OVERVIEW OF INSURANCE SECTOR IN INDIA

(FOCUS ON LIFE INSURANCE)

Chapter 1

Introduction to Insurance

1.1)

Meaning of Insurance:

Our lives, assets are valuable not only to us, but also to those who are dependent upon us. As responsible individuals we need to ensure that these remain valuable even after their loss. Hence insurance! In simple terms, insurance is a protection against financial loss arising due to the happening of an unexpected event. Insurance may be described as a social device to reduce or eliminate risk of loss to life and property. Under the plan of insurance, a large number of people associate themselves by sharing risks attached to individuals. The risks, which can be insured against, include fire, the perils of sea, death and accidents and burglary and other risks. Any risk contingent upon these may be insured against at a premium commensurate with the risk involved. Thus collective bearing of risk is insurance. In other words, Insurance is a system to make large financial losses more affordable by pooling the risks of many individuals and business entities and transferring them to an insurance company or other large group in return for a premium. 1.1.1) Meaning of Risk/ insurance:

Insurance is a contract whereby, in return for the payment of premium by the insured, the insurers pay the financial losses suffered by the insured as a result of the occurrence of unforeseen events. The term risk is used to describe all the accidental happenings, which produce a monetary loss. Insurance is a method in which a number of people exposed to similar risk make contributions to a common fund, of which the losses suffered by the unfortunate few due to accidental events are made good. Sharing of risk among large groups of people is the basis for insurance. The risk becomes insurable if the following requirements are complied with: The insured must suffer financial loss of the risk operates. The loss must be measurable in money. The object of the insurance contract must be legal.

The insurer should have sufficient knowledge about the risk that he accepts 1.2) Definitions: General definition: In the words of John Magee, Insurance is a plan by which large number of people associate themselves and transfer to the shoulders of all, risks that is attached to individuals. Fundamental definition: In the words of D.S. Hansell, Insurance may be defined as a social device providing financial compensation for the effects of misfortune, the payment being made from the accumulated contributions of all parties participating in the scheme. 2

Contractual definition: In the words of Justice Tindall, Insurance is a contract in which a sum of money is paid to the assured as consideration of insurers incurring the risk of paying a large sum upon a given contingency. 1.3) Logic of insurance: It is a system by which the losses suffered by a few are spread over many, exposed to similar risks. Insurance is a protection against financial loss arising on the happening of an unexpected event. Insurance companies collect premiums to provide for this protection. A loss is paid out of the premiums collected from the insuring public and the Insurance Companies act as trustees to the amount collected. 1.4) Basic insurance concepts: Insurance companies are business houses. The product they sell is financial protection. To succeed and survive, they must cover their costs, payments to others; cover the losses of policyholders, as also sales and administrative expenses, taxes and dividends. Insurance companies have two sources of income for covering these costs: premiums and investment income. Premiums are collected on a regular basis and invested in government bonds, gilts and stocks, Mutual Funds, real estates and other conservative avenues. However, investment income depends on market condition, interest rates, economy etc. and varies from year to year. Because of the uncertainty associated with the investment income, insurance companies must generate enough income from premiums to cover the bulk of their expenses. The primary function of insurance is protection against financial losses caused by unforeseen events. This protection is available to individuals, businessman and large companies alike.

1.5) The salient features of insurance are: It is a commercialized form of distributing risks among a group of persons. The fundamental idea underlying insurance is cooperation in the bearing of losses, which are likely to happen to any of a group of persons. The insured is relieved of a certain risk by an insurance contract and incurs a certain loss in the shape of premium. Thus it covers a few heavy losses by many small ones. The insurance company does not run any risk as the amount of the loss is known in advance and collected in small premiums. It is superior to an ordinary savings plan as it affords full protection against risk of death. In case of death, the full sum assured is made available under a life assurance policy whereas under other savings schemes only the accumulated savings alone will be made available. It allows administering the legacy for beneficiaries. An insurance policy allows a policyholder to arrange that in the event of his death, the beneficiary should receive single sum payment of net claim amount by equal installments over a specified period of years or payment of the claim amount by smaller monthly installments over the selected period followed by a lump sum at the end. It hedges risk against unforeseen circumstances. Insurance of a life or an asset hedges the risk against any damages arising as a result of unforeseen circumstances. Insurance furnishes a safe and profitable investment. Life insurance contains an accumulating investment feature, which is absolutely safe and reaches large proportions in the later years of the policy. It affords protection against claims of the insured's creditors. The desire for such protection is perfectly natural and also important in view of the hazard of bankruptcy. Mostly insurable amount exempted from creditors' claims is limited to some reasonable amount. It helps eliminate worry and increases initiative. An insurance policy relieves the policyholder of future worry and increases his efficiency. Thus possession of an adequate life and health cover causes the average policyholder to eat better, sleep better, feel better and as a result of these, to work better. 1.6) Characteristics of Insurance: Sharing of risks Cooperative device Evaluation of risk Payment on happening of a special event The amount of payment depends on the nature of losses incurred.

1.7) Functions of insurance: Primary functions 1. Provide protection - Insurance cannot check the happening of the risk, but can provide for the losses of risk. 2. Collective bearing of risk - Insurance is a device to share the financial losses of few among many others.

3. Assessment of risk - Insurance determine the probable volume of risk by evaluating various factors that give rise to risk 4. Provide certainty - Insurance is a device, which helps to change from uncertainty to certainty. Secondary functions 1. Prevention of losses - Insurance cautions businessman and individuals to adopt suitable device to prevent unfortunate consequences of risk by observing safety instructions. 2. Small capital to cover large risks - Insurance relives the businessman from security investment, by paying small amount of insurance against larger risks and uncertainty. 3. Contributes towards development of larger industries. Other Functions Means of savings and investment. 1.8) Fundamentals of insurance:
Insurable interest Utmost faith Fundamentals of Insurance Proximate cause

Subrogation

Contribution

Insurable interest:

It means the legal right to insure. Insurable interest is a must and only then the insurance contract is enforceable by law. This principle differentiates a contract of insurance from a wager. Lack of insurable interest renders the contract null and void. For insurable interest to exist there must be property, rights and interest. Life or liability must be insured and the insured should have a legally recognizable relationship thereto. The insured should be benefited by the safety of the property or is prejudiced by its loss. Insurable interest may arise in the following manner: 1. Ownership: Absolute ownership entitles the owner to insure the property. This is the commonest method whereby insurable interest arises. 2. Partial interest is also insurable e.g. a mortgage. A creditor can also insure the life of his debtor but only to the extent of his loan. 3. Administrators and executors i.e. officials appointed by a court of law to take care of a property may also insure the property. 4. Relationship does not automatically constitute insurable interest. The only relationship recognized by law for this purpose is the one of husband & wife. 5. An employer can insure an employee under a personal accidents policy as he has insurable interest in them. 5

Proximate cause:

Generally, the claims are payable under insurance policies if they arise out of events which are proximately caused by the insured perils. In other words, the proximate cause of the event has to be peril covered by the policy, so as to constitute a valid claim. Proximate cause has been defined as the active, efficient cause that sets in the motion a train of events which brings about a result without the intervention of any force started and working actively from a new and independent source. Contribution:

An insured may have several insurance on the same subject matter. If he recovers his loss under all these insurances, he will obviously make a profit out of loss. This will be an infringement of the principle of indemnity. Common law has therefore evolved the doctrine of contribution whereby the insured is prevented from recovering more than his loss, despite his having several insurances on the subject matter. Subrogation:

The principle of indemnity seeks to prevent the insured from making profit out of loss. However, it may so happen that the insured may recover his losses under his policy and may also give rights to third parties. If, after the insurance claim is settled, the insured is allowed to enforce his rights against third parties and to retain whatever damages he receives from them, he will certainly make a profit and the principle of indemnity will be infringed. Common law has therefore, evolved the doctrine of subrogation as corollary to the principle of indemnity. Subrogation may be defined as the transfer of the rights and remedies of the insured to the insurers who have indemnified the insured in respect of the loss. The common law right of subrogation is implied on all contracts on indemnity, as it arises only after payment of loss. Utmost Good Faith:

In all general insurance contacts we know that a property or interest, liability or life is offered for insurance and the insured has to take decisions on the acceptance of the proposal. If he decides to accept the proposal a premium commensurate with the risk has to be charged. To enable him to take necessary decisions in this regard, the insurer must have certain facts about the risk offered. These facts influence the judgment of the insurer in deciding about the acceptance or otherwise of the risk and the rate of premium to be charged, if accepted. Such facts are known as material facts. 1.9) Nature of insurance contracts: When the insured pays the premium and the insurers accept the risk, the contract of insurance is concluded. The policy issued by the insurers is the evidence of contract. The contract of insurance like any other contract is subject to the general law of contracts as embodied in the Indian Contract Act, 1872. According to this act, a contract must have certain essential features in order to make it legally valid and enforceable. The following are the essential elements:

1. 2.

Offer and Acceptance: Usually, the proposer makes the offer, and the insurer makes acceptance. Consideration: This means that the contract must involve some mutual benefit to the parties. The premium is the consideration from the insured and the promise to indemnify is the consideration from the insurers.

3. 4. 5.

Agreement between the parties: Both parties should agree to the same thing in the same sense. Capacity of the parties: Both parties to the contract must be legally competent to enter into the contract. For e.g.. Minors cannot enter into an insurance contract. Legality: The object of the contract must be legal and the contract should not violate any legal requirements. E.g. no insurance can be had for smuggled goods.

1.10) Origin of Insurance Insurance in the modern form originated in the Mediterranean during 13 -14th century. The earliest references to insurance have been found in Babylonia, the Greeks and the Romans. The use of insurance appeared in the account of North Italian merchant banks who then dominated the international trade in Europe at that time. Marine insurance is the oldest form of insurance followed by life insurance and fire insurance. The patterns that have been used in England followed in other countries also in these kinds of insurance. 1.10.1) Insurance In India- A brief History Life insurance in the modern form was first set up in India through a British company called the Oriental Life Insurance Company in 1818 followed by the Bombay Assurance Company in 1823 and the Madras Equitable Life Insurance Society in 1829. All these companies operated in India but did not insure the lives of Indians. They were insuring the lives of Europeans living in India. Some of the companies that started later did provide insurance for Indians. But, Indians were treated as "substandard" and therefore had to pay an extra premium of 20% or more. The first company that had policies that could be bought by Indians with "fair value" was the Bombay Mutual Life Assurance Society starting in 1871. The first general insurance company, Triton Insurance Company Ltd., was established in 1850. It was owned and operated by the British. The first indigenous general insurance company was the Indian Mercantile Insurance Company Limited set up in Bombay in 1907. By 1938, the insurance market in India was abuzz with 176 companies. Yet, the industry was plagued by fraud. Hence, a comprehensive set of regulations was put in place to stem this problem. By 1956, there were 154 Indian insurance companies, 16 non-Indian insurance companies and 75 provident societies that were issuing life insurance policies. Most of these policies were centered in the cities (especially around big cities like Bombay, Calcutta, Delhi and Madras). In 1956, the then finance minister S. D. Deshmukh announced nationalization of the life insurance business.

HISTORY OF INSURANCE IN INDIA YEAR 1850 1871 1874 1907 1912 1914 1937 1938 1945 1950 EVENT Triton Insurance company Ltd. set up in Calcutta. Bombay Mutual, Indias first life insurance company set up. Oriental Insurance Company set up. Indian mercantile Insurance ltd. the first company to transact all classes of general insurance business set up. Life Assurance Act (Act VI) of 1912 enacted. Government started publishing returns of

life

insurance

companies. Draft Insurance Bill introduced Insurance Act, 1938 enacted. Committee headed by Cowasji Jehangir set up to review malpractice and take corrective steps. Insurance Amendment Act, 1950 put in place based on recommendations of a committee under S R Ranganathan. Among other things the Act provided for a Controller of Insurance (CoI), constitution of Life Insurance Corporation and the General Insurance Council. LIC set up. Nationalization of life insurance business Reinsurance Corporation of India, first Indian Reinsurer set up. Insurance Act amended further to provide effective control over general insurance companies requiring increased deposits from them; also provided for setting up of TAC. Ordinance promulgated to replace the

1956 1957 1968

1971 1972 1973 April 1993 Jan 1996 Sep 1996 Dec 1996 1997 Aug 1997 Nov 1997 June 1998 Nov 1998 1999

General

Insurance

Emergency Provisions Act, 1971. General Insurance business nationalized GIC set up. Malhotra Committee constituted for insurance sector reforms and deregulation. Interim insurance regulatory authority setup through a resolution The IRA bill drafted IRA bill introduced in parliament & referred to Standing Committee Insurance Regulatory Authority came into existence. IRA is withdrawn following opposition to foreign participation Indian government clears greater autonomy to LIC, GIC and its four subsidiaries Union budget announces opening up of insurance sector Union budget decides to allow 40% foreign equity participation in Private sector (26% to foreign cos and 14% to NRIs, OCBs, FIIs The Standing Committee headed by Murali Deora decides that foreign equity in private insurance should be limited to 26%. The IRA bill is renamed the Insurance Regulatory and Development Authority (IRDA) Bill and cleared by parliament. IRDA made statutory body IRDA issues first set of guidelines for insurance companies. First three licenses awarded to private companies; three others receive in-principle clearance. ICICI prudential and HDFC Standard Life launch insurance policies 8

2000 July 2000 Oct. 2000 Dec. 2000

become first private companies to operate in India since 1972 and first life insurers in almost five decades. 2002 IRDA Insurance Brokers Act passed 2002-03 Formation of the Agricultural Insurance Company of India Ltd. (AICIL) to underwrite crop insurance and other allied insurance business in the country. Source: Charted Financial Analyst.

1.11) Scope or kinds of insurance

Classification Of Insurance

Nature Of Insurance
Life insurance Fire insurance Marine insurance Social Insurance, and Miscellaneous insurance.

Business Point Of View Life insurance General Insurance

Risk Point Of View

Personal insurance Property insurance Liability insurance Fidelity guarantee insurance

1.11.1) Classification according to Nature of Insurance Life insurance

Life insurance may be defined as a contract in which the insurer, in consideration of a certain premium, either in a lump sum or by other periodical payments, agrees to pay to the assured, or to the person for whose benefit the policy is taken, the assured sum of money, on the happening of a specified event contingent on the human life. Fire insurance

Fire insurance is a contract to indemnity the insured for distribution of or damage to property caused by fire. The insurer undertakes to pay the amount of the insured's loss subject to the maximum amount stated in the policy.

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Marine insurance

A contract of marine insurance is an agreement whereby the insurer undertakes to indemnity the assured in a manner and to the extent thereby agreed, against marine losses, that is, the losses incidental to marine adventure. Social insurance

Social insurance has been developed to provide economic security to weaker sections of the society who are unable to pay the premium for adequate insurance. Pension plans; disability benefits, unemployment benefits, sickness insurance, etc. are the various forms of social insurance. Miscellaneous insurance

The process of fast development in the society gave rise to a number of risks or hazards. To provide security against such hazards, many other types of insurance also have been developed. The important among them are: (i) Vehicle insurance on buses, trucks, motorcycles, etc., (ii) Personal accident insurance (iii) Burglary insurance - (against theft, dacoit etc.) (iv) Legal liability insurance, Crop insurance, Cattle insurance crime, medical insurance, bullock cart insurance, jewelry insurance, cycle rickshaw insurance, radio-T.V. insurance, etc. 1.11.2) Classification from business point of view From business point insurance can be classified into two broad categories: Life insurance; and General Insurance General Insurance

General insurance business refers to fire, marine, and miscellaneous insurance business whether carried on singly or in combination with one or more of them but does not include capital redemption business and annuity certain business. 1.11.3) Classification from risk point of view From risk point of view, insurance can be classified into four categories: Personal insurance Property insurance Liability insurance Fidelity guarantee insurance

Personal insurance

Personal insurance refers the loss to life by accident, or sickness to individual, which is covered by the policy. Property insurance

The policies of insurance against burglary, home breaking or theft etc. fall under this category. 11

Liability insurance

Liability insurance is the major field of General insurance whereby the insurer promises to pay the damage of property or to compensate the losses to a third party. The amount of compensation is paid directly to third party. The fields of liability insurance include: workmen compensation insurance, third party motor insurance, and professional indemnity insurance. Fidelity guarantee insurance

In this type of insurance, the insurer undertakes to indemnify the assured (employer) in consideration of certain premium, for losses arising out of fraud, or embezzlement on the part of the employees. This kind of insurance is frequently adopted as a precautionary measure in cases where new and untrained employees are given position of trust and confidence.

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1.12) Basic Principles of Insurance: How the Product is created: All life insurance products are mathematically and scientifically created by calculating relationships of mortality, interest, expense, and financial values attached to each based on time. These factors ultimately determine the premium at which a policy is sold. The premium must be adequate to pay the expenses incurred in creating, offering and maintaining the product, to pay all promised benefits, and to increase profit and surplus of the insurer. From an economic viewpoint, insurance is a system for reducing financial risk through transfer of risks from policy owners, and combining or pooling those losses by the insurer. From viewpoint of society, insurance is a device for accumulating funds to meet uncertain losses of economic value carried out through transfer of risks of many individuals to one person or a group of persons. The social aspect of insurance involves collective bearing of losses through contributions by all group members to pay for losses suffered by some group members. Insurance substitutes certainty for uncertainty through the pooling of hazards to which groups of people are exposed. Uncertain risks of individuals are combined, making the possible loss more certain, providing a financial solution to the problems created by the loss. Small, periodic contributions by the individuals provide a fund from which, those who suffer loss may be reimbursed. Insurance thus manages the uncertainty of one party through the transfer of particular risks to another party who offers a restoration, at least in part, of economic losses suffered by the insured individual. From a business viewpoint, insurance achieves the sharing of risk by transferring risks from individuals and businesses to financial institutions specializing in risk. Lastly, from a legal standpoint, an insurance contract or policy transfers a risk (for a premium) from one party, known as the insured or policy owner, to another party known as the insurer. By virtue of a legally binding contract, the possibility of an unknown large financial loss is exchanged for a comparatively small certain payment. This contract is not a guarantee against a loss occurring, but a method of ensuring that payment will be received for a loss that does occur. Every insurance company will add cost and pricing variables to the actual historical results of that company in designing and pricing its products. This is the same procedure for any product on the market, not just insurance. It also accounts for the variations in premiums between products that might appear to be the same. Variations can be created by differences in company operational efficiencies, investment performance and assumptions, underwriting practices, profit and marketing objectives, sales results, service practices, policy persistency, expenses and other issues. Statistical Predictability: Mortality is statistically predictable. Everyone will die, eventually. Time becomes a critical factor when we recognize that we never know when someone will die, only that everyone will. Combine the reality of death with the uncertainty of when it will occur, and you have the basis for life insurance. It is the scientifically calculated pooling, growth, and distribution of money to satisfy two objectives for paying benefits: Paying benefits to survivors of someone who dies Providing distribution of benefits with guaranteed lifetime payments to either the insured or the insureds survivors 13

Only life insurance and annuities can do these things. To accomplish this, companies keep extremely accurate records about births and deaths, especially when (by age) and how (by cause of death) people die. The size of the statistical base, now hundreds of years old, enables insurance actuaries to predict average mortality for groups of people in many different categories. This precision study of mortality and how it works helps to make life insurance a risk management tool rather than a game of chance. It is an actuarial sciencemathematical calculations of probability based on huge amounts of experiencethat establishes mortality and the statistical tables used to create and price life insurance products.

Chapter 2

Liberalization of Insurance Sector

2.1) Underlying principle for opening up of the Insurance Industry India is one of the least insured countries but the potential for further growth is phenomenal, as a significant portion of its population is in services and the life expectancy has also increased over the years. The nationalized insurance industry had not offered consumers a variety of products. Opening of the sector to private firms would foster competition, innovation, and variety of products. It would also generate greater awareness on the need for buying insurance as a service and not merely for tax exemption, which was currently done. On the demand side, there exists a strong correlation between demand for insurance and per capita income level, suggesting that high economic growth could spur growth in demand for insurance. Also there exists a strong correlation between insurance density and social indicators such as literacy. With social development, insurance demand will grow. Thus with the rising trend in the per capita income and literacy levels in the country there seemed to be increase in demand for insurance products. There also existed a mismatch in the demand and supply aspect. Thus new firms could cash-in in this increasing gap and increasing market. Thus the market was quite promising and untapped. following things: Increase in Economic development Better and variety of insurance products Healthy Competition Consumer will benefit Insurance helps to spur economic development by providing shelter against risky projects. Thus opening up of the insurance sector would result into the

This was the basis on which the Government opened up the Insurance sector in 2000.

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2.2) Rationale about Insurance Liberalization The rationale for opening up of the insurance sector can be analyzed on the basis of asking the following 3 basic questions. The Three key questions that impinge on liberalization of insurance business in India are: Why Liberalize What market structure to finally have What should be the role of the regulator

The decision to allow private companies to sell insurance products in India rests with the lawmakers in 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 amending the LIC and GIC Acts, which would end their respective monopolies. In 1994 the government appointed a committee on insurance sector reforms (which is known as the Malhotra Committee), which recommended that insurance business be opened up to private players and laid down several guidelines for orchestrating the transition. In particular, the report did not address many other related questions such as whether foreign (and not just private) players should be allowed, what cap should there be on foreign equity ownership, whether banks and other financial institutions should be allowed to operate in the insurance business, whether firms should be allowed to sell both life and -non-life insurance, and so on. The three questions that were addressed were (a) Why should insurance be opened up to private players? (b) If opened up, what should be the appropriate market structure (many unregulated players or few regulated players); and finally, (c) What is the role of the regulator in insurance business? a

Why allow entry to private players?

Some of the concerns for entry of private players were: (a) That there would be a tendency of private companies to "skim" the markets; thus private players would concentrate on the lucrative mainly urban segment leaving the unprofitable segment to the incumbent LIC. (b) That without adequate regulation, the funds generated may not be deployed in sectors (which yield long-term social benefits), such as infrastructure and public goods; similarly without regulation, private firms may renege on their social sector investment obligations. Meeting these concerns would require a strong regulatory body. Another commonly expressed fear was that there would be massive job losses in the industry as a whole due to computerization. This however did not seem to be corroborated by the countries' experience'. Then why allow private players

Moreover, apart from consideration based on theoretical principles alone, there was sufficient evidence that suggested that introduction of private players in insurance could only lead to greater 15

benefits to consumers. This could be seen from the fact that the spread in insurance in India was low compared to international benchmarks. The two convention measures of the spread of insurance are penetration and density. The former measure (premiums per unit) of GDP, and the latter, premiums per capita. Less than 7% of the population in India had life insurance cover. In Singapore, around 45 % of the people were covered and in Japan, this was close to 100 %. In the US, over 81 % of the households had insurance cover. India has the biggest life insurance sector in the world if we go by the number of policies sold, but the number of policies sold per 10 persons is very low. The demand for insurance is likely to increase with rising per-capita incomes, rising literacy rates and increase of the service sector, as has been seen from the example of several other developing countries. In fact, opening up of the insurance sector is an integral part of the liberalization process being pursued by many developing countries. There are several other factors that called for private sector presence. Firstly, a state monopoly has little incentive to innovate or offer a wider range of products. This could be seen by a lack of certain products from LlC's portfolio, and lack of extensive risk categorization in several GIC products. In fact, it could be concluded that many people buy life insurance just for the tax benefits, as almost 35% of the life insurance business is in March, the month of financial closing. This suggested that insurance needed to be sold more vigorously. More competition in this business would spur firms to offer several new products and more complex and extensive risk categorization. The system of selling insurance through commission agents needed a better incentive structure, which a state monopoly tends to stifle. For example LIC pays out only 5% of its income as commissions. The following were the reasons to allow private players: a) While nationalized insurance companies had done a commendable job in extending their presence and services throughout the country and were handling large volumes of business, the choice available to the insuring public was inadequate in terms of service, products and prices. Introduction of competition would result in better service and help improve the variety and price of insurance products. b) Even though the nationalized insurance industry had over the decades built up extensive business, there was still a vast untapped potential and many lines of business had remained under-developed. Arrival of new players would speed up the spread of both life and general insurance. c) The nationalized insurance companies were financially strong and had built up a large infrastructure in terms of professional talent, and marketing and servicing networks. They were in a position to face competition. d) There was growing competition within the banking sector, which included nationalized banks, cooperative banks and private banks, both -Indian and foreign. The private sector had also been allowed to float mutual funds and was quite active in merchant banking, leasing and non-banking financial areas. There was little reason for keeping insurance as a monopoly. It was thus decided that the private sector be allowed to enter insurance business.

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What should be the market structure?

Issues related to Market Structure

Issue of Adverse Selection

Problem of Moral Hazard

Here, we analyze the question whether there should be unlimited private entry insurance markets or whether only a few players should be allowed to operate. This question hinges around the issue of "adverse selection" described below. Individuals buying an insurance contract pay a price (called the "premium") to the insurance company and the insurance company in turn provides compensation if a specified event occurs. By making such contractual arrangements with a large number of individuals and organizations the insurance company can spread the risk. This gives insurance its "social" character in the sense that it entails pooling of individual risks. The price of insurance i.e., the premium is based on average risk. This premium is too high for people who perceive themselves to be in a low risk category. If the insurer cannot accurately determine the risk category of every customer and prices insurance on the basis of average risk, he stands to lose all the low risk customers. This increases the average risk, which means premia have to be revised upwards, which in turn drives away even more customers and so on. This is known as the problem of "adverse selection". In an extreme case, it may lead to the complete breakdown of insurance market. Another phenomenon, the problem of "moral hazard" in selling insurance, arises when the unobservable action of the buyer aggravates the risk for which insurance is bought. For eg, when an insured car driver exercises less caution in driving compared to how he would have driven in the absence of insurance, it exemplifies moral hazard. Given these problems, unbridled competition among large number of firms is considered detrimental for the insurance industry. Furthermore, even the limited competition in insurance needs to be regulated. It also calls for keeping life insurance separate from the general insurance. It suggests the regulation of insurance intermediaries by IRA and the introduction of brokers for better professionalization'. Economic Rationale

The insurance industry is a key component of the financial infrastructure of an economy, and its viability and strengths have far reaching consequences for not only its money and capital markets, but also for its real growth. For example, if households are unable to hedge their potential losses of wealth, assets and labour and non-labour endowments with insurance contracts, many or all of them will have to save much more to provide for events that might occur in the future, events that would be unfavorable to their interests. If a significant proportion of the households behave in such a fashion, the growth of demand for industrial products would be adversely affected. Similarly, if firms are unable to hedge against "bad" events like fire and on-the-job injury of a large number of labourers, 17

the expected payoffs from a number of their projects, after factoring in expected losses on account of such "bad" events, might be negative. In such an event, private investment would be adversely affected and certain potentially hazardous activities like mining and freight transfers might not attract any private investment. It is not surprising therefore; that economists have long argued that insurance facility is necessary to ensure the completeness of a market. Thus in order to spur the economic development of the country there is a need to have more insurance products. There also exists a gap between the demand and supply of insurance products. Due to increasing uncertainty in the markets there is a need for some sort of coverage of risk, when the stakes involved are high for the company. Thus in order to make the industry lucrative and to abolish the monopoly of the state it was imperative to open up the sector. 2.3) Malhotra Committee Report on liberalization of the insurance sector. Although Indian markets were privatized and opened up to foreign companies in a number of sectors in 1991, insurance remained out of bounds on both counts. The government wanted to proceed with caution. With pressure from the opposition, the government (at the time, dominated by the Congress Party) decided to set up a committee headed by Mr. R. N. Malhotra (the then Governor of the Reserve Bank of India). Liberalization of the Indian insurance market was recommended in the report released in 1994 by the Malhotra Committee, indicating that the market should be opened to private sector competition, and ultimately, foreign private sector competition. It also investigated the level of satisfaction of the customers of the LIC. Curiously, the level of customer satisfaction seemed to be high. The following were the purposes of the committee. (a) To suggest the structure of the insurance industry, to assess the strengths and weaknesses of insurance companies in terms of the objectives of creating an efficient and viable insurance industry, to have a wide coverage of insurance services, to have a variety of insurance products with a high quality service, and to develop an effective instrument for mobilization of financial resources for development. (b) To make recommendations for changing the structure of the insurance industry, for changing the general policy framework etc. (c) To take specific suggestions regarding LIC and GIC with a view to improve the functioning of LIC and GIC. (d) To make recommendations on regulation and supervision of the insurance sector in India. (e) To make recommendations on the role and functioning of surveyors, intermediaries like agents etc. in the insurance sector. (f) To make recommendations on any other matter which are relevant for development of the insurance industry in India.

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The committee made a number of important and far-reaching recommendations: (a) The LIC should be selective in the recruitment of LIC agents. Train these people after the identification of training needs. (b) The committee suggested that the Federation of Insurance Institute, Mumbai should start new courses and diploma courses for intermediaries of the insurance sector. (c) The LIC should use an MBA specialized in Marketing (a similar suggestion for the GIC subsidiaries). (d) It suggested that settlement of claims were to be done within a specific time frame without delay. (e) The committee has several recommendations on product pricing, vigilance, systems and procedures, improving customer service and use of technology. (f) It also made a number of recommendations to alter the existing structure of the LIC and the GIC. (g) The committee insisted that the insurance companies should pay special attention to the rural insurance business. (h) In the case of liberalization of the insurance sector the committee made several recommendations, including entry to new players and the minimum capital level requirements for such new players should be Rs. 100 crores (about USD 24 million). However, a lower capital requirement could be considered for a co-operative sectors' entry in the insurance business. (i) The committee suggested some norms relating to promoters equity and equity capital by foreign companies, etc.

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2.4) IRDA (Insurance Regulatory and Development Authority) After the report of the Malhotra Committee came out, changes in the insurance industry appeared imminent. Unfortunately, instability in Central Government, changes in insurance regulation could not pass through the parliament. The dramatic climax came in 1999. On March 16, 1999, the Indian Cabinet approved an Insurance Regulatory Authority (IRA) Bill that was designed to liberalize the insurance sector. The Role of IRA: (a) The protection of consumers' interest, (b) To ensure financial soundness of the insurance industry and (c) To ensure healthy growth of the insurance market. These objectives were to be achieved with minimum government involvement and cost. IRA's functioning was to be financed by levying a small fee on the premium income of the insurers thus putting zero cost on the government and giving itself autonomy. The Authority was established with a view to protect the interests of the holders of insurance policies, to regulate, promote and ensure orderly growth of the insurance industry and for matters connected therewith or incidental thereto. The bill was awaiting ratification by the Indian Parliament. However, the BJP Government fell in April 1999. The deregulation was put on hold once again. An election was held in late 1999. A new BJPled government came to power. On December 7, 1999, the new government passed the Insurance Regulatory and Development Authority (IRDA) Act. This Act repealed the monopoly conferred to the Life Insurance Corporation in 1956 and to the General Insurance Corporation in 1972. The authority created by the Act is now called IRDA. It has ten members. New licenses are being given to private companies (see below). IRDA has separated out life, non-life and reinsurance insurance businesses. Therefore, a company has to have separate licenses for each line of business. Each license has its own capital requirements (around USD24 million for life or non-life and USD48 million for reinsurance).

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With the Insurance Regulatory & Development Act, focus shifted to the following: The Insurance Regulatory and Development Authority (IRDA) was to give priority to health insurance while issuing certificates of registration; Policyholders' funds to be invested in the social sector and infrastructure. The percentage to be specified by the IRDA and such regulations would apply to all insurers operating in the country; Insurers would be expected to undertake a certain percentage of business in the rural or social sector and provide policies to persons residing in rural areas and workers in the unorganized and informal sectors; In case insurers fail to meet the social sector obligation a fine of Rs.2.5 mn to be imposed. Subsequent failures would result in cancellation of licenses. IRDA also laid several guidelines and rules governing the insurance intermediaries and various types of brokerage firms.

2.4.1) Some Details of the IRDA Bill On July 14, 2000, the Chairman of the IRDA, Mr. N. Rangachari set forth a set of regulations in an extraordinary issue of the Indian Gazette: The first covers the Insurance Advisory Committee that sets out the rules and regulation. The second stipulates that the "Appointed Actuary" has to be a Fellow of the Actuarial Society of India. Given that there has been a dearth of actuaries in India with the qualification of a Fellow of the Actuarial Society of India, this becomes a requirement of tall order. As a result, some companies have not been able to attract a qualified appointed Actuary (Dasgupta, 2001). The IRDA is also in the process of replacing the Actuarial Society of India by a newly formed institution to be called the Chartered Institute of Indian Actuaries (modeled after the Institute of Actuaries of London). Curiously, for life insurers the Appointed Actuary has to be an internal company employee, but he or she may be an external consultant if the company happens to be a non-life insurance company. Third, the Appointed Actuary would be responsible for reporting to the IRDA a detailed account of the company. Fourth, insurance agents should have at least a high school diploma along with training of 100 hours from a recognized institution. More than a dozen institutions have been recognized by the IRDA for training insurance agents (the list appears online at http://www.irdaonline.org/press.asp). Fifth, the IRDA has set up strict guidelines on asset and liability management of the insurance companies along with solvency margin requirements. Initial margins are set high (compared with developed countries). The margins vary with the lines of business (for example, fire insurance has a lower margin than aviation insurance). Sixth, the disclosure requirements have been kept rather vague. This has been done despite the recommendations of the Mukherjee Committee. (The committee recommended the inclusion of certain ratios in insurance company balance sheets to ensure transparency in accounting.) 21

Seventh, all the insurers are forced to provide some coverage for the rural sector. In respect of a life insurer, (a) five percent in the first financial year; (b) seven percent in the second financial year; (c) ten percent in the third financial year; (d) twelve percent in the fourth financial year; (e) fifteen percent in the fifth year (of total policies written direct in that year). In respect of a general insurer, (a) two percent in the first financial year; (b) three percent in the second financial year; (c) five percent thereafter (of total gross premium income written direct in that year).

The IRDA Bill also speaks about brokerage firms. Brokerage Firms are firms that are essential in the growth of the insurance business in India. These firms do the general legwork required to be done in the industry, they have expertise in risk management as well as in risk evaluation. Types of Brokerage Firms

Insurance

Re-Insurance

Composite

Brokerage firms are allowed a minor foreign equity stake in them with a cap of 49%. Composite brokers are the ones who can sell Life & General insurance products and reinsurance products. Capital requirement for the broking firm will be Rs.2.5 mn. The IRDA is also likely to cap the brokerage commissions to 15%. The number of brokers in USA is 40000, UK 4000, and 3000 for Germany. These show great potential for brokerage business in India. This is manifested in a number of foreign brokerage firms showing interest to come to India. The names include Aeon, Willis Coroon, Vitasia, Jardine insurance, Chubb Reinsurance, etc. 2.4.2) Overseeing Insurance Intermediaries Insurance intermediaries such as agents, brokers, consultants and surveyors are also under IRDAs jurisdiction. IRDA has evolved guidelines on the entry and functioning of such intermediaries. Licensing of agents and brokers should be checked to regulate against their indulging in activities such as twisting, rebating, fraudulent practices, and misappropriation of funds. IRDA also considered allowing banks to act as agents (as opposed to underwriters) of insurers in mass base types of products. Given their wide network of branches and their customer base, the banks can access this market for insurance products and also earn commission income. The incremental cost of providing such insurance products would be much lower. IRDA was to ensure growth of insurance business with better education and protection to consumers, and by making the insurance business a level playing field. It was also to support Indian insurance companies in the international field. IRDA thus has to frame the rules, design procedures for enforcement and also make operational guidelines. All this with virtually no relevant historical data made the task very difficult. An initial conservative approach (the bloodhound) was justified since there was no prior experience to fall back 22

on, and it would be prudent to err by regulating more rather than less. As experience accumulates, the IRDA can relax its initial harsh stance and adopt a more accommodating stance (the watchdog). 2.4.3) Guidelines issued by IRDA for opening up Insurance sector 1) The Committee noted the apprehensions expressed in some quarters regarding the safety of their money in case private insurance companies are allowed to operate. The measures needed to safeguard the interest of the insuring public are outlined in the following paragraphs: a) Mushrooming of small private sector companies must be avoided. Any party intending to take up insurance business should have a minimum capital of Rs 100 crore and must satisfy the IRDA about its credentials. No insurer should be allowed to transact both life and general insurance business. b) Regulation of the insurance industry must be greatly strengthened. It would be for the IRDA to ensure, inter alia, that insurance companies maintain adequate solvency at all times, invest their funds prudently and in conformity with the law, do not invest in any affiliate of the promoters, appoint proper persons as managers, and maintain high standards of transparency in company accounts. c) Insurance company auditors should have an obligation to report to the IRDA serious irregularities that might come to their notice in the course of audit. d) The new entrants in general insurance would have to observe the tariff regulations in force. 2) It is important that while the share holding in a private insurance company should be widely dispersed, the promoters should also have sufficient stake in the business. A 40% stake for the promoters would appear to be reasonable. This should at no point of time be less than 26% of the paid-up capital so that promoters have an effective say when special shareholders consider resolutions. To disperse the public share holding widely, no shareholder other than the promoters should be allowed to hold more than 1% of the company's equity. 3) There should be level playing fields for all insurance companies. There is a view that new entrants to the insurance field would, on profit considerations, concentrate on more lucrative business and neglect the common man and rural sector. It is thus necessary that new entrants into the life insurance field should write a specified proportion of their business in rural areas. It should be ensured that such insurers do not avoid writing small policies. The general insurance companies should maintain balanced portfolios and should not, in particular, avoid writing motor insurance and rural non-traditional business. 4) Competition should be introduced with considerable care. The first step should be to setup an insurance regulatory authority. Simultaneously, the conditions necessary for ensuring level playing fields among insurers should be firmed up so that intending entrants into the business are aware the stipulations which they would have to comply with. It would also be necessary control the number of new entrants. 5) With reference to the recommendation for the entry of the private sector in insurance business, it has been observed that allowing some foreign insurance companies could be useful in the context of India's objective of integrating with the global economy. If and when their entry is permitted, they should be required to float an Indian Company for the purpose, which preferably should be a joint 23

venture with an Indian partner. These conditions should aim to ensure that life insurers do not neglect the small man or the rural business and that the general insurers have balanced portfolios. These were the major points of importance while liberalizing the insurance sector in 2000. With the opening up of the Insurance sector major changes have occurred in the Life Insurance segment. Thus Life Insurance has become the most dynamic segment in the insurance industry. Therefore we need to study Life Insurance. Life Insurance, its meaning and concept is studied in the next chapter.

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Chapter 3
3.1) Why do Men Work?

Life Insurance

Men work to provide themselves and their families with these basic needs of Food, Shelter and Clothing. As well as other comforts that make life worth loving. But men wish to provide not only for todays needs but also for tomorrows as well for their comforts in old age as well as for the needs of the family. When a Breadwinner dies not only does a husband die, not only does a father die, but an income dies as well. The loss of the breadwinner is irreparable. But a prudent person can make sure that his income does not die when he is no more. In the same way, he can also make provisions for his old age. This is because man has devised many ways of saving. But most forms of savings have two enemies: Time: Granted the desire to save and the ability to save, no man can be sure that he will have time to save enough towards fulfilling his plans or dreams. Temptation: There is no safeguard against the appeal to spend on unnecessary comforts and luxuries. Hence money is difficult to conserve and easy to spend. 3.2) Meaning of Life Insurance Life Insurance made its debut in India well over 100 years ago. Today, it is widely accepted as one of the most attractive financial instruments in an individuals portfolio that provides an assurance of security with attractive returns. Life Insurance is different things to different people. For some, it is a premium to be paid on time. For others it offers liquidity since cash can be borrowed when needed. For the investment minded, it denotes a constantly growing capital account and numerous other benefits. Life Insurance is a contract for payment of a sum of money to the person assured (or failing him/her, to the person entitled to receive the same) on the happening of the event insured against. It is nothing but the creation of capital funds on an installment basis. Usually the contract provides for the payment of an amount on the date of maturity or at specified dates at periodic intervals or at unfortunate death, if it occurs earlier. Among other things, the contract also provides for the payment of premium periodically to the corporation by the assured. Life Insurance is universally acknowledged to be an institution, which eliminates risk, substituting certainty for uncertainty and comes to the timely use of the family in the unfortunate event of the death of the breadwinner. Life insurance in short is concerned with two hazards that stand across the life path of every person: that of dying prematurely leaving a dependent family to fend for itself and that of living to old age without visible means of support. Here the results are guaranteed. 3.3) Genesis of Life Insurance The early developments of life insurance were closely linked with that of marine insurance. The first insurers of life were the marine insurance underwriters who started issuing life insurance policies on the life of master and crew of the ship, and the merchants. The early insurance contracts took the nature of policies for a short period only. The underwriters issued annuities and pension for a fixed period or for life to provide relief to widows on the death of their husbands. The first life insurance policy was issued on 18th June 1583, on the life of William Gibbons for a period of 12 months. 25

It was in the eighteenth century that societies began to be formed for issuing life insurance policies. Among such societies the Amicable Society (1705), The Equitable Life Assurance Society (1762) and the West Minister Society (1792) were the important societies. The premium rates were varied in view of reputation and the health condition of the insured. During the early years of nineteenth century, a large number of life insurance companies were formed in India. Some of these companies preferred to amalgamate their business with other companies and a good number failed to function effectively. In order to stabilize and strengthen the insurance business, the Life insurance Companies Act; 1923 was passed and was later amended in 1946, 1958 and 1967. 3.4) Need for Life Insurance
Support for Retirement age and needs

Safety against future adversities

Security Needs

Changing Social Patterns

E.g. Nuclear families

Need For Life Insurance

Stress

Childrens education

Freedom from financial burden Future Plans and higher Ambitions

Insurance buys Time and Money: People like to refer to Life Insurance as a time insurance, the reason being that life insurance proceeds are paid to the insureds beneficiaries in case of death. The money proffered by Life Insurance helps buy time to adjust to the change of circumstances. Insurance provides large amounts of cash that will keep the lifestyle for the survivors the way it was before the insureds death.

Insurance offers peace of Mind: For the person who buys an insurance policy, it offers absolute and complete peace of mind. He knows that this decision will provide sound benefits in the future, whether or not he lives to see it. This is the guarantee of insurance.

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Multiple Applications: The future is uncertain for each and everyone. No one knows how long he will live. The investment benefit is paid to the insureds beneficiaries after his death or it can be used during his life as well. Life Insurance policy owners can turn to the cash value of the policy incase of a financial emergency or to meet their long-term financial needs when all avenues are either blocked or denied. They know that they can avail of loans based on their insurance policy. They may have purposefully invested in insurance to use the cash in the policy for their childrens future marriage expenses or higher education fees.

Enduring Elasticity: Since Life Insurance is flexible enough to serve several needs; the insured can keep several long-term goals in mind once he invests in an insurance plan. The cash value of the policy can be allocated towards augmenting the monthly income during the retirement years. Leisure years should be turned into pleasure years. Permanent Life Insurance is designed on the concepts of long-term flexibility.

Financial security: Insurance policy offers contractual guarantees to people looking for peace of mind when they buy life insurance. Life Insurance offers complete financial security. The purchase for Life Insurance demonstrated concern for a familys future financial well being.

Regard for family: The purchase of Life Insurance clearly displays care and concern for the people the policy owners love.

Insurance is safer: No financial institution can do what Life Insurance does. No industry can back its products with reserves and surplus as sound as those of the insurance industry. The proof of strength and safety that insurance companies have ensured even under the most adverse conditions is a matter of pride for the entire insurance industry. For generations after generations, Life Insurance has been acclaimed as the very benchmark of security against which other industries are measured.

3.5) Life Insurance A superior form of saving Life Insurance is a superior form of saving as compared to other financial instruments because of the following reasons: Protection: Savings through Life Insurance guarantees full protection against risk of death of the saver. In Life Insurance, on death the full sum assured is payable (with Bonuses wherever applicable) whereas in other saving schemes, only the amount saved (with interest) is payable. Aid to Profit: Long term saving can be made in a relatively painless manner due to the easy installment facility built into the scheme. E.g. Salary Savings Schemes provide a convenient method of paying premium each month by deduction from salary. The employer remits the deducted salary to insurer. Protection against Creditors: Proceeds of a policy can be protected against the claims of creditors of the Life assured through a valid assignment or by taking a policy under the married womens property Act.

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Liquidity: Loans can be raised on sole security of a policy that has acquired loan value. Also, a life policy is accepted as security for a commercial loan. Tax relief: Considerable tax relief in income tax and wealth tax is available to an individual/Hindu undivided families for amounts paid as premiums for Life Insurance. In such cases the assured in effect pays a substantially lower premium for his insurance than he would have paid otherwise.

Cash Estate: Life Insurance is the most practical way to ensure definite payments on ones death without having to resort to conversion of other asset at a loss. Life Insurance, therefore, is one of the most satisfactory means of making provisions for payment of Estate Duty.

Money when you need it: A suitable insurance plan or combination of different plans can be taken out to meet specific needs that are likely to arise in future, such as childrens education, marriage provision or even periodical needs for cash over a stretch of time. Alternatively, policy money can be arranged to be made available at the time of ones retirement from service to be used for any specific purpose, such as for the purchase of a house or for other investments.

It is the only savings scheme that covers life risk besides giving tax concessions at entry (premiums paid) and exit points (Maturity + Bonus). Life Insurance promotes compulsory savings besides reducing Tax burden and protecting the family in the event of an unforeseen happening. Life Insurance cover is as much a necessity as food and clothing. Loans can also be availed based on policies. Policies of some companies can be placed as collateral securities for raising loans form banks and other financial institutions.

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3.6) History of Life Insurance in India Life insurance in its existing form came to India from the United Kingdom with the establishment of a British firm, Oriental Life Insurance Company in Calcutta (1818) followed by Bombay Life Assurance Company (1823), the Madras Equitable Life Insurance Society (1829) and Oriental Government Security Life Assurance Company (1874). Prior to 1871, Indian lives were treated as substandard and charged extra premium of 15% to 20%. Bombay Mutual Life Assurance Society, an Indian insurer founded in l871, was the first to cover Indian lives at normal rates. The Indian Life Assurance Companies Act, 1912 was the first statutory measure to regulate life insurance business. Later, in 1928, the Indian Insurance companies Act was enacted to enable the Government to collect statistical information about life and non-life insurance business transacted in India by Indian and foreign insurers, including provident insurance societies. Later to protect the interest of insuring public, earlier legislation was consolidated and amended by the Insurance Act, 1938 with provisions for detailed and effective control over activities of insurers. To administer the aforesaid legislation an insurance wing was established and attached first with Ministry of Commerce and later with Ministry of Finance and was administratively responsible for deciding policy matters pertaining to insurance. The actuarial and operational matters relating to Life Insurance were looked after by an attached office headed first by the Actuary to the Government of India, then by the Superintendent of Insurance and finally by Controller of Insurance. The Act was amended in 1950, making broad changes, such as requirement of equity capital for companies carrying on life insurance business, ceilings on share holdings in such companies, stricter controls on investments of insurance companies, submission of periodical returns relating to investments and other information to the Controller, appointment of administrators for mismanaged companies, ceilings on expenses of management and agency commission, incorporation of the Insurance Association of India and formation of councils and committees.

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3.6.1) Life Story of the Life Insurance Corporation The life insurance industry was nationalized under the Life Insurance Corporation (LIC) Act of India and has become successful: Despite being a monopoly, it had 60-70 million policyholders in 2002. Given that the Indian middle-class is around 250-300 million, the LIC managed to capture some 30 odd percent of it. The level of customer satisfaction is high for LIC; one of the findings of the Malhotra Committee. This is somewhat surprising given the frequent delays in claim settlement. Market penetration in the rural areas has grown substantially. Around 48% of the customers of the LIC are from rural and semi-urban areas. This probably would not have happened had the charter of the LIC not specifically set out the goal of serving the rural areas. One exogenous factor that has helped LIC grow rapidly in recent years is a high saving rate in India. Even though the saving rate is high in India (compared with other countries with a similar level of development), Indians exhibit high degree of risk aversion. Thus, nearly half of the investments are in physical assets (like property and gold). Around twenty three percent are in (low yielding but safe) bank deposits. In addition, some 1.3- percent of the GDP are in life insurance related savings vehicles. This figure has doubled between 1985 and 1995. 3.6.2) Life insurance in India: Present Developments The financial year 2002-03, was the second full year of operations for most of the new life companies; by the end of the financial year, the number of private players had increased to twelve, and they were competing with the public sector Life Insurance Corporation of India (LIC). The premium underwritten by the industry during 2002-03 was Rs.55738.11 crore, of which Rs.54628.49 crore was underwritten by LIC and remaining Rs.1109.62 crore by the private players. As against this, the previous year figures were Rs.50094.45 crore, Rs.49821.91 crore and Rs.272.54 crore respectively. Overall, the industry witnessed growth of 11.27% in 2002-03 in terms of gross premium underwritten as against 43.54% growth recorded in the previous year. The decline in the growth rate in the year 2002-03 has to be assessed in the context of the previous year being an aberration. In the financial year 2001-02, LIC, which had underwritten 99.46% of the business in that year, had offered high yield guaranteed return plans like Jeevan Shree, Bima Nivesh, Single Premium and Individual Pension Plans. The decline in growth rate could be on account of the withdrawal of these schemes in the financial year 2002-03. Growth in the business of LIC declined to 9.65% as against 42.79% in the year 2001-02. A review of the performance of LIC during the years 1998-99 to 2000-01 further reveals that it has recorded annual growth in the range of 18 and 25%. As against this, the private insurers exhibited growth of 307.15% during the year. The sharp increase in growth for the new players can partly be attributed to the fact that their business in the financial year 2001-02 was small. In terms of market share, LIC held 98% of the life market, with the twelve new players capturing just under 2%. As against this, LIC held 99.46% of the market in the year 2001-02. On the whole, insurers had launched several innovative products aimed at catering to the specific needs of individuals/groups. Customized life insurance solutions are being offered rather than prepackaged products. Simplicity and innovation are the key words for finalizing products aimed at the masses. Products have been designed to cater to child segment with innovations like family income 30

benefits. A number of new products have been introduced with players in the life segment launching products with guaranteed additions, which were subsequently withdrawn/toned down; single premium mode was popularized; unit linked products were introduced; and add-on/riders were introduced including those for accidental death; dismemberment, critical illness rider, fixed term rider, pay rider or benefit rider, term to age 60 rider, group hospital and surgical rider, hospital cash benefit riders and a number of others. The comprehensive products having features of endowment, money back, whole life, single premium, regular premium, rebate in premium for higher sum assured, premium mode rebate, etc., having a number of riders along with the base products have been re-packaged. Government of India in the Union Budget 2003-04, announced the launch of Varishtha Pension Bima Yojana for citizens aged 55 years and above. The Varishtha Yojana is a Government subsidized scheme and LIC has been given the privilege to operate the scheme. The scheme aims at providing pension during the life time of the pensioner and in the event of unfortunate death of the pensioner, purchase price is payable to the nominee / legal heir of the pensioner. 3.6.3) Life Insurance in India: A World Perspective In many countries, insurance has been a form of savings. In many developed countries, a significant fraction of domestic saving is in the form of (endowment) insurance plans. This is not surprising. The prominence of some developing countries is more surprising. For example, South Africa features at the number two spot. (See table). India is nestled between Chile and Italy. This is even more surprising given the levels of economic development in Chile and Italy. Thus, we can conclude that there is an insurance culture in India despite a low per capita income. This bodes well for future growth. Specifically, when the income level improves, insurance (especially life) is likely to grow rapidly. Insurance Penetration International Comparison Countries Insurance Penetration (Premiums as % of GDP) 1999 2000 2001 Total Non- Life Total Non- Life Total life life United 8.55 4.32 4.23 8.76 4.28 4.48 8.97 States Canada 6.49 3.31 3.19 6.56 3.28 3.27 6.42 Brazil 2.01 1.66 0.35 2.11 1.75 0.36 2.14 Mexico 1.68 0.86 0.82 1.72 0.85 0.86 1.81 United 13.35 3.05 10.30 15.78 3.07 12.71 14.18 Kingdom China 1.63 0.61 1.02 1.79 0.67 1.12 2.20 India 1.93 0.54 1.39 2.32 0.55 1.77 2.71 Japan 11.17 2.30 8.87 10.92 2.22 8.70 11.07
Source: Swiss Re, Sigma volumes 9/2000, 6/2001 and 6/2002

Non- Life life 4.57 4.40 3.45 1.78 0.95 3.45 0.86 0.56 2.21 2.97 0.36 0.86 10.73 1.34 2.15 8.85

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Insurance Penetration in 2001 (Total premium as % of GDP)

15 10
8.97 6.42 2.14 Brazil United States 1.81 Mexico United Kingdom 2.2 China 2.71 India Japan 14.18 11.07

5
Canada

Life Insurance penetration in India

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Life Insurance Statistics Indian population GDP as on 2000 (Rs bn) Gross domestic savings as a % of GDP Size of Market (Life & Non life) Total global insurance premium (as on 2001) Rate of Annual Growth: (year 2002-03) Life Non life 11.27% 23% 1.055 bn 235613 24.5% $16 bn $2408.25 bn

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India has an enormous middle-class that can afford to buy life, health, and disability and pension plan products. The low level of penetration of life insurance in India compared to other developed nations can be judged by a comparison of per capita life premium.

INSURANCE PENETRATION

Country Japan UK USA India

Insurance Penetration (Premium as % of GDP 2001) 8.85 10.73 4.40 2.15

Source: Swiss Re, Sigma volumes 9/2000, 6/2001 and 6/2002

Clearly, there is considerable scope to raise per capita life premium if the market is effectively tapped.

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3.7) Marketing Mix for Life Insurance in India After opening up of the sector, Life Insurance is the most dynamic area for the new entrants. New entrants find insurance attractive because even a small share of a large and growing market can be profitable. The market promises to be highly competitive. This area presents tremendous scope in terms of products, service etc. Nothing much had been done in this area as LIC enjoyed monopoly. With the influx of private and foreign players and their expertise, the scene in the life Insurance sector is slowly changing. The following would be the future of the Life Insurance: Product: All firms would provide wide range of products in order to cater to the large growing market. They would offer policies to cater to every income class. They would also offer flexible and cross policies to provide value to the customer. The industry would see unconventional products becoming popular. The major focus of the sector will be Pension policies. Price: The policy premiums would be flexible and would be payable as per the convenience of the customer. The premiums would be fixed on various considerations such as Risk cover Mortality Tables Interest Rtes Expenses Bonus (incentives to be given) With the onset of fierce competition the prices would be lower and the consumer will benefit and get the best possible price. Place: Distribution holds the key to success fro any firms in this industry. Companies would focus on both Conventional and non-conventional channels of distribution. There would be an increasing trend in the use of Internet as a means of distribution. In order to tap the urban and rural markets the company would focus on Direct Marketing. Companies will constantly look out for new channels of distribution to reach out to their target at the least possible cost.

Promotion: Companies would have a specific target group and would position themselves on the security attribute and on emotional appeal.

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3.8)

Some type of life insurance policies: II. Term assurance plans Two temporary assurance plans Convertible Term assurance plans IV. Pension plans Jeeven E.g. Jeeven Suraksha Plan VI. Double and triple cover year Other generic products offered by life insurance companies are:

I. Basic Life insurance Plans Whole life Assurance Plan Endowment Assurance Plans

III. Plans for children E.g. LICs Jeeven Balya, Kishore. Jeeven Sukanya V. Plans for Handicapped Dependents E.g. Jeeven Adhar, jeeven Viswas VII. Double endowment IX. Educational annuity Group Defined Benefits Group Money Purchase Individual Money Purchase Individual Deferred Annuity Annuity products Risk Products

VIII. Marriage endowment X Money back policy

Comparison chart - Life Insurance and other Savings instruments Details Life cover Accident coverage Bonus Min. lock in Period Mode of Payment Treatment returns for Tax Tax rebate u/s 88 LIC Yes Yes ** Yes 3 yrs As per PPF No No No 7 yrs At a time Tax free U/s 10 20% NSC No No No 6 yrs ULIP Yes * Yes *** Yes 10-15 yrs ELSS No Sometimes No 3 yrs At a time Long term

At a Stipulated time Sec 80L 20% and dated Sec 80L 20%

convenience of Tax free 20%

Cap Gains 20%

* Upto 75000 only ** max of Rs. 5 lakhs *** max of Rs. 30000 only

3.9) Challenges/Opportunities for Life Insurance companies: The study, "21st Century Demographics for the Life-Health Industry, "delineates the following challenges and opportunities: Population around the world is aging, number of people in the old age bracket retirement plans have enormous growth potential. The changing composition of households from traditional family units to single households also presents untapped markets with real needs for life, health and retirement products. Growing income inequality means that insurers should find a way to market economically to all sectors, particularly the middle class, who runs the risk of being abandoned by insurers chasing the wealthy. Insurers must recognize that small businesses now make up a growing portion of the world economy, presenting a huge opportunity for growth in this market. 36 is growing continuously. As the population ages, products such as annuities, IRAs and defined contribution

Growing market place turbulence Changing customer expectation

3.9.1) Other issues related to Life Insurance Answers to these questions must necessarily provide the answers to contentious issues in the further development of the sector. These issues are ' Ownership pattern of the public sector, role of the public sector, organizational set-up, procedures, marketing, fixation of premium rates, procedures for claims settlement, accounting practices, consortium agreements, use of sophisticated technologies, automation, information technology, regulation of business, etc. Product pricing, Pricing of insurance products, as empirically available in India, shows that pricing is not in consonance with market realities.

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Chapter 4
4.1) Industry Analysis Threat of new Entrants

Insurance in India

Power of Intermediaries

Industry Competitiveness

Power of Buyers

Threat of Substitutes

4.1.1) Threat of new entrants: Product differentiation: LIC is trusted brand name and enjoys high brand identification, it being the only player in the industry fro the past 50 years. So any potential entrant will have to spend heavily on brand identification and differentiate its product so as to overcome brand loyalty. Capital requirements: According to IRDA guidelines, a company is required to bring in a minimum capital of Rs.1 billion. As per one estimate, an insurance company is required to spend 150-200 crores to carry out operations. The pool of capital is required on advertisements and research activities, which are irrecoverable expenses. So the new entrant should have a sound financial backing before entering the market.

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Switching cost: Insurance investments by their very nature are illiquid. Switching cost for the policyholder are high because if a policyholder wants to discontinue a policy before the time of its maturity, the amount realized as surrender value is very less as compared to what he would have realized had he invested in another investment opportunity. This results in a barrier for the new entrant to make the existing customers switch over to other company.

Access to distribution channels: Key to success in the insurance industry is the access to distribution network because the products are sold by personally approaching the customers. This requires creating a huge force that will have to reach the remotest area of the country to sell policies. This would pose a huge barrier for new players to enter.

Government policy: The IRDA Act governs insurance industry. Any new entrant has to obtain licenses from IRDA to enter the industry, which has very stringent requirements to be fulfilled.

4.1.2) Intense rivalry among the existing firms: Prior to the opening of Insurance sector LIC was the sole player in the market. With the opening up of the sector many new players have come into the market. With scope of product differentiation being minimal, there is fierce competition among players to gain a piece of the cake. Exit barriers: The exit barriers are high because of the following, which have lead to intense rivalry amongst the existing players: Fixed cost of Exit: The cost of settlement with policyholders will be high Strategic Interrelation: As most players are coming through joint ventures, leveraging on others image, technology, capital and distribution network etc.; dissolving alliances and exiting business will not be easy. Long gestation period: Due to the long gestation period in the insurance sector an early exit would lead to huge losses for the firm. 4.1.3) Bargaining power of buyers: Bargaining power of buyers was low till the opening up of the sector, as LIC was a monopoly and so the buyers had to choose from the products of LIC. But with the entry of new players, the bargaining power of buyers has become significant because of the following: Buyers are very selective in their buying decisions because they would be investing significant part of their savings in order to safeguard their future There are many sellers selling their products to the buyers, as the scope for product differentiation is less.

4.1.4) Bargaining power of intermediaries Since Life Insurance is still dependant on intermediaries like agents etc. they can bargain for higher commission as they have the expertise in selling which may provide benefits to the companies in the open market and more choices based on which they may demand a better return and can ask for a premium. 39

4.1.5) Threat of substitute products and services: One alternative to insurance is to provide self-insurance i.e. the individual has to create a fund to meet risk exigencies. There are many financial instruments that advocate savings and provide future returns at specific intervals such as PPF, PF, etc. Hence, insurance companies will not be competing just against each other but also against other investment options such as savings deposit, Mutual Funds, debentures, etc. that provide higher returns and greater liquidity. As the industry will face competition from other products insurance companies will have to launch products giving higher liquidity and returns, in order to get smooth flow of subscriptions, which in turn will squeeze the margins of the players.

40

4.2) The Service Continuum: Substantial shifts in the distribution of insurance are expected in India. 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. Insurance is sold by various intermediaries, not necessarily insurance companies. In the UK for example, retailer Marks & Spencer now sells insurance products. At this point, buyers look for low price. Brand loyalty could shift from the insurer to the seller. Figures 4.3 The Service Continuum

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4.3) Channels Of Distribution

Insurance Distribution

Agents / Brokers

Banks

Direct Marketing

Online

All the new insurers have a big drawback when compared with the incumbents. The network of distribution that they will have to evolve, either on their own or through some sort of alliance will see them incur very heavy costs. The distribution network of banks is what a lot of players are interested in. Initially, SBI was asking a premium for it to be partnering with any insurer on the sole premise that the bank commands a network that is unparalleled in the banking industry in India today. Similarly other banks are becoming insurers to leverage their network of branches, in joint ventures with foreign players who have the expertise in the insurance sector. Marketing alliances with people/companies having a physical presence is a good distribution strategy too. The online world is not going to be left behind. A number of sites have started offering policies online.

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4.3.1) Factors Affecting Distribution: What needs to be borne in mind is that no matter what channel one may use, the following factors in distribution will be critical in deciding the success or failure of the venture: Initial setup cost:

This will be like a capital expense that the company will have to incur to spread its reach to market its products. High margin to agents/brokers:

While the law pertaining to the remuneration is still a bit unclear, it is said that the commission to agents could be high to induce them to sell more and better products. Trained and experienced personnel will be critical to the success of the insurer:

This is so because unlike any other product like car loan or home loan, the level of expertise required is quite high in selling of insurance products. Moreover, the law allows only qualified people to sell the product. This will increase the personnel cost and also ensure professional and lawful service to the customers. An internal control mechanism to keep tab on expenses:

The above mentioned points will ensure that the debit side of the Profit & Loss account will be higher no matter what is shown on the credit side. This will make cost control and growth a fine balancing act for the insurers. 4.3.2) Future of Distribution for Insurance companies: Distribution will be a key determinant of success for all insurance companies regardless of age or ownership. The nationalized insurers currently have a large reach and presence. New entrants cannot and do not expect to supplant or duplicate such a network. Building a distribution network is expensive and time consuming. Yet, if insurers are to take advantage of Indias large population and reach a profitable mass of customers, new distribution avenues and alliances will be imperative. This is also true for the nationalized corporations, which must find fresh avenues to reach existing and new customers. 4.3.3) Use of Remote Distribution Channels: The financial services industry worldwide has successfully used remote distribution channels such as telephone or Internet to reach more customers, cut out intermediaries, brings down overheads and increase profitability. A well-known example is the UK insurer Direct Line. Established in 1985, it relied on telephone sales and low pricing to become UKs largest motor insurance operator within a decade. It then moved into household insurance. Some potential Indian players hope that their anticipated technology advantage will allow them to increase their reach, partly by using remote channels. However, financial services companies globally and in India find that customers are making the shift to such channels slowly and only for less complex transactions. In India, insurance, especially life insurance is still a service product. Indeed, even the successful international direct insurers focus on standard covers such as motor insurance. In India technology will not replace a distribution network, though it will offer advantages like better customer service due the cultural mindset and perception of the product and level of education about the product. 43

Existing Distribution Channels

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. Call Centers

Already many companies have full operation capabilities over a 12-hour period. Facilities such as customer service center are already into 24-hour mode. These will provide services such as motor vehicle recovery. Worksite Marketing

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 other general covers through employers to their employees. These products may be purchased by the employer or simply marketed at the workplace with the employers co-operation. Rural Distribution

According to Malhotra committee report, the penetration of insurance in rural India is around 22%. This indicates that a vast majority of rural population is not covered. Though GIC offers many products for this segment like crop policy, silk worm policy etc, but due to poverty, majority of the population cannot offered to get insured. Despite this, new entrants are hopeful of covering the vast tract of rural masses. Insurance Market on the Web

Currently the most common use of the Internet technology is for the distribution of personal insurance. Some sites also allow for multiple quotes thereby reducing the shopping time. It is estimated that less than five percent of total individual life and individual annuity sale occurs on direct basis with an insignificant percentage sold over the net. The biggest barrier is the complexity of products and the necessity to raise consumer awareness. It is clear that the insurers view the Internet as a tool to improve the productivity of existing distribution and increase the level of customer satisfaction rather than as a direct source of sales. Banks as a means of Distribution:

Banks and finance companies have emerged as an attractive distribution channel for insurance. Bancassurance in its simplest form is the distribution of insurance products through a bank's distribution channels. In concrete terms Bancassurance, which is also known as Allfinanz - describes a package of financial services that can fulfill both banking and insurance needs at the same time. The motives behind Bancassurance vary. For banks it is a means of product diversification and a source of additional fee income. Insurance companies see Bancassurance as a tool for increasing their market penetration and premium turnover. The customer sees Bancassurance as a bonanza in terms of reduced price, high quality product and delivery at doorsteps. Actually, everybody is a winner here. 44

In India too, banks hope to maximize expensive existing networks by selling a range of products. Therefore rather than formal ownership arrangements, a loose network of alliance between insurers and banks have emerged. In USA, banks lease space to insurers within bank branches or retail products from multiple insurers. There are several reasons why banks consider Bancassurance: a) The most important reason is increased return on assets (ROA). One of the best ways to increase ROA, assuming a constant asset base, is through fee income. Banks that effectively cross-sell financial products leverage their distribution and processing capabilities for profitable operating expense ratios. b) Sale of personal line insurance products through banks meets an important set of consumer needs. Also, a banks branch network allows face-to-face contact that is so important in the sale of personal insurance. c) Another advantage banks have over traditional insurance distributors is the lower cost per sales lead made possible by their sizable , loyal customer base. Banks also enjoy significant brand awareness within their geographic regions, again providing for a lower per-lead cost when advertising through print, radio and/or television. d) Other bank strengths are their marketing and processing capabilities. Banks have extensive experience in marketing to both existing customers (for retention and cross selling) and noncustomers (for acquisition and awareness). They also have access to multiple communications channels, such as statement inserts, direct mail, ATMs, telemarketing, etc. Banks' proficiency in using technology has resulted in improvements in transaction processing and customer service. By successfully mining their customer databases, leveraging their reputation and 'distribution systems (branch, phone, and mail) to make appointments, and utilizing 'sales techniques and products tailored to the middle market, European banks have more than doubled the conversion rates of insurance leads into sales and have increased sales productivity to a ratio which is more than enough to make Bancassurance a highly profitable proposition. Insurers have much to gain from marketing through banks. Personal-lines carriers have found it difficult to grow using traditional agency systems because price competition has driven down margins and increased the compensation demands of successful agents. Over the last decade, life agents have sold fewer and larger policies to a more upscale client base. Middle-income consumers, who comprise the bulk of bank customers, get little attention from most life agents. By capitalizing on bank relationships, insurers will recapture much of this under served market. Most insurers that have tried to penetrate middle-income markets through alternative channels such as direct mail have not done well. Clearly, a change in approach is necessary. The place to begin is to segment the strengths that the bank and insurer bring to the business opportunity.

Different distribution channels bring their own challenges. First, companies will have to ensure a strong brand identity. Distribution through third parties means that it is those companies rather than the insurers who often reap the benefits of customer loyalty. This accelerates the shift of insurance to a commodity product. Second, since many new companies already offer other financial services 45

products, they will be tempted to sell only their own products. They must balance this against the advantages of offering customers a wide product range. This is especially important because the rise of pure financial service retailers who do not have any owned products and offer a broad range of products from different providers to consumers is anticipated in the future.

4.4) Insurance Market Size in India Insurance is a Rs.400 billion business in India, and together with banking services adds about 7% to Indias GDP. Gross premium collection is about 2% of GDP and has been growing by 15-20% per annum. India also has the highest number of life insurance policies in force in the world, and total investible funds with the LIC are almost 8% of GDP. Yet more than three-fourths of Indias insurable population has no life insurance or pension cover. Health insurance of any kind is negligible and other forms of non-life insurance are much below international standards. To tap the vast insurance potential and to mobilize long-term savings we need reforms which include revitalizing and restructuring of the public sector companies, and opening up the sector to private players. Indias share of world insurance market has shown an increase of 10% from 0.31% in 1996-97 to 0.34% in 1997-98 and was just 0.41% in 2002-03. Measured in terms of the premium as % to the GDP, at 2.71 %, the country stood 49th in world ranking, in the year 2001. The per capita insurance premium in India is also very low at US$ 11.5, as compared to both developed and developing countries. India is the 23rd largest insurance market in the world and holds large potential, waiting to be tapped judiciously. The statistics on insurance penetration and density, based on industry statistics for the financial years 1999-2000 to 2002-03 are placed below: Data on Insurance Density and Insurance Penetration in India
Year Insurance premium Insurance Density
(Premiums per capita i.e., Total Insurance Premium Income/Population) (Rs.)

Insurance penetration
(Premium as % of GDP)

Life 1990-00 2000-01 2001-02 2002-03

(Rs. in crores)

Non-life 9522.17 10087.03 12694.92 14337.59

Total 36746.59 44985.5 62789.37 70075.7

Life 274.72 342.48 483.07 528.32

27224.42 34898.47 50094.45 55738.11

Nonlife 96.09 98.99 122.42 135.90

Total 370.80 441.47 605.49 664.22

Life 1.41 1.66 2.18 2.27

Nonlife 0.49 0.48 0.55 0.58

Total 1.90 2.14 2.73 2.86

(Source: IRDA Annual Report for 2002-03)

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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$ 11.5, one of the lowest in the world. In South Korea, the corresponding figure is US$1,060 and in Japan it is US$3507.5. Insurance premium in India accounts for a mere 3 % of GDP (compared to the world average of 7.8 %). Insurance premium as a percentage of savings is barely 5.95 % in India (compared to 52.5 % in the UK). The above figures show the huge scope that exists for new business in the insurance sector. 4.4.1) Life insurance: Life insurance is concerned with the economic value of a human life, which is derived from an individuals earning capacity or economic value, and the financial dependence of other lives on that earning capacity or value. The life insurance contract is the insurers promise to pay the policys face amount upon the proof of the death of the insured. The Life insurance scenario in India has already been discussed in the previous chapter. The latest development has been the Budget 2005, which is pro Insurance companies, as it encourages the common man to invest in life insurance policies. Earlier, there was a limit of Rs 70,000 on life insurance premium to avail of Section 88 benefits. This ceiling has now been raised to Rs 100,000. An individual can now allocate an enhanced amount to insure himself adequately and still get a tax benefit. He can also manage his portfolio better without having to worry about tax benefits. The changes in the budget have also come as a welcome move for individuals whose annual earnings exceed Rs 500,000. Until now, these individuals did not benefit from the tax saving on account of paying a life insurance premium. But the budget has removed this anomaly and they too can now look at life insurance upto a ceiling of Rs 100,000 premium to avail of tax benefit. Hence, Life Insurance companies have received an additional push and can expect to excel in the coming years. 4.4.2) General Insurance: What is General Insurance?" This is similar to asking "Who am I?" or "What is the meaning of life? The scope of the subject is so wide that to give a brief introduction would not do service to anyone! General Insurance basically covers all types of Insurance excluding Life Insurance. Some examples are: Health Insurance Motor Insurance Fire Insurance Marine insurance Travel medical Insurance Accident Insurance, etc.

The General Insurance market in India is still in a nascent stage as compared to developed nations. The public sector companies have a stronger holding since they have first mover advantage. In India, mainly motor and health insurance policies are popular. In 2002-03, motor premium accounted for 40.68 % of the market of which the public sector companies accounted for 38.14 % and private sector players 2.54 %. The health insurance market stood at a 7.68 % of the overall general insurance 47

premium. A notable achievement in the year 2002-03 was the health insurance premium crossing the Rs.1000 crore mark. It stood at Rs.1095.90 crore recording a growth rate of 50.10 % over the previous year. The motor and health segments, however, on account of the high claims ratio, represent the not so profitable lines of business in the industry The premium in the miscellaneous class of insurance business in 2002-03 increased by Rs. 2044.45 crore, whereas fire business increased by only Rs. 282.46 crore and marine by Rs.161.42 crore. All insurers continued to focus on personal lines of business. The marine class of business grew at 15.32%, while the fire class of business increased by 10.59%. Fire and Marine insurance segments constituted 20.67% and 8.51%, respectively, of the overall general insurance market in the country. These two lines of business are the most profitable business segments in the non life insurance industry. Non-life insurers have been introducing a number of non-tariff products. Insurers also added products with focus on the small and retail segments of the insurance market as well as personal lines of business. General insurance companies have drawn up various strategies to improve insurance penetration and density. Most companies have tied up with banks either in the form of corporate agency or under the referral arrangement for utilizing the extensive and broad reach, which the banks provide to market insurance products. For development of rural business, insurers are tying up with State Cooperative Banks, State Level Cooperatives of Cotton growers, Dairy Owners, Sugar Cooperatives, etc. New need based packaged products for rural markets, such as womens groups; handloom weavers, artisans, tribals, etc are also being devised by insurers. A number of other products that are popular in the west and could see the light of day in India are as follows: Acts of War Coverage Acts of Terrorism Coverage Kidnap & Ransom Insurance

The performance of general insurance companies in the year 2002-03 was satisfactory. However in times to come, profits of nationalized general insurers may come under pressure. The reasons for this are the increasing competitive pressures; recycling of investment portfolios at lower yields; pricing insufficiency of Motor Third Party business, high level of expenses, increase in business sourcing costs with the introduction of brokers in the Indian market, etc. It is thus vital for public sector general insurance companies to improve underwriting practices, control costs, improve claims management and service standards. On the positive side, public sector companies have strong national franchise and presence, firm financial position, good solvency, strong equity portfolio and strong re-insurance ties. As for the private players, their operations are presently at the nascent stage and they have yet to stabilize their operations and establish niche markets. However, private sector insurers are also taking active steps towards controlling claims costs, improving service standards and reducing operating costs. These steps are expected to have a positive impact on their results. 4.4.3) Reinsurance: Reinsurance is one of the major risk and capital management tools available to primary insurers. Reinsurance is insurance for insurers. The very fundamental principle of spreading of the risk is actually practiced by the insurance companies by reinsuring the risks that they have insured. Insurers buy reinsurance for risks they cannot or do not wish to retain fully themselves. Reinsurers help the 48

industry by providing protection for a wide range of risks, including the largest and most complex risks covered by the insurance system. Hence, reinsurance is a vital and indispensable part of the Insurance system that makes insurance more secure and less expensive. This ultimately benefits the policyholders as it provides better protection at lower costs.

Less expensive Insurance Products

Higher Profitability

Enhanced Insurability Reinsurance Stronger Growth Insurance Company Overall Economy Lower COC

Secure Industry

Reinsurance makes Insurance more stable and attractive

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4.4.4) Industry statistics: Life insurers: The premium underwritten by life insurance companies during the financial year 2002-03 was Rs.55738.11 crore, as against Rs.50094.44 crore in the previous year, recording a growth of 11.27 %. Prior to this, the year 2001-02 witnessed a growth of 43.54 % in the business underwritten by the life insurers. LIC's share in the first year premium (including single premium) business underwritten in the life segment in the years 2001-02 and 2002-03 was 98.65 % and 94.34 %, respectively. Overall, LIC accounted for 98.01 % of the premium underwritten by the life insurers in the year 2002-03, as against 99.46 % in the year 2001-02. Accordingly, the share of the private players went up from 0.54 % in the year 2001-02 to 1.99 % in the year 2002-03. As per statistics available for the first half of the current financial year 2003-04, the first year premium underwritten by the life insurers was Rs.5435.96 crore. The market share of LIC in premium underwritten and policies during the first half of the financial year was Rs.4840.62 crore (89.05%) and 8241776 (94.32%) respectively. As against this, the twelve private players underwrote Rs.595.34 crore (10.95%) towards 496248 policies (5.68%).

PREMIUM UNDERWRITTEN BY INSURANCE COS 100% 80% 60% 40% 20% 0% LIC Others 2001-02 2002-03 2003-04 99.46 98.01 89.04

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Non-life insurers: The general insurance industry witnessed significant changes, which are likely to impact the growth of the industry in the years to come. The pace was set with public sector non-life insurers being delinked from their holding company, the General Insurance Corporation of India (GIC). In addition, GIC, notified as the national re-insurer, has ceased to carry out underwriting of direct business. The financial year 2002-03 also witnessed the formation of the Agricultural Insurance Company of India Ltd. (AICIL) to underwrite crop insurance and other allied insurance business in the country. In consonance with its newfound status as the national reinsurer, GIC has diversified into acceptance of life reinsurance business. Another area being explored by the Corporation is that of financial/credit reinsurance. GIC has also been aiming at making its presence felt in the international markets, particularly in the Afro-Asian countries, through strategic and business tie-ups. However, there are also challenges, with the entry of the established multi-national brokers in the industry - these entities will put to use their contacts for international reinsurance placements. The gross premium underwritten by the non-life insurers, during the financial year 2002-03 was Rs.15614.85 crore, including crop insurance business underwritten by GIC, recording a growth of 23 % over the previous year. The share of the public sector insurers in the non-life segment during the financial years 2001-02 and 2002-03 was 96.32 % and 91.36 %, respectively. The share of eight private players in the financial year 2002-03 was 8.64 %, as against six players capturing 3.68 % in the previous year. The gross premium underwritten by the non-life insurers, during the first six months of the current financial year, 2003-04, was Rs.8081.06 crore, i.e., a growth of 12.71% over the previous year half year premium of Rs.7169.88 crore. The public sector insurers underwrote premium of Rs.6973.78 crore recording a growth of 6.03% (Rs.6576.87 crore) over the corresponding period in the previous year, as against which the private insurers underwrote premium of Rs.1107.27 crore, viz., a growth of 86.72% (Rs.593.01crore) over the corresponding period in the previous year.

TOTAL GROSS PREMIUM UNDERWRITTEN

20000 15000 10000 5000 0 2001-02 2002-03 2003-04

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4.5) Investments of Insurers: Insurers invest the premiums that are received by the company and accumulate them for future claims and other obligations. The cash generated by these investments represents a large sum of money, and a significant portion of the capital needed to operate the company, pay claims, and provide profits. The insurance sector, on account of the huge size of the funds that it attracts, plays a crucial part in the deployment of the same. These funds need to necessarily be invested in such manner as to ensure an asset liability match as to equip the insurers to meet their obligations to their policyholders, as and when the claims obligations arise. The other side of the coin, of course, is the role that the insurers play in creation of wealth in the economy. The regulations framed by the Authority lay down guidelines for investments by the life and non life insurance companies, including the exposure norms/ prudential guidelines. The requirements laid down by the Authority address the dual objectives of the safety and returns to the insurers combined with their meeting the socioeconomic objectives of nation building, particularly targeted at the infrastructure and the social sectors. The Authority has mandated the pattern of investments to be followed by the insurance companies. Investments in Government securities, approved securities, approved investments and in infrastructure and social sectors have been prescribed in the Insurance Act, 1938. The Authority has also specified that every insurer carrying on the business of life insurance shall invest and at all times keep invested its controlled fund (other than funds relating to pension and general annuity business and unit-linked life insurance business) in the following manner:

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PATTERN OF INVESTMENTS SPECIFIED BY THE AUTHORITY - LIFE INSURANCE Sr. No i. ii. iii. iv. Type of Investment Government securities Government securities or other approved securities (including (i) above) Infrastructure and Social Sector Others to be governed by Exposure Norms. (Investments in Other than in Approved Investments in no case to exceed 15% of the Fund). Percentage 25% Not less than 50% Not less than 15% Not exceeding 35%

SECTOR WISE INVESTMENTS - LIFE INSURANCE (As on MAr 2003)

C.G.S.

23%

12% 11% 0%

54%

Other than Approved Invst State Govt & other App Sec Infrastructure & Social Approved Invst

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PATTERN OF INVESTMENTS SPECIFIED BY THE AUTHORITY GENERAL INSURANCE AND REINSURANCE Sr. No. i) ii) iii) iv) Type of Investment Central Government securities State Government securities and other guaranteed securities including (i) Housing and Loans to State Government for Housing and Fire Fighting equipment Investments in Approved Investments: a) Infrastructure and Social Sector b) Others to be governed by Exposure Norms. (Investments in 'Other than Approved Investments' in no case to exceed 25% of the Assets.) Not less than 10% Not exceeding 55% Percentage Not less than 20% Not less than 30% Not less than5%

SECTOR WISE INVESTMENTS - GENERAL INSURANCE (As on Mar 2003)

C.G.S.
36% 28%

Housing & FFE Other than Approved Invst State Govt & other App Sec Infrastructure & Social Approved Invst

7% 9% 8% 12%

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The Authority, during the financial year 2002-03, also laid down the guidelines for investments in mutual funds. These investments as a temporary parking mechanism, are required to be made only under the other than approved category. The Authority has further laid down the exposure norms for such investments, and has provided the norms for valuation of the mutual fund investments. Given the fact that these investments impact the performance of insurance companies, and that this is a dynamic field of operations, the Authority placed a lot of significance on accuracy of information furnished by the insurers on a quarterly basis. The evolving investment environment also calls for review of the regulations on a regular basis. It is perhaps due to this that the investment regulations have undergone the most amendments in the last three years. Analysis of the returns submitted by the life and general insurers, reveals that they are broadly complying with the investment regulations as laid down by the Authority. In individual cases, clarifications have been sought from the insurers. Further, in a few instances, the insurers have had difficulty in complying with the social sector investments due to lack of adequate avenues for such investment. However, these shortfalls have been made good by making additional investments under the infrastructure category. That the Authority places crucial emphasis on prudent investment of funds at the disposal of the insurer, is well reflected from the detailed regulations laid down for the insurers. As a corollary to the investment decisions, the insurers are also required to continuously monitor their portfolio, and make adequate provisions for any deterioration in the individual investments in the portfolio. With a view to monitoring the investment decisions of the insurers, as to compliance with the regulations, prudent investment of the funds and adequate provisioning on a regular basis, the Authority has initiated steps towards investment audit on a periodic basis. The Audits are carried out by chartered accountants drawn from the panel maintained by the Authority, along with one of the technical officers of the Authority forming part of the inspection team. More recently, in the financial year 2003-04, the Authority has also reviewed and amended the existing regulations on investments. These amendments were necessitated because of the changes that have occurred in the investment environment in the country. Further, deregulation of interest rates, even though had helped in making financial market operations efficient and cost effective has also led to considerable volatility in the market resulting in a wide array of risks for insurance companies. To manage and control these risks, there has been a felt need for appropriate financial instruments such as Derivatives. Hence, as the financial sectors in India mature, Insurance companies along with the Regulator will have to find new and innovative ways of maintaining the balance between profits, safety and social obligations.

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4.6) Impediments to Insurance sector in India: Government / RBI regulations

The IRDA bill imposes tough solvency margins for private insurance firms, a 26% cap on foreign equity and a minimum capital of Rs.100 crores for life and general insurers and Rs. 200 crores for reinsurance firms. Also a number of restrictions and caps have been imposed on the extent to which insurance companies can invest in certain types of instruments. For example, general insurance companies have to invest not less than 10% of their funds in the Infrastructure & Social sectors. These stipulations imposed on the insurance companies have resulted in lack of flexibility in the optimization of risk and profit portfolio. If this inflexibility continues, the insurance companies will have very little leverage to earn more on their investments and they might not be able to offer as flexible products as offered abroad. Inefficiency of Insurance Companies in marketing products Inefficiency of Insurance Companies in utilizing funds optimally Neglect of business conservation High agent turn-over Deficient training of agents Poor after-sales service to customers Lack of control over agents

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4.6.1) Key Issues: The insurance industry has to address the following concerns over the next few years: Security: Consumer attitude towards security must improve before they start transacting online. Regulatory issues: As a regulated business insurers maybe limited in their inability to fully

transact insurance business online and unwilling to market aggressively online. Building of Brand Name: E-commerce initiatives will most likely be geared towards retail customers, making brand name an important attribute, which in turn will increase customer confidence and quality of service. IT as the Backbone: For new entrants investment in IT is crucial for success. It takes time to build IT systems and the new firms need to get off the block as soon as possible. Core processes such as finance policy, administration, investment management and basic rate system need to be set up. The following processes should be set up after the core processes: a) Sales system and publicity b) Claim management and loss control c) MIS, product design and supply system Leverage information technology to service large numbers of customers efficiently and bring down overheads. Technology can complement or supplement distribution channels cost-effectively. It can also help improve customer service levels considerably. Training & Development: Ensure high levels of training and development not just for staff but also for agents and distribution organizations. Existing organizations will have to train staff for better service and flexibility, while all companies will have to train employees to cope with new products and an intensive use of information technology. Building Relationships: Build strong relationships with intermediaries such as agents. The agency force is an important customer interface and companies must partner with this group to reach customers and serve them effectively. 4. 7) Likely Factors of Success In the now open sector on insurance, the following factors will determine the success of the company in particular and the industry in general: A Change in the Attitude of Population:

Indians have always been wary of employing their hard-earned money in a venture that will pay them on their death. Insurance has always been used as a tax saving tool. No more, no less. It is upto the insurers to educate the people to secure/insure their future against any unknown calamity and make a shield around their families and business. An open and Transparent environment created under the IRDA:

Whenever any sector has opened in India there are always some grey areas and unsure policies. These are not exactly what any player, be it Indian or foreign, looks for. It creates an air of uncertainty in the decision making process. Insurance as a sector requires players who are strong financially and are willing to wait for returns. Their confidence can be bolstered only if there is an open and transparent policy and guidelines. This will also help the consumers feel safe that the regulatory is an 57

active one and cares to do everything possible to keep things under control and help the insurance environment grow maturely. A well established Distribution Network:

To cater to the largest democracy in the world is by no means a cakewalk. Insurance profits are directly related to number of insured and this is in turn related to the reach. The case in example is of the State Bank of India. The joint ventures announced have a flavour of network being a critical decider. This is so because as per the guidelines 15% of the policies written by the 5th financial year will have to come from the rural area. The banks are the only ones who have the reach. Trained professionals to build and sell the product.

It is said that the insurance agent is the best salesman in the world. He makes you pay, regularly, an amount promising to pay back only on your death. Thus the players will require an excellent sales team to sell their products in the now competitive environment. A more rationale approach to the investment criteria.

This is a very critical area as far as the government and the players are concerned. The government has fixed the investment pattern for the players to meet social obligations. The players feel that the compulsion is unjust and will affect their ROI. The more the people insured, the better the revenues, followed by better security, followed by better morale and productivity. On a national level the criteria ensures that money does not go out of the nation. We also need to bear in mind that the insurers are here not for charity but for profits. So their interest is also to be kept in mind. Encouragement of newer and better products and letting the hackneyed ones die out will ensure market growth and that every class/society gets a product that best suits them. Stringent accounting practice to avert failures amongst the insurers .

Every insurer will have the hard-earned money of the masses. Any failure of the insurer on account of unwarranted profligacy will cost the nation and the insured. To prevent any underhand working of the insurer and to prevent them from going bust, a stringent accounting practice is imperative. A level playing field at all development stages in the sector for all players.

An unbiased environment is where the best comes out of the players. This is the beauty of capitalism that we are trying to achieve in our customized manner. This will only help the industry grow and so will the society. Patience

There should be patience amongst the players and consumers to wait for the pot of gold at the end of the rainbow

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Chapter 5

Conclusion

The process of opening up the insurance sector was initiated against the background of the economic reforms process, which commenced in the year 1991. The reform process was aimed at freeing the Indian manufacturing and services sectors from the shackles of controls that inhibited their growth and make them attain high standards to facilitate the process of integration with the world economy. It was perceived that with the markets world over becoming highly dynamic and integrated, the economic reforms process within the country was required to enable India to integrate with these markets. Steps were, therefore, initiated to elevate the Indian economic system to international standards in terms of its financial viability, competence, technology, prudential requirements, regulation and credibility. The constitution of the Malhotra Committee was another step in the initiatives in the area of financial reforms covering the banking sector and the capital markets which aimed at creating a more efficient and competitive financial system suitable to the requirements of the economy. The need for addressing the issues concerning the insurance sector was felt in recognition of the fact that the sector is an important part of the overall financial system. The Authority was established with a view to protecting the interests of the holders of insurance policies, to regulate, promote and ensure the orderly growth of the insurance industry and for attending to matters connected/ incidental thereto. The last four years have witnessed dynamic changes in the insurance industry. These include advent of a fairly large number of insurers in both the life and non-life segments. A number of foreign players, from across the globe have entered the industry as joint venture partners to established Indian promoter groups. The number of intermediaries has grown to include besides the agents, the corporate agents, the brokers, the third party administrators and of course bancassurance which has opened up new vistas, and is likely to change the canvas of the insurance industry in the years to come. Both the life and the non-life segments have been a witness to introduction of new products, with tailor made and packaged products being introduced in the market to suit the particular needs of the customers. Some initiatives have also been taken to meet the special requirements of the rural and economically backward segments of the population. The growth of the premium incomes of insurers has been satisfactory even in the face of withdrawal of the guaranteed schemes, as the insurers grapple with the returns on investments coming under strain. The evolving market conditions in which the industry is operating are continuously throwing up fresh challenges, and the regulatory framework has also striven to keep up with the times, by framing regulations, which reflect the Authoritys intent to support the ongoing process of liberalization of the environment in which the insurers and various intermediaries operate. The Authority has striven to be particularly responsive to the needs of the industry to grow at a fast pace. Possibly, the pace of evolution of the regulatory mechanism in the last four years in the country is globally unmatched. While the development of the insurance industry has been the prime focus for the Authority, it has been equally preoccupied with issues such as consumer protection, provision of quality services to the policyholder and with the resolution of their grievances. The process of liberalization was also 59

initiated to achieve a higher level of insurance penetration. This, it was perceived, could be jointly achieved by both the industry and the regulator making a concerted effort at educating the prospective customer of the benefits of insurance. Thus, with the initiatives pertaining to setting up the framework within which the industry is operating in place, today the focus has shifted to development of the insurance business on healthy lines and the benefits of the growth of the industry penetrating a wider segment of the economy, in particular providing cover to the under privileged and the weaker segments and reaching the rural and the semi-urban areas. The insurance industry has shown a steady rate of growth over the last three years following the opening up of the sector and the advent of private sector participation. While tremendous progress has been made, it is premature to rest on the laurels. The insurers most certainly have to look beyond capturing market shares, and have to speak the language of quality of service rendered and the extent of transparency in their operations to build up the faith and trust in the fledgling liberalized industry.

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