Development of Insurance in India

by Manoj Kumar
CPCU, ACII, ARe, ARM, FIII, MBA
manoj@einsuranceprofessional.com

A thriving insurance sector is of vital importance to every modern economy. First because it encourages the savings habit, second because it provides a safety net to rural and urban enterprises and productive individuals. And perhaps most importantly it generates long-term investible funds for infrastructure building. The nature of the insurance business is such that the cash inflow of insurance companies is constant while the payout is deferred and contingency related.

This characteristic of their business makes insurance companies the biggest investors in long-gestation infrastructure development projects in all developed and aspiring nations. This is the most compelling reason why private sector (and foreign) companies which will spread the insurance habit in the societal and consumer interest are urgently required in this vital sector of the economy.

With the nation's infrastructure in a state of imminent collapse, India couldn't have afforded to be lumbered with sub-optimally performing monopoly insurance companies and therefore the passage of the Insurance Regulatory & Development Authority Bill on December 2, 1999 heralds an era of cautious optimism where stakes are high for all parties concerned. For the Govt. of India, Foreign Direct Investment (FDI) must pour in as anticipated; for foreign insurers, investments must start yielding returns and for the domestic insurance industry - their market penetration should remain intact. On the fringe, the customer is pondering whether all the hype created on liberalization will actually benefit him.

The IRDA Bill provides for the establishment of an authority to protect the interests of the holders of insurance policies, to regulate, promote and insure orderly growth of the insurance industry and amend the Insurance Act, 1938, the Life Insurance Act, 1956 and the General Insurance Business (Nationalization) Act, 1972. The bill allows foreign equity stake in domestic private insurance companies to a maximum of 26 per cent of the total paid-up capital and seeks to provide statutory status to the insurance regulator. The insurance business in India is pegged at $ 6.6 Billion whereas industry leaders feel privatization will increase it to $ 40 Billion within next 3-5 years.
Background

India, with a population of 1 Billion offers great potential and opportunity for the insurance industry. Currently, two state-owned monoliths - Life Insurance Corporation and General Insurance Corporation (GIC), run the insurance industry. The General Insurance Corporation commands the general insurance sector along with four of its fully owned subsidiaries viz. National Insurance Company, New India Assurance Company, Oriental Insurance Company and United India Insurance Company.

Malhotra Committee, appointed by the Government of India for conducting a study on insurance, in its report in 1994 stated that only 22% of the Indian population are insured. The poor reach of insurance in the country and the sheer numbers make India a market with tremendous potential. The following facts show how under-developed the Indian insurance business is due to state monopoly and lack of aggressive marketing of insurance policies:

Per capita insurance premium in India is a mere US$ 6, one of the lowest in the world. In South Korea, the corresponding figure is US$1,338, in USA it is $ 2250 and in UK it is $1589.

Insurance premium in India accounts for a mere 2 per cent of GDP compared to the world average of 7.8 per cent and G-7 average of 9.2 per cent.

Insurance premium as a percentage of savings is barely 5.95 per cent in India compared to 52.5 per cent in the UK.

Nationalized insurance companies have not been able to target niche markets that are currently served poorly or not at all. Life insurance products provide a good example. They compete with investment and savings options like mutual funds. It is imperative that they should offer comparable returns and flexibility. For instance, pure protection products like term assurance account for up to 20 per cent of policies sold in developed countries. In India, the figure is less than one percent because policies are inflexible. Besides, no Indian life assurance product is linked to non-traditional investment avenues such as stock market indices. Therefore, returns are lower than those on other savings instruments.

Similar is the case with pensions. The lack of a comprehensive social security system combined with a willingness to save means that Indian demand for pension products will be large. However, current penetration is very poor. By March 1998, LIC’s pension premium was only $ 22 Million. Making pension products into attractive saving instruments would require only simple innovations already common in other markets. For example, their returns might be tied to index-linked funds or a specific basket of equities. Buyers could be allowed to switch funds before the annuities begin and to invest different amounts at different times.

Health insurance is another segment with great potential because existing Indian products are insufficient. By the end of 1998, GIC’s Mediclaim scheme covered only 2.5 per cent of total population. Indian products do not cover disability arising out of illness or disability for over 100 weeks due to accident. Neither do they cover a potential loss of earnings through disability.

Retail segment or personal lines insurance, especially in general insurance is another area unexplored. Currently personal insurance, including health, householders, shopkeepers, personal accident, travel insurance and professional indemnity covers, constitute only 12 per cent of Indian general insurance premium. This poor figure is largely due to the lack of adequate distribution channels rather than a lack of products. By tapping such under-served niches, new entrants can expand the market substantially. Since service and speed will be valued, a price premium is also possible.

Premium rates are at present set most unscientifically with very little attempt to fine tune the risk attached to different categories of businesses. The result is that they penalize the low risk category, which is in majority. This can be seen in the failure to differentiate between smokers and non-smokers in fixing premium for life and personal accident covers or between flood-prone areas and dry lands for fire and allied perils cover. This results in a great deal of cross-subsidization. Low premium rates in one area necessitate higher premium elsewhere. Mortality tables are not revised for ages and no effort is made at all to re-evaluate the rating of other classes based on recent loss experiences.
Need for Global Integration

Recent economic liberalization started few years ago have started bringing in new investments from global giants and the government was hard pressed to facilitate global integration by lowering trade barriers for the free flow of technology, intellectual and financial capital. Additionally, reforms are essential if the Indian economy is to achieve and sustain a growth rate of 7 to 8 per cent per annum. Reaching a faster growth path also implies attracting foreign direct investment inflows of $ 10 Billion every year, up from the current level of $ 3 to $ 3.5 Billion. Thus liberalization of insurance creates an environment for the generation of long term contractual funds for infrastructural investments.

The Rakesh Mohan Report on Infrastructure says that 85% of funds for infrastructure development have to come from the domestic industry. It further says that India would need $ 100 Billion over the next five years to meet its infrastructure needs. Given the rate of savings in India, there is much more room to grow and one can expect an additional revenue of about $ 10 Billion a year entering the market to enhance infrastructure. Insurance is definitely going to be one area that will assist in mobilization of these funds.
Multinationals' interest

Multinational insurers are indeed keenly interested in emerging insurance because their home markets are saturated while emerging countries have low insurance penetrations and high growth rates. International insurers often derive a significant part of their business from multinational operations. As early as 1994, many of the UK’s largest life and general insurers derived 40 per cent to 60 per cent of their total premium from outside their home markets. The figure at Commercial Union was 76 per cent in that year.

While the impact of global operations on their business may be large, typically foreign insurers take only a small share of an individual country’s market. In Taiwan for example, foreign companies took only a 3 per cent share even seven years after opening up. In Korea, their share was 1 per cent after 20 years. In China, a large and complex market like India, private insurers have not made much headway.

Yet, new entrants find insurance attractive because even a small share of a large and growing market can be profitable. The Korean insurance market for example, was only the 30th largest market in the world by premium volume in 1971. It moved up to 6th largest in 1996. In any case, in India multinational insurers will be restricted to a minority shareholding in new companies. The new entrants will therefore be private Indian companies.

The other reason why these large MNCs are interested in India is the economies of the insurance market. Insurance companies survive on the principle of spreading of risk. No matter what the size of each player, an insurer cannot afford to operate in a niche market. Operating in a particular region would expose them to the economic downtrends in the region and derail their profits.

Insurance companies, being long-term players, also have to avoid sudden dips in earnings to inspire confidence among investors to invest long-term funds. This can be achieved by spreading their operations over a wide geographical area. Moreover, for them, big is not just beautiful, but essential for survival. Which brings us to the avenues for growth.

According to the Sigma report on global insurance brought out by the world’s second largest reinsurer Swiss Re - the international market is completely saturated. In the developed world, the growth in life insurance premium has been a meager 1.5%. As compared to this, LIC despite all its handicaps has been growing at a healthy clip of around 20%.
Nationalized Sector: A Performance Review

In 1995-96, LIC had a total income from premium and investments of $ 5 Billion while GIC recorded a net premium of $ 1.3 Billion. During the last 15 years, LIC's income grew at a healthy average of 10 per cent as against the industry's 6.7 per cent growth in the rest of Asia (3.4 per cent in Europe, 1.4 per cent in the US).

LIC has even provided insurance cover to five million people living below the poverty line, with 50 per cent subsidy in the premium rates. LIC's claims settlement ratio at 95 per cent and GIC's at 74 per cent are higher than that of global average of 40 per cent. Compounded annual growth rate for Life insurance business has been 19.22 per cent per annum and for General insurance business it has been 17 per cent per annum.

However, there is other side of the coin too. Their large scale of operations, public sector bureaucracies and cumbersome procedures hampers nationalized insurers. The field staff and the agents of the GIC and its four wholly owned subsidiary companies have seldom bothered to venture out into the rural hinterland to sell crop or any other personal line insurance. Given the woeful lack of penetration of the rural market by the GIC subsidiaries, it is hardly surprising that a growing number of farmers across the country are resorting to the extreme remedy of suicide when their usually uninsured crops fail

The highest paid employees of the public sector, the estimated half-a-million employees of the nationalized insurance companies, are characterized by abysmal productivity, utter ignorance of the basic principles of the insurance business, endemic corruption, gross indiscipline and sheer laziness.

Dominating the inevitably weak management of the nationalized insurance companies, the militant and strongly unionized employees of the nationalized monopoly insurance companies have transformed Indian insurance from volume-driven into class-based business.

The domestic insurance companies, despite meeting their social objectives of going into the deepest interiors of the country, have lagged behind in meeting customer expectations in products and services.
Privatization: Start Up Strategy

Potential private entrants therefore expect to score in the areas of customer service, speed and flexibility. They point out that their entry will mean better products and choice for the consumer. Critics counter that the benefit will be slim, because new players will concentrate on affluent, urban customers as foreign banks did until recently.

This might seem a logical strategy from the point of view of new players. Start-up costs-such as those of setting up a conventional distribution network-are large and high-end niches offer better returns. However, in the long run 'middle-market' offers the greatest potential as in terms of it is the second largest market in the world. This may still be an urban market but goes beyond the affluent segment.

Insurance, even more than banking, is a volume game. A very exclusive approach is unlikely to provide meaningful numbers. Therefore, private insurers would be best served by a middle-market approach, targeting customer segments that are currently untapped.
Regulatory Issues

The IRDA Bill lays down that the Indian promoter must dilute the stake in the private insurance firms from 74 per cent to 26 per cent in ten years. The bill stipulates tough solvency margins -- Rs 500 million for life insurance firms, Rs 500 million or a sum equivalent to 20 per cent of net premium income for general insurance and Rs 1 billion for reinsurance business.

The insurer has to maintain separate accounts relating to fund of shareholders and policyholders. The funds of policyholders should be retained within the country but does not cover repatriation of profits and dividends. Insurance companies under the new regime will have to have exposure to rural and social sectors. Foreign investment in insurance, the bill states, is crucial to financing infrastructure and better insurance cover.

The key to success in opening up the insurance sector in India is regulation. An example of how poor regulation can destroy a market is the mutual fund industry. A combination of improper marketing practice and unfullfilable promises has resulted in a loss of investor faith in that industry. Incidentally, the insurance industry in India itself has gone through the same phase.

One of the reasons for nationalization of the insurance industry (LIC in 1956 and GIC in 1973) was the mismanagement and malpractice of erstwhile private players. But if the statements of IRA officials are anything to go by, the new regulations are expected to be on the right track. N I Rangachary, chairman, IRA, has already provided the time table for the changes once the Bill is passed. The IRA has already indicated that it will have tough norms for new participants.
Repositioning by Nationalized Sector

Floodgates of competition opened up by the privatization of insurance industry did throw a challenge to the well-protected nationalized sector and it seems they have picked up the gauntlet. LIC and GIC, both are trying to reposition themselves by having re-engineering done on the structure and operations of their respective organizations.

Life Insurance Corporation is at present going through presentations from top management consultants. These consultants have been asked to narrate their experiences in countries where the insurance sector has been opened up for private competition so that the public sector player can draw lessons. Based on these, LIC will appoint a consultant which can provide them broad terms of reference on what changes are required to tackle the impending competition.

GIC has already identified the areas that need to be activated and given a shape through the four subsidiary companies. Foremost is the area of providing health insurance services. A change in the GIC Act will enable the corporation to float a joint venture company for health insurance. Other areas that the GIC is looking at are savings-linked insurance products and use of alternate distribution channels including bancassurance. Also in progress is the co-ordination of all foreign operations of the group.

Even state-owned entities, SBI and UTI have serious plans for insurance sector as the banks have unsurpassed advantages over any other player. The intermediaries are also getting more organized with a little nudging from the IRA. The Reinsurance Consultants Association is planning to convert itself into the Insurance Brokers Association of India in anticipation of the laws being amended to allow insurance broking.
Cross Border Experience

Cross-country experience shows that nowhere in the world has the entry of foreign firms threatened the position of domestic companies. Whether it is Malaysia, where the insurance sector has been open for more than 50 years and foreign companies account for about 10 per cent of market penetration or it is Indonesia, Thailand, China or the Philippines, where the market has been opened more recently, the total market share of foreign companies is less than 10 per cent except in Indonesia where it is about 20 per cent. Closer home, we have the experience of the banking sector where despite the presence of 42 foreign banks, their share in total banking assets is less than 10 per cent.

Today hardly 20 per cent of the population in India is insured and insurance premium (life as well as non-life) account for just 2 per cent of GDP as against the G-7 average of 9.2 per cent. Consequently, the fear that new companies will displace public companies is misplaced. There is room for more for not only the existing companies but also for any number of competitors.

In China, insurance premium accounted for just over 1 per cent of China's GDP in 1995 but in the four years since the market has been liberalized (albeit partially), spending on insurance has grown at a compound annual rate of 33 per cent. It is not just foreign companies alone that have grown but also the national PICC as well. The story is no different in S Korea. There, the opening of the sector saw the Big Six domestic players, who initially controlled the entire market, increase their business from 7 to 37 trillion won by 1997. Meanwhile foreign companies were not able to capture more than a miniscule 0.7 per cent of the market.
Future Possibilities (Next 5-10 Years)

Job opportunities are likely to increase manifold. The number of people working in the insurance sector in India is roughly the same as in the UK with a population that is 1/7 India's; the US with a population 1/4 the size of India has nearly 4 times the number. In the emerging markets, the picture is no less encouraging. In S Korea, the no of full time employees more than doubled over a ten year period. Thailand added 50 per cent more jobs in four years.

The liberalization of the insurance sector promises several new jobs opportunities for those employed in the finance sector who are equipped with degrees in finance. Finance professionals who had witnessed a slump in the job market would be a much-relieved lot to hear about the privatization of the insurance sector.

Let us look into the type of jobs that will be created once the private players come on the scene. Certainly, it won't be far different from the traditional streams in any other industry. There will be demand for marketing specialists, finance experts, human resource professionals, engineers from diverse streams like the petrochemical and power sectors, systems professionals, statisticians and even medical professionals. Apart from this, there will be high demand for professionals in the streams like Underwriting and claims management and actuarial sciences.

There could be a huge inflow of funds into the country. Given the industry's huge requirement of start-up capital, the initial years after opening up are bound to see a strong inflow of foreign capital. Moreover, given that the break-even, typically, comes much later than in the case of other sectors, odds are that the first remittance of dividend will not happen before a good 10-15 years.

In the areas of reinsurance, huge capacity is likely to be created with players like Swiss Re and Munich Re keenly observing the unfolding saga of liberalization of insurance industry in India. Not only the outward reinsurance will reduce, it is bound to attract inward reinsurance from the neighboring countries and regions. If the regulator is forward looking and legislature is supportive, this trend may well lead to the creation of a Lloyds like market for the direct as well as reinsurance businesses.

However, increased competition is very likely to result in rate reductions in certain classes of business, but in those areas that have so far been cross subsidized, an increase in rates may be possible. Overall, the rate reductions may outweigh the increases, thus bringing down the re-insurance premium volume available.

Apart from pure re-insurance activities, which is providing insurance protection, a revolution will come in service related fields like training, seminars, workshops, know-how transfer regarding risk assessment and rating, risk inspections, risk management and devising new policy covers, etc. Also, with more players in the market, there will be significant increase in advertising, brand building, and keen pricing not ridiculous pricing and this will benefit whole lot of ancillary industries.

Another effect of de-regulation will be that, projects, especially mega-projects where one needs the capacities of the international re-insurance market, will get exposed to international trends to an even greater extent than is the case today. This will affect rates too. Areas like the personal lines segment, where we also expect to see substantial growth as also new types of covers, would usually not be affected by international trends in the same way as, there is much less need for global re-insurance support.

Substantial shift in the distribution of insurance in India is likely to take place. Many of these changes will echo international trends. Worldwide, insurance products move along a continuum from pure service products to pure commodity products. Initially, insurance is seen as a complex product with a high advice and service component. Buyers prefer a face-to-face interaction and place a high premium on brand names and reliability.

As products become simpler and awareness increases, they become off-the-shelf, commodity products. Sellers move to remote channels such as the telephone or direct mail. Various intermediaries, not necessarily insurance companies, sell insurance. In the UK for example, retailer Marks & Spencer now sells insurance products. In some countries like Netherlands and Japan, insurance is marketed using post office's distribution channels. At this point, buyers look for low price. Brand loyalty could shift from the insurer to the seller.

In other markets, notably Europe, this has resulted in bancassurance: banks entering the insurance business. The Netherlands led with financial services firms providing an entire range of products including bank accounts, motor, home and life insurance, and pensions. Other European markets have followed suit. In France over half of all life insurance sales are made through banks. In the UK, almost 95% of banks and building societies are distributing insurance products today.

In India too, banks hope to maximize expensive existing networks by selling a range of products. Various seminars and conferences on bancassurance are taking place and many bankers have clearly shown their inclination to enter insurance market by leveraging their strengths in the areas of brand image, distribution network, face to face contact with the clients and telemarketing coupled with advanced information technology systems. The mergers of Citibank with Travellers in USA and of Winterthur, the largest Swiss Co. with Credit Suisse are recent examples of the phenomenon likely to sweep India too.

Insurers in India should also explore distribution through non-financial organizations. For example, insurance for consumer items such as refrigerators can be offered at the point of sale. This piggybacks on an existing distribution channel and increases the likelihood of insurance sales. Alliances with manufacturers or retailers of consumer goods will be possible. With increasing competition, they are wooing customers with various incentives, of which insurance can be one.

Another potential channel that reduces the need for an owned distribution network is worksite marketing. Insurers will be able to market pensions, health insurance and even other general covers through employers to their employees. These products may be purchased by the employer or simply marketed at the workplace with the employer’s co-operation.

Worldwide interest in E-commerce and India's predominant position in information technology and software development is also likely to be a major factor in the marketing of insurance products in the immediate future. The internet account is increasing in arithmetic progression and the trend has already been set by some of the leading insurers and insurance brokers worldwide.

Finally, some potential Indian entrants into insurance hope to ride their existing distribution networks and customer bases. For example, financial organizations like ICICI, HDFC or Kotak Mahindra intend to tap the thousands of customers who already buy their deposits, consumer loans or housing finance. Other hopeful entrants anticipate specific alliances such as with hospitals to provide health cover.
Conclusion

Over the past three years, around 40 companies have expressed interest in entering the sector and many foreign and Indian companies have arranged anticipatory alliances. The threat of new players taking over the market has been overplayed. As is witnessed in other countries where liberalization took place in recent years we can safely conclude that nationalized players will continue to hold strong market share positions, but there will be enough business for new entrants to be profitable.

Opening up the sector will certainly mean new products, better packaging and improved customer service. Both new and existing players will have to explore new distribution and marketing channels. Potential buyers for most of this insurance lie in the middle class. New insurers must segment the market carefully to arrive at appropriate products and pricing. Recognizing the potential, in the past three years, the nationalized insurers have already begun to target niches like pensions, women or children.

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