India’s Insurance Sector Positions Itself as the Next Arena for ReformPublished: October 03, 2012 in India Knowledge@Wharton
The insurance sector in India has been thrown open for some 12 years now. Until the passage of the Insurance Regulatory and Development Authority Act in 1999, it was a public sector monopoly. The act eased some controls, but foreign direct investment (FDI) was restricted to 26%. In a capital-hungry business, this has proved a constraint to growth.
Changes in the environment have also hit private sector companies hard, particularly those operating in the life insurance space. "We are looking forward to change," says G.V. Nageshwara Rao, managing director and CEO of IDBI Federal Life Insurance. IDBI Federal is a joint venture of IDBI Bank, Federal Bank and European insurance major Ageas. (Ageas controls 26% of the equity.) "In the short term, there are many challenges. In the long term, the future is bright," Rao adds.
On Monday, Finance Minister P. Chidambaram revealed a partial roadmap for insurance liberalization. It included speedier clearance of products, fewer restrictions on distribution, tax benefits for individuals who take insurance cover, and the channelizing of more insurance money into infrastructure projects. Chidambaram has left it to the regulators – the Insurance Regulatory and Development Authority (IRDA), the Central Board of Direct Taxes and the Central Board of Excise – to announce the nitty-gritty. They have been asked to take a decision by October 10.
Chidambaram has been holding regular meetings with the heads of insurance companies. He has also met IRDA chief J. Hari Narayan. There is more action in the pipeline. IRDA ari NarayanHhas just issued draft guidelines for initial public offers (IPOs) by general insurance companies. IRDA has invited comments by the end of October and the final policy is expected in a couple of months. These are, however, small steps; the big moves are yet to come.
The principal stumbling block facing big reforms in the insurance sector is that there is a bill pending in Parliament: The Insurance Laws (Amendment) Bill was first tabled in 2008, but the government has not tried to get it passed because it lacks the voting power. The bill was modified, but even then did not gather the required support. "The government cannot change the FDI norms while that bill is pending," notes Rao. What's more, a parliamentary committee headed by former Finance Minister Yashwant Sinha has recommended that the FDI ceiling be maintained at 26%.
While the reality is that the government can't do anything much on FDI immediately (unless it risks a no-confidence motion), hope has been kindled by statements at a global seminar on insurance in Mumbai in late September, where an increase in the FDI ceiling was supported by Hari Narayan. "Insurance requires greater levels of investment," he said. "We would welcome steps to increase FDI in the insurance industry."
FDI Not Important?
Experts, however, feel that the FDI issue is not as crucial as some are making it out to be. "I don't see it making a major difference," states Sankarshan Basu, associate professor of finance and control at the Indian Institute of Management Bangalore. "[At best], if the larger global players come to India, there will be an increase in the efficiency of the insurance business. I think the opposition [to the FDI move] is more political in nature."
At the operational level, foreign joint-venture partners are already very involved in the industry, adds Robin Roy, associate director for financial services at PwC India. "They bring the product and risk-related expertise, " Roy notes. “Generally, such arrangements have worked well. Raising the FDI limit will bring capital for future growth and [a degree of] comfort to the foreign partner."
Avinash Parekh, partner and national leader for global financial services at Ernst & Young (E&Y), prefers a more segmented approach. "If FDI is increased from 26% to 49% it’s not going to create any major excitement or have any significant impact. "To understand why, Parekh notes that one must segment the insurance market into the general and life sectors. General insurance, he says, requires infusions of capital not because a company’s portfolio is growing, but because the firms have been making losses due to the pricing structures that have evolved in the industry in the past two years.
In life insurance, Parekh notes, there are three categories of players: "First are the industry leaders that are established and doing very well. They have broken even and don’t need further capital. They will not be impacted by the FDI change. Second are companies that do have an issue with capital and have not been doing too well. They are the ones who are eagerly waiting for the FDI reforms to happen," he points out. "Third are the newcomers who have been there for the past four-to-five years. Most of them are in the process of building up their portfolios and are, in fact, struggling. They also need more capital. But these opportunities don’t really excite the foreign players." In addition, he says, foreign companies have changed their outlook on India in the past few years -- "not because India is no longer attractive, but because they are facing a lot of pressure in their own markets."
If FDI is a non-starter and also relatively inconsequential, what is the excitement about? Part of it can be attributed to the "animal spirits" that Manmohan Singh exhorted Indian industry and investors to uncork, experts note. But there is also an agenda of action still possible despite the straitjacket imposed by the parliamentary bill.
Investment Norms to Change
One indicator of future reform is that the IRDA is expected to change the investment norms it prescribes for insurance companies. Under the current regulations, a firm can invest up to 50% of its fund in government securities, 15% in infrastructure bonds, and 35% in corporate paper and equities. The finance ministry has been talking to IRDA to increase investment limits in infrastructure.
More important from the insurance company point of view are the adjustments that could be made to some earlier regulations. As a watchdog, IRDA has interpreted its role to be totally consumer oriented. The once-popular Unit Linked Investment Plan (ULIP), where the cash value of the policy varies based on the net value of the underlying investments, has run out of steam because IRDA reduced distributor commissions to one-third of their earlier levels. It has certainly become a better deal for the buyer -- but there is no one to buy it from. (Insurance products in India need hard sell; unlike in the U.S., the policies don't get picked up simply because they are there.) ULIPs have dropped from 70% of sales (measured in terms of new business premium) in 2008-2009 to 15% in 2011-2012. Similarly, for pension products, IRDA has asked companies to give a guarantee. But shareholders are not comfortable with that. "IRDA has made things better for the consumers, but at the cost of the industry," says Rao. "The result is that many of these products have disappeared."
The past two-to-three years haven't been the happiest of times for the insurance industry. In the life insurance sector, for instance, there has been a slowdown because of the country's economic travails. The saving rate has come down and insurance has been impacted. (In India, insurance is looked upon as a form of savings.) And IRDA's consumer-centric orientation has been adding to the troubles, critics note.
With so many speed bumps on the path, is insurance in India still attractive? In a report titled, "India Life Insurance 2012: Fortune Favors the Bold," McKinsey & Co. sets out the positives. "All factors are in place for the Indian life insurance industry to blossom into one of the fastest-growing financial services markets in the world," the report says. "The still nascent market is at an inflection point -- rising incomes driven by economic growth are boosting demand, and increasingly sophisticated consumers with different needs are driving some differential plays."
India's life insurance market has grown at more than 40% annually (measured in terms of new business premium) in the past six years. But the ratio of insurance premium to GDP is around 4%. In developed markets, this figure typically ranges from 6% to 9%. Penetration is very low, practically zero in the unbanked segment. In addition to new customers, there will be a move by existing policyholders to increase coverage. For the industry, premium income is likely to go up sharply. This spells opportunity, experts say.
"India is poised to experience major changes in its insurance markets as insurers operate in an increasingly deregulated and liberalized environment," notes a Confederation of Indian Industry-E&Y report. "However, despite the liberalization in the insurance sector, public sector insurance companies are expected to maintain their dominant positions. [But] there will be enough business for industry entrants." According to IRDA data, there are 24 private sector companies in the life segment. The public sector Life insurance Corporation (LIC) dominates with a 70% plus market share. There are 27 private sector companies in the non-life category. The state-owned companies have a 60% share of the market.
Will the new guidelines for IPOs result in a rush to market? Not necessarily, experts say. The IRDA norms note that the company must have been in existence for 10 years. The Securities & Exchange Board of India (Sebi) rules stipulate that the company must have turned a profit for three years. That leaves very few firms in the running, except for some public-sector companies. Though it matters much more in life, the government would be loath to let the public sector players out of its control. The life insurance sector (including the smaller private companies) has an investment corpus of around US$250 billion. LIC has often been used by the government to bail itself out of disinvestment disasters. "LIC, which was estimated to invest Rs. 50,000 crore (US$9.46 billion) in equities this fiscal, has hardly invested a fifth of it with nearly half the year behind, leading to speculation that it is keeping its powder dry to bail out government share sales if investors turn their back on them," business daily The Economic Times reported.
"I don’t see a rush happening [for IPOs]," adds Parekh, who is part of the committee that IRDA has appointed to look into the IPO regulations. "Here again, you need to segment the players. The public sector general insurance companies are eagerly waiting for the IPO regulations. But look at their performance. They went through major strategizing and have burned a lot of money in those exercises. The end result is that they are continuing to lose money. Their performance doesn't comply with the existing Sebi regulations."
Of the private sector players, Parekh notes that around eight or nine are part of large conglomerates. "They don’t need to rush to the market. They have capital and can wait," he says. "They are performing well, but they are not making profits out of their portfolio; actually no one is making profits out of underwriting. They are making profits from investment income. The third category is that of players who are not performing well. So even if they were to go for an IPO, there will be no excitement on the part of potential investors."
You can't second guess the markets, however. Even on the rumors of policy changes, Max India gained 6% in one day. Mitsui Sumitomo of Japan has a 26% stake in its insurance subsidiary. Bajaj Finserv, which has an insurance JV with Allianz, was up 9%. "IPOs will happen when the climate improves," Rao predicts. Adds Basu: "If the reforms do go through, I do expect a number of companies tapping the market." Roy is not so gung ho. "There may not be a mad rush," he cautions.