Insurance acts as a catalyst in economic growth of a country. It is closely related to savings and investment that comes from, life insurance, funded pension systems and to some extent the non-life insurance industry.
LIC(Life Insurance Corporation) & GIC(General Insurance Corporation) had monopoly prior to the expansion of insurance market to private companies. LIC was established in 1956 and controlled all life-insurance policies across the nation. These were government run organizations. The Insurance business is divided into four classes :
- Life Insurance business
- Miscellaneous Insurance.
Following the Insurance Regulatory and Development Act in 1999, India abandoned the public sector exclusivity of the insurance industry and switched to a market-driven competitive industry. This shift has brought about many changes and developments in the insurance industry in India. Domestic private-sector companies were permitted to enter both the life and general insurance business and foreign companies were allowed to participate and join these domestic companies albeit with a cap of 26% investment.
The objectives of this report are to examine the current status of the insurance industry, its prospective growth and the valuation methods used for insurance companies in developed and under-developed countries.
CURRENT MARKET STRUCTURE
Today there are 16 private players with aggregate control of 27% of the life insurance market and 15 private players in the general insurance industry. Entry of private sector has fuelled the growth in the sector driven by new products and aggressive marketing strategies. LIC still covers majority market share with other private companies growing at alarming rates with market share of 48.1% . ICICI Prudential has the majority market share among the private companies and has maintain its market leadership with an estimated market share of 19.2%, SBI life(10.7%),Bajaj Allianz (14.0%), HDFC Standard Life (8.6%), Birla Sun Life (9.2%) , Reliance life(11.0%),max new york (5.9%) etc within the private sector in FY09.
With low barriers to entry, there will be increased competition and better quality of service within the next decade in the Indian insurance industry. An insurance survey by LIC & KPMG showed that annual growth in average premium is 8.2% in India compared to a global average of only 3.4%. The Associated Chambers of Commerce and Industry of India (ASSOCHAM) has projected a 500% increase in the size of current Indian insurance business from US$ 10 billion to US$ 60 billion by 2010 particularly in view of contribution that the rural and semi-urban insurance will make to it.
Below are the distribution of companies in Life Insurance Industry:
|HDFC Standard Life||8.4||8.6|
|Max New York Life||4.9||5.9|
|OM Kotak Mahindra||3.6||4.4|
Life Insurance industry is under the phase of infancy after 50 years of monopoly. LIC, the market leader in this segment, is a state owned organization and has had a monopoly in the life insurance business for over four decades until 2001. LIC still remains the market leader, by a wide margin, with an estimated market share of 48.1% (IRDA,FY09). However, at the margin, it has been loosing market share to private sector players.
Types of Insurance Policies
- Single Premium v/s Regular Premium
- Unit linked v/s Traditional
- Pure Risk Policies (Term) v/s Savings + Risk
- Participating v/s Non Participating
US$31.7 billion assets were managed by the private players(June,2009) , whereas LIC was able to manage with US$ 167.37 billion(march ,2009)
Gross direct premium income underwritten (GDPIU) by 21 generals insurance insurers grew by 12.62% in FY09 as said by insurance regulator IRDA. Some new entries in this field were Future Generali, Universal Sompo, Shriram General, Bhart AXA, Raheja QBE, Apollo DKV and Star Health , combined collected a total premium of INR11.47 bn. HDFC ERGO recorded a growth of 24%.
New india assurance secured 1st position and is enjoying market share of 14.80% , ahead of United india ny INR 1.78 billion. Among the private players ICICI Lombard stood 1st with market share of 8.52%. . star heath and Apollo DKV were new entrants.
MIX OF NON-LIFE BUSINESS & PRODUCTS
The mix of non-life business in India resembles most other developing regional economies. Motor and fire policies are the backbone of non-life business in India. They also contributed the most to overall premium growth in the last five years. Compared to other markets, personal lines insurance is also relatively well-developed in India. This is mainly manifested in personal motor and private residential fire policies. In fact, among emerging markets with a similar level of per capita income, India has the highest share of personal lines business.
After the opening of the sector to private players, more new products were introduced. To take an example, one joint-venture non-life insurer introduced 29 different products during one year, according to the IRDA. They included products liability, corporate cover, professional indemnity policies, burglary cover, individual and group health policies, weather insurance, credit insurance, travel insurance and so on. Some of these products were completely new (e.g. weather insurance) while others were already available through the public insurance companies.
REGULATION AND TARIFF
Before deregulation in 1999, non-life products that were available in the market were rather limited and similar across the four GIC subsidiaries. They could also be classified by whether they were regulated by tariffs: fire insurance, motor vehicle insurance, engineering insurance and workers’ compensation etc that came under tariff; and burglary insurance, Mediclaim, personal accident insurance etc that did not. In addition, most specialized insurance (e.g. racehorse insurance) did not fall under tariff regulations.
SCOPE FOR EXPANSION OF INDIAN INSURANCE MARKET
Currently there is a huge scope for this industry to grow with increased disposable income among the working class in India. Up to 80% of India’s population is uninsured today.
Life expectancy is growing with advances in medicine and technology. The rapid rise in income levels and the high proportion of Indians below 30 years of age (estimated at 60% of India’s total population of 1bn) should be a significant driver for life insurance in coming years.
The following table shows the age-wise distribution of population in future years:
Households earning over Rs5mn per year are growing the fastest (at 27%p.a.), and many of them are still either uninsured or under-insured. Further incrementally there is a shift happening from large joint families to nuclear families, which increases the need insurance amongst these households as the dependency ratio increases significantly. Aversion to debt by most of the new generation households has also led to higher monthly debt servicing requirement. Increasing debt servicing has also resulted in higher need for insurance as most of the families have a single bread earner.
Currently there is very low penetration in India specially in rural places. Tapping those markets will boost the insurance industry. Privatization of the insurance industry in 2000 improved penetration from 1.4% of GDP in 2000 to 3.8% of GDP in 2009 in India
SOURCE: Macquarie research, July 2009
Life insurance market in semi-urban and rural territories is expected to rise to US$ 20 Billion mark in the upcoming four years from the existing value of less than US$ five Billion. Life insurance industry has contributed to more than 3.5% to India’s GDP growth whereas non life insurance sector has contributed to only 0.6% over past 9 years. The non-life public sector insurers have been rather slow to respond to the evolving competition. Both the Authority and the industry have been playing an active role in increasing consumer awareness.
Large sections of rural India are still untouched because of long distances, poor distribution and high return costs. To understand the prospects for insurance companies in rural India, it is very important to understand the requirements of India’s villagers, their daily lives, their peculiar needs and their occupational structures. There are farmers, craftsmen, milkmen, weavers, casual laborers, construction workers and shopkeepers and so on. In the context of international comparison, insurance penetration in India is low but commensurate with its level of per capita income.
GENERATION OF EMPLOYMENT
There is a high demand for skilled insurance agents to explain the technicalities and understand the various products offered in the market. With such high demand, the insurance industry has created scope for expansion in the employment industry too. Life insurance industry provides increased employment opportunities. Brokers, corporate agents, training establishments provide extra employment opportunities. Many of these openings are in rural sectors.
India differs from other Asian markets in the sense that its life insurance market is still heavily dominated by indigenous players, partly reflecting the fact that de-monopolization only took hold in 2000. In contrast, most Asian life insurance sectors are already heavily populated by foreign insurers. Foreign non-life insurers have achieved penetration in India similar to those in other Asian markets. It can be expected that foreign insurance companies will continue to expand their market share in India in the coming years, notwithstanding the fact that public sector insurers are also proactively strengthening their business strategies to fight rising competition.
With the entry of private foreign firms, consumer knowledge is increasing through international approach of advertising and marketing. With scope for foreign investment to increase to 49% according to the planning of the government, foreign companies will pay more attention to the Indian market but currently foreign direct investment (FDI) limit in the insurance sector for foreign investors is 26 per cent. Also most of the private sector players have set up a vast distribution network, including over 250,000 agents (LIC has over a million agents), most of whom are more qualified than LIC agents. A qualified work force and an extensive distribution network has further helped the private insurance companies to increase awareness about life insurance.
The mentality of Indian policy holders is only from an investment perspective, and with foreign influence this is changing to awareness of insurance as security and protection.
POTENTIAL IN PENSION AND HEALTH CARE MARKETS
The Indian insurance industry is still dominated by investment linked insurance products like endowment and ULIP(Unit linked insurance plan). Pure insurance products like term and health are not yet popular, largely owing to the mindset of the average Indian consumer. This is predicted to change with more western exposure and awareness of other insurance products. Pension system and health insurance are increasing with urbanization.
There are around 30 health insurance products in the market right now . owing to growing awareness and rising health care costs has led to an increase in sale of health insurance products by 30% in 2009.companies are launching new health insurance products like tata launched ‘Hospicashback’ and metlife launched “met health care “ in 2009
The tax structure in India is also favorable for the insurance industry in the form of deductions and exemptions. Over the past several years, Government of India has been offering various tax benefits to encourage individuals to buy life insurance. Tax relief offered is
- Under Section 80C of Income Tax Act, “a portion of premiums paid for life insurance policies are deducted from tax liability”. Exemption is also available for Health Insurance Policy premiums.
- Money paid as claim including Bonus under a life policy is exempted from payment of Income Tax”. Under section 10(10D).
Tax Incentives have been a key growth driver for the life insurance business over the past two decades, largely owing to the absence of awareness of other benefits of life insurance. Historically LIC collected the bulk of its premium income in the last quarter of the financial year, when people used to buy insurance to reduce their tax liabilities. However the trend has changed in the past few years, with the private insurance companies driving the growth by increasing the awareness.
MARKET CHALLENGES AND DRAWBACKS
Some of the factors that have slowed down the growth of the industry are as follows:
- Slow down in single premium policies owing to a change in regulation .Sustainability of single premium policies, especially post June’06 when the new changes proposed by IRDA come into play which, in our view, could negatively impact the growth of single premium policies.
- Managing the distribution network, especially the agent attrition rates
- Managing the cost as most of the insurance companies have already priced in higher economies of scale in their load structure.
Rapid expansion of the insurance business and an attrition rate amongst life insurance agents has resulted in an estimated 30-40% rise in wage bills. In particular, the shortage of actuaries, specialized agents and marketing people has meant life insurers are paying up almost 50% more than they had originally budgeted when they had entered the sector, almost 5 years ago. This is partly due to the much higher money that life insurers have to spend on training and on retention of employees.
Distribution still appears to be a key challenge for insurers. Despite the large branch network of Indian banks, bank assurance has still not fully evolved in India.Bank branches still account for around 10% of all policies sold. In contrast, most Insurers still rely on the agency model. Almost 80% of the policies are sold through agents who have to be well trained.
QUALITY OF AGENTS AND MANAGERS
Unfortunately for the industry, in the absence of skilled manpower, employee turnover has emerged as one of the challenges facing the industry. According to many of the insurers, employee turnover in the life insurance segment is running at 35-40%. The problem appears to stem from managing business managers’ (typically people who manage about 100 agents) aspirations and keeping pace with the rise in salary levels offered by competitors. As a result, there is a concern that having sufficient employees could be the biggest challenge for the larger players to ensure that they face no capacity constraints while rapidly growing their business.
DECLINE OF ULIP’S
Decline in the growth of stock market , 2008 , due to global meltdown had also adversely affected investor sentiments towards ULIP products. ULIP contributed to around 60-70% of the business turnup of any private life insurance company. With reviving economy in the 3rd quarter of 2009 and better stock market performance , investors again started showing confidence in ULIP products. Now ULIP growth is expected to rise in the next 5 years.
On the regulatory side, there are outstanding issues concerning solvency regulations, further liberalizing of investment rules, caps on foreign equity shareholdings as well as the enforcement of price tariffs in the non-life insurance sector.
The proliferation of bank assurance is rapidly changing the way insurance products are distributed in India. This will also have strong implications on the process of financial convergence and capital market development in India.
IRDA AND REGULATIONS
IRDA(Insurance Regulatory Development Authority) Act was formed in 1999 to promote market efficiency and ensure consumer protection of the insurance industry. Several regulations were laid down to control ensure a fair market after private companies were allowed to enter the market some of which are:
A minimum capital requirement of INR 1 billion for new entrants and INR 2 billion of reinsures. This helped insure that companies were well established with long term goals.
Foreign Direct Investment:
is capped at 26% presently. This puts a strain on Indian promoters and blocks foreign investment in the insurance industry. However, currently there is an ongoing proposal to raise this cap to 49%. With this, there will be an influx of foreign investment and expansion of the insurance industry further.
All the new life insurers would have to compulsorily list their companies within 10 years of beginning their operations.
Rural sector requirement:
Life insurance players are required to issue minimum no of policies in rural areas and in social sector.
Insurers have to observe the required solvency margin (RSM).20. For general insurers, this is the higher of RSM-1 or RSM-2, where RSM-1 is based on 20% of the higher of (i) gross premiums multiplied by a factor A,21 or (ii) net premiums; RSM-2 is based on 30% of the higher of (i) gross net incurred claims multiplied by a factor B, or (ii) net incurred claims;
There is also a lower limit of INR 500 million for the RSM. Life insurers have to observe the solvency ratio, defined as the ratio of the amount of available solvency margin to the amount of required solvency margin. In addition, The required solvency margin is based on mathematical reserves and sum at risk, and the assets of the policyholders‘ fund; The available solvency margin is the excess of the value of assets over the value of life insurance liabilities and other liabilities of policyholders’ and shareholders’ funds.
In 1958, Section 27A of the Insurance Act was modified to stipulate the following investment regime:
- Central government market securities of not less than 20%;
- Loans to National Housing Bank including (a) above should be no less than 25%;
- In state government securities including (b) above should be no less than 50%; and
- In socially oriented sectors including the public sector, cooperative sector, house building by policyholders, own-your-own-home schemes including (c) above should be no less than 75%.
For General Insurance, The guideline for investment was set out as follows: (a) central government securities of no less than 25%; (b) state government and public sector bonds of no less than 10%; and (c) loans to state governments, various housing schemes of no less than 35%. The remaining 30% investment could be in the market sector in the form of equity, long-term loans, debentures and other forms of private sector investment.
General insurance business lines that are subject to tariffs include fire, motor, marine hull, tea crop, engineering, industrial all risks, business interruption, personal accident and workers’ compensation. Tariffs are managed by the Tariff Advisory Committee.
VALUATION METHODS USED FOR INSURANCE COMPANIES
Different valuation methods are used for insurance companies in different countries.
The widely used method for valuation of insurance companies worldwide is EV. This is the addition of shareholders net worth and the value of in-force business. Shareholders net worth equals the sum of net assets of life insurance companies adjusted to reflect market values of these assets. Value of in-force business equals the present value of projected future after-tax regulated profits to be generated from policies in force. Appraisal value(AV) adds the value of future new business(goodwill) to the EV.
The embedded value is higher for life insurers that can deliver across all these variables.
- Investment Returns: Higher investment return will provide better investment margins for insurers, lifting overall profitability and embedded value
- Expenses: Better cost control, running under budgeted expense will provide better expense profit
- Persistency: This measures how successful insurers are able to retain its customers
- Claims: Better mortality and morbidity experience would deliver higher risk profit
- Product Mix: and lastly, product mix will affect all of the above.
For instance, insurers having a higher proportion of the traditional endowment and whole life policies, (all else being the same) would have a higher embedded value owing to the both the higher loading in these policies and also owing to the longer life of the policy providing the insurers with a more extended cash flow. In contrast ULIP’s have lower loading and also shorter durations. The single premium policies have the lowest embedded value having no renewal premiums.
In essence, EV is the present value of the current business base, while AV is EV plus the value of the company’s growth potential. Usually for a typical life insurer, the EV would be the large component while the AV would be a much smaller proportion. Usually in markets where there is a developed life insurance market, the valuations would tend to range between the EV and AV.
Problem with using EV and Appraisal Value for India
Unfortunately, the Indian insurance industry and has just spurted growth and currently all private companies are incurring large losses and initial set-up costs, hence the EV and Appraisal value methods of valuation are not useful. For most life insurers, the expenses are likely to be still quite high owing to high start up costs and money spent on creating a distribution network, marketing and advertising and expanding agent network (as they all rely on the agency model) as they are all rapidly scaling up their businesses. Further, owing to the high reserve requirements and the high acquisition costs that most life insurers have to incur, they are still making accounting losses. Most of these insurers could break even in about another 2-3 years by around FY09.
The best suitable valuation method at the current phase of the insurance industries is NBAP(new business achieved profit). It is the present value of the future profits expected from the new business written through that policy. Each product carries different NBAP margins. ULIP’s for example have a NBAP margin of around 19-20% v/s 30-33% margins for traditional endowment products. Single premium policies, in contrast, are the least profitable with an estimated NBAP margin of around 3-4%.
An insurance company like LIC, which is at an advanced stage of its life cycle, would probably have EV accounting for 80-90% of total value of the firm, while for new companies 80-90% of the value will come from the NBAP calculation.
For the majority of the private insurers, the EV is likely to be very small owing to the very small value of the in force business as they have been in existence for just about 6-7 years. Thus, the value of the existing business (EV) will be only a small proportion of the total actuarial value of the company with the new business component of AV dominating. Hence, the valuation of these companies would largely be a function of their AV and they could potentially trade at a premium to their AV depending upon the likelihood of them being able to achieve the projected growth rates and the underlying actuarial values.
VALUATIONS OF LIABILITIES IN LIFE INSURANCE
Valuation of liabilities for life insurers requires assumptions of the rate of interest, rate of mortality, level of future expenses etc. Two methods to value liabilities of insurance companies which are Gross Premium method and Net premium method.
Gross Premium Valuation
Liabilities= (P.V of the benefits contracted to be payable + P.V of the future expenses likely to be incurred + P.V of bonuses likely to be declared in the future) – (P.V of premium receivable)
An important feature of this method is its transparency. It is possible for any one examining the valuation report to judge whether sufficient margins have been provided for possible adverse developments. At the same time, the method has one serious drawback, viz., its sensitivity to the various parameters used. A marginal increase in the valuation rate of interest or a decrease in the expected level of future bonuses could lead to a significant reduction in liability and release of larger surplus for distribution than what could be considered as prudent.
Net Premium Valuation
Liability under a policy = P.V of benefits contracted to be payable – P.V of the true/net premium.
No explicit provision is made for either future expenses or future bonuses as under the gross premium method.
Practices in Different Developed countries
1) United Kingdom: Currently, the United Kingdom may perhaps be the only industrial country in which the net premium valuation is prescribed as the statutory method of valuation.
2) Canada: The statutory method of valuation prescribed in Canada since 1992 is known as the Policy Premium Method (PPM). The PPM is a gross premium prospective method of valuation. Policy premium simply means the premium charged under a policy, i.e., gross premium. The assumptions regarding valuation parameters are based on the best estimates of future experience with provision for adverse deviations. Though this method is similar to the gross premium valuation discussed earlier, there are some significant differences.
3) Australia: The statutory method of valuation prescribed in Australia is the ‘Margin on Services Method’. In this method, the liability is defined as the sum of i) the best estimate value of policy liabilities, which is the amount required to meet future expenses and benefits and ii) the value of future expected profit margins on the services provided to policyholders such as insurance of mortality risks and on-going expenses of administration.
4) Germany:The gross premium method of valuation that is generally used in Germany. The net premium method of valuation, with Zillmer adjustment, is also permitted. Since 1986, the Indian insurance industry has been following the gross premium method of valuation.
While well defined procedures are in place in almost all the countries for the valuation of liabilities under the life insurance business, it is not so in case of the general insurance business. The systems in vogue are more general than specific. The only stipulation is that the system followed should be in accordance with the GAAP. As per the European directives, the balance sheet needs only to show the directors’ opinion about the financial position of the general insurance company. In the USA, the directors have liberty to place an appropriate value on the liabilities. In general, it is the responsibility of the accounting profession to ensure that the value placed on the liability is fair and reasonable. In many European countries, it is the tax authorities and not the insurance regulators who require that the amount of reserves shown be estimated scientifically.
Investments of insurance companies have been largely in bonds floated by GOI, PSU’s, state governments, local bodies, corporate bodies and mortgages of long term nature. Liability (known as the Technical Reserve) under a general insurance portfolio can be broadly defined as the sum of:
- The amount of premium estimated as required to cover the risk during the balance policy period falling after the balance sheet date (Unearned or Un-expired Premium Reserve – UPR),
- The amounts expected to be paid in future in respect of the claims already reported by the balance sheet date (Loss Reserve),
- The amount expected to be paid in future in respect of claims that might have occurred but could not be reported to the insurer till the balance sheet date (Incurred But Not Reported – IBNR),
- The direct expenses expected to be normally incurred for the settlement of the above two classes of claims, and
- Reserves required to be held on a prudent basis towards catastrophe losses or a single incident giving rise to multiple claims.
Generally, under life insurance policies, premiums are received in advance and after providing for acquisition and management expenses, the current cost of claims and other outgo, the balance of premium is available for investment. These balance premiums and the investment income is available to meet claims, which would occur in later years.
The objectives governing the investment are liquidity, safety and optimization of yield, provided that the asset profile is broadly attuned to the liability profile.
The liquidity, i.e., the ability of an asset to be converted into cash immediately and without loss, is more relevant in the case of the general insurance business as its contracts are for very short terms and it is also more susceptible to sharp and random fluctuations in claim outgo than the life insurance business. The liquidity may also be of importance to a life insurance company during its formative years, because of higher incidence of expenses of management.
However, this would gradually diminish with growth in size, since the premium and investment income together would then be more than sufficient to meet operational expenses and policy outgo. Safety and optimization of yield are what any insurance company would look normally to.
In Canada, Australia and the UK, the insurance companies have no restriction in the matter of investment of funds. Controls are exercised, not at the time of investment, but only at the time of demonstration of solvency. For the purpose of this demonstration, there are valuation rules for assets, cap on each asset category in any one organization and admissibility rules, so as to lead the companies towards maintenance of a prudent asset profile.
In the USA, although both the society and the Government have accepted that competition should be the driving principle that should guide their economy, there are both qualitative and quantitative investment restrictions in insurance. The qualitative limitations specify eligible types of investments and minimum quality criteria for eligible investments. Quantitative constraints have the dual objective of ensuring portfolio diversification and preventing undesirable control of other firms by insurers through large investments in any one firm. Until 1951, insurance companies were not permitted to invest in common stock.
GROWTH AND FUTURE
With a large population and untapped market, insurance happens to be a big opportunity in India. The insurance business is growing at the rate of 32-34% annually .India’s insurance sector is the 5th largest life insurance market, globally worth US$ 41 billion. With alarming growth in the past, the insurance industry is predicted to grow even faster in the coming years, with a business opportunity of $70 billion in 2020 for private players.
Life insurance industry recorded a premium income of US$ 24 billion during 2009 with a growth of 32-34% annually and non life insurance US$ 24 billion. The contribution of first year premium, single premium and renewal premium to the total premium was Rs.21275.75 crore (20.09 per cent); Rs.17509.78 crore (16.54 per cent); and Rs.67090.21 crore (63.37 per cent), respectively.
Total Sector Premiums are expected to grow at 16% p.a. for the next 5 years. Private sector is expected to grow at 59% CAGR. Private players are expected to gain market share of 45% by 2010. Life insurance sector has contributed to more than 4% in the GDP whereas nonlife insurance has contributed to around 0.6%
Projection of life insurance and non life insurance premiums, 2004-2014:
Life insurance (INR m)
Non life insurance (INR m)
|Average growth rate between 2004-2014||18.1%||15.1%|
Source: Swiss ReEconomic Research and Consulting
While the overall sector premium growth will continue to be in the 15-20% range, premium income for the private sector is expected to grow at a much faster rate as they are expected to continue to gain market share owing to:
- Increasing demand for new products like health insurance and pension funds
- Aggressive expansion of distribution network
- Low base effect
Rising share of private sector
Growth To Decelerate Near Term (FY07)
A sharp deceleration in the ‘single premium’ policies is expected as the regulator, IRDA, has recently come out with regulations stipulating that from June’06 onwards, all ULIP’s would have to have a life cover of at least 3 years and has also lowered the maximum commission that can be paid on ULIP’s. In particular, this affects all unit linked policies which were structured as single premium policies. Hence, the FYP growth my decelerate to 35% from a heady 85% last year. Players like Bajaj Allianz and SBI Life that have a high proportion of single premium policies may see sharper deceleration. We, however, expect traditional policies (endowment / whole life) to grow at +40-50% pa. Hence, in FY07, the FYP (first year premiums) growth is expected to decelerate to 30% (v/s 93% in FY06E) driven by a sharp slowdown in single premium policies to under 20% from 120% in FY06E. However, traditional products (whole life and endowment) are expected to gather more momentum and that should, help support overall industry growth (private players) at +30%.
Convergence of Financial sectors
Some economists have predicted the convergence of financial sectors with insurance companies in the future. This has already taken place in European Unions and the USA (Glass-Steagall Act 1933) will strengthen the insurance industry further.
India is among the most promising emerging insurance markets in the world. The major drivers include sound economic fundamentals, a rising middle-income class, an improving regulatory framework and rising risk awareness.
The groundwork for realizing potential was arguably laid in 2000 when India undertook to open the domestic insurance market to private-sector and foreign companies. Significantly, foreign players participated in most of these new companies – despite the restriction of 26% on foreign ownership. Incumbent state-owned insurance companies have so far managed to hold their own and retain dominant market positions. Yet, their market share is likely to decline in the near to medium term. Important steps have thus been already taken, but there are still major hurdles to overcome if the market is to realize its full potential. To begin with, India needs to further liberalize investment regulations on insurers to strike a proper balance between insurance solvency and investment flexibility. With the current proposal in the parliament to raise the foreign investment cap to 49%, the future has potential. Furthermore, both the life and non-life insurance sectors would benefit from less invasive regulations.
In the life sector, insurers will need to increase efforts to design new products that are suitable for the market and make use of innovative distribution channels to reach a broader range of the population. There is huge untapped potential, for example, in the largely undeveloped private pension market and the rural sector. Private insurers will have a key role to play in serving the large number of informal sector workers. The same is true for the health insurance business. In addition, the rapid growth of insurance business will put increasing pressure on insurers’ capital level. The current equity holding ceilings, however, could limit the ability of new companies to rapidly inject capital to match business growth.
A key challenge for India’s non-life insurance sector will be to reform the existing tariff structure. From a pricing perspective, the Indian non-life segment is still heavily regulated. Some 75% of premiums are generated under the tariff system, which means that they are often below market clearing levels. Reinsurance in India is mainly provided
by the General Insurance Corporation of India (GIC), which receives 20% compulsory cessions from other non-life insurers.
As far as reinsurance is concerned, policymakers have to recognize that insurance and reinsurance cannot be treated in the same manner. Due to the unique nature of reinsurance, it is necessary to de-link the sector from regulations governing direct insurance companies. To allow branching of foreign reinsurers, for example, would make the market more attractive for international players and secure cover for natural catastrophe risks which, today, are mainly uninsured.
Finally, the largely underserved rural sector holds great promise for both life and non-life insurers. To unleash this potential, insurance companies will need to show long-term commitment to the sector, design products that are suitable for the rural population and utilize appropriate distribution mechanisms.