MICROECONOMICS

A MICROECONOMIC ANALYSIS OF LIFE

INSURANCE INDUSTRY IN INDIA

BY-
SARTHAK AGARWAL C003
SONALI AMIN C005
AKSHAY CHANDAK C012
PRERNA CHANDRA C013
TANUJ GULATI C022
PARUL RELIA C045

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Introduction
A life insurance policy is a contract between the insurer and policyholder that the
insurer will pay a certain sum of money in case the policyholder dies or any other
contingency specified in the contract occurs. In lieu of this assurance, insurer
takes a premium amount from the policyholder.
Section 2(11) of Insurance Act 1938, defines the life insurance business as the
business of effecting contracts of insurance upon human life, including any
contract whereby the payment of money is assured on death (except death by
accident only) or the happening of any contingency dependent on human life and
shall be deemed to include
i. The granting of disability and double or triple indemnity accident benefits,
if so provided in the contract of insurance;
ii. The granting of annuities upon human life; and
iii. The granting of superannuation allowances and annuities payable out of
any fund applicable solely to the relief and maintenance of persons
engaged or who have been engaged in any particular profession, trade or
employment or of the dependents of such persons.
Life insurance is the largest segment of the life insurance market in India,
accounting for 76.5% of the market's total value. The Pension/annuity segment
accounts for the remaining 23.5% of the market.

Evolution of Life Insurance Industry in India

Monopoly during 1956-2000
Prior to 1956, the life insurance sector was made up of 154 domestic life
insurers, 16 foreign life insurers and 75 provident funds. However, in 1956, all life
insurance companies were nationalized to form Life Insurance Corporation (LIC)
of India to increase penetration and protect policy holders from mismanagement.
The Government had to pay compensation to the existing life offices, whose
business it was going to acquire.
When parliament set up LIC as a monopolistic public undertaking, it was believed
that elimination of competition and the malpractice that competition had given
rise to, would lead to:
a) Better and more economical management of the business of life insurance.
b) Reduction in administrative expenses.
c) Improvement in the quality of service.
d) Increase in volume of business.
e) Maximisation of social advantages that insurance can provide through higher
returns on investments of life fund.

Oligopoly since 2000

In 1993, the Government of India appointed RN Malhotra Committee to lay down

guidelines for the privatisation of the life insurance sector. Malhotra Committee
recommended opening up the insurance sector to private players, including
foreign players preferably in joint ventures with Indian partners. The Committee

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provided the following reasons for the introduction of private players in the
insurance sector:
a) Majority of sectors earlier reserved for public sector had been privatized,
therefore need was felt to privatize insurance services to provide wider
competition and better product, price and services to consumers
b) Insurance awareness among the Indian consumers was found to be very
low.
c) Indian insurance sector was lagging behind the international standards not
only in terms of technology, cost efficiency, innovation and product range,
but also in terms of density and penetration
d) Large amount of fund available with public companies could be used for
other development programs
Following the recommendations of the Malhotra Committee in 1999, the
Insurance Regulatory and Development Authority (IRDA) was constituted as an
autonomous body to regulate and develop the insurance industry in India. The
key objectives of IRDA were to promote competition so as to enhance customer
satisfaction through increased consumer choice and lower premiums, while
ensuring the financial security of the insurance market. While nationalized
insurance companies did a commendable job in extending volume of the
business, opening up of insurance sector to private players was necessary
in the context of liberalization of financial sector.

Features of Oligopoly Existing in the Life Insurance Industry

I. Few sellers
The life insurance sector in India has about 24 players, with LIC being the
dominant player having a market share of almost 70%.

Figure 1. India life insurance market share (% share, by value),

2015

Market Share (%)

LIC
15% ICICI
5% HDFC
5% SBI
6% Others
69%

1. Life Insurance Corporation of India (LIC)

Most dominant player in the Indian life insurance sector (69.5%
market share)
Presence of 1,132,677 active agents

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 Differentiates products through insurance plans, pension plans, unit
plans, special plans, and group schemes

2. ICICI Prudential Life

Largest private sector insurance firm (6% market share)
Joint venture between ICICI and Prudential
Has maintained its dominant position amongst private life insurers
with an array of products to match the different life stage
requirements of customer

3. State Bank of India

Joint venture between State Bank of India and BNP Paribas Cardif.
(4.7% market share)
Has a unique multi-distribution model encompassing vibrant
Bancassurance, Retail Agency, Institutional Alliance and Corporate
Solutions distribution channels.
Leverages the State Bank Group relationship as a platform for cross-
selling insurance products along with its banking product packages

4. HDFC Bank Limited (HDFC)

Joint venture between Housing Development Finance Corporation
(HDFC) and Standard Life (4.7% market share)
Product portfolio comprises solutions for customer needs such as
protection, pension, savings, investment and health.
One of the widest reaches among new insurance companies with
about 500 branches in over 900 locations

5. Other firms in the industry

Metlife India Life Insurance, Bajaj Allianz Life, Max New York Life
Insurance, Tata AIG Life, Birla Sunlife, Kotak Life Insurance, Aviva
Life Insurance, Reliance Life Insurance Company Limited, ING Vysya
Life Insurance, Bharti AXA Life Insurance Co Ltd, Future Generali Life
Insurance Co Ltd, and others.

II. Entry and exit barriers

Despite a penetration of 3%, Indias insurance sector remains very small
compared to global standards. Barriers to entry in the life insurance market are
considered to be moderate; however, new players entering the market must
decide whether to enter on a large or small scale, each having its own associated
advantages and risks.
Government regulation in the insurance sector is generally stringent, with the
IRDA imposing capital requirements of INR 1,000 million ($16.4 million) minimum
for new entrants. FDI cap was the biggest entry barrier stopping the growth
of the life insurance in India. Seeking to attract more foreign investment, the
government has relaxed FDI norms for the insurance sector by permitting
overseas companies to buy 49% stake in domestic insurers under the automatic
route. With the opening up of market for foreign players, the competition
will get a boost and will improve the overall service offered to customers.

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Leading firms like LIC have strong reputations and consumer recognition, and
they usually offer a vast range of services with which new entrants must
compete. They also have a strong distribution channel and a large number of
agents, making it difficult for new entrants to establish their own network since
one agent can work for only one insurance firm. It is important to note that most
of the threat from new entrants lies within the insurance industry itself. Repeat
business is difficult to attain in this market, since consumers will rarely replace
their life insurance policies.
Compared to entry barriers, the exit barriers are higher. The regulatory system,
through the imposition of measures like capital adequacy, is designed to prevent
insurers from going out of business, as this would be detrimental to
policyholders. As a result, loss-making players may weather poor market
conditions where necessary, eventually leading to higher rivalry. Larger
companies prefer to acquire or merge with other companies rather than going
completely out of business.
III. Product Differentiation
The life insurance companies rely on proliferation as in any other industry. It is
not surprising that there are many insurance types not only to offer better
products but also to avoid price competition.
The types of insurance plans offered in the life insurance sector are as below:

1. Term life insurance: a plan providing coverage at a fixed rate of payments

for a limited period of time
2. Whole life insurance: a life insurance policy that which is guarantees to
cover the insured for the entire lifetime at decided premiums
3. ULIPs (Unit-linked insurance plan): a plan for the insured which not only
gives insurance but benefits but also acts as an investment
4. Endowment policy: is a policy which covers the insured during the term
and acts a saving option as on maturity, the insured receives a lump-sum
amount of the policy
5. Annual Pension plans: general pension plans which provide financial
stability during old age
6. Money back policies: a policy that provides coverage at higher premiums
and also guarantees periodic payments at specified intervals of time
The life insurance companies in India provide many schemes based on the above
mentioned categories. However, as per the IRDA norms, no product lies outside

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these categories and the companies differentiate themselves based on services
and customisations possible on the premiums paid. The products provide a
variety of options and features which can be seen in the table provided below:

IV. Pricing
Since the objective of business is to make profits, the pricing in the insurance
sector must be competitive, with a consideration of discounts and offers. In
addition to affecting the sales volume and profitability, the pricing strategy also
influences the perceived quality in the minds of the consumers. There are
various methods for calculating the pricing of insurance policies, including
survival approach, sales maximization approach, and profit maximization
approach, depending on the objective of the insurance company. The following
factors are considered while deciding the price of an insurance policy, which is in
the form of premiums:

Mortality: Average death rates in the area where the policy is being issued.
Services offered: Whether critical illness, terminal illness, accidental death,
etc., is covered.
Expenses: The cost of processing, commission to agents, registration is all
incorporated into the cost of instalments and premium sum.
Interest: This is the interest that consumers will have to pay for defaulting
the payment of premium and credit facility. Consumers will prefer
investing in other financial instruments if the rate of interest is too high.

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 V. Advertisement
Insurance companies use advertising as their main channel of promotion. They
use mediums like newspapers, televisions, direct mailers and insurance agents.
There is a huge battle between Indian Insurance companies to make their brand
and win over competitors. Trust is an important factor that must be instilled in
the customers mind to make them purchase insurance products. Thus,
companies focus their campaigns on building an image of trustworthiness,
reliability and security. Also, their advertisements focused on insurance as an
investment option rather than a mere tax saving tool.

Most of the advertising campaigns laid emphasis on familys happiness, human

bonding etc. with an underlying message of the security that insurance provides.
There is a change in insurance is advertised: Instead of projecting the idea, that
an insurance policy starts actually working only after the death of the insured,
the new campaigns show that insurance protects individuals throughout their
lives. In one of its TV ads, ICICI Prudential showed a series of scenes portraying
childhood, marriage and old age of an individual. The reason of using these
visuals is to translate the companys message that it will protect people from
real-life emergencies. In order to show its commitment towards consumers to
protect at every stage of life, the company brought in the idea of sindoor, which
signifies a bond and protection. Sindoor is shown throughout the ad as a mark of

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auspiciousness and protection, and at the end, it became the red line below the
ICICI Prudential logo Max New York also started depicting positive emotions such
as trust and protection in its print advertisements.

Analysis of Oligopoly Features in the Life Insurance Industry

1. Herfindahl-Hirschman Index

Based on the market share of different companies in the sector, using Herfindahl-
Hirschman
Index, we can find the extent of oligopoly in the insurance sector. Here 10,000
represents perfect monopoly and 0 represents perfect competition.

69.5^2 + 6^2 + 4.7^2 + 4.7^2 + 15.1^2 = 5138.44

Due to an index value greater than 5000, the life insurance sector is more of an
oligopoly than a perfect competition.

2. Factor Analysis

According to an analysis of data of the past 9 years from annual report of IRDA
2014-15 it was concluded that total amount of life insurance premiums is
dependent on the number of new policies issued and number of new offices
registered.
The relation between the premiums and new policies issued showed that with
the increase in new policies, the total premium collected decreased. Intuitively,
this is true, because when more competitors enter the market (supply increases),
the price surplus enjoyed by existing firms tends to reduce, eventually reducing
the profit. If more sellers tend to join the market because of supernormal profits,
the market will tend to move towards monopolistic competition from oligopoly.

Conclusion
Indias insurance sector is now one of the largest in the world in terms of
volumes of the money involved with a value of $64 billion in 2015. This was
possible due to the opening up the insurance sector to private players since
2000. The deregulation of the industry has attracted new players and the life
insurance sector moved from the monopolistic form to an oligopolistic type of
market. The industry has also seen product innovations, given the increase in
competition. The entry barriers being high combined with a proliferation of
products, the life insurance sector foresees supernormal profits. According to
experts, the compound annual growth rate of the market in the period 201115
was 7.7% and is predicted to be 5.7% in the period 2015-20.

For the road ahead in this industry, the government has been taking measures to
spread awareness of the importance of life insurance in financial planning. Taking
a reformative step, in 2016, finance minister Arun Jaitley has approved 49% FDI
in insurance. This is a welcome move for the insurance industry which has been
looking to raise more capital from overseas for quite some time. To create
awareness about life insurance in rural areas, the government has also
introduced schemes like Pradhan Mantri Suraksha Bima Yojana and Pradhan
Mantri Jeevan Jyoti Bima Yojana. With the new governments stress on reforms
and the steps taken by IRDA to make insurance more consumer-friendly, the
future of Indias insurance industry looks great.

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insurance-industry-issues-and-challenges
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