Regulatory Challenges for Emerging

Insurance Industry

and

the Role of Insurance Sector in

Financial Stability

Presentation by

Randip Singh Jagpal, IRDA

20th Sep, 2013

2

AGENDA

Insurance

Banks vs Insurance

Types of Insurance

India Insurance Industry Status

Challenges in financial regulation and supervision

Response of the Regulator

Focus of the regulatory policy

Role of Insurance in Financial Stability

History

1818 - Oriental Life (Life)

1850 - Triton Insurance (General)

1871 – Bombay Mutual Life (Indian)

1907 - Indian Mercantile Insurance (General)

1912 – Life Insurance Companies Act

1938 – Insurance Act (Life & General)

1955/ 56 – Nationalization of Life Insurance/ LIC Act (245)

1968 – Social Controls (Gen Ins)

1972 - General Insurance Business Nationalization Act

What was the need of Reforms

TO ENHANCE Productivity

TO IMPROVE Efficiency

TO IMPROVE International Competitiveness

TO STRENGTHEN Financial System

TO ATTRACT Global Investments in the country

Key Financial Sector Reforms

Regulated Prices => Market Prices

External Sector Reforms

Capital Market Reforms

Fiscal Reforms

Public Sector Reforms

Banking Reforms

Insurance and Pension Market Reforms

Corporate Governance and disclosure

Technological Upgradation

Bankruptcy Reforms

Market Reforms (1985-91 - Initial reforms)

Reforms on the basis of recommendations of the

Chakraborty, Vaghul & Narasimham Committees

Shift from passive to active debt management

Maximum Coupon enhanced from 6.5% to 11.5%

Money Market rates freed

Non-Banking Institutions permitted to lend in Money Market

(Integration of markets)

Introduced new Money Market instruments – CD, CP, etc

(discriminatory interest rates, dis-intermediation, securitization)

Set up DFHI to activate Money Market

Market Reforms (Contd)

Setting up of SEBI/ NSE

DVP for security settlements at RBI

Evolution of PDs to strengthen security market infrastructure

Tarapore Committee - CAC

Activating repo market – Move to make call market purely inter-

bank market

Introduction of LAF

Settling up of Clearing Corporation

Insurance and Pension Sector Reforms

Impact of Financial Sector Reforms

Market Risk

Competitive Threats

Operational Risk

Business Opportunities

Governance

Credit Cycle

Insurance Sector Reforms

1994 – Malhotra Committee

1996 - Interim Insurance Regulatory Authority

1999 - IRDA Act

April, 2000 – Establishment of IRDA

July, 2000 – Notification of first set of Regulations

October, 2000 – Grant of first set of Certificate of

Registration (Licenses)

9

Evolution

Nationalised

Market

Regulated

Market

Free

Market

Regulated

Market

Insurance Act, 1938

LIC Act, 1956

GIBNA, 1972

IRDA Act, 1999

- No Regulations

- Plagued by fraud

-

- Urban centric

- Directed investments

- sub-optimal utilization

of resources

- Market development

- Standard products

- absence of consumer

choice

-poor customer service

- non-competitive market

-New entrants/ for. invst

- Level playing field

- Consumer Protection

-Competitive markets/

-Customer choices

Evolution (contd)

Current

Regulated market (Pre

Ins Amendt Bill)

New Entrants

Foreign Investments

Efficiency & customer

choice

Sectoral regulator

11

Future

Regulated Market

(Post Ins Amendt Bill)

Empowered regulator/

policyholder

Growth of health

insurance/ annuity

business

No further capital

12

Banks vs Insurance (Features)

Insurance

promise to pay

contingent upon happening of an

event/ accident/ period

exchange of consideration

sharing of risks

pooling of funds

loss of few is paid by premium of

many

transfer of risk to risk carriers

bought not sold

Banking

Assured Payments

Accept Deposits

Transport money across

time & space

lend money

maturity transformation

asset – liability management

short term liabilities

facilitate trade

13

Insurance (Principles)

Insurance

Uberrima fides (Utmost Good Faith)

Insurable Interest

Indemnity

Subrogation & Contribution

Proximate Cause

14

Types of Insurance

Life Insurance

Term Insurance

Endowment (Money Back)

Whole Life

Unit Linked

Annuities/ Pensions

Group

General Insurance

Property Insurance

Fire, Engineering,

Marine Insurance

Personal Insurance

Motor, Health, Personal

Accident Insurance

Liability Insurance

Employers Liability,

Product, Public, D&O

INDIAN INSURANCE INDUSTRY

15

Insurance Penetration with Select Countries and World Average

16

Year 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

World 4.68 4.76 4.59 4.55 4.34 4.5 4.4 4.1 4 4.01 3.8 3.69

India 2.15 2.59 2.26 2.53 2.53 4.1 4 4 4.6 4.4 3.4 3.17

PR

China 1.34 2.03 2.3 2.21 1.78 1.7 1.8 2.2 2.3 2.5 1.8 1.7

Brazil 0.36 1.05 1.28 1.36 1.33 1.3 1.4 1.4 1.6 1.6 1.7 1.99

0

0.5

1

1.5

2

2.5

3

3.5

4

4.5

5

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

World

India

PR China

Brazil

Insurance Density with Select Countries and World Average

17

Year 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

India in ` 424 571 613 681 801 1481 1761 1647 2430 2487 2212 2185

India in $ 9.1 11.7 12.9 15.7 18.3 33.2 40.4 41.2 47.7 55.7 49 42.7

PR China 12.2 19.2 25.1 27.3 30.5 34.1 44.2 71.7 81.1 105.5 99 102.9

Brazil 10.8 27.2 35.8 45.9 56.8 72.5 95.3 115.4 127.9 169.9 208 225.5

World in $ 235.0 247.3 267.1 291.5 299.5 330.6 358.1 369.7 341.7 364.3 378.0 372.6

0

500

1000

1500

2000

2500

3000

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Insurance Density in INR

Mission - To protect the interests of the policyholders, to regulate, promote and ensure orderly growth of the insurance industry and for matters connected therewith or incidental thereto

Composition - IRDA Act, 1999 provides that the Authority shall consist of the following members:

– Chairperson

– Not more than five whole-time members

– Not more than four part-time members

Presently the Authority has a composition of following members: – Chairman

– Four whole-time members

– Four part-time members

18

MISSION & COMPOSITION OF AUTHORITY

Road travelled

19

Financial Year ending 2000 2013

No. of Insurers 6 52

No. of Offices 5,429 17,861

No. of Policies (crore) 12.45 42.10*

No. of Employees (in lakh) 2.1 3.43*

No. of Agents (in lakh) 7.58 27.21*

Total Annual Premium (crore) 37,550 3,50342

Paid-up Capital (crore) 545 35,039

FDI (crore) 0 7,632

Investment ( in ‘000 crore) 218 1,861

Insurance Penetration (% of GDP) 2.32 3.96

Insurance Density (Per Capita Premium) `502 `2722

* 2012 data 1$ = `43.62 1$ = `51.16

Life Insurance as a % of Household Savings

Details 09-10 10-11 11-12

Total Savings as a %

of GDP 33.70 34.00 30.80

of which Household

Financial Savings as

% of Total Savings

35.60 30.60 26.00

Out of Household Financial Savings

Deposits & Currency

Of which deposits

51.70

41.90

59.40

45.60

64.10

52.80

Life Insurance 26.20 22.30 23.10

Provident & Pension

Fund 13.10 14.00 15.60

Shares &

Debentures 4.50 0.20 -0.70

Others 4.50 4.10 -2.10

Source: Economic Survey 2012-13 & RBI AR

2012-13 20

64.10

23.10

15.60

-0.70 -2.10

-10

0

10

20

30

40

50

60

70

Deposits &Currency

LifeInsurance

Provident &Pension Fund

Shares &Debentures

Others

2009-10 2010-11 2011-12

1st YEAR PREMIUM - LIC & PVT. SECTOR (LIFE

INSURERS) `crore

Life

Cos 01-02 10-11 11-12 12-13

PVT 269

(4000%)

39,386 (2.64%)

32,080 (-

18.55%)

30,750 (-4.15%)

MKT

Share 1% 31% 28% 29%

LIC 19,589

(102%)

87,012

(21.66%

)

81,862

(-

5.92%)

76,609 (-6.42%)

MKT

Share 99% 69% 72% 71%

Total 19,858

(104%)

1,26,39

8 (15.02%)

1,13,94

2 (-9.85%)

1,07,359 (-5.78%)

Note: Figures in brackets represents growth over previous year

21

0

10000

20000

30000

40000

50000

60000

70000

80000

90000

01-02

02-03

03-04

04-05

05-06

06-07

07-08

08-09

09-10

10-11

11-12

12-13

`CR

YEAR

1st YEAR PREMIUM - LIC & PVT SECTOR (LIFE INSURERS)

LIC

Private

22

Life Insurers 1996-97 2000-01 2001-02 2012-13

Private Sector - 6 272 78,399

Public Sector 16,277 34,892 49,821 2,08,791

Grand Total 16,277 34,898 50,093 2,87,190

Average

growth 19.78% 20.11%

Average Growth of Total Premium of Life Industry

Pre & Post Liberalization `crore

23

Trend of First Year Premium - ULIP & Traditional

Life Insurers (5yrs) `crore

YEAR 2008-09 2009-10 2010-11 2011-12 2012-13

ULIP 44660 59925 53560 17382 10877

TRD 42671 49969 72838 96560 96482

TOTAL 87331 109894 126398 113942 107359

0

20000

40000

60000

80000

100000

2008-09 2009-10 2010-11 2011-12 2012-13

ULIP

TRD

24

-989 2657 5974

-50000

0

50000

100000

150000

200000

250000

300000

350000

400000

450000

2009-10 2010-11 2011-12

Total Premium

Investment Income

Total Revenue

EOM

Benefits Paid

Profit

Performance of Life Insurance Industry

INVESTMENTS OF INSURERS

Note: Figures are cumulative and those in brackets are growth over previous year

Sector 2000-01 2011-12 2012-13

Life 1,94,009 15,81,259

(11%) 17,41,175 (10.11%)

General 24,462 99,268 (20%)

1,19,325 (20.20%)

Total 2,18,471 16,80,527

(11%) 18,60,500 (10.70%)

Life Business

2000-01 2011-12 2012-13

Traditional 1,94,009 12,11,287 13,98,668

ULIP 0 3,69,972 3,42,507

Total 1,94,009 15,81,259 17,41,175

`crore

25

LIFE INSURANCE - TRENDS

26

Growth at 20.11 CAGR has been exceptional compared to other

segments in the financial sector (2004-13)

Penetration increased from 1.77% in 2000 to 3.17% in 2012.

Density increased from `332 in 2000 to `2185 in 2012

Equity share capital - `25,519 crore.

AUM - `17.41 lakh crore as at March 2013

Significant investor in capital market

Continues to mop retail household savings, which invests in Capital

Market

Equity exposure of `3.85 lakh crore (22%) as at March 2013

General Insurers

01-02 10-11 11-12 12-13

PVT Sector

467 (6453.98%)

17,425 (24.67 %)

22,315 (28.07 %)

27,951 (25.26 %)

Mkt Share

4 % 40 % 41 % 44 %

PSU 11,917 (13.59 %)

26,417 (20.96 %)

32,263 (22.13 %)

35,201 (9.10 %)

Mkt Share

96 % 60 % 59 % 56 %

Total 12,384 (17.97 %)

43,842 (22.41 %)

54,578 (24.49 %)

63,152 (15.71 %)

GROSS WRITTEN PREMIUM – GENERAL INSURERS

Note: Figures in brackets represents growth over previous year

`crore

27

0

5000

10000

15000

20000

25000

30000

35000

40000

01-02

02-03

03-04

04-05

05-06

06-07

07-08

08-09

09-10

10-11

11-12

12-13

`CR

YEAR

GROSS WRITTEN PREMIUM GENERAL INSURERS

Private Public

28

General Insurers

1996-97 2000-01 2001-02 2011-12 2012-13

Private Sector - 7 467 22,315 27,951

Public Sector 7,347 9,799 10,979 30,532 35,201

Grand Total 7,347 9,806 11,446 53,032 63,152

Av. Growth 9.66% 16.89%

Average Growth Of Gross Direct Premium In India Pre & Post Liberalization

`crore

29

-9944 -8816

-6958

-10000

0

10000

20000

30000

40000

50000

2010-11 2011-12 2012-13

Net EarnedPremium

Net Claim Incured

Expenses ofManagement

UnderwritingProfit/Loss

Total Investments

Profit after Tax

`cro

re

Performance of General Insurance Industry

Trends in Non-Life Insurance Sector

CAGR of 20% in General & 27% Health insurance business

Retention ratio increased - 81.44 in 2011-12 to 82.20 in 2012-13

Underwriting losses are largely due to under-pricing in motor third party and group health insurance.

Declared profits are solely because of sale of accumulated investments. This is more prominent in public sector companies.

• Penetration increased to 0.78% in 2012 (0.71% in 2011)

• Density increased to `537 in 2012 (`451 in 2011)

• Average growth of premium from 2001-2013 : 16.89% (9.66% from 1997 -2001)

• Indian Motor Third Party Insurance Pool (IMTPIP) was dismantled with effect from 31.03.2012 and redesigned to Declined Risk Pool (DR Pool) with effect from 01.04.2012.

30

CHALLENGES IN FINANCIAL

REGULATION

32

CHALLENGES IN FINANCIAL REG - I

Principle based regulation vs Rule based regulation

Solvency Margin – Factor based (Solvency I) vs Risk based (Solvency II)

Products – standard products vs different products

Product approvals – file & use vs use & file

Commissions – variable/ percentage based vs fee based

Distribution – closed architecture vs open architecture

Reinsurance – maximising retentions vs risk diversification

Office set-up – branch vs subsidiary model

33

CHALLENGES IN FINANCIAL REG - II

Assets – Conservative (Book Value) vs Fair Value

Equity Faire Value – Not for solvency

Debts and other securities – Book Value

Investments – directed vs risk weighted

Liabilities – conservative vs discounting

Accounting Standards – IFRS

Acquisition costs – upfront vs deferred

Outsourcing V/s In House

Taxation Issues – if assets valued on Fair Value

Others

Financial Inclusion

High Operating Cost

RESPONSE OF THE

REGULATOR

35

RESPONSE OF THE REGULATOR

Steps taken by IRDA

Tilted towards Rule based regulation

IRDA’s Approach is for risk based solvency – strengthening of IIB ad data collection

discussions paper issued on standard products & file & use

Percentage based till Act amendments

Movement towards open architecture – banks as brokers / bancassurance

Maximising retentions

both branch & subsidiary

IFRS : Insurance sector will be subject to IFRS on finailsation of revised standard

Financial Inclusion : CSCs

Operation Cost : Repository to reduce operating cost

FOCUS OF REGULATORY

POLICY

37

FOCUS OF REGULATORY POLICY

Regulatory focus

Increased surveillance and inspections

Early warning systems – will warn IRDA in advance

Detariffing – liberalism and consumer benefit

Innovations in product design – Add-on covers

Health reforms – pre-existing disease, senior citizen, renewability clause

Careful approach to licensing – fit & proper players

Consultative approach – interest of stakeholders considered

ROLE OF INSURANCE IN

FINANCIAL STABILITY

The Indian Financial System

Percentage Share in total financial assets

59.3

2.3

5.8

6.5

2.4

13.5

4.1

6 Scheduled Commercial Banks and LABs

Urban Cooperative Banks

Rural Cooperative Credit Institutionsand RRBs

NBFCs

Development Financial Institutions

Insurance Companies

Provident and Pension Funds

Mutual Funds

Diverse but largely within a defined

regulatory perimeter

What is Financial Stability ?

• It is a condition in which the financial system is capable of withstanding shocks thus reducing the likelihood of disruptions in the financial intermediation process

• Any disruption can significantly impair the allocation of savings to profitable investment opportunities.

• Three parts of the financial system:

– financial intermediaries, such as banks, insurance companies and other institutional investors that direct funds from those willing to invest/lend to those who want to borrow.

– financial markets, where lenders and borrowers meet.

– financial market infrastructures through which money and financial assets flow between buyers and sellers..

•The dimensions of financial stability are broad and encompassing and is forward looking

Factors affecting financial stability

Vulnerabilities in the real economy

Global imbalances and rapid capital flows

Asset price bubbles

Shadow banking system

Light touch regulation

Interconnected markets and too big to fail counterparties

Highly accommodative Monetary Policy

Financial Network Analysis

The network of the financial system

Systemic Risk

• Defn: risk of widespread disruptions to the provision of financial services that have serious negative consequences for the real economy.

• Two objectives of macro prudential policy: the first it to strengthen the resilience of the financial system to economic downturns and other adverse aggregate shocks

• To actively limit the build up of financial risks. Such leaning against the financial cycle seeks to reduce the probability or magnitude of a financial bust.

Sources of systemic risk

• Time dimension:

– Financial imbalances that build up gradually over time may unravel suddenly. -procyclicality

•Cross sectional dimensions:

– Contagion risk - an initially idiosyncratic problem that becomes more widespread, often in a sequential fashion.

– Shared exposure to financial market shocks or adverse macroeconomic developments that affect a range of financial intermediaries and markets at the same time

Policy instruments

• Capital based tools (eg countercyclical capital buffers, sectoral capital requirements, and dynamic provisions)

• Liquidity based tools( countercyclical liquidity requirements, margins and haircuts)

• asset based tools such as LTV and DTI

• Managing capital account –an instrument for LDCs and emerging markets

Financial Stability and Development Council

The FSDC, set up in 2010, is a body consisting all regulators and the Ministry of Finance. It is the highest forum in matters

relating to financial stability. The Council is chaired by the Union Finance Minister

Financial Stability

Financial Sector Development

Macro prudential

surveillance of the

economy

Financial literacy and

financial inclusion

Inter-regulatory

coordination The responsibility of

FSDC includes

Financial Sector : Banking & Insurance Crisis

1. Core Insurance Not Systematically Risk

2. Insurance Pools Risks (Cash Premium)

Provides Protection

Long Term Contracts

Tight Investment Regulations

Reinsurance (Diversification)

No Liquidity Risk /Source of Stability

Source of Stability

Inverse : Maturity Transformation (Life)

Buyers : When Fire Sales occur in Money, Debt & Equity Market

Risk : Idiosyncratic & Uncorrelated. Not linked to Business Cycle

Asset Base : Marketable /Rated Securities

Payment

System : Not Running & Administering unlike Banks

Why no Liquidity Risk?

Upfront Premium

Strong Cash Flows

Controlled Outflows

Inverted Cycle of production

No Leverage

AIG : A Case Study

• AIG – Global Insurance Giant

• 2008- CRISIS- AAA rated – CDS on CDO of AAA rated mortgage by its London Office

• AAA rated securities to AA - the company had to post additional collateral, which it was unable to do without support.

• Liquidity CRISIS : Bailout in US 85billion US$- The largest bailout

Crisis In Insurance Industry in India

• Life Insurance Industry : AMP Sanmar Life Insurance Co. Ltd :

Measures : Stake Sale

• Non-life Insurance Industry : Under-provisioning of Motor TP Losses

Measures Taken

1. Infuse Additional Capital and

2. relaxation in Solvency

3. Inflation linked hike in Premium

Lessons from crisis

• That price stability and macroeconomic stability do not guarantee financial stability

• Radical change in thinking on regulatory philosophy and the Efficient Market Hypothesis

• Need to strengthen the macro-prudential framework

The need to better identify, assess and manage the systemic risks prevailing in the financial sector.

Renewed policymaker interest in developing and improving tools to promote financial stability

Monitoring Mechanism in Insurance Sector

• (i) Solvency statement

• (ii) Financial Condition Report (FCR)

• (iii) Investment Returns

• (iv) Return Shareholding pattern

• (v) Disclosure Requirement

• (vi) Grievance Redressal Mechanism

• (vii) Asset Liability Management and Stress Testing Report

• (viii) Corporate Governance Guidelines

Powers of the Authority

• Section 33 of the Insurance Act – Power of investigation and Inspection by the Authority

• Section 34 - Power of the Authority to issue direction

• Section 34B – Power of the Authority to remove managerial person from Office

• Section 34C – Power of the Authority to appoint additional directors

• Section 34E – the Authority may caution or prohibit insurers against entering into any particulars transaction or class of transactions and generally give advice to any insurer.

Powers of the Authority

• Section 34 G – Power of Authority to order closure of foreign branches

• Section 37A of the Act provides for the IRDA to prepare a scheme of amalgamation

• Section 52A of the Act provides life insurers is undertaking life insurance business to be prejudicial to the interests of the holders of life insurance policies.

• Section 54H of the Act further provides for the power of the Central Government to acquire an undertaking of insurers in certain cases.

Crisis Management Template- IRDA

– Solvency position- Ladder of Intervention – Persistency Ratio (Life), – Capital market volatility (ULIP) – Calamity / Catastrophe (Life & Non-life) – Contagion Risk- Arising from Regulatory Action

or Otherwise (Reputational Risk etc.)

• In Addition, a close watch is kept on the development in the global market including equity indices, bonds and innovation in insurance sectors and its likely impact on the insurance industry.

Cont

d.

Impact of Increase in Interest Yield

• – Increase in interest rate on G Sec coupled with the fall the equity price may attract the insurers to invest more in G Sec due to the following two reasons

• • G Sec qualify under “approved securities”

• • The rate of return on G Sec will be attracted with zero risk of default

• – LIC has purchase G-Sec worth of Rs. 20,000 Crores.

• – The increase in the interest rates of the corporate Bonds and money market has also provided an opportunity to the insurers to invest for example LIC , in the month of August, 2013, has invested a sum of Rs. 4000crores in Bonds.

Impact of fall in Capital Market

• – Redemption pressure on ULIP .

• – Insurance Companies are not going to add to the fall in the capital market as the evidence available so far suggests that the role of the insurance function in financial crisis has had a stabilizing rather than a destabilizing influence on the system as a whole.

• –Insurance companies are large investors and they(especially life insurers) typically have longer-term investment horizons than several other financial institutions such as banks. The fall in the capital has provided an opportunity to the insurance companies to invest for example LIC has invested a sum of Rs.3000Crores during the month of August, 2013

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