020-Neha Jesrani-Overview of Insurance Sector in India

7/27/2019 020-Neha Jesrani-Overview of Insurance Sector in India

1/60

OVERVIEW OF INSURANCE

SECTOR IN INDIA

(FOCUS ON LIFE INSURANCE)

1


2/60

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


3/60

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 theinvestment 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.

3


4/60

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 andcollected 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.

4


5/60

Fundamentals

of Insurance

Insurable

interest

Proximatecause

ContributionSubrogation

Utmost faith

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 deviceto 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:

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 insurableinterest in them.

5


6/60

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 ofevents 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:

6


7/60

1. Offer and Acceptance: Usually, the proposer makes the offer, and the insurer makes

acceptance.

2. 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. Agreement between the parties: Both parties should agree to the same thing in thesame sense.

4. 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.

5. 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.

7


8/60

HISTORY OF INSURANCE IN INDIA

YEAR EVENT

1850 Triton Insurance company Ltd. set up in Calcutta.

1871 Bombay Mutual, Indias first life insurance company set up.

1874 Oriental Insurance Company set up.1907 Indian mercantile Insurance ltd. the first company to transact all

classes of general insurance business set up.

1912 Life Assurance Act (Act VI) of 1912 enacted.

1914 Government started publishing returns of life insurance

companies.

1937 Draft Insurance Bill introduced

1938 Insurance Act, 1938 enacted.

1945 Committee headed by Cowasji Jehangir set up to review

malpractice and take corrective steps.1950 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.

1956 LIC set up. Nationalization of life insurance business

1957 Reinsurance Corporation of India, first Indian Reinsurer set up.

1968 Insurance Act amended further to provide effective control over

general insurance companies requiring increased deposits from

them; also provided for setting up of TAC.

1971 Ordinance promulgated to replace the General Insurance

Emergency Provisions Act, 1971.

1972 General Insurance business nationalized

1973 GIC set up.

April 1993 Malhotra Committee constituted for insurance sector reforms and

deregulation.

Jan 1996 Interim insurance regulatory authority setup through a resolutionSep 1996 The IRA bill drafted

Dec 1996 IRA bill introduced in parliament & referred to Standing Committee

1997 Insurance Regulatory Authority came into existence.

Aug 1997 IRA is withdrawn following opposition to foreign participation

Nov 1997 Indian government clears greater autonomy to LIC, GIC and its

four subsidiaries

June 1998 Union budget announces opening up of insurance sector

Nov 1998 Union budget decides to allow 40% foreign equity participation in

Private sector (26% to foreign cos and 14% to NRIs, OCBs, FIIs1999 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.

2000 IRDA made statutory body

July 2000 IRDA issues first set of guidelines for insurance companies.

Oct. 2000 First three licenses awarded to private companies; three others

receive in-principle clearance.

Dec. 2000 ICICI prudential and HDFC Standard Life launch insurance policies

8


9/60

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 insurancebusiness in the country.

Source: Charted Financial Analyst.

9


10/60

1.11) Scope or kinds of 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.

10

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


11/60

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. Theimportant 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


12/60

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.

12


13/60

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, andto 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 fromindividuals 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


14/60

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 ofexperiencethat 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. Insurance helps to spur economic development by

providing shelter against risky projects. Thus opening up of the insurance sector would result into the

following things:

Increase in Economic development

Better and variety of insurance products

Healthy Competition

Consumer will benefit

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

14


15/60

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 isknown 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 a

few regulated players); and finally,

(c) What is the role of the regulator in insurance business?

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


16/60

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 bythe 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, co-

operative 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.

16


17/60

What should be the market structure?

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

Issues related to MarketStructure

Issue of AdverseSelection

Problem of Moral Hazard


18/60

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 gapbetween 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 thecustomers 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.

18


19/60

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 GICsubsidiaries).

(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.

19


20/60

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 BJP-

led 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 privatecompanies (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).

20


21/60

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 socialsector 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
http://www.irdaonline.org/press.asphttp://www.irdaonline.org/press.asp


22/60

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.

Brokerage firms are allowed a minor foreign equity stake in them with a cap of 49%. Compositebrokers 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

Types of Brokerage Firms

Insurance Re-Insurance Composite


23/60

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 theirmoney 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 thepaid-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


24/60

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 weneed to study Life Insurance. Life Insurance, its meaning and concept is studied in the next chapter.

24


25/60

Chapter 3 Life Insurance

3.1) Why do Men Work?

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 Breadwinnerdies 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 ofLife 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 specifieddates 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


26/60

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 ofthese 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

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.

26

Safety againstfuture

adversities

Support for

Retirement age

and needs

Freedom fromfinancial burden

Childrenseducation

Stress

Future Plans and

higherAmbitions

Changing SocialPatterns

E.g. Nuclear families

Security Needs

Need For

LifeInsurance


27/60

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 childrensfuture 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.

27


28/60

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 deathwithout 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 banksand other financial institutions.

28


29/60

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 insurerfounded 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 insurancecompanies, 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.

29


30/60

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 financialyear 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 pre-

packaged 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


31/60

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, wholelife, 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 developedcountries, a significant

fraction of domestic saving is in the form of (endowment) insurance plans. This is not surprising. The

prominence of some developingcountries 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 futuregrowth. 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

Life Total Non-

life

Life Total Non-

life

Life

UnitedStates

8.55 4.32 4.23 8.76 4.28 4.48 8.97 4.57 4.40

Canada 6.49 3.31 3.19 6.56 3.28 3.27 6.42 3.45 2.97Brazil 2.01 1.66 0.35 2.11 1.75 0.36 2.14 1.78 0.36Mexico 1.68 0.86 0.82 1.72 0.85 0.86 1.81 0.95 0.86UnitedKingdom

13.35 3.05 10.30 15.78 3.07 12.71 14.18 3.45 10.73

China 1.63 0.61 1.02 1.79 0.67 1.12 2.20 0.86 1.34India 1.93 0.54 1.39 2.32 0.55 1.77 2.71 0.56 2.15Japan 11.17 2.30 8.87 10.92 2.22 8.70 11.07 2.21 8.85

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

31


32/60

8.97 6.42

2.14 1.81

14.18

2.2 2.71

11.07

0

5

10

15

United

States

Canada

Brazil

Mexico

United

K

ingdom

China

India

Japan

Insurance Penetration in 2001 (Total premium

as % of GDP)

Life Insurance penetration in India

32


33/60

Life Insurance Statistics

Indian population 1.055 bn

GDP as on 2000 (Rs bn) 235613

Gross domestic savings as a % of GDP 24.5%

Size of Market (Life & Non life) $16 bn

Total global insurance premium (as on 2001) $2408.25 bn

Rate of Annual Growth: (year 2002-03)

Life

Non life

11.27%

23%

33


34/60

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 Insurance Penetration (Premium as % of GDP 2001)

Japan 8.85

UK 10.73

USA 4.40

India 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.

34


35/60

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 sectoris 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.

35


36/60

3.8) Some type of life insurance policies:

Other generic

products

offered by life

insurance

companies are:

Group Defined Benefits

Group Money Purchase

Individual Money Purchase

Individual Deferred Annuity

Annuity products

Risk Products

Comparison chart - Life Insurance and other Savings instruments

Details LIC PPF NSC ULIP ELSS

Life cover Yes No No Yes * NoAccident coverage Yes ** No No Yes *** SometimesBonus Yes No No Yes NoMin. lock in

Period

3 yrs 7 yrs 6 yrs 10-15 yrs 3 yrs

Mode of Payment As per

convenience

At a time At a

time

Stipulated

and dated

At a time

Treatment of returns for Tax

Tax free Tax freeU/s 10

Sec80L

Sec 80L Long termCap Gains

Tax rebate u/s 88 20% 20% 20% 20% 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 is growing

continuously. As the population ages, products such as annuities, IRAs and defined contributionretirement 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.

I. Basic Life insurance Plans

Whole life Assurance Plan

Endowment Assurance Plans

II. Term assurance plans

Two year

temporary assurance plans

Convertible

Term assurance plans

III. Plans for children

E.g. LICs Jeeven Balya, Jeeven

Kishore. Jeeven Sukanya

IV. Pension plans

E.g. Jeeven Suraksha Plan

V. Plans for Handicapped

Dependents

E.g. Jeeven Adhar, jeeven Viswas

VI. Double and triple cover

VII. Double endowment VIII. Marriage endowment

IX. Educational annuity X Money back policy

36


37/60

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 thepublic 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.

37


38/60

Chapter 4 Insurance in India

4.1) Industry Analysis

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 spendheavily 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.

38

Industry

Competitiveness

Threat of new

Entrants

Power of BuyersPower of

Intermediaries

Threat of Substitutes


39/60

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

wil

020-Neha Jesrani-Overview of Insurance Sector in India

Documents

Transcript of 020-Neha Jesrani-Overview of Insurance Sector in India