Indian insurance report final

8/7/2019 Indian insurance report final

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Indian insurance sectorStepping into the next decade of growth

September 2010

Confederation of Indian Industry


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3Indian insurance sector: stepping into the next decade of growth

The insurance industry in India has progressed signi cantly over the last decade, which is amply evident in the strong growthwitnessed in the insurance premiums, strengthened outreach, increased number of players, product innovation and itsenhanced regulatory framework. A combination of these factors, along with strong economic growth in the last few years,has positioned India as a regional insurance hub and a rapidly developing nancial center.

The insurance industry is amid an exciting journey there needs to be a persistent endeavor to sustain what has already

been achieved as well as expand beyond the current level. Furthermore, several reforms and policy measures, especiallyduring the last couple of years, have enabled a favorable environment for insurance companies to ourish in the country. Thecoming years are critical as the regulator stance and approach of market participants will govern the strength, stability andthe sustained growth of the insurance sector.

The insurance sector has become a major contributor to economic development, especially to infrastructure development.This growth has been fueled by Indias multiplying consumer class, rising insurance awareness, increasing domestic savingsand investments. Moreover, it has been the joint effort of all stakeholders, including the government, regulator and insurancecompanies to enable the positive momentum of this industry. However, there is still a long way to cover on the road toachieve nancial inclusion and bring more and more people under the insurance blanket.

To this end, the Confederation of Indian Industry (CII) and Ernst & Young have co-authored this report to evaluate the currentstate of the insurance industry, implication of new regulations and the steps that can be taken to strengthen the penetration

of insurance products.

Foreword

Ashvin ParekhPartner & National Industry Leader,Financial ServicesErnst & Young Private Limited

Chandrajit BanerjeeDirector General,Confederation of Indian Industry


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4 Indian insurance sector: stepping into the next decade of growth

Executive summary ............................................ ........................................... ................................ 1

Introduction ......................................... ........................................... ............................................ .. 3

Section I: Industry overview ....................................... ............................................ ........................ 5

Evolution of the industry .......................................................................................................... 5

Current scenario ........................................... ........................................... ................................ 7

Growth drivers ....................................... ........................................... ..................................... 10

Emerging trends .................................................................................................................... 11

Contribution of the insurance sector to the economy ........................................ ........................ 12

Section II: Industry at cross-roads of development ........................................ ............................... 17Insurance industry: signi cantly untapped latent potential ................................. ....................... 17

Recent regulatory developments that govern the current market state ..................................... .. 20

Section III: Critical factors for market development ......................................... .............................. 25

Distribution channels ............................................................................................................. 25

Focus on nancial inclusion..................................................................................................... 34

Consumer needs and preferences ......................................... ............................................ ....... 36

Way forward .......................................... ........................................... ........................................... 39

Bibliography .......................................... ........................................... ........................................... 42

Contents


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Indias rapid rate of economic growth over the past decadehas been one of the most signi cant developments inthe global economy. This growth traces its origin in theintroduction of economic liberalization in the early 1990s,which has equipped India to exploit its economic potentialand substantially raise the standard of living of its people.

Together with other nancial services, insurance servicescontributed 7% of the countrys GDP in 2009. A well-developed and evolved insurance sector is a boon foreconomic development as it provides long-term funds forinfrastructure development and concurrently strengthensthe risk-taking ability of the country. Further, insurancehas been a notable employment generator, not only for theinsurance industry, but has also created signi cant demandfor a range of associated professionals such as brokers,insurance advisors, agents, underwriters, claims managersand actuaries.

By the nature of its business, insurance is closely linked tosaving and investing. Life insurance, funded pension systemsand non-life insurance have accumulated a signi cantamount of capital over time, which can be investedproductively in the economy. The mutual dependence ofinsurance and capital markets plays an instrumental role inchanneling funds and investment capabilities to augmentthe development potential of the Indian economy.

Indias growing consumer class, rising insurance awareness,increasing domestic savings and investments are among the

most critical factors that have positively driven the marketpenetration of the insurance products among its consumer

segments. However, there are large untapped areas, whichhave yet not bene ted from the upside of insurance.Imparting nancial literacy, incentivizing Indian householdsto transfer savings from physical assets to nancial assetsand taking the distribution network to rural areas areexpected to help bring more and more individuals withinthe insurance ambit. While insurance penetration in India ishigher than that in countries such as China and Brazil, it stillhas a considerably long way to go.

The insurance industry in India has visibly progressedsince the time when businesses were tightly regulated andconcentrated in the hands of a few public sector insurers.Following the passage of the Insurance Regulatory andDevelopment Authority Act in 1999, India abandonedpublic sector exclusivity in the insurance industry in favorof market-driven competition. This shift has brought aboutmajor changes to the industry. The new era of insurancedevelopment has seen the entry of international insurers,the proliferation of innovative products and distributionchannels, and the raising of supervision standards.

The period post-sector liberalization, which we call PhaseI, has witnessed an unprecedented surge in the sales ofinsurance products, with the industry recording a CAGR of24.2% in annualized premium equivalent during FY0005.The insurance industry, in its rst phase of development, hasbeen relying on regular capital infusions from the promotersas its lifeline. High new business strain and expandingdistribution networks have resulted in accounting lossesacross the industry. In order to meet their commitmenttoward claim settlement and reserve creation, promoters

Executive summary


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have been investing additional capital, resulting in cash-burn. The tradeoff between growth and pro tability washeavily inclined toward the former.

The next four to ve years can be termed as Phase II,which saw players focus on an expanding product range,developing innovative products and building a robustdistribution channel. During this period, i.e., FY0509, theindustry grew at a CAGR of 25.9%. Insurers were shiftingweight from the Phase I philosophy of growth versuspro tability to the Phase II mantra of pro table growth.As a result, the focus shifted from growth to pro tability,with product pricing becoming more rational based on moreconservative assumptions. Product innovation continuedand traditional policies gained some foothold in an otherwiseunit-linked incentive product (ULIP) driven market.

The Indian life insurance industry stands at the thresholdof launching its Phase III growth. The phase is marked bybringing the industry to a stable position, ensuring stablepro table growth. Most large players will now look todecelerate the pace of distribution growth and increasetheir focus on the retention of channel partners as well asimprove channel productivity. Further, insurance companiesare working toward improving persistency.

At this cross section, the role of the regulator becomescritical. The Insurance Regulatory and DevelopmentAuthority (IRDA) is in the nalization stage vis--vis most ofits regulations, which would be instrumental in navigating

the future course of the insurance industry. IRDA hasintroduced certain regulations to help improve disclosures,

pro tability and capital as well as ensure consumerprotection. Further, the regulator is amid nalizing thenorms for the init ial public offering (IPO) of insurancecompanies. In a sector where none of the players are listed,the IPO of insurance companies could be a milestone in thefuture growth of the sector.

Risk management plays a very critical role in the insurancebusiness. In the next three to four years, India plans to shiftfrom the current solvency I norms to risk-based solvencynorms, called the solvency II model. This change will resultin the better apportionment of risk in the backdrop of theactual risk associated with the asset.

With the rising competition, the industry may also witnessconsolidation among smaller players and the emergenceof some large players. The regulator is in the process of

nalizing guidelines for mergers and acquisitions in theinsurance space in India. The government, regulator andthe insurance companies are now focused on maintaininga favorable environment for sustainable growth, highercontribution of the industry to economic development andthe increasing reach of insurance to the underdevelopedareas of the country.

To summarize, the Indian insurance industry is poised for aquantum leap in performance with unprecedented growthopportunities, notwithstanding a temporary sliding growthcurve. The stage is now well poised for the real showto commence.


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The economic reforms initiated in the early 90s paved theway for the growth and opening up of the nancial sector,which led to a sustained period of economic growth. Theinsurance industry was opened up for private players in

2000, and has seen tremendous growth over the pastdecade with the entry of global insurance majors. India isfast emerging as one of the worlds most dynamic insurancemarkets with signi cant untapped potential.

The insurance sector plays a critical role in a countryseconomic development. It acts as a mobilizer of savings, a

nancial intermediary, a promoter of investment activities,a stabilizer of nancial markets and a risk manager. The

life insurance sector plays an important role in providingrisk cover, investment and tax planning for individuals; thenon-life insurance industry provides a risk cover for assets.Health insurance and pension systems are fundamental to

protecting individuals against the hazards of life, and India,as the second-most populous nation in the world, offerssigni cant potential for that type of cover. Furthermore,

re and liability insurance are essential for corporationsto safeguard infrastructure projects and investment risks.Private insurance systems complement social securitysystems and add value by matching risk with price.

Introduction


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signi cant untapped potential in various segments of themarket. While the nation is heavily exposed to naturalcatastrophes, the insurance cover to mitigate the negative

nancial consequences of these adverse events is still

underdeveloped. The same is true for both pension andhealth insurance, where insurers can play a critical rolein bridging demand and supply gaps. The major changesin both national economic policies and insuranceregulations will highlight the prospects of these segmentsgoing forward.

Appropriate risk pricing is one of the most powerful tools forsetting the right incentives for the allocation of resources, afeature which is the key to a fast-developing country suchas India.

By the nature of its business, insurance is closely relatedto savings and investing. Life insurance, funded pensionsystems, and to a lesser extent, non-life insurance, willaccumulate a signi cant amount of capital over time, whichcan be invested productively in the economy.

There are good reasons to expect that the growthmomentum can be sustained. In particular, there is


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Section I:Industry overview

The insurance industry in India has come a long way sincethe time when businesses were tightly regulated andconcentrated in the hands of a few public sector insurers.Following the passage of the Insurance Regulatory and

Development Authority Act in 1999, India abandonedpublic sector exclusivity in the insurance industry in favorof market-driven competition. This shift has brought aboutmajor changes to the industry. The beginning of a new era ofinsurance development has seen the entry of internationalinsurers, the proliferation of innovative productsand distribution channels, as well as the raising ofsupervisory standards.

Evolution of the industryThe growing demand for insurance around the worldcontinues to have a positive effect on the insurance industry

across all economies. India, being one of the fastest-growingeconomies (even in the current global economic slowdown),has exhibited a signi cant increase in its GDP, and aneven larger increase in its GDP per capita and disposableincome. Increasing disposable income, coupled with the highpotential demand for insurance offerings, has opened manydoors for both domestic and foreign insurers. The followingtable brie y depicts the evolution of the insurance sectorin India.


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Year Event

1818 Oriental Life Insurance Co. was established in Calcutta.

1870 The rst insurance company, Bombay Mutual Life Insurance Society, was formed.

1907 The Indian Mercantile Insurance Limited was formed.

1912 Life Insurance Companies Act and the Pension Fund Act of 1912

Beginning of formal insurance regulations

1928 The Indian Insurance Companies Act was passed to collect statistical data on both life and non-life.

1938 The Insurance Act of 1938 was passed; there was strict state supervision to control frauds.

1956 The Central Government took over 245 Indian and foreign life insurers as well as provident societies and nationalizedthese entities.

The LIC Act of 1956 was passed.

1957 The code of conduct by the General Insurance Council to ensure fair conduct and ethical business practices was framed.

1972 The General Insurance Business (Nationalization) Act was passed.

1991 Beginning of economic liberalization

1993 The Malhotra Committee was set up to complement the reforms initiated in the nancial sector.

1994 Detarif cation of aviation, liability, personal accidents and health and marine cargo products

1999 The Insurance Regulatory and Development Authority (IRDA) Bill was passed in the Parliament.

2000 IRDA was incorporated as the statutory body to regulate and register private sector insurance companies.

General Insurance Corporation (GIC), along with its four subsidiaries, i.e., National Insurance Company Ltd., OrientalInsurance Company Ltd., New India Assurance Company Ltd. and United India Assurance Company Ltd., was made Indiasnational reinsurer.

2005 Detarif cation of marine hull

2006 Relaxation of foreign equity norms, thus facilitating the entry of new players

2007 Detarif cation of all non-life insurance products except the auto third-party liability segment

Exhibit 1.1. Tracing the chronological evolution of the insurance industry


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In India, the Ministry of Finance is responsible for enacting

and implementing legislations for the insurance sector withthe Insurance Regulatory and Development Authority (IRDA)entitled with the regulatory and developmental role. Thegovernment also owns the majority share in some majorcompanies in both life and non-life insurance segments.Exhibit 1.2 depicts the structure of the insurance industryin India.

Exhibit 1.2. Indian insurance industry structure

Ministry of Finance(Government of India)

IRDA

Non-life insuranceLife insurance

Source: IRDA

Public

Private

Public

Private

Both the life and non-life insurance sectors in India, whichwere nationalized in the 1950s and 1960s, respectively,were liberalized in the 1990s. Since the formation of IRDAand the opening up of the insurance sector to privateplayers in 2000, the Indian insurance sector has witnessedrapid growth.

14

2223

26

43

27

10

0

10

2030

40

50

0

500

1,000

1,500

2,000

2,500

3,000

FY03 FY04 FY05 FY06 FY07 FY08 FY09

I N R

b i l l i o n

Non-life insurance premium Life insurance premium

Growth rate (in %)

Source: IRDA

y- 0 - y

gr ow

t h ( i n % )

Exhibit 1.3. Total premiums of the insurance industry(life and non-life)

Current scenarioA growing middle-class segment, rising income, increasinginsurance awareness, rising investments and infrastructurespending, have laid a strong foundation to extend insuranceservices in India. The total premium of the insuranceindustry has increased at a CAGR of 24.6% between FY03and FY09 to reach INR2,523.9 billion in FY09.

The opening up of the insurance sector for privateparticipation/global players during the 1990s hasresulted in stiff competition among the players, with eachoffering better quality products. This has certainly offeredconsumers the choice to buy a product that best ts his orher requirements.


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2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Life insurers

Public 1 1 1 1 1 1 1 1 1 1 1

Private 3 10 12 12 13 13 15 15 21 21 22

Non-life insurers

Public 4 4 5 6 6 6 6 6 6 6 6Private 3 6 8 8 8 8 9 10 15 15 17

Reinsurer 1 1 1 1 1 1 1 1 1 1 1

Exhibit 1.4. Growth in the number of insurance players

Most of the private players in the Indian insurance industryare a joint venture between a dominant Indian company anda foreign insurer.

Life insurance industry overview

The life insurance sector grew at an impressive CAGR of25.8% between FY03 and FY09, and the number of

policies issued increased at a CAGR of 12.3% during thesame period.

As of August 2010, there were 23 players in the sector(1 public and 22 private). The Life Insurance Corporation ofIndia (LIC) is the only public sector player, and held almost65% of the market share in FY10 (based on

rst-year premiums).

To address the need for highly customized products andensure prompt service, a large number of private sectorplayers have entered the market. Innovative products,aggressive marketing and effective distribution have

enabled edgling private insurance companies to sign upIndian customers more rapidly than expected. Private sectorplayers are expected to play an increasingly important rolein the growth of the insurance sector in the near future.

In a fragmented industry, new players are gnawing away themarket share of larger players. The existing smaller playershave aggressive plans for network expansion as their foreignpartners are keen to capitalize on the enormous potentialthat is latent in the Indian life insurance market.

Exhibit 1.5. Market share amongst private players FY10(based on rst year premiums) (in %)

Source: IRDA annual report FY09, IRDA Journal, Insurance Regulatoryand Development Authority website, www.irdaindia.org, accessed 26 May 2010

Bajaj Allianz, 11.6

Met Life, 2.8

SBI Life, 18.3

ICICI Pru,16.5

Others, 8.6

New entrants, 4.0

Tata AIG, 3.4

Kotak Mahindra, 3.5

MNYL, 4.8

HDFC Standard, 8.5Birla Sunlife, 7.7

Reliance Life, 10.2

The number of players during the decade has increased from

four and eight in life and non-life insurance, respectively, in2000 to 23 in life and 24 in non-life insurance (including 1in reinsurance) industry as in August 2010.


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ICICI Prudential, Bajaj Allianz and SBI Life collectively

account for approximately 50% of the market share in theprivate life insurance segment. To tap this opportunity,banks have also started entering alliances with insurancecompanies to develop/underwrite insurance products ratherthan merely distribute them.

Non-life insurance industry overview

Between FY03 and FY10, the non-life insurance sector grewat a CAGR of 17.05%. Intense competition that followed thede-tarif cation and pricing deregulation (which was startedduring FY07) decelerated the growth momentum.

As of August 2010, the sector had a total of 24 players(6 public insurers, 17 private insurers and 1 re-insurer).The non-life insurance sector offers products such as autoinsurance, health insurance, re insurance and marineinsurance. In FY10, the non-life insurance industry had thefollowing product mix.

Private sector players have now pivoted their focus on auto

Exhibit 1.6. Product mix (FY 10) (in %)

Source: IRDA Monthly Journal, Insurance Regulatory and Developmentuthority website, www.irdaindia.org, accessed 10 June 2010

Fire, 11.3

Marine , 6.3

Auto, 43.5

Health, 20.8Aviation, 1.2

Liability, 2.5%

All others, 7.2

Engineering, 4.8

Personalaccidents, 2.5

and health insurance. Out of the total non-life insurance

premiums during FY10, auto insurance accounted for 43.5%of the market share. The health insurance segment hasposted the highest growth, with its share in the total non-lifeinsurance portfolio increasing from 12.8% in FY07 to 20.8%in FY10. These two sectors are highly promising, andare expected to increase their share manifold in thecoming years.

With the sector poised for immense growth, more players,including monoline players, are expected to emerge in thenear future. The last two years has seen the emergenceof companies specializing in health insurance such as StarHealth & Allied Insurance and Apollo DKV.

In the last decade, it was observed that most players have

Exhibit 1.7. Market share among players in FY10 (in %)

Source: "IRDA annual report FY09 - IRDA Journal," Insurance Regulatory andDevelopment Authority website , www.irdaindia.org, accessed 26 May 2010

United India,13.6

Others, 7.9

Bajaj Allianz, 6.6%

Reliance General, 5.2

Star Health andAllied Insurance, 2.6

HDFC ERGOGeneral, 2.4

New India, 15.7

Oriental, 12.4

National, 12.1

ICICI-lombard, 8.6

IFFCO- Tokio, 4.3

AIC, 4.0

Tata-AIG, 2.3Royal Sundaram, 2.4

experienced growth by formulating aggressive growthstrategies and capitalizing on their distribution networkto target the retail segment. Although the players in theprivate and public sector largely offer similar products in the

non-life insurance segment, private sector players outscoretheir public sector counterparts in their quality of service.


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Growth driversIndias favorable demographics help strengthenmarket penetration

The life insurance coverage in India is very low, andmany of those insured are underinsured. There isimmense potential as the working population (2560years) is expected to increase from 675.8 million to795.5 million in the next 20 years (20062026). Theprojected per capita GDP is expected to increase fromINR18,280 in FY01 to INR100,680 in FY26, which isindicative of rising disposable incomes. The demand forinsurance products is expected to increase in light of

the increase in purchasing power.

Source: CMIE, Census of India 2001

Exhibit 1.8. Working population assessment and GDPper capita till 2026

0

20

40

60

80

100

120

0100200300400500600700800

2001 2006 2011 2016 2021 2026

I N R

I n m i l l i o n

Projected GDP per capita in '000sAge group 2560 (in million)

Health insurance attracts insurance companies

The Indian health insurance industry was valued atINR51.2 billion as of FY10. During the period FY0310,the growth of the industry was recorded at a CAGRof 32.59%. The share of health insurance was 20.8%of the total non-life insurance premiums in FY10.Health insurance premiums are expected to increase toINR300 billion by 2015.

Private sector insurers are more aggressive in thissegment. Favorable demographics, fast progression ofmedical technology as well as the increasing demandfor better healthcare has facilitated growth in thehealth insurance sector. Life insurance companies areexpected to target primarily the young population sothat they can amortize the risk over the policy term.

Rising focus on the rural market

Since more than two-thirds of Indias population lives inrural areas, micro insurance is seen as the most suitableaid to reach the poor and socially disadvantagedsections of society.

Poor insurance literacy and awareness, hightransaction costs and inadequate understandingof client needs and expectations has restricted thedemand for micro-insurance products. However,the market remains signi cantly underserved,creating a vast opportunity to reach a large numberof customers with good value insurance, whetherfrom the base of existing insurers or through retaildistribution networks.

In FY09, individuals generated new business premiumworth INR365.7 million under 2.15 million policies,and the group insurance business amounted toINR2,059.5 million under 126 million lives. LICcontributed most of the business procured in thisportfolio by garnering INR311.9 million of individualpremium from 1.54 million lives and INR1,726.9million of group premium under 11.1 million lives.

LIC was the rst player to offer specialized productswith lower premium costs for the rural population.Other private players have also started focussing onthe rural market to strengthen their reach.

Government tax incentives

Currently, insurance products enjoy EEE bene ts, giving

insurance products an advantage over mutual funds.Investors are motivated to purchase insurance products


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to avail the nearly 30% effective tax bene t on select

investments (including life insurance premiums) madeevery nancial year. Life insurance is already the mostpopular nancial product among Indians because ofthe tax bene ts and income protection it offers ina country where there is very little social security.This drives more and more people to come within theinsurance ambit.

Emerging trendsExploring multiple distribution channels forinsurance products

To increase market penetration, insurance companiesneed to expand their distribution network. In therecent past, the industry has witnessed the emergenceof alternate distribution channels, which includebancassurance, direct selling agents, brokers, onlinedistribution, corporate agents such as non-banking

nancial companies (NBFCs) and tie-ups of para-banking companies with local corporate agencies (e.g.NGOs) in remote areas.

Agencies have been the most important and effectivechannel of distribution hitherto. The industry is viewing

the movement of intermediaries from mere agentsto advisors.

Product innovation

With customers asking for higher levels ofcustomization, product innovation is one of the beststrategies for companies to increase their market share.This also creates greater ef ciency as companies canmaintain lower unit costs, offer improved servicesand distributors can increase exibility to pay highercommissions and generate higher sales.

The pension sector, due to its inadequate penetration

(only 10% of the working population is covered) offerstremendous potential for insurance companies to bemore innovative.

Consolidation in future

The past few years have witnessed the entry of manycompanies in the domestic insurance industry, attractedby the signi cant potential of insurance sector.However, increasing competition in easily accessibleurban areas, the FDI limit of 26% and the recentdownturn in equity markets have impacted the growthprospects of some small private insurance companies.

Such players may have to rethink about their futuregrowth plans. Hence, consolidation with large andestablished players may prove to be a better solutionfor such small insurers. Larger companies would alsoprefer to take over or merge with other companies withestablished networks and avoid spending money inmarketing and promotion. Therefore, consolidation willresult in fewer but stronger players in the country aswell as generate healthy competition.

Mounting focus on EV over pro tability

Many companies are achieving pro tability bycontrolling expenses; releasing funds for futureappropriations as well as through a strong renewalpremium build up. As a few larger insurers continueto expand, most are focused on cost rationalizationand the alignment of business models to ground level

realities. This will better equip insurers to realizereported embedded value (EV) and generate value fromfuture new business.

In the short term, companies are likely to facechallenges to achieve the desired levels of pro tability.As companies are also planning to get listed and raisefunds, the higher pro tability will help companies toget a better valuation of shares. However, in the longterm, companies would need to focus on increasingEV, as almost 70% of a companys EV is in uenced byrenewal business and pro tability is not as much of anindicator for valuation. Hence, players are now focusing

on increasing their EV than pro tability gures.


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Rising capital requirements

Since insurance is a capital-intensive industry, capitalrequirements are likely to increase in the comingperiod. The capital requirement in the life insurancebusiness is a function of the three factors: (1) sum atrisk; (2) policyholders assets; (3) new business strainand expense overruns. With new guidelines in place,capital requirements across the sector are likely to goup due to:

Higher sum assured driving higher sum at risk

Greater allocation to policyholders assets due tolower charges

Back loading of charges is resulting in high newbusiness strain, and expense overruns due to lowproductivity of the newly set distribution network (andinability to recover corresponding costs upfront)

For non-life insurance companies, the growing demandfor health insurance products as well as motorinsurance products is l ikely to boost thecapital requirement.

With the capital market picking up and valuations onthe rise, insurance companies are exploring variousways of increasing their capital base to invest in product

innovation, introducing new distribution channels,educating customers, developing the brand, etc.

This is due to the following reasons:

A major portion of the costs in insurance companies isxed (though it should be variable or semi-variable in

nature). Hence, the reduction in sales will not result inthe lowering of operational expenses, thus adverselyimpacting margins. As such, reduced margins wouldimpact pro tability, and insurers would need to investadditional funds.

The sustained bearishness in capital markets could

further pressurize the investment margins and

increase the capital strain, especially in the case of

capital/return guarantee product.Besides, companies are likely to witness a slowdownin new business growth. Companies may also optfor product restructuring to lower their costs andoptimally utilize capital.

According to IRDA Regulations 2000, all insurancecompanies are required to maintain a solvency ratioof 1.5 at all times. But this solvency margin is notsustainable. With the growing market risks, the levelof required capital will be linked to the risks inherentin the underlying business. India is likely to startimplementing Solvency II norms in the next three tofour years.

The transition from Solvency I norms to Solvency IInorms by 2012 is expected to increase the demandfor actuaries and risk management professionals.The regulator has also asked insurance companiesto get their risk management systems and processesaudited every three years by an external auditor. Manyinsurance companies have started aligning themselveswith the new norms and hiring professionals to meetthe deadline.

Contribution of the insurance sectorto the economyInsurance has had a very positive impact on Indiaseconomic development. The sector is gradually increasingits contribution to the countrys GDP. In addition, insuranceis driving the infrastructure sector by increasing investmentseach year. Further, insurance has boosted the employmentscenario in India by providing direct as well as indirectemployment opportunities.

Due to the healthy performance of the Indian economy,

the share of life insurance premiums in the gross domesticsavings (GDS) of the households sector has increased.


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Source: IRDA, National Income Statistics, July 2010, CMIE

Exhibit 1.9. Share of life insurance premiums in GDS

(household sector) (in %)

11.012.3

15.917.9 17.6

0

5

10

15

20

FY05 FY06 FY07 FY08 FY09

The increased contribution of the insurance industryfrom the household GDS has been ploughed back into theeconomy, generating higher growth. The following factorsshowcase how the contribution of the insurance industry hasstrengthened economic growth:

Contribution of insurance to infrastructure

Generally, countries with strong insurance industrieshave a robust infrastructure and strong capital formation.Insurance generates long-term capital, which is requiredto build infrastructure projects that have a long gestationperiod. Concurrently, insurance protects individualsand businesses from sudden unfavorable events. A well-developed and evolved insurance sector is needed foreconomic development as it provides long-term funds forinfrastructure development and simultaneously strengthensthe risk taking ability.

Although the insurance sector is relatively young in India, itscontribution to infrastructural development has been on avisible rise as depicted in the following exhibit.

FY06 FY07 FY08 FY09

Investments from traditional products

Approved securities including CentralGovernment Securities

3,131 3,541 4,013 4,439

Infrastructure and social sector 546 759 763 756

Investment subject to exposure norms,including other than approved investments

1,327 1,538 2,035 2,787

Housing and re- ghting equipment 31 37 39 42

Unit-linked insurance product funds (ULIPs)

Approved investments 234 576 1,115 1,515

Other than approved investments 25 95 219 213

Exhibit 2.0. Contribution of various insurance products to infrastructure (in INR billion)

Source: IRDA annual report FY09, Insurance Regulatory and Development Authority website , www.irdaindia.org, accessed 20 August 2010


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In FY09, the total investments by the insurance industry

increased to INR9,742 billion, as against INR8,183 billionin the previous year. Further, investments by both life andnon-life insurers increased by 20.2% and 4.6% to INR9,163billion and INR589 bill ion, respectively, in FY09.

However, as outlined in the Eleventh Five Year Plan (20082012), there is a signi cant fund requirement of INR20,562billion in the infrastructure sector. Given an expected robustincrease in the insurance business and the increasingparticipation of foreign insurers in India, insurancecompanies are well positioned to contribute to infrastructuredevelopment in the country.

These investments could further increase with thedevelopment of sound debt markets, especially the marketfor long-term government paper and income tax incentivesto attract savings for infrastructural schemes. Thedirect investment of policyholder funds of life insurers ingovernment bonds is another way in which the industry hashelped the development of infrastructure. In addition, IRDAsmandate for insurance companies to invest 15% of theirannual sales in infrastructure is expected to boostcapital formation.

Contribution of insurance to FDI

The importance of FDI in the development of a capital-de cient country such as India cannot be undermined.This is where the high-growth sectors of an economyplay an important role by attracting substantial foreigninvestments. Currently, the total FDI in the insurance sector,which was INR50.3 billion at the end of FY09, is estimated

to increase to approximately INR51 billion in FY10. It is

dif cult to estimate, but an equal amount of additionalforeign investment, can roughly ow into the sector if thegovernment increases the FDI limit from 26% to 49%.

The insurance sector, by virtue of attracting long-termfunds, is best placed to channelize long-term funds towardthe productive sectors of the economy. Therefore, thegrowth in their premium collections is expected to translateinto higher investments in other key sectors of the economy.Therefore, the liberalization of FDI norms for insurancewould not only bene t the sector, but several other criticalsectors of the economy.

Contribution of insurance to the offshoring business

India has become one of the most popular destinationsfor offshoring insurance processes, and leading insurancecompanies in the US and Europe has moved their processeseither to their captive units or third-party outsourcing rms.Currently, around 63% of Indias insurance outsourcingrevenues come from the US and around 22% from EMEA.

India offers varied insurance solutions dealing with health,property, life, annuities, reinsurance and casualty, amongothers. The following is a list of insurance services that areoutsourced to India.

The total revenues from the Indian offshore insurancebusiness process outsourcing services increased fromUS$367 million in FY03 to US$790 million in FY07,and are expected to reach US$2 billion by FY10. Thisincreased business will also result in increased employmentopportunities in the insurance offshoring business.


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Exhibit 2.1. Insurance services suite

Property and casualty insurance Life insurance, pensionand annuities

Reinsurance

Application developmentand maintenance

Technology andconsulting

Source: Infosys

Life, retirement services,

producer administrationplatform

Business process and operationsconsulting

Productanalytics

CustomeranalyticsAnalytics

Protability analytics Claims analytics Risk analytics

Hire-to-retire

End-to-endplatform

Procure-to-pay

Open block lifeadministration

Closed block lifeadministration

Produceradministrationservice

Procure-to-pay Hire-to-retire

Retirementservices

Hire-to-retire

Procure-to-pay

Applicationprocess

Underwritingsupport

BPO

Policyadministrationand maintenance

Claimsprocessing andadjudication

New business Policyadministration

Claims andissuance

Annuitiesservicing

Treatyadministration

Underwritingsupport

Technicalaccounting

Claimsmanagement

Customer relationship andinformation managementTechnologyenabled

Insuranceworkow

Activedesk solution

Customer relationship andinformation management Reinsurance treatyadministration

Active desk solution Insurance workow


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Contribution of insurance to employment

Insurance helps create both direct and indirect employmentin the economy. Alongside regular jobs in insurance, there isalways demand for a range of associated professionals suchas brokers, insurance advisors, agents, underwriters, claimsmanagers and actuaries.

The increasing insurance business has increased thedemand for highly skilled professionals as well as semi-skilled and unskilled people. For example, life insuranceprovided direct employment to an additional set of 30,912people, besides adding more than 407,768 individual agentsduring FY09.

Parameter FY00 FY06 FY07 FY08 FY09

Direct employees 1,23,000 1,52,449 1,87,403 2,54,332 2,85,244

Individual agents 7,14,000 14,22,609 19,85,457 24,98,513 29,06,281

IRDA has mandated the appointment of actuaries in all

insurance companies, ensuring the certi cation of allproducts before launch. The insurance regulator has alsomade it mandatory for appointed actuaries to attend allboard meetings to help the insurer ensure solvency at allpoints in time.

To ensure continued growth, the need of the hour is trainedmanpower with specialized knowledge about this industry.Insurances companies need to invest in the professionaltraining of their employees, especially for subjects such asunderwriting, claims and risk management.

Exhibit 2.2. Growing employment in the life insurance industry

Source: Life Insurance Council of India


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Section II:Industry at cross-roadsof development

Insurance industry: signi cantlyuntapped latent potentialIndias insurance industry has witnessed rapid growth duringthe last decade. Consequently, many foreign companieshave expressed their interest in investing in domesticinsurance companies, despite the Government of Indiasregulation, which mandates that the foreign shareholdinglimit is xed at 26% for the life as well as non-lifeinsurance sectors.

The countrys strong economic growth in recent years hashelped increase penetration levels substantially. Premiumincome, as a percentage of GDP, increased from 3.3%in FY03 to 7.6% in FY09. However, the penetration ofinsurance in India still continues to be low, as compared toother developed and developing economies.

Source: IRDA annual report FY0309, Insurance Regulatory and Developmentuthority website , www.irdaindia.org, accessed August 2010; CMIE

Exhibit 2.3. Insurance premiums as a % of GDP

0.6 0.7 0.7 0.80.9 0.9 0.92.7 3.0

3.5 4.1

5.5 6.46.7

3.3 3.7 4.24.8

6.37.3 7.6

0

2

4

6

8


I n p

e r c e n t a g e

Non-life insurance premium contribution as a % of GDPLife insurance premium contribution as a % of GDPTotal insurance premium contribution as a % of GDP

The Indian life insurance sector has witnessed exponentialgrowth, driven by innovation in product offerings anddistribution owing to market entrants since the opening upof the sector in 2000. Currently, it is the fth-largest life

insurance market in Asia. The rapid expansion in the lifesector coincided with a period of rising household savingsand a growing middle class, backed with strong economicgrowth. Innovative product design (e.g. launch of ULIPs)and aggressive distribution strategies (e.g. development ofbancassurance) by private sector players have signi cantlycontributed to strong premium growth. The followingdiagram shows the increasing premium per capita during thesame period.

Source: IRDA annual report FY03-09, Insurance Regulatory and Developmentuthority website, www.irdaindia.org, accessed August 2010; CMIE

Exhibit 2.4. Per capita insurance premium

109.5 147.8166.6 193.7 237.0 244.5

265.2528.4628.3

1,003.6

1,479.11,769.3

1,921.9

637.9 776.1952.0

1,197.2

2,013.82,187.1

0

500

1,000

1,500

2,000

2,500


Non-life insurance premium per capitaLife insurance premium per capitaTotal insurance premium per capita

785.4

1,716.1


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The global economy has slowly started recovering from theeconomic recession. Lagging employment, coupled withdeclining aggregate wages, a weakened residential andcommercial real estate market, tight credit and a behavioral

shift on the part of consumers from consumption to savingsare factors contributing to a delayed recovery. Althoughthe global insurance industry has not been impacted by the

nancial crisis as much as the banks, it still has its set ofissues. The leading ve issues on the global insurance watchlist are:

Managing risk: The most signi cant concern for insurancecompanies is risk in all its forms. Increasingly, insurancecompanies are adopting an enterprise-wide view ofmanaging risksemploying a framework to address themacross the organization.

Promoting compliance: The cost of regulatory complianceand the attendant reputational risk of non-compliance areon the rise.

Growing globally: The expansion into new markets isexpected to help drive pro ts, as developed economieswitness slower growth in the demand for insurance.

Lack of innovation around products and delivery: Theuse of technology and emphasis on innovation will helpprovide better service and delivery. Institutions can alsostrengthen their ties with customers and differentiatethemselves from competition.

Adapting to demographic shifts: The demographicchanges in North America, Europe, Japan and other areasis starting to shift assets from equities to annuities as wellas other xed-income products.

Non-life premiums in 2009 Life premiums in 2009

Country Premiums,US$ million

Penetration,% of GDP

Density,US$ per capita

Premiums,US$ million



Developed

Australia 27,849 3 1,308.0 32,468 3.4 1,524.8

France 88993 3.1 1,289.4 194077 7.2 2,979.8

Germany 126,591 3.7 1,518.7 111,776 3.3 1,359.7

Singapore 5,188 1.7 645.6 9,057 5.1 1,912.0

South Korea 34,527 3.9 709.7 57,436 6.5 1,180.6

United Kingdom 91,560 3 1,051.2 217,681 10 3,527.6United Arab Emirates 4,381 2.1 952.7 732 0.4 159.2

United States 647,401 4.5 2,107.3 492,345 3.5 1,602.6

Exhibit 2.5. Global comparison of insurance premiums, penetration and density for both life and non-life segments


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Non-life premiums in 2009 Life premiums in 2009

Country Premiums,US$ million



Premiums,US$ million



Developing

Bangladesh 205 0.2 1.3 636 0.7 3.9

Brazil 23,979 1.5 123.8 24,781 1.6 127.9

China 53,872 1.1 40 109,175 2.3 81.1

India 6,375 0.9 6.7 46,206 6.6 48.1

Indonesia 2,219 0.4 9.6 5,066 0.9 22

Malaysia 3,158 1.6 115 5,682 2.9 206.9

Mexico 9,664 1.1 88.2 7,688 0.9 70.1

Pakistan 650 0.4 3.6 543 0.3 3

Philippines 835 0.5 9.1 1,563 1 17

Romania 2,365 1.4 111.2 533 0.3 25.1

Russia 38,940 2.4 276.4 636 0 4.5

South Africa 8,215 2.9 163.9 28,773 10 574.2

Sri Lanka 358 0.9 17.7 238 0.6 11.8

Taiwan 11,443 3 494.8 52,204 13.8 2,257.3

Thailand 4,248 1.6 62.7 6,212 2.4 91.7

Vietnam 769 0.8 8.7 671 0.7 7.6

Source: World Insurance in 2009, Swiss Re, June 2010, Insurance Regulatory and Development Authority website , www.irdaindia.org, accessed06 January 2010

According to Swiss Re, among the key Asian markets, Indiais likely to have the fastest-growing life insurance market,with life premium poised to grow at a CAGR of 15% for thenext decade, slightly faster than the 14% expected for China.The growing consumer class, rising insurance awareness andgreater infrastructure spending have made India and Chinathe two most promising markets in Asia. Europe and theAmericas represent relatively mature insurance markets.

Though Indias penetration appears higher, it is notexcessive, given the high level of investments in insurance

policies underwritten. Nonetheless, besides India, Taiwan isthe other Asian market that shares similar characteristics.

Taiwan has the highest insurance penetration in Asia, largelydriven by the immense popularity of ULIPs.

The progress of the Indian insurance industry over thelast decade has been the most crucial period in theestablishment of this industry; post the formation of IRDAin 2000. The initial four to ve years witnessed the entry ofmany private players, each trying to acquire market share.The latter part of this phase witnessed a heightened focuson the expanding product range, developing innovativeproducts and building a robust distribution channel. The last

one to two years have been very critical as the industry is


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trying to sustain its growth in light of the new regulations

being formulated.The Indian insurance industry is at a threshold from whereit can witness the next growth wave, if presented with afavorable policy framework and an enabling distributionenvironment. The industry is poised to witness theemergence of new leaders who would carve a niche forthemselves by using instruments such as alternativechannels of distribution, cost management and productinnovation, among others.

At this cross section, the role of the regulator is verysigni cant. IRDA is in the nalization stage of most of theregulations pertaining to the industry. The regulator hasintroduced certain regulations to help improve disclosures,pro tability, capital, consumer protection, etc.

Recent regulatory developmentsthat govern the currentmarket stateThe development of the insurance industry in India, asin other international markets, is likely to be criticallydependent on the nature and quality of regulation. The roleof the regulator in most markets is to ensure ef ciency,transparency and fair play, while at the same time, protectthe interests of the consumer. The IRDA Act 2000 hasdelineated the broad regulatory framework within whichinsurance companies are expected to operate in India. Theprovisions of this act address issues related to ownership,solvency, investment portfolio construction, commissionstructures, reporting formats and accounting standards.

The minimum paid-up equity capital requirement hasbeen set at INR1 bill ion. The insurance business is capitalintensive, and international experience suggests that, onan average, non-life insurance companies require four to

ve years to break even. In the interim, these companieswould require regular capital infusion for funding expected

losses and meeting solvency requirements. In this context,

given the existing regulatory constraints of foreign directinvestment by the overseas partner, a substantial part of thefunding would have to be done by the Indian partner, whose

nancial strength is likely to in uence the credit strength ofthe joint venture.

Given the evolutionary stage of the Indian insuranceindustry, one of the focal points for the regulator has beento drive stability and solvency in the industry. The act alsomentions broad guidelines for the construction of theinvestment portfolios of life insurance companies. Thesenorms have been designed to make sure that an insurerdoes not take on unsustainable risks in deploying funds

collected by way of premiums. Overall, the regulatoryenvironment is favorable and takes care that playersmaintain prudent underwriting standards, and reservevaluation and investment practices. The primary objectivefor the current regulations is to promote stability and fairplay in the market place. Some of the recent regulatorychanges and their impact include:

New disclosure norms

IRDA has come up with the following disclosure norms:

IRDA has issued disclosure norms for insurancecompanies, mandating them to publish accounts on a half-

yearly basis. The disclosure norms are seen as a precursorto allowing insurance companies to hit the primarymarket. According to the new norms, insurers will have topublish their balance sheet on a half-yearly basis, startingfrom the period ending 31 March 2010.

Disclosures to be made for a company launching an IPO

All nancial disclosures for the past ve years prior tothe IPO have to be available on the company website. Inaddition, insurance companies have to disclose the dataon various parameters such as the calculation of economiccapital, surrender and lapse experience of business andexpense patterns for the ve-year period.


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Insurance companies that intend to go public would

also need to disclose required and available solvencymargins for ve years, capital structure and details ofinvestment performance. A wide range of risk factorsrelated to credit, market, insurance, liquidity, operationaland asset and liability management need to be disclosedclearly by the insurers, accompanied by a report froman independent external actuary on the reasonablenessof the methodology adopted and assumptions made todetermine valuations.

IRDA has also instructed all life insur ers to explicitlydisclose, in their bene t Illustration document, the exactamount of commission/brokerage paid by insurers toinsurance agents. This circular came into effect from 1July 2010.

Implications

The regulator has directed all rms to come up with a publicdisclosure framework to ensure a fair and stable insurancemarket. These norms would help investors to be fully awareof the nancial performance, company pro le, nancialposition, risk exposure, elements of corporate governance inplace and the management of the insurance companies.

The standard on public disclosures for the insurancecompanies, which has been prepared out of the leadinginternational practices followed by the InternationalAssociation of International Supervisors (IAIS), willstrengthen corporate governance and market discipline.

According to IRDA, the circular on the disclosure of agentcommission will enhance transparency by providingprospective policyholders with details of the exact amount ofcommission/brokerage paid by insurers to insurance agents,thus making it pro-investor. However, on the negative side,this move may encourage many insurance agents to rebatecommissions to their clients, which is an illegal practice.

Altered commission structure of agents

Insurers would be allowed to charge up to 4% on annualpremium paid on ULIPs for the rst ve years, andthereafter, charges will be reduced during the tenure ofthe policy. This gure narrows down to 3% by the tenth

year in a tapered scale, ending with 2.25% after the

fteenth year. The new guidelines apply from 1 September2010. Earlier, the regulator had allowed commissionscharged by agents to not exceed 40%.

For single-premium products, the maximum commissionrate is 2% of the premium paid, and for regular premiumproducts, the rate is in the range of 15%30% of premiumin the rst year, followed by 5%7% in the subsequentyears.

According to the draft guidelines, all life insurance agentswill have to gather a minimum of INR150,000 as the

rst-year premium or sell a minimum of 20 life insurancecontracts. When an agent falls short of achieving eitherof the above, they would have to proportionately achievemore in either one to make up for the shortfall. Wherethe average annual persistency ratio is less than 50%, thelicense of the agent will not be renewed.

Implications

This move by the IRDA re ects its efforts to ensuretransparency and implement more stringent disclosurenorms to avoid mis-selling. This is likely to allow insurers torecover their cost in a more transparent and informed way,thereby reducing unfair practices and the informationgap in domestic insurance to enhance market discipline.

Any variation in the payment structure of agents will alsohelp companies to reduce their costs. Further, tenure-based commissions will de nitely bene t the industry. Highcommission is also expected to come down and there willbe better reward for longer-term policies than the shorter-term ones.

Customers are the largest gainers from this change, asproducts will now be more transparent, customer-friendlyand aimed at protecting their long-term interests.

With the implementation of the IRDAs new norm, insurancecompanies may initially face a setback in policy salenumbers and total premiums. Although the IRDA stance is infavor of bringing transparency in the commission structureof agents, this norm could negatively impact agents as well,at least in the short term. To address the impact of reduced


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commission, insurance companies may resort to innovative

ways of compensating their top-performing agents. Non-commission-based remuneration may increase. Companiesmay expand their different reward and recognition programsto make the sale of ULIPs attractive for agents in light ofthese recent changes.

In the long term, the role of agents is expected to evolvewith this policy change. In future, increased transparency islikely to make agents more accountable not only in sellingthe right products, but also in providing better customerservice. This is also likely to guarantee that agents justifythe commissions they earn. From being mere agents, theywill be expected to serve as nancial planners selling a

bouquet of nancial products.IPO norms for insurance company

The insurance regulator has reduced the waiting period foran insurance company to make an IPO from 10 years to 5years after commencing operations.

IRDA has nalized its IPO guidelines and has sent themto the Securities and Exchange Board of India (SEBI).SEBI will club IRDAs recommendations with its generalguidelines on IPOs for any company that wants to raisemoney from the public through equity shares.

The norms for correct valuation, disclosure of operatingresults and pro t and loss account and ling of thedraft red herring prospectus are the three essentialsthat a company has to ful ll when opting for a public

oat. Besides, companies would have to make nancialdisclosures, risk disclosures, investment performance, etc.(details stated in the above section Newdisclosure norms).

Implications

Insurance companies need capital to expand, innovateand sustain in the market. Insurance companies typicallyprefer to raise capital by oating an IPO. There can be a

mix of a fresh issue of shares as well as the sale of sharesby the parent company. Most companies prefer this routewhen they do not have enough capital to plough back intotheir business. With the IPO route of raising capital, Indian

promoters will get the opportunity to put their equity into

the market as well as FIIs will also be able to participate andacquire stakes.

Promoting health insurance

IRDA has allowed insurance companies to offer Healthplus Life Combi Product, a policy that would providelife cover along with health insurance to subscribers.Under the guidelines issued by the IRDA, life and non-lifeinsurance rms can also partner in offering the health-plus-life cover. The combi products may be promoted by alllife insurance and non-life insurance companies, however,a tie up is permitted between one life insurer and one non-life insurer only. Thus, a life insurer is permitted to enteran alliance with only one non-life insurer and vice-versa.

The sale of combi products can be made through directmarketing channels, brokers and composite individual andcorporate agents, common to both insurers. However,these products are not allowed to be marketed throughbank referral arrangements. The regulator furtherspeci ed that the guidelines do not apply to micro-insurance products, which are governed by IRDA (MicroInsurance) Regulations, 2005.

Under the Combi Product, the underwriting of therespective portion of the risks will be underwritten by

respective insurance companies, i.e., life insurance riskwill be underwritten by the life insurance company and thehealth insurance portion of risk will be underwritten by thenon-life insurance company.

Implications

Life insurance has a much deeper penetration in India, ascompared to the non-life insurance segment. This step is insync with the governments, regulators and the insurancecompanys strategy to cover more people under theinsurance umbrella.

As insurers leverage on the marketing and operational

network of their partner insurers, the proposed productinnovation is expected to facilitate policy holders to selectan integrated product of their choice under a single roofwithout shopping around the market for two different


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insurance coverage options from two different insurers.Therefore, insurers are expected to offer appropriate coversas an attractive proposition for the policyholders.

Alteration in ULIPs

IRDA has attempted to make ULIP a long-term protectioncontract covering risks related to mortality, longevityand health by simultaneously offering a fair deal to thepolicyholder and doing away with the excesses in thesystem. The key changes introduced through the newguidelines are as follows:

Lock-in period: IRDA has increased the lock-in period forall ULIPs from three years to ve years, including top-up premiums, thereby making them long-term nancialinstruments that provide risk protection. All limitedpremium ULIPs, other than single premium products, willhave a premium paying term of at least ve years.

Level paying premiums: All regular premium/limitedpremium ULIPs will have uniform/level paying premiums.Any additional payments will be treated as a singlepremium for the purpose of an insurance cover.

Even distribution of charges: The charges on ULIPs aremandated to be evenly distributed during the lock-inperiod in order to eliminate high front ending of expenses.

Increase in risk component: Further, all ULIPs, other thanpension and annuity products, will provide a mortalitycover or a health cover, thereby increasing the risk covercomponent in such products.

Cap on surrender charges: IRDA has recommended a capon the surrender charges at up to 15% of the fund value in

the rst year for policies with a tenor more than 10 yearsand 12.5% for policies with a tenor of less than 10 years.This charge comes down to 5% and 2.5%, respectively, inthe fth year of the policy, and becomes nil for policies ofless than 10 years after the fth year. For tenors above 10years, the charge in the sixth year is 2.5%, which becomesnil in the seventh year.

Minimum guaranteed return for pension products:Regarding pension products, all ULIP pension/annuityproducts will offer a minimum guaranteed return of 4.5%per annum, or as speci ed by the IRDA from time to time.This will provide protection to the life time savings ofpensioners from any adverse uctuations at the timeof maturity.

Implications

The impact of these new guidelines on customers will befavorable due to lower charges and guaranteed returns,among other reasons. However, these changes willalso impact the margins of life insurers, as the charges,particularly surrender charges, are capped. This could havean adverse impact on their pro tability.

The possibility of a decline in the pro tability and increasein the capital requirements of life insurers has resulted indiscounting the previously high multiples assigned to thenew business achieved pro ts (NBAP), and as such, therecould be a decline in the valuation assigned to the lifeinsurance business. The changes in ULIPs guidelines couldalso result in a delay in the IPO plans of a number of playersas they will have to rework their product offerings.

Though it may make selling dif cult as it would makeproducts in exible, it would certainly reduce persistencyrisk, make AUMs stable, and boost the overallcertainty on assumptions and the pro tability of thebusiness underwritten.

Other regulations

Besides the above regulations, IRDA and the governmentare in the process of drafting more regulatory reforms forthe industry such as:

With the private players completing nearly 10 years ofexistence, the industry is seeking alternative ways tomeet its capital needs. The government is considering


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increasing the upper limit in FDI from the current 26% to49%. Foreign partners are largely unwilling to dilute theirstakes below 26%, since most of them enter the businessin anticipation of the limit being increased. This may resultin the local partner being compelled to reduce its staketo 49% to meet the new norms. This could create its owncomplications, since according to the Indian company law;a 51% stake ensures ownership.

IRDA is nalizing directives and detailed guidelines formergers and acquisitions in the insurance sector.

The policy document for the smooth transition fromSolvency I to Solvency II is in the draft stage.

A data warehouse is being set up to monitor thesettlement of insurance claims, better customerrelationship management and facilitate betterdecision making.

IRDA is considering allowing banks to tie up with multipleinsurance companies to vend their products. This will givebank customers a wider menu of options to select from, sothat they can buy insurance products based ontheir needs.

IRDA will soon come up with norms to de ne terms suchas critical illness and hospitalization cost, among others,a move that will reduce the scope for disputes betweeninsurers and hospitals.

Regulation affects the economics of both the supplyside (the policyholders supplier of funds) as well as thedemand side (the insurers borrowers of funds). The Indianconsumer, being extremely price sensitive, adjusts rapidlyto the altered economics, which could affect the persistencytrend in the industry. IRDAs role will be critical for furtherindustry growth and the rise in penetration levels.


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Section III:

Critical factors formarket development

Distribution channelsThe effectiveness and cost of diverse distribution strategiesof different players is crucial in ensuring the success of

players in the insurance business, particularly in the retaillines of business. The low differentiation among retailinsurance products suggests the criticality of distributionreach and ef ciency for success in this business.

The factors that determine the choice of the distributionchannel of an insurance company are:

Where are the customers?

What is target customer pro le?

Which product (linked, traditional, term, etc.) can be soldthrough distribution channel?

Which channel provides best buying experience and valueto target customer segment?What is the operational cost involved in each typeof channel?

The customer preferences vary by market segmentvis--vis geography, age, income, life style, etc., and marketcharacteristics change over time.

Role of intermediaries/distributors/ nancial advisors

Insurance has to be sold the world over, and the Indianmarket is no exception. The touch point with the ultimatecustomer is the distributor or the producer, and the roleplayed by them in insurance markets is critical.

Insurance distribution is not simply about pushing products.An outsized share of the value across the entire insuranceindustry value chain is added in distribution. For customers,it is in distribution that needs are understood and assessed,options (from full risk transfer to self insurance and moreexotic methods of managing risk) are identi ed, and counselon the choice of carriers and other providers is given. Itis because of distribution that relationships and trust arebuilt with agents, brokers and customers, opportunities areidenti ed and created, and products and services are sold.

It is the distributor who makes the difference in terms ofthe quality of advice for the choice of product, servicing ofpolicy post sale and the settlement of claims. In the Indianmarket, with their distinct cultural and social ethos, theseconditions play a major role in shaping the distributionchannels and their effectiveness.

The gure below provides an estimate of the currentmarket share of the various distribution channels used bylife insurers, and gives a view of how these channels coulddevelop in the future.


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Exhibit 2.6.: Current market share and potentialmarket growth

Low

High

P o t e n t i a l c h a n n e l g r o w t h

( M e d i u m

t e r m )

Current market share

Bancassurance

Bancassurance: Insurance products

offered through banks

Source: Watson Wyatt

Brokers: Representatives for buyerswho deal with either agents orcompanies in arranging for coverage

Corporate agents: Non-bankinstitutions involved in thesale of insurance products

Direct: Sales through call

centres and/or direct mailingInternet: E-commerce salesthrough internet portals

Tied agents: Insurancecompanies aligned agency force

Worksite: Marketing arrangementswith entities to sell insurance totheir employees

Tied agents

Internet

Direct

Low High

Worksite

Brokers

Corporate agents

In todays scenario, insurance companies must move fromselling insurance to marketing an essential nancial product.The distributors have to become trusted nancial advisorsfor the clients and trusted business associates for the

insurance companies.

The most prominent models of insurance distribution are:

Agents

Insurance agents have to know which product will appealto customers, and also know their competitors productsin the same space to be effective sales individuals who cansell their company and its products to the customers. Tothe average customer, every new company is the same. Lifeinsurance in India has been mostly distributed through anelaborate network of agents.

The agency force has a high gestation period and ismore suitable to sell complex risk-based products. Theproduct market focus on relatively simpler ULIPs makespredominantly agency-based models relatively expensive.

Agents are divided into various categories, depending on theskills, experience and productivity. Companies are focusingon identifying training needs and increasing the productivityof agents. Exhibit 2.7 provides features of agents atdifferent levels:


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Exhibit 2.7. Tied agency model

Low productivity

Source: Life Insurance, Edelweiss, 6 August 2010, via Thomson Research

Heavy investment required in product and process training

Insurers focus on controlling attritionInsurers' brand strength, product innovation and commission rates are critical in preventing attrition

High productivity

Loyalty (propelled by trailing commission build up)

Equips the organization with the ability to sell complex risk and asset protection products

Nascentagency force

"Trained" and"independent"agency force

"Mature" and"highly" productive

agency force

Agents are responsible for the reputation of the companythey are working for and have their obligations towardtheir clients. Here are some of the basic functions thatagents perform:

Provide all the necessary application forms

Submit application forms to the company

Arrange for all the medical tests and related formalities

Provide reminders premiums payments and

return receiptsShould help customers make necessary changes inaddress, nomination, etc.

Help in the process of assignment

Assist customers for any loan applications andrelated formalities

Should help customers revive lapsed policies

Assist in claiming death bene ts, if required

Besides the above, agents are now moving from thesole contact point between a customer and an insurancecompany to become nancial advisors. Agents would now

be responsible for explaining the nature of a policy tocustomers as that will help customers to take informeddecisions. Their role is likely to enhance, as they will not

only sell insurance products, but offer other nancialproducts as well to enhance customer bene ts.

The limiting factor for prospective insurers will be theextensive and costly distribution structure equipped forreaching this segment. While public sector companies areable to attract agents, they continue to suffer from highattrition rates due to the indiscriminate agent appointment.The most successful of these companies tied agents are

hardly of the elite variety of salespeople. They are still theneighborhood do-gooders the postman, the schoolteacherand the shopkeeper who know the people and arethemselves known in the community.

The challenge here is the lack of knowledge of thecompetitive market and the inability to do intelligentcomparisons with the competitors products. New companiesare looking for educated and aware individuals with amarketing air, an elite group that can be attracted onlywith high remuneration and the lure of a fashionable job, allof which may not be possible in this business with its pricepressures and the complexity of selling insurance. With

this kind of segmentation of intermediaries, the test forthe insurance company lies in training and educating thesepeople to become effective sales individuals.


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Further, IRDA holds a mandatory test and other training

programs for agents in India. IRDA norms are becomingincreasingly stiff for agents (commission reduced and spreadover a longer period of time) is likely to be even more strict,which would impact agents in the short term.

Bancassurance

Market entrants cannot expect to replicate the extensivedistribution network of the nationalized insurancecompanies. Building a distribution network is expensiveand time consuming. As a result, private insurers havelargely followed a strategy similar to that of the foreignbanks, i.e., starting from the af uent segment and graduallystrengthening the distribution network to reach out to themiddle-income segment.

Bank-backed insurers and those promoted by large banks that

are better positioned due to their relatively lower developmentcosts, predominantly variable cost structure (typically openingown sales branches imply higher xed and semi-variable costs)and the integration of systems that may reduce the costof operations.

Though bank-backed insurers are better placed because oftheir strong brand, variable cost business models, access tothe banks database and walk-in customers, which help reduceoverall acquisition costs, LIC clearly stands as an exception tothis tenet because of its scale of operations and productivityachieved over years of operations.

The bancassurance model functions at various levels, eachparty having a different level of agreement. Exhibit 2.8explains the various bancassurance models with their features.

Exhibit 2.8. Bancassurance model

Insurer able to leverage the bank's infrastructure; source of fee-based income for the bank

Source: Life Insurance, Edelweiss, 6 August 2010, via Thomson Research

Bank and insurer may have a fragmented view of their customers

Low level of integration

Reluctance of bank staff to sell insurance; insurer has little control over distribution

Insurer able to leverage the bank's infrastructure; source of fee-based income for the bankIntegration in product development and channel management

Sharing of customer database

Reluctance of bank staff to sell insurance to sell insurance; insurer has little control over distribution

Joint decision making; bank participation in product and distribution design

High system integration, infrastrucural utilization; low-cost model

Insurer loses control on distribution

Bank may be able to realize higher protability as an insurance distributor rather than as a producer

Full integration of system; lowcost model

Potential for fully integrated products and developing a onestop shop for nancial services

Insurer is ill equipped to exercise control over distribution

Bank may be able to realize higher protability as an insurance distributor rather than as a producer

Distributionagreement

Strategicallowance

Jointventure

Financialservices

group


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Technological advances are expected to enable new

distribution channels, while recent regulatory changes(banks entry into insurance) are expected to allow cross-selling between nancial services companies. However,banc-assurance is expected to gain considerable popularity.

The increased alliances between banks and insurancecompanies position the selling of insurance products bybanks as an opportunity to leverage their extensive branchnetwork and broaden their income base to include morefee-based business. Insurers equally see bancassurance asa low-cost option to expand their distribution network andforay into previously inaccessible segments of the market.

Other distribution methods

Alternate distribution channels are needed for thefollowing reasons:

To increase insurance penetration in the country

To differentiate on the basis of customer service; toretain and attract new customers to expand business

To increase insurance awareness and knowledgeamong people

To satisfy the needs of more demanding customers

To improve cost ef ciency in insurance distribution

Private players are exploring several alternatives to reducethe cost of replicating the distribution network of publicsector insurance companies. While third-party distribution infast-moving consumer goods is a possibility, the complexityof insurance products, especially given the low awarenesslevels, would necessitate direct selling.

One potential channel is marketing through corporateemployers, i.e., employers purchase products on behalf ofthe employees or at least support the marketing effort. Theconcept of worksite marketing, i.e., the sale of voluntaryinsurance products to employees at the worksite throughpayroll deduction has become common. Worksite marketing,which was once the realm of a few small companies, selling

just a few products, has now stretched to large companies,offering a variety of worksite products.

Brokers and corporate agents constitute a small part of

the distribution system in India. As on 31 March 2010,there were 259 direct brokers, 33 composite brokers and6 re-insurance brokers. While not many large brokers arepresent in the Indian market at the moment, the overallcontribution from corporate brokers is likely to increase asmany corporate agents are now becoming brokers. Globalinsurance brokers such as Aon, Marsh, Willis and Howdenhave also entered the Indian market.

Some products, once they receive a high level of penetrationand awareness, can become commodities and be soldthrough more impersonal channels. The use of the internetto distribute life insurance products has only recently

emerged, and has not made a signi cant impact so far,partly because of the substantial advisory component ofmost life insurance products.

The penetration in rural and semi-urban areas has becomethe core of distribution strategy of insurers. As in metrosand urban areas, insurers have targeted the mass-af uentsegment in rural areas as well. The cost of setting upoperations in rural/semi-urban areas is far lower comparedwith those in metros and urban areas. There is a promisingpotential of rural and semi-urban of ces with unrelentingexpansion in these areas and the presence of multipleinsurers may result in sub-optimal operations.

These distribution networks have reached an unprecedentedscale from mobile phone companies to micro nanceinstitutions to supermarket chains and churches. Customers,in vast numbers, who were previously off the grid are nowwithin reach.

Challenges with the existing distribution model

India is arguably one of the most challenging and promisingemerging insurance markets. Its rapidly growing economy,coupled with a young and diverse population, open ampleopportunities for the development of insurance. However,

there is much to be done to realize this potential. In todays


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Indian insurance market, the main challenge to insurers andintermediaries are:

Building faith about the company in the minds of clients

Intermediaries being able to build personal credibilitywith clients

Controlling operating expenses by reducingdistribution costs

Coping with IRDA norms on their commission

It is the traditionally tied agents that have been the primarychannels of insurance distribution in the Indian market.Public sector insurance companies have their branchesin almost all parts of the country and have attracted localpeople to become their agents. These agents are fromvarious segments in society and collectively cover the entirespectrum of the society. A person who has lived in thelocality for many years sells the products of the insurancecompany with a local branch nearby. This ensures the lastmile touch point being closer to the customer. Of course,the pro le of the people who acted as agents suggests thatthey may not have been suf ciently knowledgeable about

the different products offered, and may not have sold theappropriate product to the client. Nonetheless, the customer

trusted the agent and the company. This arrangementworked satisfactorily in the absence of competition.

In todays scenario, agents continue as the prime channelfor insurance distribution in India, as is the case in mostmarkets, supported by call centers to a small extent. Nearlyall the new players follow this model primarily because theregulations for other channels are yet to be put in place.However, there is great excitement in the industry over theimpending broker regulations and companies are planningall possible channels in their enthusiasm to strengthenvolumes. The belief that all these channels will grow andseamlessly integrate to bring in business seems a fallacy.

Since controlling expenses has become a challenge andmost of these expenses are incurred on distribution, theissue of ef cient cost management is strongly linked toeffective distribution. With the new IRDA regulation onthe commission structure, distributors will earn lowercommissions, going forward, and will have to accordinglyadjust their business models. The challenge will be no lessfor insurance companies. The xed and semi-variable costsin the business are high. With restriction on the ability topush the product, gaining scales will not be easy for all.


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A two-pronged approach to cost management can

be envisaged:Cut commission pay-outs

Shift toward variable cost distribution models

For a standalone insurer, achieving this will be a herculeantask, requiring the potential to execute low-cost customercapture independent of the distributor. In the absence ofproduct differentiation, the options available to insurers arelimited to:

Build a low-cost reach, which is the most desired andmost dif cult

Generate higher investment yields that may strengthen

the sales pitchBuild a strong retail brand, which will be expensive

The insurance industry in India has seen the emergenceof large bank-backed insurers. So far, the regulator hasallowed banks to enter only into corporate agency tie-upswith insurers. Hence, banks promoting insurance companiesremained tied to their ventures, putting to question theexistence of the arms length relationship between the bankand insurance subsidiary.

The emergence of a much more dif cult and evolvingmarket scene, with existing players,

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