Overview:Insurance sector

The insurance sector, which was nationalised in 1956 (life) and 1973 (non-life), has been playing an important part in the country’s financial development. In 1999 the Insurance Regulatory and Development Authority (IRDA) Act was enacted, which opened the insurance sector to private players. During the past 5 years, the sector grew in terms of size and in terms of penetration. After the sector was deregulated, the market was invaded by diverse insurance product offerings that stressed on marketing and distribution strategies. Though the insurance sector was highly concentrated, it showed a declining trend in concentration after the sector was opened to private participation.

Global insurance market witness slowdown amid bleak economic outlook
During CY 2007, the global insurance market (worldwide insurance premium) was worth around US$ 4,061 bn. In the same year, the global economic environment entered a slowdown, as there was an increase in commodity prices, rising interest rates and inflation. During CY 2007, the global total premium increased by 3.3% in real terms as compared with 5.0% in 2006. Of the total premium, life insurance premium grew by about 7.4% to US$ 2,393 bn in CY 2007. The general insurance premium, on the other hand, grew by 0.7% yearly at US$ 1,668 bn.

Emerging economies exhibit higher business potential

The life insurance premium in industrialised countries grew by 4.7% and by 13.1% in emerging market economies. The premium growth was lower in the industrialised nations, as it constituted premium paid for life insurance. This business expanded continuously in these nations through pension and annuity products due to the aging population and decreasing state social security benefits. However, in emerging economies, the insurance sales were boosted by the strong economic growth, relatively young population and a burgeoning middle-class population.

Non-life insurance business grew at a negative 0.3% in industrialised countries but it grew by a robust 10.2% in emerging countries on account of strong economic development and mandatory cover in certain areas like motor, third party liability and health. According to Swiss Re (a global re insurance company), the total life and non-life insurance market (total premium) during FY08 was around Rs 2,291.7 bn (US$ 54.375 bn).

The table below shows the impact of the global meltdown on the insurance sector. During FY08, the yearly premium growth, in US$ terms for the emerging economies was higher than that of global economies.

Owing to the global economic slowdown, the outlook is grim for the global insurance sector and it is likely to witness moderation in growth. Likewise, the growth in unit-linked life insurance plans is likely to get affected by the crash in stock markets across the globe and fall in income levels. The slowdown in economic activity will reduce the premium growth in non-life business. While the premium in industrialised economies is expected to decline, the premium in emerging economies may witness moderation.

Indian market attractive for global companies

Saturation of markets in developed economies has increased the attractiveness of the Indian market for global insurance majors. The level of insurance penetration, particularly in life insurance, tends to increase as income levels rise; rising income levels in India’s huge middle-class population exhibits high growth potential for the insurance industry. Considering the size and population of India, the insurance market is under-served and provides attractive market potentials.

The overall insurance penetration¹ during CY 2007 in India was 4% as against 7.5% for the world, showing the extent of untapped potential in India.

The comparison of the insurance-density ratio² across the economies shows that this ratio is significantly lower for India; during CY 2007 the ratio was US$ 46.6 in India while it was US$ 4,086.5 in the US. However, this ratio has improved over the last year due to increase in India’s per capita income following the robust growth in real GDP.

Rise in income and savings boost insurance penetration

Over the past few years robust GDP growth in India has helped to raise the income levels as well as the savings rate. The gross domestic savings as a percentage of GDP at current market prices increased from 34.3% in 2005-06 to 34.8% in 2006-07 mainly due to increase in savings of the private corporate sector and the public sector. There was also a slight shift in the saving preference from the bank deposits in 2007-08 as compared with 2006-07. According to the preliminary estimates released by the RBI on household financial savings for 2007-08, insurance funds constituted 17.5% of the total gross financial savings of households in 2007-08. In fact, there was an increase in the share of insurance funds in the total household savings. The shift in investment preference was brought about by the run-up in equity markets and the flood of various ULIP products. The contribution of banking and insurance sectors (as a component of GDP) has also seen a rise on similar lines.

Structure of the Indian insurance industry

As on March 31, 2008, the Indian insurance industry consisted of 21 life insurance companies, 21 general insurance companies and one reinsurance company. Among these companies the public sector owned one life insurance, six general insurance and one reinsurance company However, the public sector companies accounted for approximately 73% of the total insurance premium.

During the CY07, insurance penetration in the life insurance segment was approximately 4% as against 4.1% in CY06. Non-life insurance penetration remained unchanged at 0.6% in CY07. During the same period, life insurance density improved to US$ 40.4 in CY07 from US$ 33.2 in previous year. Similarly for non life insurance business density improved from US$ 5.2 to US$ 6.2 in CY07.

When the insurance sector was opened up for private insurance companies in 1999 many players opted for JVs with foreign players who were recognised across the globe. Over the last 8 years, consumer awareness about insurance improved considerably. Moreover, increased competition pushed up product innovation and stepped up customer servicing options in the sector. All these positive developments made a good impact on the economy and generated income and employment within the sector.

Private companies making rapid inroads in the life insurance industry

In April 2000 the IRDA Act was enacted and up to 26% FDI was allowed in the sector through the automatic route, which opened the insurance market to the private sector with limited exposure to foreign equity; as a result, the network of private companies increased significantly.

Substantial extension in reach of private life insurers

Private life insurance companies are investing heavily to increase their reach in the untapped markets and to increase their market share in the overall growing pie. This is evident by the extent of their office and branch expansions. During FY08, there was a significant increase in the number of offices held by life insurers. As on March 31, 2008, the number of offices was 8,913 as compared with 5,373 in the previous year. A major portion of this expansion occurred in the private sector, where the number of offices more than doubled from 3,072 to 6,391. In the meanwhile, the number of offices held by LIC increased at a modest 10% to 2,522 offices.

Life insurance still scores amid financial slowdown

The insurance industry largely depends on the life insurance segment, sharing of 91% in the total net premium of the industry. During FY08 financial markets across the globe witnessed a sharp setback in their operations, which also affected the Indian economy, however, at a less severe note. Favourable investment opportunities helped the insurance industry to post significant growth in the first year premium and renewal premium. During FY08, the life insurance industry reported yearly growth of about 23.8% and 28.9% in the first year and renewal premium, respectively; however, this growth was far lower than the previous year’s respective growth rates of 95% and 47%. Among the life insurance companies, there is only one public sector company viz. LIC, which accounts for about 74% of the total net premium earned.

LIC faces stiff competition from the private players

Even though the LIC enjoys a monopolistic market position, private companies are rapidly making inroads in the industry by increasing their share in the total premium. Moreover, the number of policies issued by private companies has been increasing significantly over the past few years. Considering the pace of newcomers in capturing the market share from existing players in terms of premium and number of policies issued, LIC faces significant competition from the private companies in near future. Market

Among all the companies, private companies posted a significant yearly growth during each of the three previous years. LIC, on the other hand reported low growth of about 6.7% in the first year premium during FY08 mainly due to negative growth of 1.6% in new policies.

The strategy of high investment and increase in number of players has led to the high growth in the private sector. The greater marketing and advertising push by private players led to a steady growth in the number of new policies issued over the last three years. Also higher product innovation, like ULIPs and greater emphasis on customer education has also paid well for the private players.

Unit linked business registers better growth

Product innovation has led to better investment management keeping intact the basic motive of risk cover. There has been a paradigm shift in the way insurance plans are modelled. Traditionally they were modelled to act as a savings option to meet one’s financial objectives; however, this traditional insurance product has its own drawbacks, as the sum assured on maturity turns out to be much lesser in the real term due to long-term inflationary conditions, which causes the real value of money to depreciate. Due to this drawback, new and innovative products like ULIP or unit linked insurance plans were introduced to lure investors.

ULIPs are insurance plans that combine the benefits of investment with insurance, and include an option that allows the policyholder to allocate a part of their premium in various investment portfolios and to derive the benefits depending on the performance of the asset class chosen by them. ULIPs were launched when stock markets were booming and received huge response from investors. However, in the backdrop of financial meltdown, capital markets turned volatile; moreover, the monetary policy stance to increase liquidity bottomed out interest rates, which lowered interest on money markets instrument, and thereby affected potential returns from the ULIP. In the near future, any further downfall in investor sentiments may cause these plans to witness some moderation.

Private companies reap the benefits of synergy in distribution

Channel wise analysis of new business premium revealed than public sector life insurer viz. LIC has stick to their traditional channel of doing the business, through individual agents. During FY08, the individual agents of LIC contributes approximately 98% of their total new individual policies issued and premium earned, whereas in case of private players, individual agents share about 60% of total new individual policies issued and premium earned. However, corporate agents played a major role in the insurance penetration for the private players, sharing approximately 27% and 30% of their new business policies and premium respectively. On the contrary it is seen that LIC has very few tie-ups with the corporates. Apart from above, private players are also indulge in the direct selling, which mobilise approximately 12% of new policies issued.

During FY08, LIC reported negative growth of 1.6% in total individual new policies whereas private companies reported significant yearly growth of about 67.4%. Corporate agents and brokers were the major contributors to the growth for private companies, new policies issued through this channel, grew by more than 100% on y-o-y basis. Moreover, aggressive direct selling has mobilised huge business for private companies, which reported stupendous growth of more than 10 times in the new policies issued.

Being solely depended on the individual agents for the business, LIC faces stiff competition from the private players, given the fact that private players are well positioned to use the synergic benefit of reaching the mass through corporate agents (including banks) and brokers. Moreover, poor agent awareness about innovative products, high agent turnover in the industry and huge training cost may affect the business of the LIC.

Aggressive business practices led to higher operating expenses for private companies

The comparison of costs between players revealed that agent commission expenses had more than 35% share in the total cost. Agents are the most important component across the value chain of the insurance industry. Similarly, other operating costs were found to have more than 50% share in the total cost in FY08, as compared with approximately 43% in FY07.

Among the companies the commission paid as a percentage of total premiums was higher for private companies as compared with LIC because private players doled out higher commissions to lure agents for promoting their products and also had a higher initial allocation charge structure.

Apart from the commission expenses, the operating expenses of private players were also significantly higher as most of them were in the early stages of business and hence had to incur heavy advertising and marketing expenses. In the long term, the benefits of these expenses will accrue to companies and their operating expenses as a percentage of total premiums will decrease.

Agent turnover remain the major problem for the insurance industry

Apart from the expenses mentioned above, the training and recruitment expenses of the new players also increased over the period due to significant yearly increase in number of agents recruited and high agent turnover rate. Companies also spent huge amounts on recruiting and providing training to these agents.

During FY08, the number of individual agents grew by 26% at 2.5 mn over the previous year. During the same year, approximately 480,000 agents were terminated, which decreased the amount spent on these agents but increased policy lapses, as termination of agents left no one to service these customers.

Lack of awareness and high agent turnover led to higher policy lapsation

Lapse in an insurance policy means termination of the risk cover set out in the policy document. A policy lapses when the premium instalment is not paid within the stipulated due dates. Agent turnover is one of the other major causes for policy lapses, as in the absence of the agent there is no one to service the policy holder; this is the case especially when the policy holder is not aware of the product and is totally dependent on the agent. During FY08, about 480,000 agents were terminated. Even though the insurer forfeits the entire premium during the initial year of policy term in case the policy lapses , in the long run it affects the company in terms of opportunity cost incurred due to loss of potential business. Moreover, if the rate at which policy lapses is higher it may also affect the company’s reputation.

Another major reason for the lapse in policies is lack of awareness among the policyholders; for instance, Clause 6 (2) of the IRDA (Protection of Policyholders’ Interests) Regulations, 2002, has free-look provision, which allows a policy holder to scrutinise the policy document for 15 days from the receipt of policy bond for validity of claim made by the companies. If the policy holder is unaware of this clause and he does not want to continue the policy then he has no other option but to allow the policy to lapse and surrender his first premium to the company.

During FY08, number of policies lapsed in relation to the non-linked business grew yearly by more than 40% as against negative growth of above 15% in FY07, moreover sum assured under such policies also reported yearly growth of about 25% compared to 7% in FY07.

In recent times, the global economy witnessed economic slowdown, which resulted in lack of demand followed by pile up of losses for companies. Most companies lay off their excess staff to offset some of the cost but this move could increase the number of policy lapses for reasons mentioned above.

Private insurers rapidly invading vast untapped non life insurance segment

Non-life insurance business is not as huge as the life insurance segment and it accounts only for about 9% of the industry’s total net premium. As on March 31, 2008, there were 19 companies operating in this segment, of which 6 were public sector companies that accounted for about 70% of the total net premium. During FY08, the gross direct premium and net premium grew by 12.3% and 20.2%, respectively. In the non-life space also, private insurers stole the show by recording yearly growth of about 60% and accounting for 30% of the total net premium in FY08 as against 22.9% in the previous year.

Like the life insurance business, the number of policies issued in the non-life business increased consistently for private players, due to liberalisation of the sector and entry of foreign players; though limited capital base has increased the risk for an entity.

The cut throat competition in the non life space has been hurting the business of all the players in the industry. Due to the global economic slowdown, the business growth maybe moderated for these companies during FY09.

Motor insurance majorly accounts in underwriting business

Underwriting refers to evaluation of the risks and exposures of potential clients. Underwriting involves measuring risk exposure and determining the premium that needs to be charged to insure that risk. In short, the function of the underwriter is to acquire or to write business for the insurance company, and to protect the company from losses. The quality of underwriting determines the quality of earnings for the insurance companies; moreover, it also helps companies to bring down the cost of operation.

During FY08, the gross premium underwritten by the general insurance companies increased at a yearly rate of 12% to Rs 278.2 bn as compared with Rs 249.1 bn in the previous year.

Among the companies, private companies reported higher growth in the premium underwritten at 27.1% as compared with 3.5% reported by public companies.

Among the different segments of the general insurance business, motor insurance had a 45.5% share in the total premium underwritten and reported a yearly growth of about 18.5%. The gross premium underwritten under the health insurance segment reported a growth of about 47.4%.

Public Sector non-life companies displayed poor underwriting experience

Profitability from underwriting largely depends on the quality of underwriting. During FY08, the net claims incurred out of net premium were about 77.8%. Among the companies, this ratio was approximately 87.5% for public companies as compared with 59.3% in private companies. The public companies reported a higher ratio because of poor quality of underwriting policies, which subsequently resulted in higher underwriting losses.

During FY08, the total underwriting losses were approximately Rs 38.9 bn as compared with Rs 25.6 bn; the share of public companies in these losses increased by 24% to Rs 33.0 bn in FY08 from Rs 24.5 bn in FY07. The high ratio of net claims to net premiums underlined the need for better quality control in underwriting new businesses, better risk management, and increasing reinsurance.

Retention ratio stood higher for public sector companies on the back of large capital base

Until March 2008, domestic non-life insurers, both public and private sector, were mandatorily required to cede 15% of their insurance risks to GIC (before this, the statutory cession was 20%). This clause was made to optimise the retention within the country. During FY08, the total gross premium underwritten by the GIC, sole reinsurer in the country, was approximately Rs 93.1 bn as compared with Rs 74.0 bn in the previous year.

The retention ratio of private companies is lower than the ratio of public companies almost all segments due to the primary reason that private companies do not match public companies in respect of capital base and business volumes; hence, they are required to opt for reinsurance for any risk in excess of their capacity, which lowers their retention ratio.

Additional infusion of the capital, need of the hour private players

The statutory cessation of 15% of insurance risk has been reduced to 10% with effect from April 2008. Though this move aims at optimising the retention within the country, the limited capital base of private players will either require them to infuse additional funds or to increase their adequacy or will make them look out for global substitute for reinsurance of risk, as India has only one reinsurer - GIC.

The expense ratios in the case of non-life companies are also not very healthy. The Indian insurance sector is an emerging sector, which is developing at a rapid pace and will need to continue its momentum. For the players to increase their market share, companies are increasingly enhancing their branch networks and are trying to access the market through innovative distribution channels. However, this is to be done at high investments, which again necessitates better expense management by these companies.

Potential business growth coupled with increased in the perceived risk, requires maintenance of higher solvency margin for sustainable growth.

Every insurance company is required to maintain a solvency margin as stipulated under section 64VA of the Insurance Act 1938. The required solvency margin stipulated by IRDA is Rs 500 mn and which further depends on net premiums and net claims incurred. Moreover, the IRDA has prescribed the solvency ratio of 150% for all insurance companies. The solvency ratio is the ratio of available solvency margin to the required solvency margin. If this ratio is more or equivalent to 150%, then the insurer is considered solvent. As on March 31, 2008, all the insurance companies including non-life and reinsurers compiled with the required solvency ratio.

Though the insurance companies maintain the prescribed solvency ratio, it is advisable to keep this ratio sufficiently higher because the total net premium grew yearly by approximately 28.1% in FY08. Furthermore, there was a significant increase in the risk perceived due to natural calamities and terror attacks in the country.

Financial inclusion arising due to geographical dispersion is more acute which need urgent solution

In the insurance industry, exclusion means, depriving any individual or person from insurance against unforeseen risk. Exclusion arises mainly due to two reasons, one is social segmentation that is affordability of insurance for the poor people and second is geographical segmentation that is high cost of marketing and administration, lack of literacy and poor infrastructure for companies to stay away from certain segments of the population and geographies. Exclusion arising from geographical segmentation is more acute as more than 70% of the people in India live in geographically disperse rural areas; hence, there is urgency of inclusion on this front.

Insurance penetration in India is lower than other countries. The insurance density ratio in India was very low at US$ 46.6 during CY07 as compared with US$ 4,086.5 in the US due to lack of awareness among the people and low financial inclusion. Given the low penetration and density ratio, the insurance industry in India has huge potential to grow in the rural untapped markets by resorting to inclusive growth.

Private companies through the inclusive growth poised to capture vast untapped rural market

After liberalisation of the insurance sector, many private companies forayed into this space to capture the large untapped market by expanding their network across the length and breadth of the country. During FY08, the total number of offices grew by more than 65% to 8,913 and 6,337 offices out of these 8913 offices were located in the semi-urban and rural areas. Among the companies, private companies expanded the most in rural areas and their expansions grew by more than 140%.

In recent times, changes have been made in the regulations to augment financial inclusion. With the amendment to IRDA (obligations of insurers towards the rural or social sector) Regulations, 2002, notified in 2007-08, the insurance companies including non-life companies are obliged to cover specified percentage of their business or number of people in the rural and social sector. Moreover, according to a notification from IRDA (micro-insurance) Regulations 2005 there has been a steady growth in the products designed for or catering to the needs of the poor.

The micro-insurance portfolio has made steady progress in 2008. More life insurers have commenced their micro-insurance operations and many new products have been launched during the year in the segment. The distribution infrastructure has also been considerably strengthened in this area. New businesses has shown a decent growth in this area, though volumes are still small. With the steady rise in offices the number of micro insurance agents has also increased to about 4,584.

Nine life insurers have so far launched 26 micro-insurance products, of which 13 are individual products and the remaining 13 are group micro-products.

The way ahead

The insurance penetration in the country has improved, which is a good sign, but this could improve further with slight change in the regulations that cover the industry today. The participation of foreign joint venture partners through the FDI route, for instance, is limited to 26% of the paid-up capital and proposals are rife to increase this FDI cap to 49%. This may not be possible in the immediate future owing to the global financial turmoil; but the industry is looking forward to the enactment of The Insurance Laws (Amendment) Bill 2008. This Bill proposes to increase the FDI limit in insurance and to permit foreign re-insurers to open branches in the country. If the sector is opened up for outside re insurers the Indian general insurance companies will be able to cede their risk to other companies, which will help them cope up with capital adequacy and solvency requirements. The Bill also proposes to allow the state-run general insurance companies to tap the equity markets for raising funds.

¹Insurance penetration = premium volume as a ratio of GDP

²Density ratio = Total premium to total population