. The present social security system in India is
largely
confined to the organized sector. For the rest, a job is the best guarantee of
social
security. Even in the organized sector, social security measures such as
pension funds
are expected to be increasingly inadequate in providing retirees with a
comfortable
standard of living. Employers, who are mainly government and public sector,
have
severe financial limitation. There is increased fiscal pressure on the
Government to
reduce its role in the provision of old age insurance. The pension liability of
the Central
Government employees has risen from 0.6% of the GDP (at constant prices)
in FY 1994
to 1.6% in FY 2003. Over the same period, actual outgo has increased from
Rs. 52
billion to Rs. 220 billion. Total pension liability as a percentage of net tax
revenue has
increased from 9.7% to 12.7%. For Central Government employees, the
dependency
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ratio (the ratio of pensioners to active employees) is 0.85. With rising
longevity and live
expectancy, the pension liability is expected to increase further. In the
unorganized
sector, there are a large number of self-employed persons with reasonable
levels of
income, but without access to any mechanism for earning a risk-free and
reasonable
return on their savings for retirement. Thus, there is significant potential for
insurance
products in the unorganized sector, where persons in the unorganized sector
can save
in insurance products during their active working life.
The GoI, realizing the need for increased old age income security, constituted
the interim
Pension Fund Regulatory Development Authority (PFRDA) in October 2003.
The
PFRDA has been entrusted the task of regulating and developing the pension
market in
India, and also developing privately-managed pensions in India. In such a
scenario, the
insurance industry is expected to play a key role as the GoI shifts the future
burden of
some of its retirement provision obligations.
Favorable Regulatory Environment
The development of the insurance industry in India, as in other international
markets, is
likely to be critically dependent on the nature and quality of regulation. The
role of the
regulator in most markets is to ensure efficiency, transparency and fair play,
while at the
same time protecting the interests of the consumer. The IRDA Act 2000 has
laid down
the broad regulatory framework within which insurance companies are
expected to
operate in India. The provisions of this Act address issues related to
ownership,
solvency, investment portfolio construction, commission structures, reporting
formats
and accounting standards. The minimum paid-up equity capital requirement
has been
set at Rs. 1 billion. The insurance business is capital intensive, and
international
experience suggests that, on an average, general insurance companies
require four to
five years to break even. In the interim, these companies would require
regular capital
infusion for funding expected losses and meeting solvency requirements. In
this context,
given the existing regulatory constraints of foreign direct investment by the
overseas
partner, a substantial part of the funding would have to be done by the Indian
partner,
whose financial strength is likely to influence the credit strength of the joint
venture.
Given the evolutionary stage of the Indian insurance industry, one of the focal
points for
the regulator has been to ensure stability and solvency of the industry. The
IRDA Act
specifies that all insurance companies must maintain an excess of asset over
liabilities,
to the extent not less than Rs. 0.5 billion, or a sum equivalent based on the
prescribed
formula, not exceeding 5% of the mathematical reserves, and a percentage
exceeding
1% of the sum at risk for the policies on which the sum at risk is not negative,
whichever
is the highest. A general insurance company would at any point in time need
to maintain
a minimum solvency capital of Rs. 500 million, or a sum equivalent to 30% of
the net
incurred claims, whichever is the highest. The Act also lays down broad
guidelines for
the construction of the investment portfolios of life insurance companies.
These norms
have been designed to ensure that an insurer does not make on
unsustainable risks in
deploying funds collected by way of premium. Overall, the regulatory
environment is
favorable and one which ensures that players maintain prudent underwriting
standards,
and reserve valuation and investment practices. The primary objective for the
current
regulations is to ensure stability and fair play in the market place.
Distribution
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The effectiveness and cost of different distribution strategies of different
players is likely
to be crucial in ensuring the success for players in the insurance business,
particularly in
the retail lines of business. The low differentiation among retail insurance
products
suggests the criticality of distribution reach and efficiency for success in this
business.
The most attractive segment for the private insurance players in the life
segment will be
the Indian middle-class. Life insurance in India has been distributed through
an
elaborate network of agents. The limiting factor for prospective insurers will
be the
extensive and costly distribution structure equipped for reaching this
segment. The new
entrants cannot expect to replicate the extensive distribution network of the
nationalized
insurance companies. Building a distribution network is expensive and time
consuming.
As a result, private insurers have largely followed a strategy similar to that of
the foreign
banks i.e. starting from the affluent segment and gradually building up the
distribution
network to reach out to the middle-income (even if urban) segment. In
general insurance,
the target group of customers targeted are the corporates, who have sizeable
insurance
business that is compulsorily insurable. By comparison, personal insurances
of affluent
individuals in urban and semi-urban areas, retail segments like to
shopkeepers, etc. and
insurance for rural population are mostly voluntary and optional in nature.
The private
sector companies are expected to leverage on the existing distribution
franchise of their
Indian promoters to access this potentially large retail insurance market. The
importance
of distribution is particularly important in life insurance and the retail
segment of non-life
insurance. By contrast, the marketing of insurance products aimed at
corporate
customers would continue to involve a fair amount of direct customer
interface, and
insurance companies are expected to develop customized product packages
and offer
allied risk management services as a differentiation strategy. The strong
relationships
that the public sector companies have with their existing corporate clients
are likely to
enable them to sustain their market position in this segment. However, the
private sector
players are likely to leverage the business relationships of their parents and
their service
quality to gain strategic entry into large corporate accounts.
Private players are exploring several alternatives to reduce the costs of
replicating the
distribution network of the public sector insurance companies. One potential
channel is
marketing through corporate employers, that is, the employers purchase the
product on
behalf of the employees or at least co-operate in the marketing effort. While
third-party
distribution, as in fast moving consumer goods, is a possibility, the
complexity of
insurance products, especially given the low awareness levels, would
necessitate direct
selling. However, some products, once they receive a high level of
penetration and
awareness, can become commodities and be sold through more impersonal
channels.
Technological advances are expected to enable new distribution channels,
while recent
regulatory changes (bank’s entry into insurance) are expected to allow cross-
selling
between financial services companies. The use of the Internet to distribute
life insurance
products has only emerged recently and has not made a significant impact so
far, partly
because of the substantial advisory component of most life insurance
products. However,
Banc-assurance is expected to gain considerable popularity.
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CONCLUSION
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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