Life Insurance In India: Opportunities, Challenges and Strategic Perspective (Response Books)

….From micro insurance to the macro economic environment, Dr Sadhak provides a solid foundation for anyone that wants to understand the transformation of one of the world’s most important insurance markets. As an active participant in this market, both before and after liberalization, the author brings a range of experience that makes the volume extremely useful to everyone from industry newcomers to policymakers and regulators. All of the above would benefit from the wise counsel of Dr Sadhak as they face the challenge of ‘managing change’ in the coming years. Robert J Palacios Senior Economist, South Asia Human Development Sector (World Bank) Life Insurance in India: Opportunities, Challenges and Strategic Perspective by Dr Sadhak is a pioneering work on Indian Life Insurance Industry with a new perspective. The book is a culmination result of research and practical experience for a number of years by an internationally acknowledged financial economist and practicing manager with proactive and visionary thoughts. The book has been written in the context of Globalization, Economic Reforms and Liberalization of Indian insurance and capital markets and overall financial sectors. The scope and dynamics of growth of Indian Life Insurance Industry has been discussed in the light of changes in macro economic environment, demographic transition, changing market structure, changing product–market relationship, emerging convergence in financial markets, etc. Dr Sadhak has also focussed on certain critical issues like Strategic Planning and Market Research, Change in Management Systems dealing with distribution and customers expectation with futuristic perspectives which, I think, would provide immensely helpful guidance to the practicing managers. Tarun Das ADB Adviser, Fiscal Management and Strategic Planning, Ministry of Finance, Government of Mongolia; Former Economic Adviser, Ministry of Finance and Planning Commission, Government of India Dr H Sadhak is one of a rare breed of Industry Executive and Practitioner with serious academic credentials, His new book Life Insurance in India: Opportunities, Challenges and Strategic Perspective rightly puts the spotlight on the new reality facing the industry in India following reforms and globalization. He has dealt with all three components of the life insurance industry—protection, pension and investment—in the overall framework of a rapidly changing financial services marketplace. The historical data and current statistics supplied in the book are of particular importance. Dr Sadhak focuses on risk management as a key management function, which is a relatively new concept for the nationalized sector of the industry in particular. Finally, I am particularly pleased that corporate governance issues have been highlighted. In a globalized economy best management and governance practices are indispensable tools of survival. The old industry and its management culture must change to prosper in the new paradigm. I congratulate Dr Sadhak for his contribution to the process and will look forward to more intellectual output from him in days to come. Dilip Chakraborty Finance Director, Life & Pension Business, Canada Life Limited, UK

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LIFE INSURANCE IN INDIA Life insurance industry in India is transforming with the fast changing economic condition, emerging needs of the rising middle class, and evolutions in the capital markets. With its unique development history, India’s insurance industry has its unique challenges. An accomplished writer and an industry expert, who also has extensive practicing experience in various financial sectors, Dr H Sadhak provided unique and powerful insights on the changes and strategies of the Indian life insurance companies. As an actuary and a practitioner in the pension and insurance industry in Asia, I have thoroughly enjoyed reading this book and I am deeply impressed by the depth and breadth of knowledge of Dr H Sadhak. I would encourage anyone who would like to gain deeper understanding of India’s insurance industry and keep this book in his library. Vanessa Wang FSA, Regional Head of Retirement Consulting, Mercer Asia, Beijing Dr Sadhak’s work Life Insurance in India: Opportunities, Challenges and Strategic Perspective is a comprehensive treatise on Life Insurance industry in India. The book is unique in that it spans both breadth and depth of knowledge. It provides powerful insight with a historical perspective into the life insurance sector. It is a great book in terms of lucidity of presentation of a complex subject. I strongly recommend this book to academicians as well as practicing managers. Pritam Singh Professor of Eminence, Management Development Institute, Gurgaon; Former Director, Indian Institute of Management, Lucknow Long-term drivers for growth in life business are increasing awareness of life-protection, higher income and savings levels and increasing working age population. Factors like booming capital markets and an inclination of consumers to use life products as an investment-cum-protection vehicle, greater awareness spread by players in terms of innovative product design, aggressive marketing and widening distribution also drive life business. A practicing author like Dr H Sadhak harmonizes the drivers to accelerate the process of life business to carry it to a disruptive growth phase. K C Mishra Director, National Insurance Academy, Pune, India

Life Insurance in India

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LIFE INSURANCE IN INDIA

Life Insurance in India Opportunities, Challenges and Strategic Perspective

H Sadhak

Copyright © Manjushree Sadhak, 2009 All rights reserved. No part of this book may be reproduced or utilized in any form or by any means, electronic or mechanical, including photocopying, recording or by any information storage or retrieval system, without permission in writing from the publisher. First published in 2009 by Response Books Business books from SAGE B1/I-1 Mohan Cooperative Industrial Area Mathura Road, New Delhi 110 044, India SAGE Publications Inc 2455 Teller Road Thousand Oaks, California 91320, USA SAGE Publications Ltd 1 Oliver’s Yard, 55 City Road London EC1Y 1SP, United Kingdom SAGE Publications Asia-Pacific Pte Ltd 33 Pekin Street #02-01 Far East Square Singapore 048763 Published by Vivek Mehra for SAGE Publications India Pvt Ltd, typeset in 11/13 pt Minion by Star Compugraphics Private Limited, Delhi and printed at Chaman Enterprises, New Delhi. Library of Congress Cataloging-in-Publication Data Sadhak, H. Life insurance in India: opportunities, challenges and strategic perspective/H. Sadhak. p. cm. Includes bibliographical references and index. 1. Life insurance—India. I. Title. HG9163.S23 368.3200954—dc22 2009

2009006971

ISBN: 978-81-7829-846-7 (PB) The SAGE Team: Anjana C. Saproo, Meena Chakravorty, Anju Saxena and Trinankur Banerjee Disclaimer: This Publication has been designed with a view to disseminate academic information. While every effort has been made to enhance reliability of the same from multiple sources, readers must not construe the contents of this book as investment advice. The views expressed by the author are purely personal. Neither the Author nor the Publishers are liable for any discrepancy, which may have appeared. Sound professional advice and services relating to investment by the reader can be sought from professionals in the field. The author(s) of this book has/have taken all reasonable care to ensure that the contents of the book do not violate any existing copyright or other intellectual property rights of any person in any manner whatsoever. In the event the author(s) has/have been unable to track any source and if any copyright has been inadvertently infringed, please notify the author(s) and the publisher in writing for corrective action.

To Partha and Cosmica

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Contents

List of Tables Foreword by T S Vijayan Preface Acknowledgements

x xiii xv xviii

Chapter 1

Globalization, Liberalization of Financial Markets and Life Insurance

1

Chapter 2

Reforms and Emerging Economic and Financial Environment in India

30

Chapter 3

Indian Life Insurance—Changing Market Structure and Emerging Opportunities

74

Chapter 4

Product–Market Relationship and Distribution in Convergent Financial Market

158

Chapter 5

Managing Life Insurance Investment

219

Chapter 6

Issues in Life Insurance Governance

295

Chapter 7

Managing Change and Challenges

343

Glossary Bibliography Index About the Author

359 372 378 383

List of Tables

1.1 1.2 1.3 1.4 1.5 1.6 1.7 1.8 1.9 2.1 2.2 2.3 2.4 2.5 2.6 2.7 2.8 2.9 2.10 2.11 2.12 2.13

Extent of Globalization Exports Growth and Share in World Trade Distribution of Household Assets in Financial Instruments in 2000 Asset Allocation of Life Insurance Companies—A Global Scenario Mature Markets: Assets under Management by Institutional Investors—A Gobal Scenario Assets under Management of Insurance Companies in Emerging Markets (in terms of GDP) Global and Regional Growth in GDP and Life Insurance Premium Regional Variation in Market Share, Penetration and Density State and Foreign Ownership, Tariffs and Entry Barriers, 2003

11 12 16 17

Sectoral Real Growth Rates in GDP (at Factor Cost) Macro Economic Aggregates (at Current Prices) BRICs Real GDP Growth: 5-year Period Averages Financial Assets of Banks and Financial Institutions (as on 31 March) Trend in Domestic Savings in India Distribution of Financial Saving (Gross) of the Household Sector in India Changes in Financial Assets of the Household Sector (at Current Prices) Trends in Institutional Investment Stock Market Index, Turnover and Market Capitalization GDP, GDS, HDS and Life Fund PDI, Savings and Life Insurance Premium Inflation, Interest Rates and Life Insurance Savings in India The Population and Life Insurance Business from 1980–81 to 2004–05

32 34 35 41 44

19 20 22 24 26

47 48 52 54 67 69 69 70

List of Tables

3.1 3.2 3.3 3.4 3.5 3.6 3.7 3.8 3.9 3.10 3.11 3.12 3.13 3.14 3.15 3.16 3.17 3.18 3.19 3.20 3.21 3.22 3.23 3.24 3.25 3.26 3.27

Growth of Life Insurance Business in India 1914–48 New Business for the Years 1953–57 Total Business in Force during 1952–57 Distribution of Total Investment of Corporation as on 31 December 1957 LIC—Some Basic Statistics: 1957–2006 LIC of India Investment as on 31 March 2006 Surplus, Share of Government and Taxes Paid by LIC Entry of Private Life Insurance Companies Equity Share Capital of Life Insurance Companies Premium Underwritten by Life Insurers Company-wise Total Life Insurance Premium New Policies Issued by Life Insurers Market Share of Life Insurers First Year Premium Underwritten by Life Insurers during 2006–07 Commission and Operating Expenses of Life Insurers as Per cent of Premium Projected Changes in Indian Demography Health Insurance Coverage in India Income Class-wise Savings Rates in India Post-reforms Projections of Contributions under Pillars 2 and 3 Asset Preference Pattern: Distribution of Households by Type of Instruments Distribution of All Households in Instruments by Income Class Indian Life Insurance Industry in the Context of World, Emerging Market and Asia Life Insurance Penetration and Density in Some Selected Countries in 2004 Top 10 Emerging Markets in Terms of Life Premiums Emerging Markets—Regional Insurance Premium 2004 in US$ Million Key Insurance Indicators of Life Insurance in Emerging Economies (in 2004) Life Insurance in Emerging Markets (2004)

xi

81 81 82 82 85 89 90 94 95 98 99 100 100 101 103 105 109 128 129 138 138 143 144 146 147 148 150

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Product–Market Characteristics of Major Global Life Insurance Markets, 2004 New (Premium) Business (Life) Underwritten through Various Intermediaries 2003–04

5. 1 Investment of Life Insurance Corporation of India (as on 31 March) 5. 2 Loans and Debentures Advanced to Various Entities for Infrastructure and Social Purpose 5.3 Growth in Investment of Life Insurance Industry 5.4 Fund-wise Investment of Life Insurance Companies 5.5 Individual Investment of Life Insurance Companies (as on 31 March) 5.6 Fund-wise Pattern of Investment of Life Insurers: Life Fund (as on 31 March) 5.7 Fund-wise Pattern of Investment of Life Insurers: Pension and General Annuity Fund (as on 31 March) 5.8 Fund-wise Pattern of Investment of Life Insurers: Group Excluding Group Pension and Annuity Fund (as on 31 March) 5.9 Fund-wise Pattern of Investment of Life Insurers: Unit Linked Fund (as on 31 March) 5.10 Items and Quotation for WPI 5.11 Money Supply and Consumer Price Index in India

164 186 236 237 237 238 239 241 242 244 245 277 278

Foreword

Life insurance has emerged as the most vibrant segment in the financial sector in India particularly since the liberalization of the market in the year 2000. The growth of life insurance was fuelled by nationalization of the industry in 1956 and Life Insurance Corporation (LIC) has not only played an unparalleled role by spreading the message of life insurance throughout the country, but also a significant role in the economic development of the nation. However, liberalization has provided a further boost to growth by allowing domestic and foreign insurance companies to operate in the Indian market, which not only increased the depth of the market and competition in the marketplace but also improved the service quality, product range and life insurance literacy. However, compared to the importance of life insurance in economy and society, not much standard literature on life insurance is available in India. This book of Dr Sadhak will fill up the vacuum to a great extent. The author has followed a much needed integrated approach, examining the growth of life insurance in the light of globalization and changing dynamics of macro economy. The book deals with a large number of important issues in life insurance critical to growth in post-liberalized competitive marketplace and offers many valuable suggestions for good governance and faster growth of Indian life insurance industry. The author has made a successful attempt to evaluate changes in financial economy and to integrate development of life insurance and contractual savings in the globalized environment. Development of life insurance in the emerging market has also been discussed in the context of globalization and market reforms. Indian financial market including life insurance has come a long way since the days of centralized planning, which has impacted the management of life insurance in a big way, particularly since economic reforms and liberalization. These issues have been discussed in detail with reference to the emerging trend in macro economy, savings market and capital market. One of the lesser known areas of the Indian life insurance industry is the changing dynamics and market structure, which the author has focussed upon, beginning with the 1818 regulation of the industry till today. Readers will be delighted to know many less known facts

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in the context of reforms, liberalization and changing market structure; the scope of future life insurance market including annuity market, health insurance market and microinsurance market have also been discussed. Another interesting area in the life insurance industry is the changing product–market relationship and this has been discussed in the context of convergence of the financial services industry. The author has focussed on some critical issues in marketing and distribution of life insurance products including current practices in distribution and also highlighted strategic issues in marketing. While the author has focussed on scenario planning and marketing research for penetration into the hidden market, he has also suggested a Macro–Micro Model for managing the changes in the marketplace. The book also deals with important issues and relevant investment strategies to manage life insurance funds for better returns. Another important area of focus of the book is risk management in life insurance in the era of volatility and complexities in the market. Readers will also be benefited by the addition of the section on understanding macro economic indicators. Today, governance in life insurance is a very important and most focussed area. The book has dealt at length with various methods of supervision, issues in ethical practices, corporate governance, corporate social responsibilities, etc. This book is a valuable contribution to life insurance literature and I visualize that it will find great acceptability not only amongst the managers in life insurance industry but also amongst all those who have interest in life insurance and the financial services industry. T S Vijayan Chairman LIC of India, Mumbai

Preface

Life insurance industry is an important and integral component of macro economy and has emerged as a dominant institutional player in the financial market impacting the health of economy through its multi-dimensional role in savings and capital market. While the primary role of a life insurance company is to provide insurance coverage for managing personal financial risks, it plays a very crucial role in promoting savings by selling a wide range of products and also actively contributes in promoting and sustaining the capital market of a country. In the emerging economy, characterized by the reduced role of state and declining statesupported social security, the importance and the role of the life insurance industry has increased significantly not only as a risk manager but also as retirement security and annuity provider. Moreover, growing institutionalization of the financial market has also provided a momentum to boost the life insurance companies. Therefore, a reassessment of the role of life insurance in the context of the changing market and economic environment is required for managing life insurance companies effectively. This book is an attempt to work in this direction. Most of the publications available on life insurance in India are basically a kind of historical account which focus on life insurance as an insurance entity rather than an important component of financial services industry. Therefore, a need was felt to study life insurance industry in India in the context of changing dynamics of macro economy and financial markets in the backdrop of ongoing globalization and economic reforms. Moreover, several emerging and crucial issues which are critical to growth such as risk management, business ethics, corporate governance, etc., have not been given the required attention by industry managers. These are not merely the required conditions to enhance customer value but are necessary for strategic market expansion. All these issues have been covered in the seven chapters of this book. In Chapter 1, an insight into the trend of globalization has been provided along with liberalization and its impact on financial market. The changing role of institutional investors and life insurance has also been discussed which is undergoing a significant transformation and gradually emerging as a dominant player in the financial economy in developed and emerging markets industry. Globalization has also opened avenues for the growth of the life insurance industry benefiting the emerging economies and the same has been discussed in the context of market deregulation and its impact on growth of life insurance in emerging markets.

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Globalization and liberalization also induced transformation in the Indian economy, which is experiencing financial market integration and is gradually becoming a service-driven economy. These phenomena of change have been discussed with reference to evolving macro economy, savings and capital markets in Chapter 2. Since the changes in life insurance industry closely depend on changing macro economic variables, we have examined the relationship between the macro economic variables and life insurance market in India. In Chapter 3 one can get an insight into the transition of the Indian life insurance industry since 1818 and evolving market structure from pre-nationalization period to the postliberalization period. In modern economy the life insurance market has expanded in many directions by offering products for various financial needs such as health and retirement. We have also made an attempt to examine the existing market as well as the future market potential for life insurance industry in India. One of the basic questions before the Indian life insurance industry is how to expand the market base in an era of financial market convergence. In spite of opting for several new distribution channels such as bank assurance, corporate agencies and internet marketing, the Indian market base remains more or less stagnant in terms of coverage of insurable population. Probably the problem lies with an appropriate marketing strategy and understanding life insurance market and its customers through scientific marketing research. Therefore, in Chapter 4, the changing product–market relationship has been discussed in the context of financial integration, emerging product market for life insurance, scope and necessity of marketing research and strategic planning and distribution methods to realize market potential and to manage emerging life insurance market. One of the most important responsibilities of any life insurance company is to manage its liability efficiently, to realize the value of the funds of the policyholders received by it as premium income. Therefore, investment management is critical to efficient management of an insurance company. Efficiency in funds management calls for depth in understanding of investment science, particularly the strategic issues. Keeping this in view, various conceptual issues have been briefly discussed and in the light of that the management of investment has been examined by Indian life insurance companies in Chapter 5. Since investment management is basically a function of liability management, which in turn is an important component of risk management, the issue of risk management has been focussed upon in a life insurance company. Here, various issues have been dealt with such as sources of risks, instruments of risk management and practices of risk management in life insurance. Today ‘system of governance’ is one of the most intensely discussed issues all over the world. No business organization can sustain its growth unless it puts in place an appropriate system of governance. However, there may not be any straitjacket ideal solution to this, but a system comprising sound regulatory regime, corporate governance, ethical standard of business and corporate social responsibility, etc., can be put in place. This issue is more important because a life insurance company has to protect the interest of a large number of stakeholders. We have discussed these issues in Chapter 6 of the book.

Preface

xvii

A conclusion has been avoided because the market and its influencing parameters are changing constantly. Moreover, management is a dynamic phenomenon which changes with economic and social expectation, and environment. In view of this, instead of providing any concluding view, some of the important issues have been highlighted which are critical to good management of any life insurance company—to enhance the contribution of managers and employees, expand the market base and optimize the customer value, etc., in Chapter 7. This work is an individual initiative undertaken to enhance insurance knowledge in the interest of millions of customers, managers of life insurance and students of life insurance. The work has been completed in my spare time and at the cost of leisure and sacrifice of family life. I would like to mention that the views expressed in this book except those quoted are my personal views.

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Acknowledgements

Writing an acknowledgement is probably the most difficult task for an author as a book is an outcome of direct and indirect support of many, but only some of whom end up receiving a mention due to several constraints. Yet, I would be failing in my duty if I do not mention the names of at least a few of the many institutions and individuals without whose support this work would have remained incomplete. Of the many institutions which offered me invaluable help by allowing me to study and use their publications, I would specially mention and thank the international reinsurance and research company Swiss Re. I have been immensely benefited by referring to the publications of Life Insurance Corporation (LIC) of India, Reserve Bank of India (RBI), Insurance Regulatory and Development Authority (IRDA), Federation of Indian Chambers of Commerce and Industry (FICCI), New Delhi and many other institutions and would like to thank them all. In addition to the ones mentioned there are many other institutions and authors whose work has enlightened me and they have been cited in this book to make it richer in content. I am grateful to them and would like to thank them all. There are many eminent experts who have provided immense technical support and encouraged me during this work and I am thankful to them all. But I would like to express my sincere thanks to Dr Robert Palacios, Senior Economist, World Bank; Ms Vanessa Wang, Regional Head, Retirement Consulting, Mercer-Asia, Beijing; Dr Tarun Das, former Economic Advisor, Ministry of Finance, Government of India; Dilip Chakraborty, Finance Director, Canada Life Limited, London; Dr Pritam Singh, Former Director, Indian Institute of Management, Lucknow and Dr K C Mishra, Director, National Insurance Academy, Pune for kindly offering their valuable comments on this book. There are many friends and colleagues who have provided immense mental and moral support to bring out this edition. To name just a few of them, I would like to mention my friends and colleagues, namely, Mr T S Vijayan, Chairman, LIC of India; Mr D K Mehrotra, MD; Mr Thomas Mathew T, MD and Mr A K Dasgupta, MD, of Life Insurance Corporation of India, for their encouragement and moral support. There are many other well wishers, who have constantly encouraged me during this work. A few of them are Mr G N Bajpai, former Chairman, LIC

Acknowledgements

xix

and Securities Exchange Board of India (SEBI); Jagdish Capoor, Chairman, Bombay Stock Exchange and Former Dy Governor, Reserve Bank of India; Shailesh Haribhakti, Chairman (Haribhakti & Associates); M N Singh, IPS (Retd.); Yoshihisa Ishii, General Manager, Dai-Ichi Mutual Life Insurance Company, Tokyo; Dr D P Rath, Director, Economic Analysis Department, Reserve Bank of India and Dr Rajesh K Parchure, Gokhle Institute of Economics & Politics. I would also like to thank the anonymous referee who had painstakingly gone through the first draft and offered many valuable suggestions which have improved the quality of this book. I am also thankful to the staff members of Response Books, for successfully bringing out this book. Last but not the least I owe a great deal to my wife Manjushree, son Partha and daughter Cosmica, who stood by me when I used to struggle after office hours. Finally, I would like to mention that while I share my success with all those mentioned above, I alone remain responsible for any shortcomings.

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Chapter 1 Globalization, Liberalization of Financial Markets and Life Insurance Since 1991, Indian economy has undergone a sea change in the wave of globalization and restructuring of domestic economy through a large number of measures in real sector as well as in financial sectors. These measures intended to improve macro economic efficiency and make our production system internationally competitive. Understanding these changes and international marked integration is essential from the point of long-term strategic initiatives of corporate management. The process of globalization has brought structural changes in the financial market and financial intermediaries particularly, institutional investors have emerged as important players in the newly emerging market-based financial structure. In institutionalized financial market, institutional investors such as life insurance, pension funds and mutual funds play an active role as saving immobilizers and resource alligators. Understanding the new role and emerging linkages in an integrated financial market will enable us to estimate the place of life insurance industry in a long-term perspective, particularly in the context of cross-border flow of savings and investment. Globalization has further increased the scope of the life insurance business. Liberalization of financial markets and opening up of the insurance sector to foreign and domestic private operators induced market competition and scope for market expansion. Emerging market, due to their high growth potential, are destinations of foreign investment. Therefore, the need for insurance market liberalization in the interest of national economy and domestic consumers requires to be examined in the light of the ongoing process of market integration and globalization. Therefore, an attempt has been made to highlight these issues as follows: 1. 2. 3. 4.

Financial economy in the era of globalization. Economic reforms and global integration of Indian economy. Contractual savings, institutional investors and life insurance. Globalization and emerging trends in life insurance.

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Financial Economy in the Era of Globalization and Liberalization Financial market plays a crucial role in the economic development of a country through allocation of scarce resources. It transfers resources from savers to borrowers, thus directs resources from the idle sector to the productive sector, therefore, accelerating investment activities in the economy. This allocation function of financial market has been nicely put by Stiglitz (1994): Financial markets essentially involve the allocation of resources. This can be thought of as the brain of the entire economic system, the locus of central decision making; if they fail, not only will the sectors profit be lower than would otherwise have been, but the performance of the entire economic system may be impaired.

Since early 1970s repressive financial policies came under criticism and economists like Gurley and Shaw (1995) advocated the need for institutionalization of savings and investment activities in an economy. They showed that banks and other financial intermediaries can create excess supply of investment over desired savings and influence the rate of growth in an economy. Ramond Goldsmith (1969) advocated the existence of a financial superstructure thereby meaning financial institutions, instruments and market for economic growth. According to him a financial superstructure facilitates the migration of funds to the best use in terms of social return through acceleration of economic growth. Mckinnon also suggested liberalization of the economy, unification of the capital market and doing away with the repressed financial system. Financial intermediaries also play an important role in eliminating market imperfections which arise out of non-dissemination of information about borrowers. According to Kaizuka (1987) distortions in the market can be eliminated or mitigated by several institutional devices, including financial arrangements such as issuing market for securities, besides financial intermediaries. According to Kaufman (1986), financial institutions are ‘expected to embody the essence of integrity and their entrepreneurial drive is well balanced by a strong sense of fiduciary responsibility and that is why financial regulations have always been a part of economic development’. Structural changes in financial markets induced a reverse trend in financial intermediation, that is, financial disintermediation—where the central role of banking is moving away to make room for investment institutions and institutional investors. The process of disintermediation has been introduced by the shift of financial system from credit-based to capital market-based. Institutions such as insurance, pension funds and mutual funds play a central role in capital market-based system unlike the credit-based system, where banks are the key players. Growing emphasis on adopting capital market-based system for economic development in liberalized economies has enhanced the importance of financial disintermediation and the role of institutional investors, particularly contractual savings institutions like life insurance and pension funds for their unique role as the risk transferor,

Globalization, Liberalization of Financial Markets and Life Insurance

3

asset allocator and contributor to economy-wide development. We may discuss the importance and role of these institutions in the context of globalization and integration of the global financial market.

Globalization Economic liberalization is the gateway of globalization and financial liberalization plays the most crucial role in global economy. Globalization, according to Penguin Dictionary of Economics (Bannock G), ‘Stresses…the geographical dispersion of industrial and service activities (for example research and development, sourcing of inputs, production, distribution) and the cross border networking of companies (for example, through joint ventures) and the sharing of assets.’ According to Herman E Daly, globalization serves the vision of a single, cosmopolitan, integrated global economy. This definition focuses on the cross-border movement of goods, services and resources (financial and human) impacting the domestic and global assets and employment. Globalization, thus focuses on an integrated economic world in which economy is a single market characterized by trade and investment flows, cross-border economic activities in production, investment financing, movement of capital, technology, labour, internationalization of consumption, capital and services. Towards globalization, a country must move to economic liberalization by dismantling entry barriers and licensing system, reduction in physical restrictions on imports, reduction in control on capital and current account, reforming financial system and opening up financial market to private (domestic and foreign) players, reduction in controls on foreign capital (FD and portfolio) flow to the country, etc. Globalization is not a new phenomenon of the current world activities. Economic historians have traced two strong waves of globalization. The first wave of globalization spread over 1870–1914 while the second wave of globalization began roughly in 1960 and is continuing. However, the current wave of globalization is much faster and deeper. Fundamentally, today globalization is a new economic phenomenon and a process to set up a new economic order; globally increased integration and interdependence of production, consumption and services.

Drivers of Globalization The present wave of globalization has been significantly influenced by advances in Information Technology (IT), increased flow of trade and capital, improved resource allocation, productivity, innovation, adaptability and utilization of technology. These have not only reduced the cost of production and distribution but also boosted competition and necessitated the need for cross-border economic activity for all the countries. Therefore, important drivers of globalization are expansion of international trade, internationalization of financial market and migration. According to Baldwin and Martin (1999) both waves of globalization were driven by radical reduction in technical and policy barriers

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to international transactions. But the uniqueness of recent globalization is heavily shaped by the dramatic reduction in communications cost, which is sometimes referred to as ‘the death of distance’. Increased speed of globalization during recent times further strengthened global integration as there were significant improvements in major parameters of global integration. According to ‘Global Development Indicator, 2004’, published by the World Bank, trade in goods as per cent Gross Domestic Product (GDP) went up from 32.5 per cent in 1990 to 40.3 per cent in 2002. During the same period the ratio of commercial service exports to merchandize trade went up from 21.5 per cent to 23 per cent, gross private capital flows as per cent to GDP 10.1 per cent to 20.8 per cent and gross Foreign Direct Investment (FDI) flows as per cent of GDP went up from 2.7 per cent to 5 per cent. International Trade

The most important feature of globalization is the liberalization of trade in goods and services and unrestricted flow of capital across the border, which brings global integration and interdependence among economies. Globalization has a direct positive impact on trade, as observed by Fischer (1998) ‘over the past 50 years the volume of world trade has increased more rapidly than GDP and more economies have become more open to international trade’. Trade liberalization plays an important role in integration of international commodity market through reduction in tariffs and removal of entry barriers. It also opens up possibilities of faster growth and reduction in inequality. Cooper (2002) has observed that: A new trading possibility, brought about by import liberalization or by changes in the prices of foreign goods, is closely analogous to an improvement in technology at home, both enlarge the menu of choice, raises the utility of consumers of the products in question and worsen the terms of trade of producers of competing products.

World exports of goods and services which averaged US$ 2.3 billion a year during 1983–92 have more than tripled to an estimated US$ 7.6 billion in 2001 (Hausler 2002). Recent globalization is significantly marked by liberalization of tariffs, particularly since the signing of General Agreement on Tariffs and Trade (GATT) in the late 1940s. Baldwin and Martin (1999) observed that today: The world trade system is viewed by almost all nations as an essential public good, a system that is worthy of support even for purely nationalistic reasons…the GATT and WTO govern almost 70 per cent of World Trade including the European Union’s (EU) external Trade…WTO/GATT membership has grown from 19 nations in the late 1940s to over 120 nations today, the coverage of GATT has been expanded to include agriculture, service and clothing. Additionally, the rules and institutions have been greatly strengthened by creation of the WTO. International Migration

Migration of labour is considered to be an important driver of globalization. Mass migration from poor countries to the rich countries will have a long-term impact on inequality and

Globalization, Liberalization of Financial Markets and Life Insurance

5

reduction of poverty in poor countries. The present wave of globalization has also witnessed significant increase in migration of labour force from developing to developed countries. The United Nations has estimated that the world stock of migrants was 2.3 per cent of the world population in both 1965 and 1990. It has been further mentioned that the share of migration of people from developing countries in total US immigration rose from 50 per cent in 1960s to 80 per cent in 1990s (Zlotnik 1999). Increased flow of migration from poorer countries to the richer countries helps in global convergence.

Financial Globalization The process of globalization is strongly supported by financial globalization. There is an inextricable relation between increased international trade in goods and services and the increased flow of international capital. It is due to increased trade followed by increase in payments, banking service hedging, etc. Further, increased international trade is also supported by increase in capital flow—FDI and portfolio investment, etc. It has been observed that during the recent wave of globalization, trade liberalization of financial and capital market was strongly supported by increased speed and sophistication of IT. James Tobin (1998) ‘the logic of financial globalization is to increase the elasticity of substitution between the risk adjusted rates of return on local assets and debts and those in dollar markets until the local central bank has no margin within which it is free to determine domestic interest rates’. Financial globalization is often equated to financial integration, though they are different concepts. While financial globalization refers to increased global linkages particularly through cross-border flow of financial resources, financial integration refers to integration of domestic capital market with the global capital market through flow of capital in a liberalized capital account regime. However, our focus is quite broad and includes both the concepts but refers to financial globalization discussed in terms of capital mobility and market integration.

Benefits of Financial Globalization Liberalization and globalization produce immense benefits to the integrated countries. Liberalization creates a conducive climate for faster economic growth, allows upgradation of technology, provides scale economy, expansion of markets domestically and internationally. Economic integration through liberalization can also expand job opportunities in the domestic market and through migration of labour in general. Financial globalization produces higher economic growth through direct and indirect impact on the economy. Direct influence of global financial integration reflects in augmentation of the much required domestic saving which boosts capital investment in investment starved countries. It also provides avenues for better allocation of capital and minimizes risks. Capital flow is accompanied by transfer of technology and finally assists in promoting healthy capital market. Indirect influence of globalization includes integration of domestic economies followed by improving the macro economic policy framework and setting up economic institutions

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and better governance systems. Financial liberalization has forced many countries to open up financial markets and relax the rules of intermediation allowing financial service institutions such as investment banks, asset management companies, mutual funds and pension funds to operate in newly liberalized markets. The forces of change unleashed by financial globalization reflected disintermediation of the banking system, increase in cross-border financial activity, increased competition in savings market and convergence in financial services industry. Financial globalization offers unprecedented benefits to the credit-starved countries which can raise funds by issuing securities in the international market; both borrowers and investors can obtain better terms for borrowing and lending and borrowing at low cost. James Tobin (1998) observed ‘while globalization of financial markets—the liberalization and deregulation of international financial transactions—has made important contribution to the economic progress of developing and emerging economies and can continue to do so, these trends also threatened the monetary sovereignty of these countries’. We may examine some recent trends in cross-border capital flow. International Capital Flows: Financial liberalization through liberation of capital account by many countries has provided momentum to cross-border flow of capital. According to Gerd Hansler (2002) ‘Global gross capital flows in 2000 amounted to US$ 7.5 trillion, a four fold increase over 1990. The growth in cross-border capital movement also resulted in larger net capital flows, rising from US$ 500 billion in 1990 to nearly US$ 1.2 trillion in 2000.’ According to Global Financial Stability Report (International Monetary Fund [IMF] April 2004), Global capital inflow has increased by 3.3 times from US$ 779 billion in 1993 to US$ 2,535 billion in 2003. During the same time, capital inflows to the emerging markets and developing countries increased by 1.6 times from US$ 204.9 billion to US$ 332.8 billion wherein developed countries were the major beneficiaries. Flow of Foreign Investment: Inflow of foreign capital accompanied by FDI is critical for a developing country which may result in improvement of management system, upgrading of production techniques, improvement in quality control and further access to foreign market. FDI has a significant impact on production in the emerging market. By encouraging FDI, developing economies can import the much needed technology, which would further generate spillover for local firms. Saggi (2002) mentioned three types of potential channels of spillover, namely demonstration effect (local firms adopting technologies introduced by multinationals), labour turnover (switch-over of trained labours to local firms enabling technology diffusion) and vertical linkages (multinationals supplying technology to suppliers of intermediate goods). Dobson and Hufbauer (2001) estimated that cumulative foreign investment (mainly FDI) contributed over 6 per cent to the GDP of emerging market countries by 2000. Cooper (2002) has noted that some aggregate evidence credits FDI with a significant growth-enhancing impact, especially where adequate skills are locally available. Free flow of capital, as noted by Feldstein (2000) reduces the risks which owners face by diversifying lending across borders. It also allows transfer of technology and promotes competition in the host country. FDI flow has a definite investment impact in the host country.

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7

A study by Bosworth and Collins (1999) regarding the impact of capital inflows (FDI, portfolio investment and bank loans) on domestic investment of 58 countries covering Latin America, Asia and Africa noted that an increase of a dollar in capital inflows is associated with an increase in domestic investment of about 50 cents both expressed as percentage of GDP. While FDI appears to produce about one for one increase in domestic investment, no such relationship was observed with respect to other types of capital. Annual flows of FDI now exceed US$ 700 billion and the total stock exceeds US$ 6 billion. Over the past decade, FDI flows have grown at least twice as fast as trade. Gorg and Greenaway (2004) has pointed out that benefits of FDI flows, particularly through location of foreign firms arises through several spillover channels. Gorg has further observed that ‘FDI is a key driver of economic growth and development’. Theory points to reason why spillover might arise, but finding robust empirical evidence to support their evidence is more difficult. This could indicate that the benefits are in fact illusory, that is, multinational firms are effective in protecting their assets. However, they further suggest that for effective spillover, the characteristics of the economic environment are generally much more important: infrastructure, local labour market condition, reliability of communication system, etc., as well as overall macro economic and trade policy climate. Capital flow in emerging markets: According to Global Financial Stability Report (IMF 2004), Global capital flows in emerging and developing countries could not keep pace with total global flows. While total capital inflows increased from US$ 574.1 billion to US$ 2,202.2 billion in developed countries, the same in emerging markets and developing countries increased from US$ 204.9 billion in 1993 to US$ 332.8 billion in 2003. In fact in terms of percentage share it had declined in emerging markets from 26.3 per cent in 1993 to 13.13 per cent in 2003. However, the flow of direct investment to the emerging countries showed a better trend. While the flow of direct investment to emerging countries increased from US$ 70 billion in 1993 to US$ 175.7 billion in 2003, that is, by 2.51 times for the developed countries; the same declined by 0.93 times during the same period. An opposite picture emerged with respect to portfolio investment which increased from US$ 189.9 billion in 1993 to US$ 788.2 billion in 2003, that is, by 4.2 times in developed countries but the portfolio investment in developing and emerging economies declined from US$ 94.7 billion to US$ 62 billion, that is, by 0.65 per cent. Financial globalization has brought significant changes in the financial market, in the form of structural changes pushed forward by institutional investors. Emerging and developing countries are resorting more and more to the process of securitization by issuing debt and equity securities. Global Development Report 2004, released by the World Bank, indicates that bank and trade related lending to low- and medium-income countries has substantially declined from US$ 15,581 million in 1990 to US$ 10,039 million in 2002, while the flow of portfolio investment in (bonds) increased by 11.8 times from US$ 1,076 million to US$ 12,739 million and that in equity increased by 1.6 times from US$ 3,004 million to US$ 4,945 million. However, FDI increased at a higher rate by six times from US$ 24,032 million to US$ 147,086 million. Though total capital flows in emerging and developing countries in absolute volume increased

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from US$ 204.9 billion in 1993 to US$ 332.8 billion in 2003, the share of portfolio investment declined from 46.2 per cent to 18.6 per cent in the same period. Developments in Stock Markets: Stock markets, in a globally integrated financial market facilitate risk sharing, improve efficiency in resource allocation, impact savings decisions and provide liquidity, thus, supporting faster economic growth. Globally integrated stock markets facilitate economic growth by improving liquidity in the market, providing support to resource allocation prospects by creating an environment for flow of savings, reducing uncertainty of capital in the market, thereby reducing risks through global diversification. A well-organized and well-governed capital market can provide financial capital to the economy by attracting savings from domestic savers as well as from foreign investors. The size of the global capital market estimated by adding market capitalization (US$ 31,202.3 billion), debt securities (US$ 51,965.1 billion) and bank assets (US$ 40,627.8 billion) totalled to US$ 123,795.2 billion in 2003, which as percentage of GDP was 342.3. The assets of emerging capital market stood at US$ 9,015.3 billion, that is, 7.3 per cent and as percentage of GDP was 232.9 (IMF 2004). Data provided in World Development Indicators, 2004, further showed that market capitalization as percentage of GDP increased from 45 per cent in 1990 to 74.6 per cent in 2002. However, in India the GDP increase was more than double, that is, from 12.2 per cent to 25.7 per cent. However, portfolio investment is more volatile and volatility is often associated with risks and can produce stock market crisis. On the other hand FDI is more stable and can withstand the crisis. Therefore, many countries prefer FDIs than portfolio investment. In India while FDI increased by about 130 times during 1990–91 to 2003–04, portfolio investment increased by about 475 times.

Globalization and Economic Growth We have noted above that there are numerous benefits which can be derived from economic liberalization in general and financial liberalization in particular. Theoretically, expected benefits of liberalization have also been empirically established by researchers. It has been noted that the average per capita income is higher in countries with more open economic policies and better global linkages than in the countries with less openness in the financial sector. Globalization has helped promote convergence of per capita incomes among countries, per capita incomes have grown faster in globalizing developing countries (those lowering trade barriers) than in rich countries—5 per cent versus 2.2 per cent in 1990s. Non-globalizing developing countries have lagged behind (Hausler 2002, p. 8). Rourke and Kevin (2002) has observed that ‘the trend of rising inequality over the past 200 years, primarily between countries, now appears to have been reversed and the experience of the 19th century suggests that increased globalization will accelerate this decline’. Research of Borensztein et al. (1998) shows that FDI contributes more to domestic growth than domestic investment also FDI is more productive than domestic investment. Liberalization of capital markets attracts foreign

Globalization, Liberalization of Financial Markets and Life Insurance

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investment which influences the price of equity, thereby reducing the cost of capital. Research of Bekaert and Harvey (2000) indicated that post-liberalized regulatory reforms bring down the cost of capital and also help to increase inflow of capital. Financial liberalization also imparts structural formats of capital markets and improves disclosures, transparency and corporate governance which commonly create growth prospects in a liberalized country. Prasad et al. (2003) has noted that ‘International financial integration can help to promote domestic financial sector development, which in turn can help to moderate macro economic volatility. However, so far these benefits of financial integration appear to have accrued primarily to industrialized countries.’ The main conclusion of Prasad et al. (2003) on financial globalization is: So far it has proved difficult to find robust evidence in support of the proposition that financial integration helps developing countries to improve growth and to reduce macro-economic volatility. Of course, the absence of robust evidence on these dimensions does not necessarily mean that financial globalization has no benefits and carries only great risks. Indeed most countries that have initiated financial integration have continued along this path despite temporary set back. This observation is consistent with the notion that indirect benefits of financial integration which may be difficult to pick up in regression analysis, could be quite important.

Globalization of Indian Economy It has been observed that the current world has absorbed the wave of globalization and countries are increasingly getting integrated with the world market through free trade, removal of domestic restrictions on capital movement and switching over to market determined exchange rates. In 1980s, India initiated a move towards closer integration of Indian economy with the global market by removing many restrictions. However, a more effective process began only in 1991 when the country confronted serious balance of payment (BOP) crisis. Since then a wide range of measures have been introduced which include reforms in trade, industry, financial and public sectors in order to improve efficiency, productivity and international competitiveness of Indian industries with a view to impart dynamism to the overall growth process with emphasis on liberalization, privatization and globalization. According to Das (2003) the basic characteristics of reforms in India are: 1. Gradual, step-by-step and evolutionary approach, not a big bang, shock therapy or revolutionary approach. 2. General political consensus and strong emphasis on ‘human face’. 3. Preference for decentralization and prioritization and sequencing of reforms. 4. No write-off/rescheduling of external debt. 5. Practically no sacrifice made by people.

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According to Dr R N Ghosh, India’s economic reforms since 1990s have involved two basic sets of policy measures. The first set aims to achieve macro economic stabilization by reducing both fiscal (budgetary) and balance of payments (BOP) deficit. The second set plans to alter the production structure by increasing the role of markets in the economy, directly through privatization or by way of reduction in state investment and interventions and directly through domestic deregulation and trade liberalization. To achieve these objectives—India has taken a number of steps, for example, improve revenue collection, tax/GDP ratio and to reduce public expenditure through fiscal consolidation. Abolition of import licensing on most products, rationalization of customs duty, etc. Number of measures were also introduced to increase productivity, expansion and modernization of Indian industry and to encourage FDI and portfolio investment. The major reforms implemented for globalization include: 1. Indian rupee has been made fully convertible on current account and almost fully convertible for foreign residents. 2. Introduction of market determined exchange rate and abolition of licences for foreign trade. 3. Liberal regime for foreign investment and technology transfer. 4. Gradual reduction of customs duties and removal of foreign exchange control. 5. Liberal policy for external commercial borrowing and outward investment. 6. Liberalization of financial and capital markets.

Extent of Globalization in India The reforms introduced since 1991 have brought some fundamental change in the Indian economy. A desired and decided move from post-independence Nehruvian socialism based on the concept of self-sufficiency and import–substitute industrialization to export directed industrial base economy. The other noticeable change is with respect to global integration through a more competitive market. Economic reforms have resulted into more closer economic and market integration of the Indian economy with global market, which can be seen from the following:

GDP Impact of reforms have been noted in the growth rate of GDP. Overall GDP at factor cost improved from 5.6 per cent in 1990–91 to 6.9 per cent in 2004–05 (Table 1.1). Thanks to reforms, India has been able to overcome the Hindu rate of growth (around 4 per cent) and achieved an average growth rate of about 6 per cent during 1990–91 to 2004–05. Growth impulse created by reforms is expected to continue and sustain.

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TABLE 1.1 Extent of Globalization 1990–91 Overall GDP (at factor cost) (%) Export value (US$ million) Import value (US$ million) Trade balance (US$ million) Invisible (net) (US$ million) Current account balances (US$ million) Capital account (US$ million) External assistance US$ (net) Commercial borrowing (net) Foreign investment (net) (US$ million) (a + b) (a) Direct investment (b) Portfolio investment Foreign exchange reserve (US$ million)

5.6 18,477 27,915 –9,438 –243 –9,680 8,402 2,204 2,254 14,445 5,536 8,909 1,278

2004–05 6.9 80,831 118,961 –38,130 31,699 –6,431 32,175 1,922 5,947 11,944 3,037 8,907 –26,159

Source RBI Annual Report 2004–05 and Government of India Economic Survey 2004–05.

Impact of Trade Reforms Successful trade reforms since 1991 reflected in robust growth of exports and significant change in export components reflected heavily in favour of service exports. Trade in goods and services as ratio of GDP increased from 18 per cent in 1990–91 to 48 per cent in 2004–05, as against merchandize trade from 14.6 per cent to 28.8 per cent during the same period. There was an upward shift in trade of goods and services during the post-reform period which in terms of US dollars increased from 7.9 per cent in the first half of the decade of the 1990s to 15.3 per cent during 2000–01 to 2003–04 led by software and other miscellaneous services (Economic Survey 2004–05). The success of trade reforms and degree of global integration through trade may be noted in terms of increase in export and import in value as well as in GDP terms. It can be noted from Table 1.1 that there was manifold increase in Indian exports and imports. While exports in US dollar (million) increased from US$ 18,477 in 1990 to US$ 80,831 in 2004–05. Imports had increased from US$ 27,915 million to US$ 118,961 million during the same period (Table 1.1). India has also achieved higher growth in exports compared to developing countries as a whole as well as the world growth rate in 2004. Growth rate of Indian export in 1995–2001 was 8.5 per cent as against the world growth of 5.5 per cent. However, in 2004 it had gone up to 28.1 per cent as against 21.6 per cent of world growth. Thanks to domestic reforms in diversification, modernization and policy encouragement (Table 1.2). But India still lags behind China, which has witnessed 35.5 per cent growth in exports in 2004. Though India’s share of exports in world trade increased from 0.7 per cent during

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LIFE INSURANCE IN INDIA TABLE 1.2 Exports Growth and Share in World Trade % Growth in Exports

India China Developing countries World

Exports Share in World Trade

1995–2001

2004

2001

2004

8.5 12.4 7.9 5.5

28.1 35.5 27.0 21.6

0.7 4.3 36.8 100

0.8 6.2 38.7 100

Source Economic Survey (2004–05).

1995–2001 to 0.8 per cent in 2004, it was still far behind China which had a world share of 6.2 per cent in exports in 2004 (Table 1.2). Other indicators of global integration also registered sharp improvement, namely exports/GDP ratio increased from 5.8 per cent in 1990–91 to 11.7 per cent in 2004–05 and imports/GDP ratio increased from 8.8 per cent to 17.2 per cent during the same period.

Merchandize Trade The growth and expansion of India’s merchandize trade is an indication of India’s global integration and openness. The ratio of merchandize trade to GDP increased from 14.6 per cent in 1990–91 to 28.8 per cent in 2004–05. Though still marginal, India’s share in world trade went up from 0.52 per cent in 1990 to 0.84 per cent in 2004–05. According to the United Nations Conference on Trade and Development (UNCTAD), India is among the top 10 exporters in 32 commodities out of 70 leading export items from developing economies (Economic Survey 2004–05).

Invisibles During recent years, India has emerged as one of the leading service exporters in the world. According to IMF’s Balance of Payments Statistics Yearbook 2004, India was the 18th largest service exporter of the world in 2003 with expanded market share of 1.3 per cent (as against 0.6 per cent in 1990). During 2004–05 net invisible surplus of India at 4.6 per cent of GDP was able to finance 83 per cent of trade deficit. The structural shift in service exports shows that since 2000–01, software exports made largest single contribution to invisible exports, whose share increased from 39 per cent in 2000–01 to 48.9 per cent in 2003–04 though it declined marginally to 33.7 per cent in 2004–05. It also has been noted that contribution of software in 1990–91 was nil. India has progressively improved its market share in global IT spending from 1.5 per cent in 2000–2001 to 2.2 per cent in 2004–05 (RBI Annual Report 2004–05).

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Current Account Successful trade reforms and robust export growth also reflected in improvement of current account which recorded surplus from 2001–02 to 2003–04, but returned to deficit in 2004–05. This improvement was led by export growth—merchandize and invisible export, particularly due to increase in invisibles receipts and the invisibles/GDP ratio increased from 2.4 per cent in 1990–91 to 11.2 per cent in 2004–05.

Capital Account Capital account of India’s balance of payments (BOP) gained strength due to improvement in foreign investment due to favourable policies followed by the Government of India. While there has been a decline in the external assistance from US$ 2,204 million in 1990 to US$ 1,922 million in 2004–05 the commercial borrowing increased from US$ 2,254 million in 1990 to US$ 5,947 million (Table 1.1). Similarly, the reforms in India attracted substantial flow of foreign investment which stood at US$ 11,944 million in 2004–05, net foreign investment increased from US$ 103 million to US$ 2,554 million during the same period. India has emerged as a favoured destination of portfolio investment due to attractive valuation of Indian stock market. Portfolio investment had increased from US$ 979 million in 2002–03 to 8,909 in 2004–05. Portfolio investment has integrated global sharing and investment market with India. Net foreign investment/GDP ratio which was virtually nil in 1990–91 stood at 2.1 in 2004–05 and foreign investment/export ratio improved from 0.6 per cent to 17.9 per cent in 2004–05 . It has been noted by Dr Virmani that FDI contributed to 1 per cent of India’s gross fixed capital in 1993, which went up to 3.2 per cent in 2001 (Virmani 2004). The achievement of India as indicated above since 1991 is the result of structural adjustment programme and reforms in the domestic sector. Liberalization in external sector has not only increased efficiency in the domestic sector but removed the near isolation of Indian economy in the global market and closely integrated it with global economy.

Contractual Savings, Institutional Investors and Life Insurance Deregulation and liberalization of national economy had significant impact on institutional investors such as life insurance, pension funds and investment institutions (like mutual funds). These institutions, particularly the life insurance and pension funds provide boost to contractual savings and also support growth and stability to the country’s capital markets. Liberalization of financial markets provides opportunity and incentives to foreign and domestic institutions to operate in country’s savings and capital markets. They not only support growth in domestic savings but also directly assist asset allocation and economic growth.

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Economic growth among others requires an efficient financial system for intermediation and asset reallocation. Institutional investors impart the required efficiency. Vittas (1998) emphasized that institutional investors played a key role in improving clearing and settlement system, they are large and reliable sources of resources and they efficiently allocate resources across regions and industries, efficient in managing risks and uncertainties, operate with lowcost information system and call economy. They also have an advantage of efficiently dealing with corporate management.

Contractual Savings Among institutional investors, contractual savings institution by virtue of differentiated function play a crucial role, particularly in a less-developed country which needs to enhance the growth rate in domestic savings and have an efficient financial sector. In contrast to investment institutions such as mutual funds; contractual saving institutions like life insurance and pension funds stimulate long-term savings that are required for financial and economic development. Since the savings mobilized by these institutions are long-term in nature, they are invested in long-term bonds mainly issued by the government of finance development projects mainly issued by the government. According to Catalan et al. (2000) a developed contractual savings sector contributes to build a more resilient economy—one that would be less vulnerable to interest rates and demand stocks—while creating a more stable business environment—including macro economic stability. The result will be a lower country risk premium hence lower equilibrium interest rates, which increase investment and ultimately accelerate growth.

Life Insurance One of the important contractual savings institutions is life insurance which provides multidimensional services having a significant impact on economic growth. According to Skipper (1998) insurance companies promote financial stability, indemnify individual risks, act as viable substitute for government social security system, and facilitate risk transfer and faster efficient capital allocation. The role of life insurance as contractual savings institutions is often examined in the light of various services it provides in different financial structures. According to Dolar and Meh (2002) there are four competing views of financial structure. The intermediary-based view emphasizes the importance of resource mobilization, identifying good projects, monitoring managers and managing risks, while stressing upon deficiencies of the market-based system. Through these functions, the financial system can increase the quantum and quality of investment within the economy. The market-based view stresses upon the role of markets in diversifying and managing risks while arguing the financial intermediaries can extract information rents from firms.

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Financial services view suggests that financial intermediaries may provide complimentary services to those provided by markets. The emphasis in this system is more on the quality and the level of financial services rather than on the channels through which it is provided. The law and finance view emphasizes on the legal environment and enforcement of contracts. In a developed financial system, the financial market and financial intermediaries efficiently reallocate funds from savers to the users of productive investment. However, the efficiency depends on performing the following in a cost-effective manner: 1. 2. 3. 4.

Mobilization of savings from a cross-section of investors. Supporting healthy growth of domestic capital market. Managing risks. Acquisition of information.

Mobilization of Savings Life insurance is one of the most important financial intermediary in any financial system and contributes to the development of financial markets—savings and capital markets. As an important financial intermediary, insurance industry particularly the life insurance industry assists in accumulation and reallocation of productive capital in the economy. Life insurance companies design financial contracts which can be purchased even by small investors who can invest a small amount periodically, which in turn is invested in capital markets. Life insurance as a financial intermediary boosts savings by helping mobilization of savings at a relatively lower cost from a cross section of people in the economy. It also mitigates moral hazards and adverse selection inducing the less willing savers to save. Contractual nature of savings in life insurance companies promotes the habit of savings and pools a large amount of money in an economy. Hence, life insurance companies not only grow by themselves but also stimulate long-term savings in a country to support economic growth. It has been observed that efficiency in capital accumulation and transfer in the economy depends on the improved efficiency of intermediaries like life insurance. It is evident that insurance savings constitute a relatively high position in household portfolios in many countries. The share of life insurance products in the financial portfolio of households was 29 per cent in UK, 23 per cent in France, 19 per cent in Germany and 18.1 per cent in Japan (Table 1.3). But in India Life Insurance funds accounted only 12.4 per cent of household financial assets in 2004–05 (Reserve Bank of India, Annual Report 2004–05).

Development of Capital Markets Capital markets is the mechanism through which life insurance companies transmit investments, collected as premiums, in the economic system. The investment made by the life insurance companies in the domestic capital markets is quite huge and provides stimulus to the growth

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LIFE INSURANCE IN INDIA TABLE 1.3 Distribution of Household Assets in Financial Instruments in 2000

Deposits and money funds Bonds Equity Equity MFs Bond MFs Balanced MFs Real estate MFs Life insurance—unit linked Life insurance—non-unit linked Pension fund DC Pension fund DB Other

USA (%)

UK (%)

Italy (%)

France (%)

Germany (%)

Japan (%)

15 7 54 9 2 1 0 4 3 6 16 2

20 1 18 4 0.5 0.4 0 12 17 3 20 4

25 19 28 6 6 4 0 2 4 1 0 6

32 3 25 6 1 2 0 5 18 1 0 7

35 10 16 6 2 1 2 0 19 5

53 4 6 1 0 1 0 0.1 18 0 10 4

5

China (%) 69a 4.4 10 – – 4.1b – – 4.2 – – 7.9c

Source Daniele Fano (2005). Notes MFs: Mutual funds; DC: Defined contribution; DB: Defined benefits. For China year 2002: a Deposits; b Housing saving funds; c Cash in hand and other investment.

of the local capital markets. Since life insurance companies invest huge amounts in diversified financial instruments they can absorb higher risks than an ordinary small investor and can provide better rate of return to the investors. However, to make life insurance an important vehicle for savings mobilization and to provide support to the capital market, there is a need to provide flexible regulations for investment of funds by life insurance companies and also the availability of a wide range of financial instruments. Life insurance companies also support the market by absorbing market risks through underwriting new bond and equity issues and thus provide depth to the market. In competitive insurance market, competition among the insurers increases productive efficiency, provides investors with diversified portfolio choice, enhances liquidity and induces better monitoring and corporate governance. Life insurance as a financial intermediary contributes significantly in promoting the capital market. Asset allocation pattern of any life insurance company among the financial instruments provides a significant insight into its support to various segments of market. It can be noted from Table 1.4 that the larger share of assets are invested into fixed income securities like government and corporate bonds while equity investment is relatively low. Traditionally, equity formed a major part of investment in UK while corporate bonds in USA and India—Japan preferred fixed income government bonds and loans. In case of LIC of India, about 60 per cent of assets were invested in central and state government bonds while about 14 per cent of the assets were invested in equity in 2004–05. However, this 14 per cent amounts to Rs 484,930 million as against total investment of Rs 3,431,290 million. Further, capital market investment by insurance companies not only

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TABLE 1.4 Asset Allocation of Life Insurance Companies—A Global Scenario USA Instruments Equity Bonds of which Government bonds Corporate bonds Foreign security Loans Real estates Mortgages Other Memorandum items Total assets in billion US dollars Life insurance Non-life insurance

1994–97 3.9 70.7 18.8 41.5 – – – 12.8 –

– –

Japan

UK

Euro Areas

2002 1994–97

2000 1997

2001

1999

2001

3.6 79.7 17.7 60.8 – – – 11.2 –

16.1 22.2 15.2 3.6 6.6 40.0 – – 6.1

8.8 40.3 27.3 606 14.5 32.2 – – 4.2

55.8 27.9 18.6 9.3 – – – – 16.3

43.4 38.9 17.7 21.2 – – – – 17.7

25.2 39.1 – – – 21.3 4.4

25.9 38.8 – – – 19.6 4.2

9.9

11.5

2,172 758

1,249 312

1,213 22.7

430 –

565 –

– – 2,081 2,479

Source IMF (2004).

provides depth to the market but also supports the transparency, disclosure and corporate governance of the firms and institutions in which insurance companies invest their funds. Insurance companies thus assist wealth distribution through institutionalization of capital market.

Risk Transfer Insurance services create productive impact in the economy by assisting to transfer risk from risk averse individuals and induce savings. They also facilitate risk sharing by reducing transaction cost and diversification of investment portfolios. Liquidity risk is also managed by a financial intermediary more efficiently than an individual, making savings and investment a more attractive proposition.

Information Acquisition In a complex and competitive financial market collecting accurate information about the firms, its management and future growth potential is a matter of cost, processing skill and time. Often it not only becomes difficult but also impossible for an individual investor to carry-out all these activities, but a financial intermediary like a life insurance company can perform this function efficiently and in a cost-effective manner. Financial intermediaries like life insurance companies can gather cost-effective information, process it using their highly skilled managers

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LIFE INSURANCE IN INDIA

and well-established assessment mechanism to scrutinize and select the best available investment opportunities. They can also monitor the performance of the company and growth of return on their investments. This not only enhances investment efficiency but also improves efficiency in capital allocation in the economy and boosts economic growth.

Emerging Trend in Institutional Investment Growth in assets under management of institutional investors is an indicator of their contribution to financial markets and asset creation. According to Global Financial Stability Report (IMF 2004) total assets managed by the institutional investors (insurance companies, pension, investment and institutional investors) in mature economies increased from US$ 18,248 billion in 1993 to US$ 34,723 billion in 2001, while the assets of insurance companies grew from US$ 6,991 billion to US$ 11,146 billion. The share of insurance in total assets declined from 38 per cent to 32 per cent. In terms of GDP, assets of institutional investors increased from 94.7 per cent in 1993 to 147.2 per cent in 2001 as against increase of bank assets from 23.3 per cent to 26.2 per cent during the same period. This shows that relative importance of banking in financial market declined significantly leaving the marketplace open for institutional investors (Table 1.5). Sharp increase in assets of non-bank institutional investors during 1990s was supported by contractual savings institutions (like life insurance and pension funds) and investment institutions like mutual funds, which increased by 90 per cent during 1993–2001. Further, institutionalization of capital market was strongly supported by contractual savings. The assets of life insurance in terms of GDP increased from 36.3 per cent to 47.3 per cent, of pension funds from 27.7 per cent to 40.3 per cent and of investment companies from 21 per cent to 47 per cent from 1993 to 2001 (Table 1.5). However, the growth of institutional assets in emerging markets could not keep pace with the growth of institutional assets in mature market. As a result the share of emerging markets in total institutional assets declined from 15.5 per cent to 14.4 per cent during the same period. Further, the stock market capital of institutional investors assets also declined from 11.3 per cent to 9 per cent during the said period. Slow growth of institutional assets in emerging market draws attention to inadequate flow of funds to these economies and weak domestic institutional structure and need of reforms in financial markets. Institutional investors in emerging markets are unable to come up to their counterparts in mature market primarily because of low level of insurance penetration, unfunded pension benefit system and lack of lustre to the growth of mutual funds due to underdevelopment of stock markets. However, the economic and market environments are changing in emerging economies. Insurance penetration and density has been increasing rapidly. Reforms in social security system, introduction of contributory pension system (particularly in Latin America and Central Europe) and growth of stock markets boosted up mutual funds and other investment institutions in the emerging market. These developments have been induced by the ongoing phenomena of globalization and reforms in domestic economies.

Globalization, Liberalization of Financial Markets and Life Insurance

19

TABLE 1.5 Mature Markets: Assets under Management by Institutional Investors—A Global Scenario

Institutional investors (US$ in billions) Insurance companies (US$ in billions) Pension funds (US$ in billions) Investment companies (US$ in billions) Other institutional investors (US$ in billions) Memorandum items (US$ in billions) Hedge funds Mature market bank assets In percentage of institutional investors asset Mature market bank assets Emerging markets Stock market capitals Bond outstanding In percentage of mature market GDP Institutional investors Insurance companies Pension funds Investment companies Other institutional investors Mature market bank assets Bank asset

1993

1999

18,248 6,991 5,332 4,050 1,876

36,596 11,960 10,337 11,168 3,132

36,233 11,519 10,279 11,293 3,143

2000

34,723 11,146 9,515 11,091 2,971

2001

– 4,491

150 5,699

172 5,917

217 6,192

24.6 15.5 11.3 4.2

15.6 14.5 10.1 4.4

16.3 13.9 9.1 4.8

17.8 14.4 9.0 5.4

94.7 36.3 27.7 21.0 9.7

154.4 50.5 43.6 47.1 13.2

151.4 48.1 43.0 47.2 13.1

147.2 47.3 40.3 47.0 12.6

23.3

24.0

24.7

26.2

Source IMF (2004).

Emerging developments also indicate a distinctly different trend in institutional investment in emerging markets. Pension funds have emerged as stronger institutional investors in Latin America and Central Europe due to reforms in social security system whereas in Asia pension funds remained secondary to life insurance companies. Global Stability Report 2004 also noted this and mentioned that ‘In contrast to Latin America and emerging Europe, local life insurance companies are heading the institutional investors in emerging Asia. This is related in part to the Asian tradition of using insurance products as savings products’. It is amply indicated in assets of life insurance companies (in terms of GDP), for example, the assets of life insurance companies in Singapore, Korea, Malaysia was 37.6 per cent, 25.8 per cent and 21 per cent, respectively, while that in Chile, Argentina, Brazil was 19.9 per cent, 4.6 per cent and 2.8 per cent, respectively, in the year 2002. However, highest assets of life insurance among emerging market was in South Africa 60.7 per cent in the same year (Table 1.6). Though, institutionalization of capital market provides the much needed capital requirements for growth as a resource allocator it often produces many unmanageable shocks to the economy. Institutional investors are often sources of stock market volubility, financial crisis and

20

LIFE INSURANCE IN INDIA TABLE 1.6 Assets under Management of Insurance Companies in Emerging Markets (in terms of GDP)

Country Korea Malaysia Philippines Singapore Thailand Hungary Poland Turkey South Africa Argentina Brazil Chile Colombia Mexico Peru India

2000 (%)

2002 (%)

30.2 14.9 3.8 24.4 6.6 4.2 4.3 1.5 – 2.7 2.6 18.6 0.8 1.3 Na 4.52

25.8 21.0 4.0 37.6 8.3 3.8 6.0 Na 60.7 4.6 2.8 19.9 1.0 1.7 2.2 4.73∗

Source IMF (2004). Note ∗Life insurance.

may even create corporate crisis due to funds management activism. To restrain this unwanted development prudent regulatory measures and well-designed corporate governance practices need to be in place.

Globalization and Emerging Trend in Life Insurance Insurance is an integral part of national economy and a strong pillar of financial market. The waves of globalization have also deeply influenced the insurance market worldwide. Financial market globalization has also been strongly supported by globalization of insurance. With increase in trade, direct investment and portfolio investment the demand for insurance services has been ever growing, particularly in the emerging markets. Globalization of insurance market, as part of the overall process of liberalization in emerging and other countries enabled the foreign insurance companies to enter those countries and benefited both. The driving forces of insurance market globalization have been identified as the ‘push factors’ and ‘pull factors’. The push factors are the motives behind the movement of foreign insurance companies to local countries while the ‘pull factors’ are the motives for allowing foreign companies to operate in local market. Important push factors are increasing global trade, growing direct investment, potential future growth in emerging markets, while the important pull factors in emerging markets are requirement of capital, etc.

Globalization, Liberalization of Financial Markets and Life Insurance

21

Benefits to Emerging Markets There are several benefits to the countries allowing foreign insurance companies to operate in their countries which can be broadly classified into economy related and insurance marketrelated.

Economy Related Benefits to the Local Country Foreign insurance companies along with local companies add further momentum to mobilization of savings. Institutional net worth in the savings market increases, which also influence the savings behaviour of household and corporate savings. Resources and capital allocation in the domestic market increases due to increased sophistication brought by the foreign insurance companies. It also improves the financial stability in the host country as well as facilitates improvement in production and trade.

Insurance Market-related Benefits Capital structure of the entire insurance industry improves because foreign companies bring fresh capital with them. Market efficiency improves due to information dissemination, global operating knowledge and increased competition. Management efficiency increases because foreign companies bring with them global experience and management innovation. The range of available products increases because foreign companies bring with them a wide range of products and product development expertise. Customer service improves. Increased competition, technology led service and cost competition finally benefits the consumer. Globalization also improves regulatory and governance systems. It also improves market conduct and ethical business standards. The process of insurance globalization is significantly influenced by the GATT/WTO. A major breakthrough was achieved in 1997 with an agreement for liberalization of financial services following which 102 countries committed to remove entry barriers and liberalize their markets. The GATT agreement offers legal security and protection to global insurance players. With the removal of entry barriers in emerging and less-developed countries there has been an increased flow of funds from developed countries to the emerging and less-developed countries. According to Swiss Re (Sigma No. 4/2000) in recent years there has been a strong increase in the demand for insurance in the emerging markets. The average annual growth rate in the emerging markets has since 1990 been twice as high as industrial countries in both life and non-life insurance. There is already an indication of slow growth and saturation of insurance market in industrially developed countries. During 2003, global life business witnessed a decline of 0.8 per cent. However, emerging market life business grew by 6.6 per cent as against –1.7 per cent decline in

22

LIFE INSURANCE IN INDIA

industrialized countries. In non-life business, while industrialized countries achieved 5.7 per cent growth in real premium income, emerging markets registered 8.5 per cent growth rate in 2003. However, total premium income of emerging market in 2003 was US$ 314,128 million which represented 10.68 per cent of global premium income, whereas share of industrialized countries with US$ 2,626,542 million representing 89.32 per cent of global premium. This is an indication of huge potential emerging market.

Emerging Trend in Global Life Insurance Market One of the major beneficiaries of financial market liberalization and economic reforms is the global life insurance industry. The decade of 1990s saw an upswing in the growth of life insurance industry as well as shift of major activities of life insurance industry from industrialized countries to the emerging markets. Average growth in world and regional premium income to a great extent followed the trend in GDP growth rate except in Asia. While the average GDP growth rate (during 2000–04) of the world was 2.7 per cent the average growth in life insurance premium was 2.3 per cent. Similar trend was noticed in North America where 2.8 per cent GDP growth was followed by 2.4 per cent growth in life premium. It was reversed in Europe where average growth in the life premium as 2.6 per cent was higher than average growth in GDP at 2.1 per cent. However, Asia was lagging with much low growth in the premium 2.5 per cent as against average GDP growth rate of 3.3 per cent during 2000–04 (Table 1.7).

Top 40 Life Insurance Companies in the World Top 40 life insurance companies collected US$ 1,032,905 million with global market share of 55.9 per cent. Top in terms of premium was AIG (premium US$ 66,837 million) having market

TABLE 1.7 Global and Regional Growth in GDP and Life Insurance Premium 2000

2001

Country

GDP

Pre

North America Latin America Europe Asia Africa Oceania World

4.2 4.0 3.6 3.6 3.8 3.8 3.8

7.8 11.0 17.0 3.0 8.9 1.9 9.1

GDP 0.3 0.3 1.5 1.2 3.0 2.6 1.0

2002

2003

Pre

GDP

Pre

–1.5 5.9 –6.6 2.6 4.0 –4.5 –1.8

2.5 –1.0 1.4 2.6 2.9 3.7 2.0

6.3 4.8 0.8 2.1 7.0 –9.3 3.0

GDP 3.0 1.2 1.3 4.2 3.3 2.9 2.7

Source Swiss Re Sigma, (various issues). 6/2001, 6/2002, 6/2003, 6/2004, 6/2005. Note Pre: Premium.

2004 Pre GDP

–2.2 –0.4 –2.1 2.7 –14.8 –8.4 –0.8

4.3 5.4 2.7 5.0 5.3 3.3 4.0

Pre 0.7 17.1 3.8 2.0 –4.7 6.2 2.3

Globalization, Liberalization of Financial Markets and Life Insurance

23

share of 3.6 per cent. It may be noted here that Life Insurance Corporation of India (LIC) is the 30th largest company of the world with premium income of US$ 13,746 million and market share of 0.7 per cent. Twelve global companies (having substantial operation outside domestic markets) had 28.2 per cent global market share.

Regional Variation in Market Share In spite of slow growth in premium volume, industrialized countries still dominate the world life insurance market, though its market share has declined from 91 per cent in 2000 to 87.71 per cent in 2004. Interestingly the market share of industrialized America and Europe has increased as against decline in market share of Asia, Africa and Oceania. Market share of America increased from 27.8 per cent in 1997 to 29.45 per cent in 2004 as against that of Europe from 30.39 per cent to 37.57 per cent but in case of Asia it declined significantly from 38.43 per cent to 30.09 per cent. The sharp decline in the Asian market share was led by Japan, the largest life insurance market in Asia, which is undergoing slow growth and financial market downslide. Even South and East Asian countries witnessed slow growth and decline in market share (Table 1.8).

Regional Variation in Life Insurance Density Level of development and depth of insurance industry in a country and continent is often judged in terms of insurance density, that is, per capita spending of insurance and insurance penetration. Insurance premium in terms of GDP and level of penetration and density when viewed in terms of overall GDP also provides an indication of existing and future insurance market potential. Over the years life insurance spending has increased in continents like Latin America, Asia and Africa but still remain much lower than North America, Europe and Oceania. Per capita insurance spending (density) in Asia and Africa still remain low at US$ 147.2 and US$ 30.3 (in 2004) as against in America, Europe and Oceania which where it was US$ 628.4, US$ 848.1 and US$ 851, respectively (in 2004), while global spending has increased from US$ 246.4 in 1997 to US$ 288.7 in 2004. Low level of insurance density in the emerging market countries was mostly due to low per capita and disposable income and pattern of income distribution. However, it shows that with growth momentum being continued in emerging market there is enough scope for expansion of life insurance business.

Regional Variation in Life Insurance Penetration Life insurance penetration, which is premium as percentage of GDP is an important indicator to measure the level of maturity of life insurance market in an economy. During the year 1997–2004, life insurance penetration in the world increased from 4.26 per cent to 4.55 per cent.

29.45 28.36 1.09 37.57 36.96 0.61 30.09 20.93 8.95 0.22 1.43 1.46 100.00 87.71 12.29 0.92

2004 3.19 3.80 0.49 3.85 4.28 0.39 6.27 9.42 2.89 0.55 4.13 4.99 4.26 Na Na 0.50

1997 3.81 4.40 0.69 5.34 5.71 0.94 5.96 8.70 3.01 0.58 3.03 5.43 4.88 5.70 1.94 1.77

2000 3.70 4.12 1.01 4.68 5.10 0.80 5.61 8.26 3.77 0.47 3.41 3.75 4.55 5.14 2.41 2.53

2004

Penetration (%) 461 1,114 21.7 482.5 943.9 10.9 153.0 3,092.0 28.7 27.8 52.7 1,022.6 246.4 Na Na 5.4

1997

Source Swiss Re Sigma, (various issues). 3/1999, 6/2001, 6/2004. Note Market share in per cent; Penetration in premium in per cent of GDP; Density premium per capita.

2000 31.51 30.61 0.90 32.86 32.43 0.43 32.84 26.39 6.21 0.24 1.23 1.57 100.00 91.00 9.00 0.50

1997

Region

America 27.8 North America 26.9 Latin America 0.82 Europe 30.39 Western 30.05 Central/Eastern 0.34 38.43 Asia 31.0 Japan 6.66 South and East Asia 0.27 Middle/East Europe Africa 1.53 Oceania 1.85 World 100.00 Industrialized countries Na Emerging countries Na India 0.42

Market Share (%)

TABLE 1.8 Regional Variation in Market Share, Penetration and Density

586.1 1,525.5 26.6 445.2 1,059.0 10.3 138.8 3,165.1 29.5 13.3 23.5 806.2 239.9 1,497.2 25.3 7.6

2000

Density (US$) 2004 628.4 1,617.2 37.2 848.1 1,430.6 33.7 147.2 3,044.0 49.2 13.8 30.3 851.0 288.7 1,691.1 42.2 15.7

24 LIFE INSURANCE IN INDIA

Globalization, Liberalization of Financial Markets and Life Insurance

25

The emerging markets did improve the level of penetration from 1.94 per cent in 2000 to 2.41 per cent in 2004, as against decline of the same from 5.70 per cent to 5.14 per cent in the industrialized countries during the same period, which happened basically due to reforms in insurance sector in emerging markets followed by global movement of insurance industry. An indication of major developments in global life insurance market has been given through changing growth rates, market share penetration and density. However, we may look into some further developments during the period 1997–2004, which produced the above results in the global life insurance market.

India in the Emerging Market Emerging market economies continue to exhibit a positive trend in growth rates in GDP and gradually open up through deregulation in financial and insurance markets. New technology, new products, new distribution system, and improved supervision and regulatory system helped to improve the performance of the life insurance sector in emerging economies. Reforms in the pension and social security system have further supported the growth of life insurance industry in emerging economies—and jointly the emerging economies controlled about 12.3 per cent of global life insurance market. This is going to improve in future as noted by Swiss Re (Sigma No. 5/2005) ‘life insurance expected to grow by 8 per cent between 2005 and 2010 (in emerging markets)’. Though 32 countries are counted in the emerging market, only 10 countries account for 87.3 per cent of premium of total emerging market premium. The top five countries (in 2004) were South Korea (21.7 per cent), China (15.7 per cent), Taiwan (15.1 per cent), South Africa (10.8 per cent) and India (7.5 per cent). Annualized changes in growth in life premium during 1999–2004, for South Korea, China, Taiwan, South Africa and India was –0.3 per cent, 29.4 per cent, 19.6 per cent, 2.4 per cent and 17.7 per cent, respectively. Comparing to the growth rates of top five markets, smaller markets witnessed better growth, for example, Vietnam (76.9 per cent), Saudi Arabia (45.3 per cent), Hong Kong (22 per cent) and Kuwait (24.9 per cent) witnessing continued upsurge in growth rate.

Market Reforms and Growth Rates Growth of emerging markets has been strongly supported by market reforms and dismantling or uniting the entry barriers. For example, countries such as South Korea, Taiwan, Singapore, Philippines, Brazil and Argentina have removed all entry barriers, while in some countries foreign ownership was allowed to a large extent, for example, Indonesia (80 per cent), Vietnam (70 per cent), Malaysia (51 per cent), while in India it is restricted to 26 per cent (Table 1.9).

Latin America

Asia

3 0 0 0 0 1

Chile Argentina Venezuela Colombia

0 10 0 44

Thailand Indonesia Philippines Vietnam

Brazil Mexico

0 0 0

11 92

Taiwan India

Hong Kong Singapore Malaysia

23 57

South Korea China

Life

0 0 0 12

1 0

16 10 0 94

0 0 0

0 86

4 72

Non-life

Market Share of State-owned Insurers (>50 per cent State-owned) (%)

62 53 39 38

32 75

41 48 61 56

87 58 71

33 0

10 2

Life

63 35 50 46

43 58

7 25 29 6

74 53 25

12 0

1 1

Non-life

Market Share of Foreign-owned Insurers (>50 percent Foreignowned) (%)

None No branch offices allowed; 100 per cent foreign ownership allowed for North American Free Trade Agreement (NAFTA) members (limited to 49 per cent for non-NAFTA members) No branch offices allowed None No branch offices allowed No branch offices allowed

None Only joint venture with a 26 per cent foreign participation capital is allowed None None Existing foreign investors may hold 51 per cent, new entries by foreign shareholders into local incorporated companies are limited to 30 per cent Foreign ownership limited to a maximum of 25 per cent Foreign ownership limited to a maximum of 80 per cent None Foreign ownership is limited to a maximum of 70 per cent

None Joint ventures required for entry of foreign life insurers; no restrictions for non-life insurers

Entry Barriers for Foreign Insurers

TABLE 1.9 State and Foreign Ownership, Tariffs and Entry Barriers, 2003 26 LIFE INSURANCE IN INDIA

Lebanon Kuwait

Turkey Iran United Arab Emirates (UAE) Saudi Arabia

Egypt

0 0

0 100 0

69

0 0

64 14

Na

<31 0 0

12 0 Na

11

0 52

85 17 97

52 81

Na

0 100 0

75

1 0

0 55 0

0 74 0

South Africa Morocco

53 6

46 0

Poland Czech Republic Hungary Slovenia Slovakia

Na

Na

Russia

Source Sigma No. 5/2004.

Middle East

Africa

Eastern Europe

35 14

Na

27 0 Na

10

14 28

89 2 96

41 89

Na

Insurers must be stock companies and act in accordance with principles of Islamic Shari’a None None

No branch offices allowed Closed market No branch offices allowed

No branch offices allowed No branch allowed, foreign ownership limited to a maximum of 80 per cent No branch offices allowed

Ceiling of 25 per cent of foreign capital in combined capital of Russian insurance companies EU regulation-freedom of establishment/services directives EU regulation-freedom of establishment/freedom of services directives EU regulation-freedom of establishment/services directives EU regulation-freedom of establishment/services directives EU regulation-freedom of establishment/services directives

Globalization, Liberalization of Financial Markets and Life Insurance 27

28

LIFE INSURANCE IN INDIA

Some Significant Developments in the World Market During the last decade some important developments have taken place in global life insurance industry in addition to the growth mentioned, particularly in areas of product preference, channel management, merger and acquisition, etc. Some such developments are discussed in the following part of the text.

Trend in Product Preference There is a diverse products choice among the major markets, for example, savings products with guaranteed return are very popular in France (66 per cent), Italy (64 per cent), Germany (53 per cent) and Japan (38 per cent). Individual pension products are popular in USA (35 per cent), Canada and UK (25 per cent), Germany (26 per cent) and Japan (23 per cent). Unit linked products are popular in Italy (36 per cent), UK and France (20 per cent) and Germany (10 per cent). Group pension is popular in UK (34 per cent), US (31 per cent), Canada (30 per cent) and Japan (16 per cent). Risk products such as term life, disability and critical illness are less popular—but in Canada (28 per cent), USA (15 per cent) and UK (11 per cent) which are worth mentioning ( See Table 4.1).

Trend in Channel Management A significant change in distribution channel and bank assurance has emerged strongly; particularly in France (63 per cent sales), Italy (60 per cent sales). However, US, UK and Canada strongly depend on individual agents and brokers and sales by them in 2004 were 54 per cent, 51 per cent and 63 per cent, respectively, while own sales in US, Canada and UK were 43 per cent, 31 per cent and 27 per cent, respectively. Germany has strong dependence on brokers and sold 26 per cent product value in 2004.

Trend in Merger and Acquisition Global life insurance industry has been undergoing a significant structural change not only by spreading growth momentum but also in terms of regulatory reforms, product diversification, merger and acquisition, etc., and consolidating its operational structure and mechanism. Following Swiss Re (Sigma No. 1/2006), we may mention these factors as: 1. Strong capitalization in the 1990s followed by substantial depletion of capital—due to stock market boom in 1990s followed by decline in 2000–02. 2. Decline in investment yield—due to decline in interest rates leading to decline in fixed return investment and negative interest rate in Japan.

Globalization, Liberalization of Financial Markets and Life Insurance

29

3. Deregulation in Europe and other emerging markets and de-mutualization of mutual companies. 4. Globalization and saturation of developed market moved the insurance companies beyond the national border particularly to emerging markets intensifying competition and growth. 5. There were intensified merger and acquisition activities as Swiss Re (Sigma No. 1/2006) reported ‘12 Globals acquired 130 companies with aggregate premiums of US$ 104 billion—equivalent to 5.6 per cent of industry premium in 2004’. 6. Large companies consolidated their market position and 40 largest life insurance companies increased their market share from 48.9 per cent in 1998 to 55.9 per cent in 2004.

Chapter 2 Reforms and Emerging Economic and Financial Environment in India Globalization and financial market liberalization as we discussed in Chapter 1, have changed the global economic landscape and released the growth impact. Emerging economies, which liberalized their insurance sector have been immensely benefited from the recent waves of globalization. The waves of globalization also swept India. Although India had initiated reforms out of compulsion in early 1990s and opened the economic frontier to foreign investment, which in turn facilitated the domestic economic transformation. In tandem with changes in global economy, service sector in India has emerged as the engine of growth and led the economy in a high growth trajectory, which has enhanced the potential growth in the savings market. Contractual savings, one of the two major areas of operation of a life insurance company in any economy, plays the most crucial role as a resource supplier which causes a tremendous boost in a liberalized environment. The other major area of operation is the capital market through which a life insurance company canalizes resources to the productive sector. Therefore, a well-developed and efficiently functioning capital market is equally important for growth and efficiency of a life insurance industry. To understand the growth potential of life insurance business and importance of a life insurance company as an institutional investor, we need to examine the emerging trend in macro economy savings market, capital market and the interrelationship between them. 1. 2. 3. 4. 5.

Emerging macro economy of India. Emerging financial markets in India. Emerging savings market in India. Emerging capital markets in India. Life insurance and macro economy—Indian experience.

Reforms and Emerging Economic and Financial Environment in India

31

Emerging Macro Economy of India As indicated in Chapter 1, changes in economic environment and consequent changes in economic policies/systems in a country are a constant phenomenon. Globalization and its impact in emerging markets including India in the 1990s had led to momentous changes in these markets. These changes have further strengthened the forces of service sector which have emerged as drivers of change and growth. In a service-oriented economy, which incidentally India is moving towards at a rapid pace, the institutional mechanism must be flexible enough to readjust to changes. Organizational perspective must have social orientation. Transformation of managerial thinking and their capability as drivers of change to bring about a balance between social and profit motives viewing employees as valuable assets and customers as focal point while making all decisions. These are preconditions of successful transition to achieve sustained growth. The economic environment of India has undergone a radical transformation since 1991 when the country was exposed to severe crisis due to a sharp plunge in foreign exchange reserve, a downgrading of Indian credit rating, suspension of foreign private capital flows, and decline in industrial output the country was on the verge of defaulting its foreign debt obligations. To overcome this difficult situation, there was no other way but to initiate reforms and structural adjustment programme by dismantling restrictions on foreign investment, flow of private capital and private initiatives in many areas of economic activities. To address the immediate BOP crisis, the government introduced stabilization measures including fiscal contraction, currency devaluation, monetary tightening and finance from IMF. The structural reforms focussed on liberalizing industry, trade, taxation, foreign investment and reforming the financial sector. The objective of industrial policy reforms was to deregulate industry and trade by dismantling state control and licensing system to encourage private investment, allowing Indian and foreign investment in the areas hitherto reserved for the state sector. Several measures were also initiated for tax reforms—to streamline the rate structure and widen the tax payers base. The government had also reformed tariff structure and current account convertibility of rupee to make Indian economy more open. The structural measures in the real sector have made Indian economy more attractive to foreign investors and it has become a destination for foreign entrepreneurs and investment. Real sector reforms were simultaneously supported by reforms in the financial sector, which aimed at improving the functioning of banks and financial institutions, and to strengthen the money and capital markets. Institutional reforms in the financial markets removed many archaic provisions of government interventions, directed FOFs and interest rate structure. Financial sector reforms sought to remove the impediments of growth and improve transparency, market efficiency and self-regulation. Measures were also introduced to prevent market failures and strengthen the mechanism of investors protection. Reforms and structural change carried since 1991 have impacted economic growth rates which put India in a high growth trajectory and

32

LIFE INSURANCE IN INDIA

made it a choice destination of investment. Except occasional deviation, India has witnessed continued growth in real sector thanks to sustained growth in service economy.

Changing Trend in Growth Rates The overall average growth in GDP during 1998–99 to 2003–04 was 5.9 per cent marginally higher than 5.8 per cent during 1980s. However, the changes in sectoral contribution were more significant. While service sector gradually emerged as the engine of growth of the Indian economy with average growth of 7.8 per cent during 1998–2004 and pushed agriculture and industry to the third and second place with 2.6 per cent and 5 per cent average growth rates, respectively. Among the service sector, transport storage and communication sector achieved average growth of 11.7 per cent followed by trade, hotels and restaurants (7.4 per cent), community personal and social service (7 per cent). During 2004–05, overall GDP growth of India was 6.9 per cent as against 8.5 per cent in 2003–04. Agriculture registered a growth rate of 1.1 per cent as against 8.6 per cent growth rate in service sector. Overall growth rate in industry was 8.3 per cent but manufacturing registered a growth rate of 9.2 per cent. It is expected that the industrial growth rate would sustain further. During recent years, industrial sector particularly the manufacturing sector has been showing an upward trend in growth and during 2004–05, it virtually caught up with the growth rate of service sector (Table 2.1). TABLE 2.1 Sectoral Real Growth Rates in GDP (at Factor Cost) Percentage Changeover the Previous Year

Item I. Agriculture and allied II. Industry 1. Mining and quarrying 2. Manufacturing 3. Electricity, gas and water supply 4. Construction III. Services 5. Trade, hotels, transport and communications 6. Financial services 7. Community, social and personal services IV. Total GDP at factor cost

1999– 2000– 2001– 1997–98 1998–99 2000 01 02

2002– 2003– 03 04 (P) (Q)

2004 –05 (A)

–2.4 4.3 9.8 1.5 7.9

6.2 3.7 2.8 2.7 7.0

0.3 4.8 3.3 4.0 5.2

–0.1 6.5 2.4 7.4 4.3

6.3 3.6 2.5 3.6 3.7

–7.0 6.6 9.0 6.5 3.1

9.6 6.6 6.4 6.9 3.7

1.1 7.8 5.3 8.9 6.3

10.2 9.8 7.8

6.2 8.4 7.7

8.0 10.1 8.5

6.7 5.5 6.8

4.0 6.8 9.0

7.3 7.9 9.8

7.0 9.1 11.8

5.7 8.9 11.3

11.6 11.7

7.4 10.4

10.6 12.2

3.5 5.2

4.5 5.1

8.7 3.9

7.1 5.8

7.1 6.0

4.8

6.5

6.1

4.4

5.8

4.0

8.5

6.9

Source Central Statistical Organization (CSO). Note A: Advance estimates; Q: Quick estimates; P: Provisional estimates.

Reforms and Emerging Economic and Financial Environment in India

33

Sectoral Contribution to GDP The significance of service sector in the Indian economy can be seen further in terms of its contribution to GDP, which has been steadily increasing over the years. The share of service sector in real GDP increased from 54.4 per cent in 2001–02 to 57.6 per cent in 2004–05 whereas the share of industrial sector increased very marginally from 21.5 per cent to 21.9 per cent but the same for agriculture declined substantially from 24 per cent to 20.5 per cent during the same period.

Financial Services Structural change in Indian economy and emergence of service sector as the engine of growth directly and indirectly impacted the financial services and contractual savings as well as growth in the financial sector benefiting institutional investors like life insurance. Overall growth and growth in service sector also boosted domestic savings of India expanding the scope and market potential for contractual and other institutional investors in India.

Per Capita and Disposable Income Another important development during the post-reform period is the significant improvement in per capita income and disposable income. Though, per capita income is not a very reliable index, particularly in a country like India having a very skewed distribution of income, it is often used to measure the economic well-being and purchasing power. It can be observed from Table 2.2 that since 1990–91, per capita income has improved significantly from Rs 6,000 to Rs 21,140 in 2002–03. Personal Disposable Income (PDI) is also a measure of purchasing power and improvement in general economic well-being. PDI in India increased from Rs 461,192 in 1990–91 to Rs 2,108,935 in 2002–03. A part of PDI goes for consumption and the other part is saved. This second part is most crucial for saving institutions like LIC.

Emerging Macro Economy Since liberalization in 1991, India has come a long way and its economic performance has been quite encouraging, though so far China surpassed India in many respects. However, the total impact of reform has not been realized as yet in the case of India. Moreover, reform is an ongoing process and a lot more is going to happen in the near future. This makes India more optimistic. This view is shared by many economists in their writings including a recent study of Dominic Wilson and Roopa Puroshothamam, which is popularly known as BRICs, published by Goldman Sachs (2003) in Global Economics Paper No. 99 (2003). The study commented that over the next 50 years Brazil, Russia, India and China—the BRICs economies could become a much larger force in the world economy. If things go right, in less

359 434 541 679 692 708 723 739 755 771 788 805 822 839 856 872 892 910 928 946 964 983 1,001 1,019 1,037 1,055 1,073

Year

1950–51 1960–61 1970–71 1980–81 1981–82 1982–83 1983–84 1984–85 1985–86 1986–87 1987–88 1988–89 1989–90 1990–91 1991–92 1992–93 1993–94 1994–95 1995–96 1996–97 1997–98 1998–99 1999–2000 2000–01 2001–02P 2002–03QE 2003–04RE

9,934 17,167 45,677 143,762 168,600 188,262 219,496 245,515 277,991 311,177 354,343 421,567 486,179 568,674 653,117 748,367 859,220 1,012,770 1,188,012 1,368,209 1,522,547 1,740,985 1,936,831 2,089,499 2,282,143 2,469,564 2,772,194

9,893 17,095 45,393 144,107 168,640 187,628 218,552 244,091 276,562 309,372 351,724 417,071 480,448 561,129 643,050 736,722 847,140 999,687 1,174,528 1,355,127 1,509,342 1,726,017 1,921,400 2,072,214 2,270,057 2,450,343 –

9,529 16,151 42,423 131,819 153,932 170,453 198,987 221,604 249,845 278,983 317,750 377,378 433,888 507,865 578,638 662,210 763,787 901,693 1,056,602 1,218,624 1,357,345 1,557,951 1,739,041 1,874,319 2,052,303 2,215,300 –

Gross National Net National GDP at Market Product (GNP) Product (NNP) Prices at Market Prices at Market Prices

Source Reserve Bank of India (2004–05a). Note P: Provisional; QE: Quick estimate; RE: Revised estimate.

Population (million) 8,876 14,638 37,891 12,0642 138,869 153,126 181,359 202,245 224,371 250,920 286,328 340,292 392,223 461,192 527,018 611,390 707,692 834,764 949,191 1,127,541 1,253,142 1,461,827 1,611,928 1,790,828 1,967,577 2,108,935 –

PDI

TABLE 2.2 Macro Economic Aggregates (at Current Prices)

265 372 775 1922 2,198 2,385 2,734 2,994 3,286 3,586 3,977 4,646 5,259 6,000 6,764 7,587 8,624 9,934 11,420 13,007 14,284 16,105 17,447 18,506 20,047 21,140 –

2,550 3,500 7,200 17,410 19,850 21,430 24,640 26,900 29,320 31,910 35,460 41,530 46,930 53,650 60,120 67,320 76,900 88,570 101,490 115,640 127,070 143,960 156,250 165,630 179,470 189,120 208,620

Per Capita NNP at Per Capita GNP at Factor Factor Cost (Rupees cost (Rupees in million) in crore)

34 LIFE INSURANCE IN INDIA

Reforms and Emerging Economic and Financial Environment in India

35

than 40 years, the BRICs economies together could be larger than the G6 in US dollar terms. With regard to growth of India the study says that over the next 50 years India’s growth rate will remain above 5 per cent while the growth rate of G6, Brazil, Russia and China is expected to go slow by 2032 (Table 2.3). India’s GDP will outstrip Japan and by 2050 India is expected to raise its US dollar per capita income by 35 times, though it will be significantly lower than other countries. TABLE 2.3 BRICs Real GDP Growth: 5-year Period Averages Year 2000–05 2005–10 2010–15 2015–20 2020–25 2025–30 2030–35 2035–40 2040–45 2045–50

Brazil (%) 2.7 4.2 4.1 3.8 3.7 3.8 3.9 3.8 3.6 3.4

China (%)

India (%)

Russia (%)

8.0 7.2 5.9 5.0 4.6 4.1 3.9 3.9 3.5 2.9

5.3 6.1 5.9 5.7 5.7 5.9 6.1 6.0 5.6 5.2

5.9 4.8 3.8 3.4 3.4 3.5 3.1 2.6 2.2 1.9

Source GS BRICs Model Projectiris.

This study estimated that, in GDP growth rate, India will maintain a steady growth rate of 5.3 per cent during 2000–05 being more or less same at 5.2 per cent during 2045–50. However, for China the same was estimated to decline from 8 per cent to 2.9 per cent during the same period. India’s GDP is expected to go up from US$ 469 billion in 2000 to US$ 27,803 billion in 2050 and at the same time GDP of Brazil, China and Russia is expected to rise from US$ 762 billion to US$ 6,074 billion, US$ 1,078 billion to US$ 44,453 billion and US$ 391 billion to US$ 5,870 billion, respectively. Combined GDP of BRICs economies is estimated to rise from US$ 2,700 billion in 2000 to US$ 8,420 billion in 2050. However, in per capita income India is expected to loose before Russia, China and Brazil. India’s GDP per capita in 2050 is estimated to be US$ 17,366, against US$ 49,646 of Russia, US$ 31,357 of China and US$ 26,592 of Brazil. This is due to population growth expected in these countries. However, the estimates in BRICs analysis are based on the main ingredients of sound macro economic policies and a stable macro economic background, strong and stable political institutions, openness and high levels of education. We expect that in India these ingredients are further strengthened and the Indian economy becomes stronger. However, the existing evidence suggests that India is on the right path to achieve the desired goal with extended social participation and distribution of gains from growth.

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Emerging Financial Markets As observed, the Indian economy has gradually tended to be service dependent in terms of GDP contribution. In the service sector, financial services play a very critical role to support the real sector by channelizing the required resources. Improvements in financial services thus provides long-term stability during growth and efficiency in resource allocation. Liberalization in financial services provides the much needed momentum to growth. Therefore, reforms all over the world including India have focussed on this sector. However, the financial service sector is very complex because of a variety of activities and products handled by a wide range of organizations such as banks, insurance companies, investment banks, non-bank financial service companies and mutual funds. Complexities in financial services have further increased during recent times owing to convergence in the financial service industry—with emergence in multiproduct, multilocation and cross-border activities of these institutions. In addition, fragmented regulatory regime has also compounded complexities of financial services operation. Service operation has further undergone tremendous transformation due to the technological advancement, improved management quality and application of quantitative decision-making tools. Therefore, in order to manage service industry with a wide range of complexities and continued innovation and change in the state of operation, the industry needs well-developed institutional structure and well-developed mechanism to integrate emerging linkages. Thus, the role of institutions becomes important, particularly in an evolving service industry economy like India, which is integrated with the global market. Fortunately Indian policy market focussed on this since 1950, and a number of specialized financial institutions were promoted over the period to manage financial economy. Financial institutions were promoted to support the growth of real sector and the financial market. While financial institutions were created to support and manage financial market, the financial market on the other hand also supported the growth and change in institutional environment. Therefore, the market and institutions both played complementary and supportive roles for each other. Changes in the macro economic policies, opening up of the market to domestic and foreign investors, free pricing of public issues, public sector disinvestment and structural changes in Household Savings, etc., provided the much needed boost to the economy. Changes in economic policies and reforms in financial sector have not only reduced the predominant influence of public sector in the financial market but also changed the traditional role of many specialized financial institutions, for example, development finance institutions have entered into diversified commercial banking and capital market activities through mutual funds, investment banking and broking activities. Many commercial banks have set up mutual funds, housing finance and many institutions have entered into insurance business hitherto monopolized by LIC and General Insurance Corporation (GIC). The public sector financial institutions and banks are readjusting their business objectives and business focus keeping in view the changes in the market environment.

Reforms and Emerging Economic and Financial Environment in India

37

Structure of Financial Markets Broadly the Indian financial market consists of money market (call money, certificate of deposits, commercial papers, etc.), credit market (bank loans, loans from term-lending institutions, etc.) and capital market consisting of government securities market and stock market (equity and debt). Though there are some similarities and linkages in these markets, they differ widely in product range and scale of operation. So also, the regulatory requirements and monitoring require a separate set of rules. Therefore, for divergence in role, service and operation call for setting up institutions with divergence in purpose and management skill. To manage the market and financial services a wide range of financial institutions are in place today. Operational skills and sophistication of these institutions are quite comparable with such institutions in any country. Reforms in financial services induced structural changes and in the new environment the predominant role of public sector institutions declined significantly. However, introduction of financial sector reforms in India since 1991, has brought significant change with the declining dominance of public sector due to the entry of private sector banks mutual funds and insurance companies. Several new generation private sector banks have entered the banking sector successfully challenging the public sector banks. Domestic and foreign private sector mutual funds have taken away a significant market share from Unit Trust of India (UTI) and public sector mutual funds. Indian insurance sector has also opened up and private sector insurance companies have started operation by setting up joint ventures with foreign insurance companies. The foreign broking firms are actively involved in broking business in Indian stock market. All these developments have changed the Indian financial landscape significantly. Financial institutions in organized sector can be grouped into the following categories.

Financial Institution 1. Banking sector includes commercial and co-operative banks. The commercial banking sector includes public sector banks, private sector banks and regional rural banks (RRBs). 2. Non-banking financial institutions include wide and diversified financial institutions, namely, contractual savings institutions like insurance (life and non-life) operated by public and private sector entities, investment institutions like mutual funds and UTI operated by public and other development financial institutions, such as Industrial Development Bank of India (IDBI), Industrial Financial Corporation of India (IFCI), Industrial Credit and Investment Corporation of India (ICICI) and Small Industries Development Bank of India (SIDBI). We have mentioned in Chapter 1 that financial structure of a country has a strong impact on development and growth. This growth impact is transmitted through operation and efficiency of financial intermediarie, particularly financial institutions. The capital role of financial

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institutions is reflected through their activities in savings mobilization, efficient resource allocation, information gathering, and discrimination and risk management.

Banking Sector Over a period India has developed a wide and well spread banking network in the country and served in the growth of economy. Indian banking sector consists of commercial banks and cooperative banks. Among commercial banks there are public sector banks, private sector banks (domestic and foreign) and RRBs. Ever since banks have been nationalized in India the number of commercial banks increased from 89 in 1969 to 284 in 2005, while the number of non-schedule banks declined from 16 to 4. Nationalization also assisted branch expansion particularly in rural and semi-urban areas. Total number of branches in 1969 were 8,262, out of which 1,833 (22.11 per cent) were situated in rural areas, 3,342 (40.55 per cent) in semi-urban areas, 1,584 (19.2 per cent) in urban areas and 1,503 (18.2 per cent) in metropolitan areas. By 2005, the total number of branches increased to 67,188, out of which 32,082 were in rural areas, 15,403 in semi-urban areas, 11,500 in urban areas and 9,370 in metropolitan areas. Nationalization of commercial banks took the banking services to remotest and rural areas of the country providing opportunity to savers and assisted reallocation of capital for productive activities. Post-nationalized banking sector witnessed rapid expansion of branches, mobilization of deposits and improvement in credit deposit ratio. However, it also suffers from overstaffing, low quality of service, low level of profitability and high operation costs. Low return on banking funds since the government used captive banking funds for developmental work forced the banks to retain a large part of funds for non-interest bearing reserves. All these came in the way of improving operational efficiency comparable to global standards. In order to improve the operational efficiency of the Indian banking sector the government appointed Narasimham Committee which suggested a wide range of reforms in the banking system and these reforms were implemented by the Government of India. The objectives of the reforms were to improve banking efficiency, to enhance resource mobilization and credit allocation, and at the same to increase productivity and quality of credit allocation. A number of reforms were introduced including relaxation of controlled and entry norms, setting up of new private banks, removal of restrictions on opening and closing branches, allowing Foreign Institutional Investors (FIIs) and Non Resident Indians (NRIs) equity participation to the extent of 40 per cent, allowing banks to determine deposit rates (except savings account), etc. Expansion of banking activities not only assisted the growth of savings but also assisted growth of other financial activities including life insurance business.

Contractual Savings Institutes The major contractual savings institutions in the Indian financial markets are insurance companies, and pension and provident funds.

Reforms and Emerging Economic and Financial Environment in India

39

Insurance Institutions

Indian insurance industry was exclusively controlled by the government-owned LIC of India, GIC of India and four of its subsidiaries. However, the monopoly of the governmentowned insurance companies has ended with the entry of private sector insurance companies. Government-owned LIC and GIC played an important role by mobilizing funds and investing a large part of it in socially oriented economic activities, project promoted by central and state government and their agencies in addition to financing private corporate activities. By 31 March 2005, there were 14 life insurance companies including one public sector and 13 private sector companies in India (details are discussed in the Chapter 3). Pension and Provident Funds (PFs)

These are important institutions in the financial market operated by the government and government agencies under strict regulatory control. However, they play a very important role in mobilizing public savings particularly from organized sector employees, and provide crucial support to the Indian debt market. Indian pension market is expected to undergo a drastic change once the proposed reforms in pension system are introduced. The proposal to introduce privately financed and Defined Contribution (DC) scheme in India is expected to explode the pension market in India. Household financial savings invested in provident fund and pension fund increased by 4.8 times from Rs 111,550 million in 1990–91 to Rs 544,070 million in 2003–04.

Investment Institution Major investment institutions in the Indian financial markets are insurance institutions, pension and provident funds, and UTI and mutual funds. We have already discussed about insurance companies, and pension and provident funds so we will restrict ourselves to UTI and Mutual Funds. Mutual Funds

Indian mutual fund industry has come a long way since 1964 when UTI was established by an Act of Parliament. Upto 1987 the Industry was exclusively controlled by UTI. Thereafter, the industry was opened to public sector and government-owned banks such as SBI, Can Bank, Punjab National Bank (PNB), Bank of India, Indian Overseas Bank and financial institutions like LIC and GIC set up their own mutual funds. The industry was further opened up to the private sector and a large number of mutual funds were set up by Indian institutions either independently or as joint ventures with foreign institutions. By the end of January 2006, there were 28 mutual funds operating in the Indian Market, out of which five were public sector funds and 23 funds were in the private sector. With entry of private sector mutual funds, the industry witnessed momentous growth in assets and resource mobilization. There has been a significant increase in gross mobilization during 2003–05. Gross mobilization of mutual funds increased from Rs 5,901,900 million in 2003–04 to Rs 839,708 million in 2004–05. The total

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assets size of Indian mutual funds including UTI, increased 3.2 times from Rs 470,000 million in March 1993 to Rs 1,496,010 million in March 2005. The net assets have further gone upto Rs 207,970 million in January 2006. Many new kinds of schemes—in addition to income, growth and balanced funds—namely index funds, fund of funds and sector specific funds have been launched by the mutual funds. The mutual funds industry is regulated by Securities Exchange Board of India (SEBI). SEBI has regulations including regulations on registration, distribution, asset management disclosure, corporate governance, etc. Transparency in market operation strengthens disclosure and corporate governance and improves fund managers’ accountability. Increased use of technology has improved dissemination of real time information and investors education. Association of Mutual Funds in India (AMFI) has gradually evolved itself as a self-regulator. AMFI, which is an association of Indian mutual funds, takes initiatives for promoting healthy competition and growth of mutual funds in India. It has also come out with several initiatives to improve transparency and ethical practices in the industry. AMFI also introduced certification programme for agents and distributors and also undertaken investors education programmes.

Development of Financial Institutions The institutions such as IDBI, IFCI, ICICI were set up to cater to the needs of long-term finance for the corporate sector. However, the scope of financing of these institutions has undergone significant change since 1991 though the predominance of government control remain over them. There are a variety of specialized financial institutions catering to the needs of specialized sectors of economy. The important institutions are: Export Import Bank of India (EXIM Bank), National Bank for Agricultural and Rural Development (NABARD), Industrial and Investment Bank of India (IIBI), State Financial Corporations (SFCs), State Industrial Development Corporations (SIDCs) and venture capital funds. These public sector institutions have played a crucial role in providing important financial and other support services to the industry and economy, especially during the initial period of economic development in India. In the emerging new economy another type of financial institution, that is, venture capital funds is gradually emerging as the leading institution to finance new economic ventures.

Assets of Financial Institutions Growing importance of the financial sector can be seen with respect to growth in assets of financial institutions. According to RBI (Statistical Tables Relating to the Banks in India 2004–05) total assets of financial institutions including banks had increased by 7.5 times from Rs 3,607,610 million in 1990–91 to Rs 26,984,830 million in 2004–05. However, assets of financial institutions grew at a faster rate than bank assets. Assets of banks increased by 8.8 times from Rs 2,327,860 million to Rs 20,466,430 million as against increase in assets of financial institutions

2,327,860

1990–91 (2)

8. Other institutions##

(c) GIC and its subsidiaries

(b) LIC

19,880

63,620

290,400

1. All scheduled commercial 226,130 banks∗ 2. Non-scheduled 770 commercial banks∗∗ 3. Total commercial 2,226,900 banks(1+2) 4. State co-operative 100,960 banks+ Financial institutions 1,279,750 (5 to 8)++ 5. Term-lending institutions# 573,720 (All India) 6. State level institutions@ 100,490 7. Investment institutions@@ 585,660 (a) UTI 231,640

All banks (3+4)

Banks/FIs (1)

5,897,410 (12.9) 2,420,620 319,930 3,077,320 854,260 (13.7) 1,924,820 (20.3) 298,240 (11.1) 79,540

5,224,660 (12.5) 2,291,090 245,180 2,618,850 751,020

69,540

268,340

–

389,040 3,505,380 642,230 (–24.8) 2,444,480 (27.0) 418,670 (40.4) 85,960

5,692,530 (–3.5) 1,712,150

460,260

10,091,500 12,230,080

–

411,260

1,599,490

2001–02 (5)

10,502,760 12,690,340 (18.2) (20.8) 10,091,500 12,230,080

2000–01 (4)

376,810

8,511,000

–

8,887,810 (16.7) 8,511,000

1999–2000 (3)

2003–04 (7)

–

2,896,300 (18.5) 449,400 (7.3) 95,230

530,440 3,345,700 Na

5,778,770 (1.5) 1,807,400

491,720

673,570 (10.2) 123,360

37,205,200#

609,420 >> 4,394,090 Na

6,518,400 (–6.9) 1,391,530

591,870

19,874,560

20,466,430 (20.6) 19,874,560

2004–05P (8)

(Rs in million)

(Table 2.4 Continued)

3,720,520 (28.5) 611,260 (36.0) 109,730

609,420 4,331,780 Na

7,003,400 (21.2) 1,952,470

531,270

14,016,820 16,434,470

–

14,508,540 16,965,740 (14.3) (16.9) 14,016,820 16,434,470

2002–03 (6)

TABLE 2.4 Financial Assets of Banks and Financial Institutions (as on 31 March)

Reforms and Emerging Economic and Financial Environment in India 41

1999–2000 (3)

64.5 35.5

63.0 37.0

3,607,610 14,11,2470 (15.1)

1990–91 (2)

2001–02 (5)

64.0 36.0

69.0 31.0

16,40,0170 18,382,870 (16.2) (12.1)

2000–01 (4)

2003–04 (7)

71.5 28.5

70.8 29.2

20,287,310 23,969,140 (10.4) (18d)

2002–03 (6)

75.8 24.2

26,984,830 (12.6)

2004–05P (8)

Source Reserve Bank of India, 2005b. Notes P: Provisional. >> : Figures repeated. ∗All Scheduled Commercial Banks. As per returns under Section 42 of the RBI Act, 1934 and since 1991 relate to the reporting Friday of March, except the ICICI Bank Ltd. for which the data relate to end of March 2002. ∗∗Non-scheduled Commercial Banks. As per returns under Section 27 of the Banking Regulation Act 1949. Data relate to the last Friday of March. + The data since 1990 are in respect of last reporting Friday of March. ++ Figures pertain to the accounting year of the respective financial institution. # Term-lending institutions include IDBI, NABARD, ICICI, Industrial Finance Corporation of India (IFCI), EXIM Bank, Industrial Investment Bank of India (IIBI), National Housing Bank (NHB) and Infrastructure Development Finance Company (IDFC). Data exclude ICICI from 2001–02 as it was merged with ICICI Bank Ltd. since May 2002 and IDBI from 2004–2005 which was converted into a bank since October 2004. State level institutions include SFCs and SIDCs. @@ Investment institutions include UTI (till 2002 since its conversion into a mutual fund), LIC and GIC and its former subsidiaries. ## Other institutions include Deposit Insurance and Credit Guarantee Corporation (DICGC) and Export Credit Guarantee Corporation (ECGC). Figures in parentheses indicate percentage variation over the previous year. Data of financial assets of banks include: (i) Cash in hand and balances with the Reserve Bank. (ii) Asset with the banking system (iii) Investments (iv) Bank credit (total loans, cash credits, overdrafts, bills purchased and discounted) and (v) Dues from banks.

Percentage share: (a) I in III (b) II in III

Aggregate (I+II)

Banks/FIs (1)

(Table 2.4 Continued)

42 LIFE INSURANCE IN INDIA

Reforms and Emerging Economic and Financial Environment in India

43

by 5.1 times from Rs 1,279,750 million to Rs 6,518,400 million. Therefore, asset growth in banks was 8.8 times higher than assets growth of financial institutions. However, assets growth of investment institutions, including UTI, LIC, GIC and its subsidiaries increased by 7.5 times during 1990–91 to 2004–05. (Table 2.4) While Year-On-Year (YOY) growth rates of bank assets showed an upward increase from 16.7 per cent in 1999–2000 to 20.6 per cent in 2004–05, it was the same for financial institutes. However, assets of Financial Institutions declined from 12.5 per cent in 1999–2000 to –6.9 per cent in 2004–05. Post-reform growth in bank assets and decline in the assets growth of financial institutions was caused by the expansion of banking and decline in activities of All India Development Financial Institutions. Among the financial institutions, the investment institutions namely LIC, GIC and UTI together held 51 per cent of total assets of all financial institutions. Growth rate analysis for financial assets of financial institutions indicate that during the year of reforms, that is, from 1991 to 2000, the assets of all financial institutions and banks increased by 29 per cent on annualized basis. The rate of growth for bank assets increased at a lower rate of 28 per cent than the financial institutions, which registered an annual growth rate of 30.4 per cent. Among the financial institutions, the all India investment institutions registered a faster growth rate of 40 per cent. This was due to the diversification of activities of these institutions, increased focus on stock market investing and the change in government policy of controlling investment activities of such institutions. In the post-reformed period Department of Financial Institutions (DFI) such as IDBI, ICICI focussed more on the banking activities than on their traditional role as term-lending institutions. Industries on the other hand preferred to raise funds for capital by reducing their dependence on the term-lending institutions. Added to these were the emerging growth emphasis on financing development, which replaced the model of bank finance led growth by the model of capital market led growth in India like many market economies abroad.

Emerging Savings Market in India Financial liberalization among others intended to increase domestic savings and improve mobilization and in that process, contractual savings institutions like insurance institutions and pension funds are expected to play a significant role. Increase in savings is expected to increase due to income growth of households and corporates caused by higher growth rates of economy in a more liberalized environment. This increase in savings is expected to channelize into production systems and capital market via contractual savings institutions like insurance and pension funds. Liberalization of financial markets provides these institutions with the opportunity to compete, expand the market and scope to improve mobilization. However, liberalization may not necessarily boost up saving since a liberalized market offers more opportunities to increase consumption, which may exert contractionary impact on savings growth. Therefore, the impact of liberalization will depend on the strength of these two forces, particularly on the savings mobilization strategy and efficiency of the institutions. Quantum of

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savings in the economy will also be influenced by the policy of taxation, availability of social security and other incentives or disincentives introduced by the state. Economic reforms, financial and insurance market reforms therefore exert a variety of influence on HDS in general and life insurance in particular. Ranade and Ahuja (2001) observed that during the course of insurance and overall financial sector liberalization as real rates of interest rise, typically substitution effect is weaker than the opposing income effect which tends to reduce savings. In the context of insurance reforms as the precautionary motive is diminished due to availability of greater insurance options this avenue also works towards reducing savings. However, India seems to be an exception to this contention and there was no perceptible decline in domestic and HDS in India during the post-liberalized era. In fact the rates of savings remained steady and improved further with the opening up of Indian insurance sector in 2000–01. Domestic saving which oscillated around 23 per cent in terms of GDP, reached its peak at 29.1 per cent in 2004–05.

Gross Domestic Savings (GDS) According to the RBI ‘the Indian savings experience during the period 1970–71 to 1998–99 was marked by a simultaneous secular increase in the rate of GDS (GDS as percentage of GDP at current market prices)’ (RBI, Report on Currency and Finance 1999–2000). During the 1990s household financial savings emerged as the single most important contributor to GDS by contributing over 70 per cent. India has maintained more than 23 per cent growth in average GDS (as percentage of GDP) during 1990s as against 20 per cent in 1980s. Since 2000–01 GDS in India increased steadily from 23.5 per cent in 2000–01 to 29.1 per cent in 2004–05.

HDS One of the most significant development in Indian savings economy in 1990s was the continued increase in financial savings and gradual decline in physical savings of the household sector. TABLE 2.5 Trend in Domestic Savings in India

GDS (a) Public (b) Private (i) Household Financial Physical (ii) Private corporate

1990– 91

1999– 2000

2000– 01

2001– 02

2002– 03

2003– 04

2004– 05

23.1 1.1 22.70 19.3 8.7 10.6 2.7

24.2 –1.0 25.2 20.9 10.6 10.3 4.4

23.5 –2.3 25.8 21.6 10.4 11.3 4.1

23.4 –2.7 26.2 22.6 11.2 11.4 3.6

26.5 –0.7 27.2 23.1 10.3 12.7 4.1

28.9 1.0 27.9 23.5 11.5 12.0 4.4

29.1 2.2 26.8 22.0 10.3 11.7 4.8

Source Reserve Bank of India (2005–06).

Reforms and Emerging Economic and Financial Environment in India

45

The share of household sector is the most important component in India’s domestic savings. The share of HDS (as percentage of GDP) in GDS has also gone up substantially from 15.2 per cent in 1980s to 18.3 per cent in 1990s. The share of household savings in GDS increased from 19.3 per cent in 1990–91 to 23.5 in 2003–04 but declined to 22 per cent in 2004–05.

Corporate Sector Savings The 1990s decade was however marked by the gradual increase in share of private corporate sector savings in GDS which went up from 2.7 per cent in 1990–91 to 4.8 per cent in 2004–05. On the contrary, share of public sector savings, which was 1.1 per cent in 1990–91 witnessed continuous decline from –1 per cent in 1999–2000 to –0.7 per cent in 2002–03, but subsequently showed an improvement from 1 per cent in negatives during 1999–2000 to 2002–03 but the share of corporate savings was 4.8 per cent in 2003–04 however this improved to 2.2 per cent in 2004–05.

Savings in Financial Assets The share of financial assets in private savings used to be lower than that of physical savings but the gap between them increased since 2002–03 (Table 2.5). The share of financial assets in HDS in 1999–2000 was 10.6 per cent as against 10.3 per cent, the share of physical assets. Although, in the subsequent years physical assets continued to be higher than financial assets household sector.

Contractual Savings Contractual savings such as life insurance, pension funds along with banks and mutual funds along with banks play an important role in household savings market as fund mobilizer and resource allocators. Deepening of market also supports growth of institutional investors and the same has been noted in India too. Analysis of instrument wise distribution of Household Savings in Financial Assets (HSFA) indicate a steady increase in the share of contractual savings like insurance, pension and PF. The share of contractual savings in total household financial savings declined from 34.6 per cent in 1980–81 to 33.2 per cent in 1990–91 but increased steadily to 37.5 per cent in 1998–99. Non-contractual savings on the other hand declined from 66.8 per cent in 1990–91 to 62.5 per cent in 1998–99. However, since 2001–02 there has been a sharp decline from 31.1 per cent to 26.4 per cent in 2003–04.

Institutional Share in Household Financial Assets Since 1991, several reforms have been undertaken during 1990s and the Indian capital market has witnessed a significant structural change. However, these reforms had very little impact

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on the savings preference of the household sector. The share of capital market instruments like shares and debentures in HDS has witnessed a significant decline during the post-reform period. These instruments together accounted for 14.3 per cent of total HDS in 1990–91, it went up substantially to 23.3 per cent in 1991–92, but declined sharply during the subsequent period and touched to 2.5 per cent in 1998–99. Similarly, the share of units of UTI and mutual funds in household financial savings after witnessing an increase in 1991–92 declined sharply. The share of mutual funds including UTI, was 9.1 per cent in 1990–91, it went up to 16.4 per cent in 1991–92, only to decline subsequently and to reach to 1 per cent in 1998–99 and further to—0.7 per cent in 2003–04. Traditional investments such as bank deposit, life insurance, PF and Public Provident Fund (PPF) continued to enjoy the support of investors. Data in (Table 2.6), indicates that the share of bank deposit in household financial savings went up from 33.3 per cent in 1990–91 to 41.8 per cent in 1998–99, while the share of PPF and PF went up from 18.9 per cent to 22.7 per cent and that of insurance funds went up from 9.5 per cent to 10.5 per cent during the same period. By the end of March 2004, the share of banks, life insurance, PF and PPF was 39.4 per cent, 13.2 per cent, respectively. Interest rates have an important influence on savings and impact the FOFs from household sector to other sectors as well as to various instruments of investment. While low rate of interest improves the competitive capacity of domestic industries in international market it may also discourage domestic savings. Indian industry, vociferously demanded reduction of interest rates and it became one of the important objectives of financial sector reforms in India and there has been a substantial decline in real rate of interest. One significant point to be noted here is that inspite of decline in real rate of return from bank deposits and other contractual savings, the preference of investors remained mostly unaltered. The decade of 1990s is marked by financial sector reforms and all efforts have been made to open up the capital markets and to promote a capital market-based economy. However, they have failed to induce confidence in the household sector and to attract HDS to capital markets. This is probably due to the fact that reforms could not create an environment of fundamental based market structure hence, market imperfection continued and volatility persisted. Moreover, transition period was also marked by lack of sequencing of reforms as well as too many reforms within a very short period, without having a sufficient infrastructure.

Emerging Trend in Capital Market Market Structure Indian capital market has undergone radical transformation since 1991 due to the reforms introduced in economy and particularly in the financial sector. Macro economic reforms have transformed the economy from agriculture dependent to service dependent, altered the composition of HDS in favour of financial assets and also impacted the structure of interest rates, savings and FOFs. Economic reforms also brought down overall inflation rate, imparted stability in the rate of growth, and provided freedom to private initiatives and private investment. All

0.0 0.1 (0.0) 0.0 –2.2 0.0 1.2 20.2 (2.8) 4.7 15.57 13.5 (1.9) 12.8 0.3 0.4

0.0 1.1 (0.2) 1.4 –0.0 –0.7 0.0 0.4 24.0 (3.3) 5.0 19.0 13.0 (1.8) 12.4 0.3 0.4 13.2 1.8

6. Provident and pension fund #

Source Reserve Bank of India, Annual Reports (various issues). Notes Figures in bracket indicate household financial savings in terms of GDP. # Preliminary; P: Provisional.

14.1 (2.0)

100 (14.0) 10.5 1.5 41.6 5.8 36.7 0.9 4.0

100 (13.7) 9.2 1.3 39.4 (5.4) 37.1 0.4 2.0

Financial saving(gross) # 1. Currency # 2. Deposits # (i) With banks (ii) With non-banking companies (iii) With co-operative banks and societies (iv) Trade debt (net) 3. Shares and debentures # (i) Private corporate business (PCB) (ii) Co-operative banks and societies (iii) Units of UTI (iv) Bonds of public sector undertakings (PSUs) (v) Mutual funds (other than UTI) 4. Claims on government # (i) Investment in government securities (ii) Investment in small savings, etc. 5. Insurance funds # (i) Life insurance funds (ii) Postal insurance (iii) State insurance

2003–04P

2004–05

Item

15.0 2.0

14.9 16.5 (2.1) 15.5 (0.3) 0.4

1.3 17.4 (2.3) 2.5

–0.1 1.7 (0.2) 0.8 0.0 –0.5 0.1

100 (13.1) 8.95 (1.2) 40.9 (5.4) 35.56 2.7 2.0

2002–03P

16.1 2.0

12.1 14.2 1.8 13.5 0.3 0.4

1.8 17.9 2.3 5.8

–2.1 2.7 0.3 1.5 0.1 –0.6 0.0

100 12.7 9.7 1.2 39.4 5.0 35.3 2.6 3.6

2001–02P

TABLE 2.6 Distribution of Financial Saving (Gross) of the Household Sector in India

19.3 2.3

14.0 13.6 1.6 12.9 0.2 0.5

1.3 15.7 1.9 1.7

0.1 4.1 0.5 3.1 0.0 –0.4 0.1

100 11.9 6.3 0.7 41.0 4.9 32.5 2.9 5.6

2000–01

22.8 2.8

11.3 12.1 1.5 11.2 0.3 0.6

3.4 12.3 1.5 0.9

–0.4 7.7 0.9 3.4 0.0 0.8 0.1

100 12.2 8.8 1.1 36.3 4.4 30.8 1.7 4.3

1999–2000

Reforms and Emerging Economic and Financial Environment in India 47

(3) 67 378 894 870 1,019 960 1,423 1,512 1,326 1,580 1,839 1,286 2,218 6,035 11,654 11,547 13,198 25,980 6,733 7,670 3,981 7,131 7,470 5,299 764

(4) 207 915 1,037 1,235 1,376 1,556 1,779 2,159 2,589 3,423 4,415 5,599 7,003 7,114 9,548 11,370 13,894 16,121 19,410 23,428 28,644 33,861 41,236 52,126 62,206

(5) 490 2,122 2,480 2,865 3,052 3,759 4,188 5,055 6,509 7,552 9,508 11,155 12,501 14,814 18,323 21,414 22,343 30,390 32,267 46,408 53,907 48,042 46,611 48,271 54,182

(6) 105 712 1,784 1,243 1,976 3,107 3,413 3,092 3,680 5,478 6,758 7,883 4,845 3,885 6,908 13,186 9,588 11,783 22,162 28,220 28,985 39,007 51,940 62,560 74,001

(7) 68 412 510 646 555 762 1,394 1,768 813 1,136 2,655 4,972 6,800 8,212 10,067 13,473 8,839 6,631 4,464 5,105 16,308 11,148 9,634 7,122 7,554

8 14 31 114 122 222 567 586 943 1,196 1,427 2,179 3,438 9,087 5,612 4,705 3,908 262 3,776 595 1,887 1,811 –934 –1,856 –1,617 –1,856

9

Life Provident Claims on Shares and Non-banking Insurance and Pension Government Debentures Units of Deposits Fund Fund + ++ UTI 50 373 643 429 –164 41 –44 –280 504 359 –763 –453 –414 –1,398 –1,190 –1,148 –252 –708 –770 –6,870 –1,023 183 –6,173 –219 –215

10

Trade Debt (Net)

2,110 12,118 13,621 16,097 18,790 23,549 25,562 31,849 36,106 39,958 48,233 58,908 68,045 80,354 109,618 145,501 124,337 158,519 171,740 207,103 236,351 248,774 289,953 336,609 417,675

11

Changes in Financial Assets (2 to 10)

Source Hand Book of Statistics on the Indian Economy 2004–05. Notes + includes compulsory deposits. ++ includes investment in shares and debentures of credit/non-credit societies, public sector bonds and investment in mutual funds (other than UTI). $: Preliminary estimates. P: Provisional.

355 754 1,625 5,550 965 5,194 2,026 6,661 2,776 7,978 2,938 9,859 2,220 10,603 3,090 14,510 4,815 14,674 4,256 14,747 7,655 13,987 6,251 18,777 8,157 17,848 6,562 29,518 13,367 36,236 15,916 55,835 16,525 39,941 13,643 50,902 12,780 74,099 21,822 79,433 20,845 82,892 15,632 94,703 28,156 112,935 28,447 134,620 42,200 178,839

(2)

(1)

1970–71 1980–81 1981–82 1982–83 1983–84 1984–85 1985–86 1986–87 1987–88 1988–89 1989–90 1990–91 1991–92 1992–93 1993–94 1994–95 1995–96 1996–97 1997–98 1998–99 1999–2000 2000–01 2001–02P 2002–03P 2003–04$

Currency

Year

Bank Deposits

TABLE 2.7 Changes in Financial Assets of the Household Sector (at Current Prices)

Reforms and Emerging Economic and Financial Environment in India

49

these factors provided momentum to capital market growth. Reforms in Indian capital market have strengthened the regulatory mechanism. Though the overall market control remains with the Ministry of Finance, Government of India, market supervision rests with SEBI. Reforms have reduced the entry barriers and a large number of financial intermediaries have entered the capital market. Financial sector reforms in India were aimed at broadening the market, increasing the depth of liquidity and transparency in the market. According to the Ministry of Finance the overall strategy for broader financial sector reforms, was: to make a wider choice of instruments accessible to the public and producers. This requires a regulatory framework which gives reasonable protection to investors without smothering the market with regulation. It requires breaking up of monopolies and promotion of competition in the provision of service to the people. It requires the development of new markets such as securities, markets for public debt instruments and options, futures and Forward market for financial instruments and commodities’ (Ministry of Finance, 1993).

With these objectives in view, the Government of India took several measures towards institutional reforms, investors protection, transparency in market transactions, increasing the liquidity, innovation of new products and introduction of technology. The government has also introduced many new regulations and reversed old regulations in tune with changing market environment and also put in place a world-class regulation to move quickly towards market economy. With the repeal of Capital Issues (Control) Act 1947 in May 1992 the government control ceased over the pricing of public issues, fixing premium and rates of interest. SEBI Act 1992 entrusted statutory powers to SEBI, for promoting and developing securities market and to protect interest of investors. Enactment of SEBI Act was the first attempt to promote a welldeveloped and well-regulated securities market in India. Securities Contract (Regulation) Act 1956—introduced to integrate and regulate securities market and powers under Securities (Regulation) Act 1953—was delegated to SEBI. A number of steps have been taken to remove the constraints of growth, to make market operation transparent, investor friendly and technologically efficient. Reforms have also been introduced in banking, corporate security and in the government securities market.

Capital Market Regulation Since then SEBI has taken several steps to integrate capital market, to bring investor friendly transparency and issued a number of guidelines which include: SEBI (Merchant Bankers) Regulations 1992, SEBI Guidelines for Disclosure and Investors protection 1992, SEBI (Stock brokers and sub-brokers) Regulation 1992, SEBI (Mutual Funds) Regulation 1993, SEBI

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(Debenture Trustee) Rules and Regulations 1993, SEBI (FIIs) Regulation 1995 and SEBI (Substantial Acquisition of Shares and Take Over)Regulation 1997. Depositories Act 1996 was passed in 1996 to facilitate establishment of National Securities Depositories Ltd (NSDL) and Central Depositories Service Ltd (CDSL), Securities Contract (Regulation) Act 1956 was amended in 1995 to lift the ban on options trading in securities and further in 1999 to introduce derivative trading accounting standard, in order to bring disclosures and accounting standard of listed companies measures were initiated in 1999–2000. During the year 1999–2000, SEBI appointed a committee on corporate governance which has submitted its report. The recommendations have been accepted, SEBI has also appointed a committee of experts to suggest measures to promote and regulate venture capital funds. The recommendations of the committee have been accepted by SEBI. As a result of the reform initiatives, Indian capital market has undergone tremendous transformation. Some such changes have been reflected in the following: Institutionalization of Market

There has been a significant change in market characteristics and Indian market tended towards institutionalization due to the increasing presence of mutual funds, foreign institutional investors and increased market penetration of domestic financial institutions. Free Pricing of Securities

Abolition of Controller of Capital Issue (CCI) has provided freedom to domestic issuers to price their issues independently. They are also allowed to raise capital from the global capital market by issuing Alternative Dispute Resolutions (ADRs) and Global Depository Receipts (GDRs). The entry norms for capital issue and continuing disclosure norms for the issuers were introduced. Flow of Information

Due to the introduction of continuing disclosure norms, increasing presence of FIIs, and investment research; frequency and extent of flow of information has increased which facilitates investors to take informed decisions. Technology-led Transparency and Safety

Due to the introduction of latest technology in stock exchanges, the trading system has changed, locational constraints have been removed, level of transparency has increased and the transaction cost has come down. Level of safety in the secondary market has increased due to shortening of trade cycles, introduction of electronic book entry and dematerialization of scrips. Credit Rating

The number of rating agencies has increased and they are providing important services regarding issue quality, market research, etc., to the investors, enabling them to take data-based informed decision.

Reforms and Emerging Economic and Financial Environment in India

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Market Intermediaries

There has been a significant growth as well as qualitative change with respect to market intermediaries, merchant bankers, stock brokers, etc. The number of registered brokers increased from 6,711 (out of which 616 were corporate members) in 1995 to 9,192 (out of which 3,316 were corporate members) in March 2000. SEBI also introduced the capital adequacy and prudential regulations for brokers, sub-brokers and other intermediaries. Regulatory Norms

SEBI has laid down the regulatory norms and code of conduct for mutual funds, merchant bankers, underwriters and market intermediaries. Decline in Transaction Costs

The reforms in the securities market has a favourable impact on transaction costs in the securities market. Average transaction costs declined for all types of investors. Transaction costs also declined for retail investors of dematerialized deliveries. Decline in transaction costs provided the opportunity for higher returns to investors and also made the Indian market more competitive for foreign investors.

Trend in Resource Mobilization The reforms in the corporate securities market have changed the pattern of resource allocation, extended the market beyond the geographical boundary (due to introduction of screen-based trading and fast track settlement). Several measures have also been introduced in the government securities market to strengthen the market structure, which has helped the growth of secondary market and introduction of several innovative products in the marketplace. These reforms have successfully dismantled the entry barriers and today there are domestic and foreign financial institutions such as mutual funds, broking firms, insurance companies operating in the Indian market. The confidence of domestic and foreign institutions have been strengthened due to introduction of capital adequacy norms, strict disclosure prudential regulation and introduction of world-class regulatory mechanism to protect interest of investors. Indian economy has slowly integrated itself with global economy and financial markets. Resource Mobilized by Corporate

With the liberalization of financial market and reforms in corporate security market, Indian corporates are resorting to equity financing by mobility funds from primary equity market by issuing capital instead of loan financing. New capital issued by the corporate sector increased by three times from Rs 43,122 million in 1990–91 to Rs 130,792 million in 2004–05. The year 1995–96, saw the highest number of issues, that is, 1,663 raising an amount of Rs 159,976 million in domestic primary market (RBI, Handbook of Statistics on Indian Economy 2004–05).

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Decline in Debt Financing

One important development immediately after liberalization of Indian capital market was a spurt in debt financing by the corporates. This was observed in predominant share of debt instruments in resource mobilization through public issue in the primary market. According to SEBI (Quoted in Indian Securities Market—National Stock Exchange of India [NSEI] 2000) the share of debt instruments in resources raised through public issue increased from 27.61 per cent in 1995–96 to 84.66 per cent in 1998–99. However, it maybe noted that dependence on debt financing declined gradually. The share of debenture in total capital raised by the corporate declined from 69 per cent in 1990–91 to 25 per cent in 1995–96 and 12 per cent in 2004–05. It is because debt financing is relatively costlier than equity financing and stock market reforms have made this more attractive. Resource Raised in International Market

In addition to raising funds in the domestic capital markets more and more corporates are going to the international markets and raising capital through ADR and GDR. However, FOFs through ADR and GDR have started declining from US$ 613 million in 2004–05. One of the reasons is that FIIs have increased their direct investment in the Indian capital market which has gone up from US$ 1,505 million in 2001–02 to US$ 8,280 million in 2004–05. However, during the year 2004–05, there was an increase (8.2 per cent) in resources raised by the private corporate from the international market through ADR/GDR and foreign currency convertible bonds. TABLE 2.8 Trends in Institutional Investment (Rs in million) FIIs Net Investment Year 2001–02 2002–03 2003–04 2004–05

Mutual Funds Net Investment

Equity

Debt

Equity

Debt

80,670 25,270 399,590 441,230

6,850 1,600 58,050 17,590

–37,960 –20,670 13,080 4,480

109,590 126,040 227,010 169,870

Source Reserve Bank of India, Annual Report (various issues). Fund raising through ADRs/GDRs

Reforms have opened up the foreign markets to Indian corporates and started raising funds by issuing ADRs and GDRs since 1992–93. Therefore, in addition to raising funds in the domestic capital markets more and more corporates are going to the international markets and raising capital through ADR and GDR.

Reforms and Emerging Economic and Financial Environment in India

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The amount raised through the Euro issue increased from Rs 2,510 million in 1992–93 to Rs 61,100 million in 1994–95, though it declined subsequently to Rs 4,960 million in 1995–96 but went up to Rs 34,870 million in 1999–2000. As the percentage of total funds raised through corporate securities it was at its peak at 16.8 per cent in 1993–94. FOFs through ADR and GDR has started declining from US$ 613 million in 2004–05. One of the reasons is that FIIs have increased their direct investment in the Indian capital market, which has gone up from US$ 1,505 million in 2001–02 to US$ 8,280 million in 2004–05. However, during the year 2004–05, there was an increase (8.2 per cent) in resources raised by the private corporate from the international market through ADR/GDR and foreign currency convertible bonds.

Mutual Funds Though mutual funds (including UTI) have expanded their scope of operation by launching a variety of schemes their share in the household financial savings declined. The share of UTI in HDS declined from 5.8 per cent in 1990–91 to 0.7 per cent in 2004–05. While that of mutual funds (excluding UTI) declined from 3.4 per cent in 1999–2000 to 0.24 per cent in 2004–05. Net resource mobilized by all mutual funds declined by 20 per cent from Rs 75,084 million in 1990–91 to Rs 30,146 million. Highest ever net mobilization (Rs 474,827 million) was in 2003–04. Gross mobilization in 2004–05 was higher at Rs 8,415,350 million as against Rs 5,913,790 million in 2003–04. However, the most preferred schemes are debt/income schemes which constituted about 95 per cent of gross mobilization in 2003–05. Net asset of mutual funds increased from Rs 140,410 million in 2003–04 to Rs 1,505,810 million in 2004–05.

Development in Secondary Market The reforms in the capital market have brought enormous quantitative and qualitative changes in the Indian capital market and it has grown exponentially in terms of growth of stock exchange, growth of market intermediaries, increase in the amount raised, growth of market capitalization, increase in turnover and the growth of investors population, etc. There has also been a change in the financing pattern of the private–corporate sector—a shift from debt financing to equity financing. Moreover the All India Financial Institutions, which earlier depended on the government and other financial institutions for cheap finance, had to turn to the market for necessary capital. Reforms in the financial market in general and in the capital market in particular have provided the much needed boost to the secondary market. Increase in the number of stock exchanges, improvement in the management of exchanges, upgradation of technology, setting up of clearing corporation, de-materialization of securities, curtailing settlement period, etc.,

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have imparted speed in transaction and also reduced transaction costs. All these institutions have made the Indian market comparable to markets in the developed countries. Therefore, the secondary market has witnessed phenomenal growth in terms of number of listed companies, market capitalization, turnover, etc., during post-reform period. The number of stock exchanges in India increased from 19 in 1990–91 to 22 in 1999–2000. Taking into account the Interconnected Stock Exchange of India, it is 23. However, two major exchanges namely, Bombay Stock Exchange (BSE) and National Stock Exchange (NSE) together accounted for more than 98 per cent in 2003–04, total turnover of all exchanges in India was Rs 16,204,970 million out of which Rs 1,602,151 million, that is, 98.87 per cent was accounted by BSE and NSE. Listed companies—there was a significant increase in the number of listed companies in India from 6,229 in 1990–91 to 9,877 in 1999–2000, that is, an increase of 58.6 per cent during 1990s. However, there has been a significant decline since then and it declined to 5,528 in BSE during 2003–04. Number of listed companies in BSE and NSE by the end of 2004–05, stood at 4,731 and 970, respectively. The decline was due to delisting of companies and merger and acquisition of some companies. Market capitalization—there was an impressive increase in market capitalization in BSE and NSE. Annualized average market capitalization increased by 186 times from Rs 90,830 million in 1990–91 to Rs 16,984,280 million in 2004–05. However, the increase during 1995–96 to 2004–05 was 3.2 times, very close to rise in market capitalization of NSE which witnessed annualized market capitalization by 3.8 times—from Rs 3,409,410 million in 1995–96 to Rs 12,969,690 million in 2004–05. At the end of March 2005, market capitalization of BSE was Rs 16,984,280 million as against Rs 15,855,850 million of NSE (Table 2.9). TABLE 2.9 Stock Market Index, Turnover and Market Capitalization Turnover (Rs in million)∗

Index Year 1990–91 1995–96 2000–01 2001–02 2002–03 2003–04 2004–05

Sensex 1,049.53 3,288.68 331.29 3,206.29 4,492.19 5,740.52 6,779.22

Nifty 366.18 556.48 1,336.49 1,077.13 1,036.10 1,428.13 1,808.53

BSE 360,110 500,630 10,000,320 3,072,920 3,140,730 5,026,200 5,187,080

Source Hand Book of Statistics on Indian Economy. ∗Annual Average. Note

NSE 672,880 2,945,030 13,395,100 5,131,670 6,179,880 10,995,350 11,400,710

Market Capitalization (Rs in million)∗ BSE 90,830 5,264,760 5,715,530 6,122,240 5,721,980 12,012,070 16,984,280

NSE – 3,409,410 7,706,220 5,805,640 6,165,370 8,884,900 12,979,690

Reforms and Emerging Economic and Financial Environment in India

55

Market turnover—the market took an upturn, particularly with the introduction of screenbased trading. Turnover during 1993–94 to 1999–2000, rose by 914 per cent. Similarly, the turnover ratio increased from 50.9 per cent in 1993–94 to 132.3 per cent in 1996–97 and moved further to 245.3 per cent in 1999–2000. Annualized turnover of BSE and NSE during 2004–05 was Rs 16,984,280 million and Rs 12,979,690 million, respectively. Stock market intermediaries—ever since reforms have been initiated, there has been a significant increase in market intermediaries. By the end of March 2004, there were 78 registrar and share transfer agents, 55 bankers to the issue, 123 merchant bankers and 47 underwriters registered with SEBI. Investor’s population—Indian capital market also witnessed a significant growth in investors population as indicated in the growth of NSDL accounts, which has gone up to 6 million in 2005 as against 3.8 million in 2004. If we add the number of Central Depository Services Limited (CDSL) it would increase further.

Development in the Debt Market Debt market is considered to be the pulse of macro economic development and the future direction of economy can be judged by monitoring the movement of the debt market. Although, the Indian debt market expanded significantly during 1990s it remained to be a small market compared with the debt markets of developed countries. While debt markets in developed countries are much larger than equity markets, they are different in India. While the ratio of equity market capitalization to GDP is 60 per cent, the ratio of debt market capitalization to GDP is about 30 per cent in India. Debt market in India is still in the process of development. Debt Market in India have suffered from chronic neglect on the part of policy makers, despite the fact that there is clear evidence of fairly strong debt preference among households for their financial investment portfolio. Very little has been done to create the infrastructure required for an efficient developed debt Capital Market. In fact, the debt markets in India are currently at a similar stage of their evolutions as the equity markets were prior to the reform process in the early years of 1990’s. (Sen et al. 2003: 3)

Corporate Debt Markets A study of EPW Research Foundation observed: The broad magnitude of domestic debt stock has risen from about 30% of GDP in the mid1990s to 36% now, but, interestingly the sharpest expansion has taken place in sovereign debt (from 21% to 25% of GDP). Increase in commercial debt, on the other hand, has been very

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moderate from 9.8% to 10.8% of GDP. Also, of the later, a preponderant part (over 45%) has been the result of resource mobilisation by the top four FI’s. (Economic and Political Weekly, February 17–23, 2000)

Important reasons behind the poor development of debt market are (a) sourcing cheap capital from the market by the government, which kept the market suppressed, (b) corporate preference for loan capital to market borrowing for financing their activities and (c) absence of active secondary market for debt, which kept investors away. The main segments of Indian debt markets are: government securities, PSU bonds and corporate debt securities; sovereign debts (14 day Treasury bills, 91 day Treasury bills, 364 day Treasury bills); dated government securities are issued by the central and state government; commercial debts (CDs and CPs) corporate debentures and bonds (debentures, bonds, floating rate notes, PSU Bonds, etc.). The participants in the debt markets are: government, RBI, financial institutions, industry and individual investors. Debt market development needs to focus on targeting small investors. Since household sector is the largest contributor to national savings (around 70 per cent), this segment must be attracted to the debt market. Attracting small investors requires improving market microstructure and medium to long-term products for retail investors. In addition to these, as (Sen et al. 2003) suggested to initiate the process of inducing savers to move to market-based debt instruments to begin with those having high risk-taking capacities through removal of tax concessions from all small savings schemes and flattering of the yield curve for small savings schemes of different maturities.

Government Securities Market in India In order to activate and expand the government securities market, government has initiated several measures to improve activities in the primary and secondary market by introducing new products, improving the liquidity and by expanding the base of investors. Some of the important measures are introduction of the 14-day Treasury Bills in 1997; introduction of auction system for central government securities including T-Bills; introduction of the system of Primary Dealers (PDs) and Satellite Dealers (SDs); innovations of new instruments such as Zero Coupon Bonds, Index Linked Bonds, Floating rates, 14-Day, 19-Day, 182-Day and 382-Day T-Bills; introduction of delivery versus payment system for settling scruples; Subsidiary General Ledger (SGL) account; introduction of settlement period of T+0 or T+5 between SGL participants and upto T+5 days for transaction; liquidity support to Public Distribution System (PDS) and abolition of Tax Deduction at Source (TDS) on government securities; setting up of debt clearing corporation, etc. Structural changes in the securities market have also impacted the government securities market particularly in terms of primary issues of central and state government. An upsurge in government bond market has been noticed in 1990s gross issue of Government of India Bonds

Reforms and Emerging Economic and Financial Environment in India

57

increased from Rs 1,110,000 million in 2001 to Rs 1,202,130 million in 2002, but declined to Rs 1,195,000 million. However, market capitalization went up from Rs 541,710 million in 2001 to Rs 9,963,410 million in 2004. Given the present scenario of predominant preference of riskfree investment, corporate preference for debt financing and the growing market penetration by the central and state government, Indian debt market has the potential of tremendous growth.

Derivatives Market Derivatives are important instruments for risk management and price discovery. In a volatile financial market derivative instruments like futures and options enable investors to manage risks against market fluctuations. Though derivatives came into limelight in 1970, they have recently emerged as a powerful hedging mechanism among the investors, particularly among the institutional investors. Today, scientific risk management strategy cannot be thought of by excluding derivatives. There are two major types of derivatives, namely, Over The Counter (OTC) instruments including Interest swaps and options, currency swaps and options, FRAs, etc., and exchange traded instruments including interest rate futures and options, currency futures and options, and stock market index futures and options. After a considerable amount of deliberations, SEBI approved derivative trading in Indian market. To start with, approval was granted for trading in futures contracts based on S&P CNX Nifty Index of NSE and BSE-30 (Sensex) Index. NSE introduced derivative trading on 12 June 2000. BSE introduced Sensex futures on 9 June 2000. The derivative products that are available in India include index futures, index option, stock option and single stock future. However, single stock future is most popular with 55–65 per cent in NSE and in BSE index futures, which contribute to about 60 per cent of market share (SEBI Annual Report 2003–04). During 2004–05, turnover in derivatives increased by about three times in NSE from Rs 1,431,420 million to Rs 25,867,380 million and in BSE it increased by two times from Rs 91,030 million to Rs 191,730 million.

Foreign Institutional Investors Liberalization of Indian capital market has provided easy entry of foreign capital to India and the flow of foreign funds has increased significantly during the post-reform period. Foreign funds are coming to India in the form of FDI and in the form of portfolio investment, through FIIs. FIIs are very active in the Indian stock market and play a very crucial role in market movement. However, since they operate under a global investment strategy, their activities often impact the market even adversely. The sales and purchase of such FIIs are not only influenced by the conditions of Indian market but also by the developments in the other markets of the world.

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Net investment of FIIs in India has increased substantially from Rs 134 million in 1992–93 to Rs 458,820 in 2004–05. Out of Rs 458,820 million and Rs 441,230 million, that is, 96 per cent was invested in equity and Rs 17,590 million was invested in debt instrument. Investment in equity instruments increased by 10.4 per cent whereas investment in debt declined by 30 per cent in 2004–05 over the previous year (SEBI Annual Report 2003–04). It has been observed that the FIIs sales and purchases have a very strong influence on the monthly movement of stock market indices in India. Though often their purchase and sales are not that significant compared to the market volume their entry and exit always creates disproportionate psychological impact, which may not be a very healthy sign for long-term growth of the market. The brief review of developments in capital market during the post-reform period indicates that the market has not only expanded in terms of various transactions, introduction of a number of new instruments but also several prudential norms have been put in place by the regulator to promote and protect a healthy and stable environment. Market stability is very crucial for financial institutions to work. This is also very essential for growth of life insurance companies, since they are long-term investors and need to manage long-term liabilities. The size, structure and growth of capital market has a strong bearing on the performance of life insurance companies. Developments in the Indian capital market indicate long-term potential of life insurance industry.

Life Insurance and Macro Economy—Indian Experience Life insurance business is significantly influenced by the state of economy of a country and the major impacting factors are rate of growth of GDP, domestic savings, household financial savings, disposable income, etc. The size of the life insurance market is also influenced by the growth of population rate, social security system, health care system, changes in customs and social practices, changes in attitude, risks, etc. It has been observed that societies in which the standard of living has been steadily improving experience a higher insurance penetration. Market competition exerts a very positive influence on market expansion, higher life insurance penetration as well as higher life insurance density. Recent upsurge in Indian economy particularly since the liberalization and market reforms leading to competition has created tremendous opportunities for growth of life insurance industry. In this chapter an attempt has been made to focus on some key factors of growth of Indian life insurance industry in the context of emerging macro economic changes.

Determinants of Life Insurance Demand The determinants of insurance demand and the interrelationship between insurance and economic growth have been examined by many eminent authors such as Outreville (1996), Cargill and Troxel (1979), Babbel (1985), Browne and Kim (1993), Rubayah and Zaidi (2000),

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Ward and Zurbruegg (2000). Outrevile’s work is notable for establishing links between development of insurance market and the development of financial sector in the economy. He observed that the levels of financial development directly affect the development of the life insurance sector. Ward and Zurbruegg (2000) studied the relationship between development of insurance sector and the growth of economy. However, empirical analysis of Ward and Zurbruegg suggest that the role of insurance in the economy may be varied across the countries. They observed that growth in the insurance sector, potentially has an effect on the economic growth via the short run dynamics of the lagged premium terms in the restricted VAR, through the long run equilibrium relationship between the markets or both. They found this relationship in many countries such as Australia, Canada, France, Italy and Japan. Studies conducted by these authors have also identified major macro economic and other factors impacting the demand for life insurance. Accordingly, the major macro economic factors are: Income level—per capita and disposable income, inflation and price level, price of insurance, comparative return on investment of life insurance, demographic factors, etc. The income level has a very strong influence on life insurance demand in any country. Cargill and Troxell (1979) and Babbel (1985), studied the impact of income level on life insurance by using disposable personal income, income per capita and found that there exists a very positive relationship between income level and the insurance demand. However, inflation has a very negative effect on the demand for life insurance. It has been observed by Browne and Kim (1993), Outreville (1996), Cargill and Troxell (1979) that high inflation exerts a very strong dampening effect on life insurance demand because of rise in cost of living which makes life insurance purchase costlier and less attractive. These authors have also examined the relationships between the return of life insurance and the yields on the competitive savings products. Cargill and Troxell (1979) observed that a higher interest rate on alternative savings products tends to make insurance products less attractive, on the other hand a higher rate of return on life insurance tends to attract individuals to purchase insurance from them. Price of insurance also has an important influence on the demand for life insurance as noted by Rubayah and Zaidi (2000) and Lim and Haberman. They observed that the price of insurance is significantly and inversely related to the demand for life insurance. A higher insurance cost is a discouraging factor for the demand of life insurance. Lim and Haberman also noted that the elasticity of demand with respect to price change is—1.115. The demand for life insurance tends to have a greater magnitude of change when there is a small change in the price change of insurance. A small percentage of reduction in the price change would help to increase the demand for life insurance. Among other factors, life expectancy at birth plays an important role in influencing the growth and demand for life insurance in a country. A higher life expectancy at birth plays an important positive role in influencing the demand for life insurance. A higher life expectancy is positively related to the life insurance demand.

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Measuring Impact of Macro Economy on Development of Insurance Market Life insurance plays an immensely important role in economy as mentioned in the earlier part of the chapter. There are several yardsticks to measure this role and relationship of life insurance and macro economy in the context of market development. However, the most important yardsticks to measure the level of development for life insurance markets are: life insurance penetration and life insurance density.

Life Insurance Penetration and Density Life insurance penetration is calculated as life insurance premium as a percentage of GDP of a country and life insurance density is the premium per capita. However, the level of economic development and population has a very strong influence on the level of development of financial as well as life insurance market. This relationship has been examined with the help of continent wise and country specific data of Swiss Re in Table 1.8. Level of GDP has significant influence on the level of life insurance premium, for example in 2004 Europe with 35.65 of world GDP accounted for 37.57 per cent life insurance premium in the world market, while North America and Canada together with 31.3 per cent of world GDP accounted for 28.35 of world’s life insurance premium, whereas Africa with a share of 1.9 per cent of world GDP accounted only for 1.4 per cent of world’s life insurance premium. On the other hand Asia with 24.5 per cent of world GDP accounted for 30.1 per cent life insurance premium in the world market (Swiss Re Sigma No. 2/2005). It can be noted that North America (USA and Canada) with 31.3 per cent of world GDP in 2004 accounted for 28.3 per cent of world’s life insurance premium, whereas Africa with 1.9 per cent of world GDP accounted for 1.4 per cent of world life insurance premium. Other continents like Europe with 35.6 per cent GDP accounted for 37.6 per cent premium, while Asia with—24.5 per cent of world GDP accounted for 31.1 per cent of world premium. This relationship has also been reflected in the life insurance penetration level. As against world penetration of 4.55 in 2004, Asian life insurance penetration was 5.58, Europe 4.68, North America 4.12 and the lowest 1.1 in Latin America. However, since the level of density is decided by life premium and population it is little different than penetration in the United States. In fact, the density level was highest in North America with US$ 1,617.2. Level of density was also much better in continents with higher GDP and lower population, for example, Oceania (US$ 851) and Europe (US$ 848.1), while in highly populated continents like Asia it was (US$ 147.2). Though in general, higher level of GDP causes higher life insurance penetration, yet, at the country level the penetration level maybe lower than the level of GDP, whereas low GDP countries have achieved better penetration. It can be noted that higher GDP countries such as

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USA, Japan, UK and France had penetration level of 4.22 per cent, 8.26 per cent, 8.92 per cent and 6.38 per cent, respectively. However, some countries with lower GDP, had better penetration level, for example, South Africa had the highest level of penetration 11.43 per cent, followed by Taiwan 11.06 per cent. India with reasonably higher level of GDP had low level of penetration 2.5 per cent (as against world penetration of 4.55 per cent). It can be mentioned that the level of penetration in a developed country like USA may be lower than the world average due to the fact that here other segments like pension and mutual funds are highly developed and a large amount of savings are directed there, resulting in lower penetration of life insurance. Density is the other important indicator of life insurance and macro economic relationship. Since density is measured as the premium per capita; higher premium and lower population will generate higher density level. This can be noted with respect to low population high premium countries which have achieved better density such as Switzerland (US$ 3,275.1), UK (US$ 3,190.4), Japan (US$ 3,044), Belgium (US$ 2,291.2) and France (US$ 2,150.2). Density in highly populated countries like India and China was quite low with US$ 15.7 and US$ 27.3 in 2004, respectively. It is therefore evident that industrially developed and mature economies have achieved better penetration and density indicating that macro economy and life insurance market is very closely related.

Trend in Growth of Selected Macroeconomic Variable and Life Insurance in India During recent times, Indian economy has been performing well and the momentum of growth has picked up particularly since liberalization, which was initiated in the 1990s. Though the overall growth rate during the last decade fluctuated it remained well above many emerging economies of the world. With further reforms initiated in early 1990s, there has been a significant structural change in macro economy and in the process service sector has emerged as the leading sector and engine of growth. In the previous sections we have already noted the trend in growth rates of GDP, domestic and household savings, etc., and would like to examine the relationship between life insurance and these macro economic variables. But before proceeding further, we must briefly examine the past trend in growth of life insurance business, which was predominantly influenced by the LIC of India.

Trend in Growth of Life Insurance Since nationalization, Indian life insurance has registered a very significant growth and gradually increased its share in household financial savings and premium income has also done reasonably well. Growth of insurance can be seen in terms of growth of life funds assets, number of policyholders and premium income. Growth in life fund is considered to be an important indicator of growth of life insurance industry and as can be seen from Table 3.5, LIC

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has performed exceedingly well. LIC, after nationalization of 256 life insurance companies, started with a life fund of Rs 410.40 crore, which in course of time increased rapidly and stood at Rs 463,147.62 crore by the end of March 2006. Similarly, the total assets of LIC keeping pace with the Life Fund have increased from Rs 465.04 crore in 1958 to Rs 552,447.33 crore in March 2006 and LIC has emerged as the largest financial institution in India. High growth of Life Fund and assets of LIC was possible due to significant growth in New Business, which got a boost during the post-liberalization period. Premium income of LIC increased from Rs 88.65 crore in 1958 to Rs 90,759.20 crore in March 2006. LIC started with Rs 1,474 crore SA under 56.86 lakh in force policies which went upto Rs 1,282,467.87 crores SA under 1,796.63 lakh inforce policies in March 2006. An overall view of Indian life insurance market can be obtained through data released by IRDA. Accordingly the total premium underwritten by the Indian life insurers went up from Rs 55,747.55 crore in 2002–03 to Rs 105,875.77 crore in 2005–06 (see Table 3.11) and the total number of policies underwritten by Indian Life Insurance went up from Rs 25,370,674 crore in 2002–03 to Rs 35,462,117 crore in 2005–06 (Table 3.13). This is a clear indication of positive outcome out of competitive market environment in a liberalized economy.

Interdependence of GDP, HDS and Life Insurance Funds Since middle of 1980s, Indian economy has moved away from low level of GDP growth (termed Hindu rate of growth) which has substantially impacted the growth rates in Gross Domestic Saving (GDS), which scaled up from 18.2 per cent of GDP in 1984–85 to 31.1 per cent in 2004–05. Higher growth rates in GDS were strongly supported by savings in the household sector. Overall growth in GDP and HDS have significantly influenced the growth of Indian life insurance. In fact, growth of LIC’s premium income in general, has been higher than the growth rate in GDP, except during the last two years when it was lower than that in 2001–02. Further, if we add the premium income of other private insurance companies, growth rates are higher than shown below. This leads us to the crucial question about the nature of relationship between macro economic growth and development of the insurance industry. A new dimension of this relationship has been opened up by financial liberalization and reforms in Indian insurance sector. Reforms and liberalization expected to exert significant impact on income, savings and insurance purchase and financial reforms are expected to improve allocation of savings. We have made an attempt to examine the relationship between various macro economic variables and life insurance purchase by the household sector and also the impact of financial liberation and insurance sector reform. Pearson Correlation Matrix analysis has been carried out with the help of data relating to GDP, personal disposable income, household financial savings and share of life insurance funds in household financial savings to examine the impact of these factors on life insurance purchase. Since life insurance purchase is also influenced by the rate of inflation, rate of interest and return from alternative investment, we have also made an attempt to examine the impact of inflation, interest rates, etc., on life insurance purchase.

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We have selected yearly inflation rate for Industrial Workers (IW), above five years deposit rates of commercial banks, dividend on units of UTI and return and gross return on life insurance funds (LIC). Finally, growth of population is expected to be directly related to the sales growth of life insurance. We have therefore, carried out Pearson Correlation Matrix analysis for population and Sum Assured (SA).

Pearson’s Correlation Matrix The findings in general are quite significant and reveal a strong relationship between life insurance demand and various macro economic variables. Relationship between GDP, GDS, HDS and Life Insurance

GDP is a reflection of overall growth of economy, which has its impact on disposable income savings and consumption. High growth rate is expected to boost savings and thus support higher demand for financial instruments by the household sector. It can be observed from Chart 2.1 that growth rates in GDP have in general influenced growth rates in GDS and savings in life insurance (LI Fund). It can also be noted that there is a direct positive relationship except for the year 1951–52 to 1955–56 when in spite of decline in GDP growth rate savings in general and life insurance savings in particular higher growth rates were registered. Perhaps this was due to the fact that saving motives such as interest rates and tax incentives were stronger to push up savings and particularly that of life insurance. Further, during 2002–03 there was a sharp decline in the life insurance savings in spite of increased growth rates in GDS, it was because LIC registered a lower growth rate in life insurance business. A closer look at Chart 2.2 will reveal that HDS has mostly followed the GDS growth rate; it is because the other two sectors, that is, public private and corporate sector have minimal role in domestic savings. It can be seen from Table 2.5 that the contribution of private sector is around 4 per cent (in GDP terms) while that of public sector is negative since 1999–2000. However, growth in life insurance fund (premium) followed the growth trend of HDS. It can also be observed that growth of life insurance fund kept pace with the growth of HDS except for a short period 1979–80 and 1989–90. In fact for many years life funds show higher growth than HDS. However, as indicated in Chart 2.2 opening up of the insurance market to private players has not brought a radical change in the trend from what was noticed in the pre-liberalization period, except a very sharp decline in the year 2002–03. In order to examine the extent of relationships among the above selected variables (GDP, GDS and HDS) with Life Insurance Fund, Pearson Correlation Matrix analysis was carried out and the analysis indicated that overall there are very strong positive correlations among the selected variables with the life insurance fund. Also the correlations were statistically significant at 1 per cent significance level. Among the variables household domestic savings appear to have very high correlation (0.992) with Life Insurance Fund, followed by GDS (0.981) and GDP (0.977) and all were highly significant at 1 per cent level of significance. All these indicate that

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LIFE INSURANCE IN INDIA FIGURE 2.1 Growth Rate of GDP, GDS and LI Fund (Premium)

FIGURE 2.2 Growth Rate of Gross Domestic Savings, Household Savings and Life Insurance Premium (Fund)

when there is an increase in savings and national productivity it has a direct impact (positive) on the life insurance sale. Relationships between PDI, HDS, HSFA and Life Insurance Funds

PDI is another important variable determining the growth of life insurance market. We have therefore, examined this issue and also carried out Pearson Correlation Matrix Analysis. PDI

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is arrived at after deduction of payment of direct taxes and other miscellaneous receipts of the government from personal income. PDI is distributed between HDS and private final consumption. It can be seen from the data that in terms of GDP, PDI was 89.3 per cent while household sector savings was only 6.2 per cent. While the same declined to 85.4 per cent for PDI, it increased to 23.3 per cent in 2002–03. Savings as percentage of PDI was 14.5 per cent in 1950–51 but declined to 3.6 per cent in 2002–03. Therefore, in relative terms though savings volume increased during 1950–51 to 2002–03, but more and more funds from PDI were diverted to private final consumption leaving a small amount to be saved from PDI. This also affected growth of Life Insurance Fund, which failed to keep pace with PDI (Chart 2.3). FIGURE 2.3 Personal Disposible Income, HHS, FS in HHS, LF

However, there seem to be strong relationships among these factors, when Pearson Correlation Matrix analysis was carried out with data relating to PDI, HDS, HSFA and Life Insurance Fund. Our analysis indicated that overall there are very strong positive correlations among the selected variables with the life insurance fund and the correlations were statistically significant at 1 per cent significance level. Among the variables PDI (0.991) and HSFA (0.990) appear to have very high correlation with Life Insurance Fund, followed by HDS (0.988) and all were highly significant at 1 per cent level of significance. All these indicate that PDI and household investment in financial assets have a strong impact (positive) on the life insurance sale.

Inflation, Interest Rate and Life Insurance Growth Inflation is expected to have a negative correlation with life insurance demand since it exerts damping effect, because high inflation pushes up the cost of living thus making insurance

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purchase less attractive. Data in the Table 2.10 shows inflation (consumer price index for industrial workers) and YOY growth of Life Insurance Funds. In general, the year of low inflation witnessed higher growth in life insurance but for some exceptions. Rate of interest and competitive yield is said to be negatively rated to life insurance selling, since higher interest rates in other alternative savings and instruments may discourage purchasing life insurance. The impact of inflation interest rates, return from alternate investment and life insurance has been studied with the help of annualized consumer price index for IWs and deposit rates of commercial banks. Rate of interest is realized on Mean Life Fund of LIC, UTI Dividend Rates. Pearson Correlation Matrix analysis was performed and the analysis indicated a strong correlation between the variables, particularly consumer price index (–0.524), bank interest rate (–0.696) and UTI (–0.246) have a negative correlation with life insurance premium (New Business) as expected. Of the selected variables, bank interest has greater negative correlation with life insurance business, followed by Consumer Price Index (CPI), while UTI has a low correlation. Thus, when the bank interest rate and the inflation decreases life insurance New Business increases. Similarly, there is moderate correlation between LIC’s return and the CPI (0.360), bank interest (0.461) and UTI (0.457).

Population Growth and Life Insurance Population growth is expected to have a positive relationship with life insurance growth. To test this relationship Pearson Correlation Matrix analysis was performed with population, life insurance premium (New Business) and number of policies (New Business) for the period 1981–2005. Pearson Correlation Test was carried out and the results are given in the following part of the chapter. The analysis indicated a very strong correlation with the selected variables, particularly life New Business both premium income (0.867) and number of policies (0.913) seem to have very strong correlations with population growth. This confirms the belief that greater the population growth greater is the potential for life insurance (Table 2.13) It can be observed from the statistics given that there is a significant relationship between the demand for life insurance and various macro economic variables. The high growth of GDP induces economic effect through higher per capita and disposable income and savings, which in turn creates favourable market and demand for life insurance. On the other hand life insurance also provides support to the capital market and generation of savings data pertaining to Indian life insurance and macro economic variables broadly indicate a close relationship and interdependence between economic variables and life insurance demand. However, it has also been observed that in India while the economy in general and disposable income and savings in particular have registered significant growth, life insurance demand has not picked up (or alternatively the life insurance industry could not capitalize the growth of income and savings). Therefore, in order to capitalize the growth potential particularly in the post-liberalized economy, concerted efforts need to be made to spread financial literacy,

1950–51 1951–52 1952–53 1953–54 1954–55 1955–56 1956–57 1957–58 1958–59 1959–60 1960–61 1961–62 1962–63 1963–64 1964–65 1965–66 1966–67 1967–68 1968–69 1969–70 1970–71 1971–72 1972–73 1973–74 1974–75 1975–76 1976–77 1977–78 1978–79

Year

9,934 10,566 10,366 11,282 10,678 10,873 12,951 13,349 14,874 15,675 17,167 18,196 19,566 22,482 26,220 27,668 31,305 36,649 38,823 42,750 45,677 48,932 53,947 65,613 77,479 83,269 89,739 101,597 110,133

Na 6.36 –1.89 8.84 –5.35 1.83 19.11 3.07 11.42 5.39 9.52 5.99 7.53 14.9 16.63 5.52 13.15 17.07 5.93 10.12 6.85 7.13 10.25 21.62 18.08 7.47 7.77 13.21 8.4 2.33 2.84 6.09 4.24 2.56 5.69 –1.21 7.59 2.19 7.08 3.1 2.12 5.06 7.58 –3.65 1.02 8.14 2.61 6.52 5.01 1.01 –0.32 4.55 1.16 9 1.25 7.47 5.5

GDP GDP Market GDP Market at Factor Cost Price Price (at current (at current (at current prices) prices) prices) 887 985 861 888 1,005 1,370 1,584 1,384 1,207 1,748 1,989 2,127 2,479 2,763 3,129 3,870 4,375 4,355 4,721 6,104 6,649 7,367 7,872 10,999 12,380 14,346 17,408 20,142 23,676

GDS (Rs in crore)

HDS (Rs in crore) 6.16 5.52 6.15 5.81 6.73 9.62 9.10 7.47 6.83 8.30 7.30 7.04 7.84 7.20 7.15 9.40 10.30 8.76 8.63 10.39 10.15 10.67 10.43 12.17 10.43 11.70 13.20 14.13 15.45

HDSs YOY HDS Growth as % of (%) GDP

Na 612 Na 11.05 583 –4.74 –12.59 637 9.26 3.14 655 2.83 13.8 719 9.77 36.32 1,046 45.48 15.62 1,178 12.62 –12.63 997 –15.37 1.66 1,016 1.91 24.24 1,301 28.05 13.79 1,254 –3.61 6.94 1,281 2.15 16.55 1,533 19.67 11.46 1,618 5.54 13.25 1,875 15.88 23.68 2,602 38.77 13.05 3,223 23.87 –0.46 3,210 –0.4 8.4 3,349 4.33 29.29 4,440 32.58 8.93 4,634 4.37 10.8 5,219 12.62 6.85 5,624 7.76 39.72 7,985 41.98 12.56 8,080 1.19 15.88 9,743 20.58 21.34 11,849 21.62 15.71 14,354 21.14 17.55 17,015 18.54

GDS YOY Growth (%)

TABLE 2.10 GDP, GDS, HDS and Life Fund

Na –35 38.46 38.89 12 10.71 –3.23 –3.33 10.34 43.75 8.7 30 26.15 –4.88 12.82 9.09 8.33 17.31 13.93 15.11 18.13 14.29 21.3 24.43 –1.23 19.57 24.68 16.46 15.92

Life Insurance Savings of Household YOY Growth (%)

(Table 2.10 Continued)

20 13 18 25 28 31 30 29 32 46 50 65 82 78 88 96 104 122 139 160 189 216 262 326 322 385 480 559 648

Life Insurance Savings of Household (Rs in crore)

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GDS (Rs in crore) 24,314 27,136 31,355 34,368 38,587 46,063 54,167 58,951 72,908 87,913 10,699 13,130 14,398 16,296 19,361 25,143 29,877 31,721 35,218 37,469 46,861 49,009 53,224 64,228 77,640 –

Source Centre for Monitoring Indian Economy (CMIE).

Year 1979–80 1980–81 1981–82 1982–83 1983–84 1984–85 1985–86 1986–87 1987–88 1988–89 1989–90 1990–91 1991–92 1992–93 1993–94 1994–95 1995–96 1996–97 1997–98 1998–99 1999–00 2000–01 2001–02 2002–03 2003–04 2004–05

GDP GDP Market GDP Market at Factor Cost Price Price (at current (at current (at current prices) prices) prices) 120,841 9.72 –5.2 143,764 18.97 7.17 168,600 17.28 5.97 188,262 11.66 3.06 219,496 16.59 7.68 245,515 11.85 4.31 277,991 13.23 4.45 311,177 11.94 4.33 354,343 13.87 3.83 421,567 18.97 10.47 486,179 15.33 6.7 568,674 16.97 5.57 653,117 14.85 1.3 748,367 14.58 5.12 859,220 14.81 5.9 1,012,770 17.87 7.25 1,188,012 17.3 7.34 1,368,208 15.17 7.84 1,522,547 11.28 4.79 1,740,985 14.35 6.51 1,936,831 11.25 6.06 2,089,500 7.88 4.37 2,271,984 8.73 5.79 2,463,324 8.42 3.98 2,760,025 12.04 8.51 3,105,512 12.52 6.91

(Table 2.10 Continued) GDS YOY Growth (%) 2.69 11.61 15.75 9.61 12.28 19.37 17.59 8.83 23.68 20.58 21.69 22.77 9.57 13.2 18.85 29.87 18.8 6.2 11.01 6.38 25.1 4.56 8.62 20.67 20.88 – HDS (Rs in crore) 16,690 19,868 21,225 23,216 28,165 35,067 39,795 45,072 59,157 70,657 86,955 109,897 110,736 131,073 158,310 199,358 216,140 233,252 268,437 326,802 404,401 452,268 513,110 574,681 671,692 –

HDSs YOY Growth (%) –1.91 19.04 6.83 9.38 21.32 24.51 13.48 13.26 31.25 19.44 23.07 26.38 0.76 18.37 20.78 25.93 8.42 7.92 15.08 21.74 23.74 11.84 13.45 12 16.88 –

Life Insurance Savings of Household HDS (Rs in as % of crore) GDP 13.81 739 13.82 859 12.59 982 12.33 1,149 12.83 1,283 14.28 1,453 14.32 1,676 14.48 2,005 16.69 2,453 16.76 3,311 17.89 4,152 19.33 5,338 16.96 6,623 17.51 6,766 18.42 9,197 19.68 11,016 18.19 13,523 17.05 15,574 17.63 18,737 18.77 22,572 20.88 27,684 21.64 32,679 22.58 46,104 23.33 40,508 24.34 48,722 – –

Life Insurance Savings of Household YOY Growth (%) 14.04 16.24 14.32 17.01 11.66 13.25 15.35 19.63 22.34 34.98 25.4 28.56 24.07 2.16 35.93 19.78 22.76 15.17 20.31 20.47 22.65 18.04 41.08 –12.14 20.28 –

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TABLE 2.11 PDI, Savings and Life Insurance Premium (Rs in crore)

Year 1950–51 1955–56 1960–61 1965–66 1970–71 1975–76 1980–81 1985–86 1990–91 1995–96 2000–01 2001–02 2002–03 2003–04

PDI (Figs in Million)

Savings of Household Sector (HS)

HDS in Fin. Assets

Life Insurance Fund

(1)

(2)

(3)

(4)

8,876 9,574 14,638 22,975 37,891 67,810 120,642 224,371 461,192 949,191 1,776,815 1,967,576 2,108,935

89.3 88.0 85.3 83.0 83.0 81.4 83.9 80.7 81.0 79.9 85.0 86.2 85.4

612 1,046 1,254 2,602 4,634 9,743 19,868 39,795 109,897 216,140 458,215 513,110 574,681 671,692

6.2 9.6 7.3 9.4 10.1 11.7 13.8 14.3 19.3 18.2 21.9 22.6 23.3 24.3

62 429 456 1,072 1,371 3,918 8,610 18,538 49,640 105,719 222,721 253,964 254,439 314,261

0.6 3.9 2.7 3.9 3.0 4.7 6.0 6.7 8.7 8.9 10.7 11.2 10.3 13.0

20 31 50 96 189 385 859 1,676 5,338 13,523 32,679 44,157 41,027

0.2 0.3 0.3 0.3 0.4 0.5 0.6 0.6 0.9 1.1 1.6 1.9 1.6

Source EPW Research Foundation. Note Figures in italic indicate in GDP term. TABLE 2.12 Inflation, Interest Rates and Life Insurance Savings in India

Year 1984–85 1985–86 1986–87 1987–88 1988–89 1989–90 1990–91 1991–92 1992–93 1993–94 1994–95 1995–96 1996–97 1997–98 1998–99 1999–2000 2000–01 2001–02 2002–03 2003–04

Inflation Consumer Price UTI Dividend Index (a) Rate (July–June) 6.3 6.8 6.7 8.8 9.4 6.1 11.6 13.5 9.6 7.5 10.1 10.2 9.4 6.8 13.1 3.4 3.8 4.3 4.0 3.9

14.25 15.25 16.00 16.50 18.00 18.00 19.50 25.00 26.00 26.00 26.00 20.00 20.00 20.00 13.50 13.75 10.00 – – –

Commercial Gross Rate of Interest Life Ins. Savings Bank Deposit Realized on Mean of Household Rate Life Fund of LIC (YOY Growth %) 11.00 11.00 11.00 10.00 10.00 10.00 11.00 13.00 11.00 10.00 11.00 13.00 12.75 11.75 11.00 10.25 9.72 8.25 5.875 5.375

9.46 9.87 10.30 10.50 10.95 11.13 11.44 11.95 11.56 12.43 12.21 12.29 12.39 12.37 11.96 12.08 11.60 11.59 10.40 10.08

13.25 15.35 19.63 22.34 34.98 25.40 18.56 24.07 2.16 35.93 19.78 22.76 15.17 20.31 20.47 22.65 18.04 41.08 –12.14 20.28

Source Accounts Statistics of India 1950–51 to 2002–03, EPW Research Foundation, Mumbai, 2004.

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LIFE INSURANCE IN INDIA TABLE 2.13 The Population and Life Insurance Business from 1980–81 to 2004–05

Year 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

Premium 148.79 158.39 181.21 191.25 225.57 286.69 373.49 531.62 715.93 980.98 1,195.85 1,405.05 1,616.58 1,899.81 2,055.75 2,332.13 2,612.94 3,195.17 3,986.60 4,756.10 5,590.75 6,965.00 8,288.87 10,885.93 11,192.31

Population

Number of Policies

668.31 683.30 698.07 713.17 728.58 744.34 760.43 776.87 793.66 810.82 828.35 846.26 883.90 899.90 916.00 939.50 955.20 971.00 988.00 1,005.00 1,012.40 1,027.60 1,043.50 1,060.00 1,076.90

1,954,424 2,103,134 2,231,385 2,366,057 2,699,654 3,285,607 3,868,316 4,693,788 5,979,260 7,392,251 8,645,386 9,238,264 9,957,848 10,725,633 10,874,682 11,020,825 12,268,476 13,311,294 14,843,687 16,976,782 19,656,663 22,491,304 24,278,775 27,740,916 31,122,534

Source CMIE, Annual Report of LIC (various issues).

to create awareness about personal financial risk management, market marketing-driven distribution management, customer-focussed service management, and technology and knowledge-based funds management. The insurance market in India during the post-liberalized period transformed itself from a supply directed market to demand determined market and an upsurge in multiproduct—multiinstitution, competition is very eminent. Understanding this emerging market dynamics and institutionalizing the same in a futuristic corporate policy will enable the insurance companies to capitalize.

Convergence and Financial Market Integration Recent reforms and growing globalization in financial services also produced an important phenomenon called integration in financial services, which occurs whenever production or distribution of a financial service traditionally associated with one of the three major financial sectors is by actors from another sector. Terms such as bancassurance, allfinanz, universal banking and financial conglomerates, are all used to convey some notion of integration.

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The process of integration has opened up avenues for expansion of business and scope for new products. The process of financial services integration has offered tremendous opportunities for launching innovative new products, entering into new areas of business, improving the scale of operation, reducing cost, improving the balance sheets and quality of risk management. However, these are not without any cost and financial institutions need to reposition themselves in the marketplace with new vision, mission and goals. What is more important is to institutionalize the new vision and goal by promoting market friendly organizational culture and a new set of operational rules and management philosophies. This is a challenge for the management of a company. Transition does not come without a cost or pains. However, transitional costs can be reduced and pains can be minimized only by forward-looking strategic initiatives. There are several forms of financial services convergence or integration. In a fully integrated form all financial services are produced and distributed by a single entity like a corporation. In such a form, a corporation may offer commercial banking, investment banking, insurance and other financial services. In most cases, we particularly find integrated financial services. However, in most of the cases we find a partial integration offering two to three services like German banks, which offer universal banking services (commercial banking and investment banking) and also insurance and other services through separate subsidiaries. Other variant of integration is to offer various services under a parent company—services produced by one subsidiary and sold by other for example in France or UK bank assurance. In France either banks promote insurance companies or insurance companies promote banks. Insurance services produced by an insurance company sold by a bank. We may quote some instances of integration in major markets such as Australia, France, UK and USA. In Australia four major banks operate in conglomerates in all areas of commercial and investment banking, in life and non-life insurance and in pension (Bain and Harper 1999). In France there is a close link between banks and insurance services, and bank assurance is a major source of income. Most of the life insurance products sold by banks are tax saving simple products. According to Daniel (1999), in 1998 banks accounted for 61 per cent of total life premium and 63 per cent of new premium production in France. A close tie integration is also observed in the Netherlands, where non-life insurance has historically been more prominent than life insurance but this is changing especially as banks have moved aggressively into life insurance marketing. In 1998, banks accounted for an estimated 75 per cent of new life premium (Skipper 2000). In UK life insurance products are being sold by subsidiaries promoted by banks. These subsidiaries sell life insurance products through a number of channels such as direct sales, brokers, representatives (agents) or bank branches. Direct sale is quite strong in UK as distributors like Lloyds TBS transact about 20 per cent of sales via direct response. In Canada there is greater integration between banks and insurance since large number of banks have been promoted by insurance companies and a large number of insurance companies are promoted by banks. The Canadian financial services business is concentrated and is

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becoming more so with consolidation and demutualization, driven by competition. The largest six banks control about 85 per cent of the Canadian bank assets and the largest six insurers, most mutual, control 70 per cent of insurance assets (Skipper 2000). Financial services in USA moved towards greater integration particularly after Financial Services Modernisation Act (also known as Gramm–Leach–Bliley Act) 1999. More and more banks have started selling life insurance products particularly individual annuities and according to some estimates they write nearly 15 per cent of annuity consideration. The trend of global convergence in financial services is gaining momentum in India, particularly after reforms since 1991 removing the entry barriers. Early 1990s witnessed the trend in integration when many public sector institutions and banks set up their non-core business, for example, IDBI started banks and mutual funds; LIC started mutual funds, housing finance; and many banks like SBI entered into mutual funds, housing finance and subsequently life insurance. This trend further gained momentum with opening up insurance to the private sector. Private financial institutions such as Housing Development Finance Corporation Ltd. (HDFC) and ICICI entered into the insurance business. The process of integration further strengthened with more and more banks taking up insurance selling, with this bank assurance has emerged as an important channel of distribution. With further reforms, the process of integration is expected to move forward by breaking the existing obstacles. However, financial integration has its own pitfalls through negative externalities via systematic risks. It also tends to have an adverse impact on competition. Moreover, integration may create regulatory complexities since there are more than one regulators such as RBI for banking, IRDA for insurance, SEBI for securities market and Pension Fund Regulatory and Development Authority (PFRDA) for pension market. To tackle regulatory problems there is need for a super regulator. Alternatively, a strong coordination among these regulators through a coordinating mechanism is required.

Future Prospects The irreversible process of recent waves of globalization have swept the national barriers of economy. Tremendous flow of trade in goods and services, FDI and portfolio investment positively impacted the growth of emerging economies. Globalization has created a tremendous impact on financial sector development via influence on market micro structure and governance which is essential for FDI and portfolio investment. Life insurance companies are important institutional investors in the emerging market characterized by institutionalization of market and globally they have grown significantly in a liberalized market environment. Insurance industry has been immensely benefited by opening up the sector to foreign participants. Though life insurance in mature markets has saturated to some extent, tremendous scope for expansion exists in emerging market due to low level of penetration, density, etc.

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The process of globalization has impacted India significantly and large number of measures have been taken to integrate Indian market with global economy which has made India an important destination of investment and global economic activities. Indian life insurance market, which is already an important player among the emerging markets, is poised for further growth following the liberalization of insurance market; emergence of competitive insurance market with entry of domestic and foreign players; consistency in high growth momentum in GDP, domestic savings, disposable income, booming capital market, etc. However, experience of global economies, particularly the emerging markets, indicates that India needs to follow-up further reforms in the financial economy.

Chapter 3 Indian Life Insurance—Changing Market Structure and Emerging Opportunities Indian life insurance market has undergone tremendous structural changes since 1818, when the first life insurance company was established in Calcutta. Life insurance industry in India progressed from a loosely regulated market controlled by two groups of private life insurance companies in the early phase to a non-competitive monopoly phase where the industry was represented by a single entitity, that is, LIC of India in a planned economic environment. From government controlled monopoly, the industry moved on to the third phase into a competitive market environment with the presence of many private sector and public sector life insurance companies under a well-designed regulatory environment. In all the three phases, the characteristics and structure of the life insurance market was quite distinct, having different dimensions of regulation of supervision, reach and strategic orientation. However, in every phase, Indian life insurance industry strengthened itself in terms of reach, concern about consumers and management strategy. Life insurance also played a very crucial role in development of national economy, particularly during the post-nationalization period. But the most dynamic phase of possible growth has begun with the deregulation and liberalization of the insurance sector. Insurance industry has not only been deregulated but the regulator has taken a number of initiatives for healthy growth. In this chapter we have discussed about this trend of transformation and further scope of expansion and growth of life insurance industry in India in the light of the following. 1. Changing market structure—pre-nationalization to post-nationalization. 2. Emerging health insurance market in India. 3. Pension reforms and emerging annuity market in India.

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4. Informal sector and microinsurance market in India. 5. Scope for expansion of life insurance market in India. 6. Indian life insurance in the global context.

Indian Life Insurance—Changing Market Structure Introduction The concept of market structure is an important issue of financial market analysis and a critical factor of strategic planning for corporate management. Market structure enlighten us about economic characteristics of market and business dimension and underlying opportunities and constraints. Market structure analysis also provides meaningful ideas about evolutionary process of any market in the context of changing politico-economic environment of a country. However, the analysis often suffers from bias as there are differences between perspectives of economists and managers. While an economist focuses on general economic problem related to pricing, competition, economic welfare, etc., managerial concern is centered around market regulation, product development and distribution, post-sales servicing, customers benefits, corporate profitability, etc. These objectives are however not contradictory, rather closely interlinked to promote a well regulated customer-centric industry market. Therefore focus of any market structure analysis is with relation to the explicit market objectives of core economic and managerial issues. However, whatever way the market structure is considered, the customers, suppliers of products, product pricing and substitutability of products remains the focal point. In economic analysis of markets—number of suppliers (here life insurance companies), buyers of the products (life insurance policyholders) and products (life insurance plans) are the major criteria to distinguish market structure. Accordingly, a market can be perfectly competitive with a large number of insurance companies and policyholders. In a perfectly competitive life insurance market there would be many sellers with products, in a monopoly market there is a single seller of products without core substitute. In a monopolistic market there are many sellers of a differentiated products, while in oligopoly there are few sellers with standardized or non-standardized products. These definitions of market structure from economist’s point of view is closer to managerial perspective of market since the nature of competition structure influences the strategic action and identification of product–market relationship. Market regulation is an integral part of market structure since regulation in a competitive market environment attempts to promote healthy competition and protect the consumers whereas in a non-competitive monopoly market it protects the interest of consumers. Therefore, central to all market environment are the customers and their benefits in terms of optimization of return and value addition to their investment. We have examined this issue of market structure and market environment of life insurance industry in this chapter. A well regulated market structure is a critical condition for growth of any financial service including life insurance. While a well-regulated competitive market protects the interest of the

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consumers, imparts efficiency in resource allocation, risk management and decentralization of economic benefits as well as economic well-being, which in turn supports the market to expand further, an unregulated non-competitive market may stagnate and may even tend to become a burden for the society. However, the structure of financial market is greatly influenced by the political economic process and is always a dynamic phenomenon. Life insurance which is an important constituent of financial economy is no exception to this process and always evolves around the economic and financial system of the country. Indian life insurance industry and market have always been influenced by political and economic policies and mood of the people, since 1818 when the first few insurance companies were established in India. Since then Indian life insurance industry has undergone cycles of changes but these changes have always provided new impetus of growth to the industry. Life insurance industry since 1818 has witnessed three distinct phases of growth: 1. Life insurance in pre-nationalization period (from1818 to 1956). 2. Life insurance in post-nationalization period (from 1956 to 2000). 3. Life insurance in post-deregulation period (from 2000 onwards).

Market Structure during Pre-nationalized Period Life insurance in its modern form came to India from England. The journey of Indian life insurance industry started from the then British capital of India—Calcutta with the establishment of the British Insurance company Oriental Life Insurance Society in 1818. This was followed by establishment of Bombay Life in Bombay in the year 1823 and Madras Equitable Life in Madras in the year 1829 and Madras Widows in 1834. In 1850, a non-life insurance company called Triton Insurance Company started in Calcutta. During this period many overseas companies came to India, the prominent ones are ‘Medical, Invalid and General’(incorporated in London in 1841); ‘The Universal Life Assurance Company’ established in London in 1836, opened its branch in India in 1840. Another British company known as the Colonial Life Assurance Company came to India under the auspices of Standard Life Assurance Company in 1846. The great social reformer of India, Raja Ram Mohan Roy also took serious interest to establish life insurance for Hindu widows. During this period Indian insurance industry was a city-centric phenomenon, it followed discriminatory practices in product pricing and basically served the colonial masters. Many life insurance companies did not cover lives of Indians and even those who were selling policies to Indian would charge 10 per cent or more from indigenous policyholders. This raised protests from many and forced the British companies to sell policies to indigenous policyholders at equal premium. The year 1870 is remarkable in the history of insurance in India, since it witnessed the birth of an Indian insurance. The first Indian Life Insurance to sell insurance to Indian nationals at normal rate was Bombay Mutual Life Assurance Society established in 1870. Another milestone of Indian insurance movement was the formation of Hindu Family Annuity Fund in 1872 in

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Calcutta by Pandit Ishwar Chandra Vidyasagar. These were followed by formation of Oriental Government Security Life Assurance Company in May 1874, by a distinguished actuary Mr D M Dastur. Another notable entity is ‘Indian Life’, which was formed in 1892 by some citizens of Goa settled in Karachi. During 1876 and 1893 a large number of small society funds were established in various provinces on community lines. Apart from the associations and funds, a large number of provident societies were also formed. The year 1883 was the beginning of postal insurance in India, when a scheme of life insurance and monthly allowance was introduced for its employees by the postal department. Initially whole life policies were allowed but the endowment assurance was introduced in 1898. Growth of national movement in India provided a new momentum to the Indian life insurance and saw the beginning of formation of many companies which brought significant changes in the life insurance landscape. A purely Indian company ‘Bharat Insurance’ was established in Lahore in the year 1896, in the very next year ‘Empire of India’ was formed in Bombay. Spirit of nationalism gave birth to ‘Swadeshi Movement’ (1905–06) urging people to buy Indian and be Indian. This resulted into establishing Indian enterprises by Indians in many fields of trade and commerce. Insurance industry was no exception to this movement. Swadeshi Movement led to the formation of the first Indian life insurance company, namely, ‘National Insurance Company’ in 1906. On the same day of formation of National Insurance Company by Mr Pannalal Banerjee another company namely ‘National Indian Insurance Company’ was formed by Sir Rajendra Nath Mukherjee in Calcutta. In the same year, that is, 1906 another Indian company ‘United India’ was established in Madras by M/S Lingam Brothers. Another great company ‘Hindustan Cooperative Insurance Company’ was established in a room at Jorasako, the house of Rabindranath Tagore. In 1908, Swadeshi Life Insurance Company was formed in Bombay, which changed its name to Bombay Life in 1913. Swadeshi movement also witnessed the formation of India’s first general insurance company ‘The Indian Mercantile’ in 1907.

Life Insurance Regulation Regulatory supervision has an important impact on the development of market structure. Though life insurance business started in 1818 in India it took about a century to formalize insurance regulatory supervision. Till 1912, life insurance business and life insurance companies were governed and regulated by Indian Companies Act (1866). Regulatory supervision was very weak during this period and insurance companies did not bother much about the consumer’s interest. However, things improved after an act was put in place in 1912 called the Insurance Act 1912 exclusively for regulation of life insurance industry. Under 1912 Act two sets of legislations were passed. 1. The Life Insurance Companies Act 1912. 2. The Provident Insurance Societies Act 1912.

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The Life Insurance Act 1912 introduced a measure of control under which the rate tables and periodic valuation required to be certified by an actuary. However, the law was discriminatory since Indian companies were required to keep a deposit with the government but no such deposits were required for foreign companies. Subsequent to two legislations in 1912 no legislative initiatives were taken till 1928 because of the involvement of Great Britain in the First World War. Passing of the Insurance Act 1912 saw many Indian and foreign companies ceased to New Business. However, many new companies were established. Immediately two companies, namely, The Western India Life Insurance Company Ltd. at Satara and The Industrial and Prudential Life Insurance Co. Ltd. in Bombay in the year 1913 were established. In the same year, that is, 1913 two other companies, ‘Mysore Life Assurance Co.’ Mysore, and ‘The East and West Insurance Company’ in Bombay were established. During the War, that is, from 1914–18 there was a slack in the formation of new companies but since 1919 a fresh momentum to open new companies was witnessed and in 1919 itself as many as nine companies were formed. During the 10-year period from 1919, 39 companies were promoted many of them with active support of national leaders. Formation of all these companies helped to increase New Business which went on from Rs 29 million in 1918 to Rs 49 million in 1914 and further to Rs 154 million in 1928. At the end of the period there were 412,446 policies in force with aggregate SA of Rs 711.1 million. The number of life offices increased from 42 in 1919 to 56 in 1927 (Saga of Security). The year 1928 was also remarkable for another reason. In 1928, The Indian Insurance Offices’ Association and the Indian Life Assurance Offices Association came into existence, the former being the representative of general insurance companies. Another outstanding event happened in 1928 with the passing of Indian Insurance Act 1928. This Act stated that the surplus shall be allocated to shareholders and to policyholders in the proportion in which the profits were allocated during the 10 years immediately preceding the commencement of the winding up. It also provided for disposal of surplus assets in the event of liquidation of an insurance company. The Indian Insurance Act 1928 also required every insurance company which conducted transactions in any class of insurance business in British India to submit annual statements showing details of its business both in and outside India. Legislation allowed the government to collect statistical information from foreign and Indian insurance companies operating in India. In the decade following 1928, there was an unprecedented growth of new companies in India. It has been recorded in the Blue Book (as the Indian Insurance year Book came to be known) that during 1929–39, 176 new companies were promoted Calcutta took the lead and more than 20 companies were established in Calcutta, followed by Bombay with 13 companies, Delhi with 6 companies and Madras with 5 companies. Some important companies formed during this period were Metropolitan Insurance Company Ltd. in 1930 in Calcutta, Aryasthan

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Insurance Company Ltd. in 1933 in Calcutta, The South India Cooperative Insurance Society Ltd. in 1932 in Madras, The Canara Mutual Assurance Co in 1935 at Udipi, Sunlight of India Insurance Company in 1932 at Lahore, Free India at Kanpur, etc. Insurance Act 1938: A Landmark Regulation

Rapid increase in number of insurance companies and growth in New Business also prompted several malpractices, such as increase in lapsed policies, doubtful valuation, unhealthy competition and undesirable rivalry. There were a number of free insurance societies, which were exploiting the trusting masses. Also a number of frauds were detected. As a remedial measure to stop unhealthy competition of foreign companies, indiscriminate growth—both of insurance companies and provident companies, malpractices and frauds, all demanded some sort of control at the highest level and the government could not remain silent for long. A committee under Chairmanship of Mr S C Sen was appointed to examine various aspects of insurance operations. This committee held a wide range of interaction with a large number of people. Recommendations of this committee were widely debated and finally a bill was passed which became the Insurance Act 1938. It covers several aspects of the insurance business such as deposit mobilization, commission of agents, policyholders servicing, supervision of insurance companies and appointment of directors. Subsequent insurance legislation in India is drawn with reference to Insurance Act 1938. The salient features of the Act are: 1. Constitution of a department of insurance under a superintendent vested with wide powers of supervision and control of all kinds of insurance companies. 2. Regulation for the compulsory registration of insurance companies and for filing of returns of investment and financial conditions. 3. Provision for deposit to prevent insurers of inadequate financial resources or speculative concern from commencing business. 4. Provision that 55 per cent of net life fund of an Indian or a non-Indian insurer should be vested in the Indian Government and approved securities with at least 25 per cent in Indian government securities. 5. Prohibition of rebating, restriction of commission, licensing of agents, etc. Maximum rates of commission were fixed at 40 per cent for first year premium and 5 per cent of renewal premium with respect to life assurance policy. 6. Actuarial and financial regulations such as valuation of assets and liabilities, solvency margins and submission of annual financial statements. Subsequent insurance legislation the Insurance Regulatory and Development Authority Act 1999, replaced Insurance Act 1938. However, it was the backbone of Indian insurance industry till 1999, the most vibrant insurance industry before 2000 was governed by the Insurance Act 1938.

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The Second World War disrupted the growth of life insurance industry. Even though the industry maintained its growth momentum. ‘New Business in India during the early war years fluctuated from Rs 46.6 crores in 1,939 to Rs 36.1 crores in 1940 to Rs 42.9 crores in 1942’ (Saga of Security, p. 202). The year 1943 was remarkable in many ways, namely, due to the formation of many prominent companies such as ‘Jay Bharat’ at Bombay, ‘New Great’ at Baroda, ‘Prithvi’ at Madras and also there was steady growth in business which was Rs 629.94 million in 1943 and went up to Rs 1,227.8 million in 1945. This trend of steady growth continued till it reached its peak at Rs 1,314 million in 1946. Another development during this period was the decline in percentage share of foreign insurers in total business, which declined from 16.2 per cent in 1938 to 9.3 per cent in 1945. A turbulent time started with the country attaining freedom on 15 August 1947. Partition of the country took its toll on the life insurance business. At the time of partition, 150 branches of insurance companies were located in Pakistan. Though many companies shifted their offices in the Indian territory, most could not shift their records. Therefore, ‘Evacuee Insurance Companies’ Association’ was formed with Mr Santhanam as the Chairman, by the end of 1947 Inter-Dominion Agreement on insurance was introduced in India and Pakistan to solve business related issues arising out of partition but nothing could be achieved. In March 1948, insurance companies met in Calcutta and finally decided to severe connections with Pakistan. During post-partition period the government initiated steps to put the industry on the correct path. Following the Cowasjee Jehangir Committee report, a bill was introduced in April 1946 providing for adequate control on expenses, capital structure, voting rights, excessive remuneration, part time and common executives, etc. Based on this a fresh bill was introduced which ultimately became the Insurance Amendment Act 1950.

Progress in Life Insurance Business 1914–57 Though the first insurance company was established in 1818, no business statistics are readily available upto 1914. Insurance Year Book 1914, provided some information for 1914 onwards. In 1914, there were 44 life insurance companies in India with total in-force business to the tune of Rs 22.44 crore and life fund of Rs 6.36 crore (Table 3.1). By 1948 the number of insurance companies increased to 209 out of which 189 were Indian companies. Total in-force policies serviced by these companies were 3,016,000 as against 748,997 in 1914. Total life fund amounted to Rs 150. 39 crore in 1948 as against Rs 6.36 crore in 1914. The first Annual Report of LIC of India—(1 September 1956 to 31 December, 1957) provides some information of the status just before nationalization in 1956. According to the figures published in this report the total number of policies underwritten in India and outside India was 796,030 and 35,461, respectively in 1955 (Table 3.2). Sum Assured (SA) under these policies

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was Rs 240.51 crore and Rs 20.33 crore, respectively. Total number of in-force policies and sum assured under them was 47.92 lakhs and Rs 1,220 crore in 1955. In fact life insurance industry was virtually stagnating before nationalization, but got a boost since nationalization. While the number of in-force policies in 1954 and 1955 was less than 48 lakhs, it went up nearly to 57 lakhs in 1957, the SA under these policies increased from Rs 1,220 crore in 1955 to Rs 1,474 crore in 1957 (Table 3.3). TABLE 3.1 Growth of Life Insurance Business in India 1914–48 Sl No. 1.

2.

3.

4.

1914 Number of insurers (a) Indian

44 44

(b) Non-Indian Total number of policies in force (a) Indian

– –

(b) Non-Indian (c) Indian outside India Total business in force (Rs in crore) (a) Indian

22.44 22.44

(b) Non-Indian (c) Indian outside India Total life funds (Rs in crore)

– – 6.36

1930

1940

1945

1948

– 748,997

195 179 (91.79) 16 1,628,381

215 200 (93.02) 15 2,714,000

209 189 (90.43) 20 3,016,000

513,925 (68.61) 220,703 14,369 258.42

1,371,963 (84.25) 181,247 75,171 304.03

2,376,000 (87.55) 261,000 77,000 573.07

2,791,000 (90.15) 234,000 202,000 712.76

84.89 (32.85) 69.76 3.77 20.53

225.51 (74.17) 60.12 18.40 62.41

459.43 (80.17) 91.85 21.79 1,07.4

566.38 (79.46) 101.08 45.30 150.39

68 68

Source Report on the activities of the Life Insurance Corporation of India during the period 1st September, 1956 to 31st December, 1957, LIC of India. Note Figures in brackets show percentage of the total. TABLE 3.2 New Business for the Years 1953–57 In India

Outside India

Year

Number of Policies

SA (in crore)

1953 1954 1955 1956 1957

574,749 740,093 796,030 549,401 810,738

156.26 237.60 240.51 187.69 277.67

Number of Policies 30,441 32,682 35,461 17,956 5,055

SA (in crore) 14.66 17.65 20.33 12.59 5.40

Source Report on the activities of the Life Insurance Corporation of India during the period 1st September, 1956 to 31st December, 1957, LIC of India.

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LIFE INSURANCE IN INDIA TABLE 3.3 Total Business in Force during 1952–57 In India

Year 1952 1953 1954 1955 1956 1957

Number of Policies (in lakh)

Outside India SA and Bonuses (in crore)

40.17 925 41.67 970 45.05 1,091 45.16 1,128 Figures not available 54.17 1,375

Total

Number of Policies (in lakh)

SA and Bonuses (in crore)

Number of Policies (in lakh)

SA and Bonuses (in crore)

2.66 2.72 2.77 2.76

70 77 86 92

42.83 44.39 47.82 47.92

995 1,047 1,177 1,220

2.69

99

56.86

1,474

Source Report on the activities of the Life Insurance Corporation of India during the period 1st September, 1956 to 31st December, 1957, LIC of India.

It has been indicated earlier that before nationalization the life insurance industry was suffering from many malpractices, money was being misused by many promoters and many companies were in insolvency. Investment management was in doldrums. Therefore, total investment of the entire life insurance industry at the time of nationalization was meagre and stood at Rs 381.90 crore in 1957. Out of the total investment of Rs 318.90 crore, Rs 260.61 crore was invested in Indian and state government bonds and other approved securities, while Rs 69.14 crore was invested in debentures and shares of joint stock companies (Table 3.4). TABLE 3.4 Distribution of Total Investment of Corporation as on 31 December 1957 (Rs in crore) Indian, state government and other approved securities Debentures and shares of joint stock companies in India Mortgages of properties House property Other investments Total investment

260.61 69.14 13.86 21.38 16.91 381.90

Source Report on the activities of the Life Insurance Corporation of India during the period 1st September, 1956 to 31st December, 1957, LIC of India.

Mortality Table Life insurance business is driven by mortality table, which is used for fixing premium. Mortality table is normally based on the statistics collected through mortality investigation. Indian insurance companies used to refer to Oriental Mortality (OM) Table which was based on British experience during 1925–35. However, the first Indian Mortality Table was Oriental

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Government Security Life Assurance Co. Ltd. (1905–25) it was updated in 1970s and 1990s and further modified in 1994–96.

Market Structure during Post-nationalized Period Prelude to Nationalization During this period Indian life insurance industry gained new momentum of growth. There was increased competition which expanded the insurance market further. However, Indian life insurance still remained an urban phenomenon and suffered from many deficiencies. 1. Per capita insurance in India was only Rupee one and eight annas (Rs 1.50) which increased to Rs 8 by 1944 and Rs 25 by 1955 as against Rs 2,000 in USA, Rs 1,300 in Canada and Rs 600 in UK (Tryst with Trust 1991). Further growth and competition generated many malpractices such as frequent liquidation of insurance companies and depriving policyholders savings. 2. Managing agency system also contributed inefficiency. A team of managing agents used to control and direct several firms and used them as source of credit. 3. Malpractices crept into the insurance industry due to acquisition of insurance companies by financiers who used them for their own interest. 4. Sir Cowasji Jehangir Committee was appointed by the Government in April 1945 to enquire into the unwanted development in insurance industry pointed out at acquisition of interest in insurance companies by payment of exorbitant price of shares, manipulation of life funds of insurance companies, payment of large emoluments to the financiers or officers appointed by them, interlocking between banking and insurance companies (Tryst with Trust 1991). 5. Investment management of insurance companies was questionable. Government for the first time obtained detailed returns of investments made by the management and the findings were appalling. 6. Loans had been given on any kind of security—good, bad, indifferent, etc. Sometimes there was no security at all. Policyholders money was used to finance enterprises irrespective of their intrinsic merits. 7. During 1945–55, 25 insurers went into liquidation. In 1953–54, 75 insurance companies were unable to declare bonus (Tryst with Trust 1991). All these adverse developments influenced the thoughts of the government about corrective measures.

Nationalization—A Landmark Decision Post-independent India adopted socialistic pattern of society and economic for faster growth and there was a countrywide mood to promote nationalized financial sector. Imperial Bank

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was nationalized in 1955. This was followed by the announcement of nationalization of the life insurance industry, which was announced by the then Finance Minister Shri C D Deshmukh on 19 January 1956 on All India Radio (AIR). The finance minister announced that: This afternoon the Government has promulgated an ordinance regarding life insurance. All life insurance companies, Indian as well as foreign, doing business in India came under Government Management and control. This is the first and preparatory step towards the nationalization of life insurance.

He further added that ‘Nationalization of life insurance is a further step (after the nationalization of Imperial Bank) in the direction of more effective mobilization of people’s savings’. On 18 February 1956, a Finance Bill was introduced in the parliament. Subsequently, after a select committee and Presidents assent the bill became an Act on 17 July 1956. The LIC Bill was passed on 19 June 1956, an act to provide for the nationalization of life insurance business in India by transferring all such business to a corporation established for the purpose and to provide for regulation and control of the business of the corporation and for matters connected therewith and incidental there to—LIC of India was born by merging 245 Indian and foreign life insurance companies operating in India (Annexure 3.A.1).

Growth of Life Insurance Market during 1956–2000 Since nationalization of life insurance, the Indian market has undergone significant changes and the industry has witnessed multifaceted growth and passed through several stages of ups and downs. During this period life insurance industry played a bigger role in the national economy by actively participating in national reconstruction and economic planning. India embarked upon economic planning and life insurance emerged as an important supplier of resource for the planning process since 1956. Moreover, acceptance of socialistic pattern of society and the aim to eliminate poverty also imposed immense social responsibility on LIC to spread the message of life insurance in rural areas and among the under privileged after LIC of India was formed by merging 245 private companies. LIC has played its role quite successfully. However, before we examine its performance let us see the circumstances leading to the formation of LIC of India. During 1956–2000, Indian life insurance market was completely dominated by LIC of India. It was state monopoly but it definitely worked for the people and the country. The objectives of nationalization were achieved to a great extent if we look into the performance and spread of LIC starting with a very little base of insurance understanding. One of the greatest non-financial achievement of LIC is spreading knowledge about the necessity of life insurance throughout the country and setting up offices even in remote villages in rural areas. Moreover, it has been able to create trust even among ordinary and illiterate people. A comparative position of LIC in two periods, namely, in 1957 and 2005 would indicate that LIC has completed a successful journey since its formation (Table 3.5).

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TABLE 3.5 LIC—Some Basic Statistics: 1957–2006 Sl No. 1. Business in Force No. of policies (in lakh) Sum assured (in crore) (Individual assurance only) 2. Premium Income First year (in crore) Renewal (in crore) Total premium (in crore) 3. Policy Payments Death claim (in crore) Maturity claim (in crore) Total 4. (a) Life fund (in crores) (b) Total assets (in crore) 5. Investment (Rs in crore) 6. Government’s share (5%) in valuation surplus (in crore) 7. Number of divisional offices 8. Number of branches 9. Number of agents on roll 10. Number of employees on roll 11. Expense ratio

As on 31 December 1957

As on 31 March 2000

As on 31 March 2006

56. 86 1,474.00

1,013.89 536,450.82

1,796.63 1,282,467.87

13.72 74.35 88.65

4,956.10 19,251.88 27,461.71

12,805.56 56,915.71 90,759.20

7.89 20.81 28.70 410.41 465.04 381.90 14.50

1,637.70 7,628.55 9,266.25 154,043.73 161,002.22 139,032.15 2,65.02

3,769.04 24,743.42 28,512.46 463,147.62 552,447.33 524,017.25 621.77

33 240 207,373 30,768 27.30%

100 2,048 714,615 122,867 21.16%

101 2,048 1,052,283 113,184 14.47%

Source First Statutory Report of LIC (presented to Parliament on 13.03.59 for the first sixteen months from 01.09.56 to 31.12.57) Annual Report of LIC for the year 1999–2000 and 2005–06. Mobilization of Savings

Since nationalization, Indian life insurance industry has registered a significant growth and gradually increased its share in household financial savings. As noted earlier the share of insurance funds in household financial savings has increased from 12.1 per cent in 1999–2000 to 13.0 per cent in 2004–05, while the share of life insurance funds increased from 11.2 per cent to 12.4 per cent during the same period. In terms of GDP it went up from 1.5 per cent to 1.8 per cent. This was a significant achievement of life insurance industry considering the fact that till 2000, the industry was represented by LIC of India alone. Increase in Life Fund and Assets

Growth in Life Fund is considered to be an important indicator of growth of life insurance industry. An organization which began its journey with a mere asset base of about Rs 465.04 crore in the first year has successfully accumulated an asset base of Rs 5,524,473.3 crore by 31st March 2006, that is, an increase of about 940 times. Similarly, the Life Fund of LIC increased by about 996 times, from Rs 410.41 crore in 1957 to Rs 4,631,476.2 crore in 2006. (Table 3.5)

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This is an excellent achievement for LIC which sells long-term intangible products like life insurance. This is an excellent achievement particularly in view of the low rate of literacy and lower level of per capita disposable income in India. New Business Growth

High growth of Life Fund and assets of LIC was possible due to significant growth in New Business, which however got a boost during the post-liberalization period. First time in 1999, LIC sold more than one crore (1.48 crore) policies in a single year and in 2006 it crossed the 3 crore mark by selling 3.15 crore policies. During 1999–2000 New Business (Individual Assurance including Annuity) of LIC was Rs 92090.01 crore (SA) under 172.12 lakh policies which increased further to Rs 288,522.55 crore under 31,585,917 policies in 2005–06. Rural Thrust in New Business

What is more significant is the growing rural thrust not only in terms of opening up offices, recruiting agents and development officers in rural areas, but rural penetration in terms of New Business. As per the rural/social sector definition of IRDA, New Business from rural areas amounted to Rs 609,718.5 (SA) under 7,466,484 policies representing 23.65 per cent and 21:21 share of policies and SA, respectively, during the year 2005–06 (LIC Annual Report 2005–06). Similarly, policy payment towards death and maturity claim increased from Rs 28.70 crore in 1957 to Rs 28,512.46 crore in 2006. Growth Rates—New Business

During 1951–2006, LIC has expanded in many dimensions including New Business, assets and investment. An analysis of growth rate would give us an indication of decadal performance. We may analyze New Business in terms of SA and number of policies. Two outstanding years of achievement in SA growth were 2002 (54.34 per cent) and 1995 (32.08 per cent). The decadal average growth in SA under New Business during 1960–69, 1970–79, 1980–89, 1990–99 and 2000–06 was 8.7 per cent, 8.6 per cent, 24 per cent and 18.5 per cent, respectively, indicating that so far the best decade of growth was 1980s (1980–89) which had average growth of 24 per cent. The performance of nationalized LIC of India, as assessed in terms of only few areas revealed that LIC has been able to fulfil the expectations of the policymakers, with its outstanding achievement in almost every aspect—providing a Personal Financial Risk Management (PFRM), expanding the life insurance market, spreading insurance in rural areas, promoting savings habit among the people, contributing to national development particularly through socially oriented investment and creating employment opportunities for millions of people in the country. While implementing national planning the Indian government created many national institutions which played a significant role in building today’s India and LIC is one such precious institution of India.

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Premium Income

Increase in life fund and assets was possible due to significant increase in business of LIC. While the first year premium income went up from Rs 13.72 crore in 1957 to Rs 12,805.56 crore in 2006, the total premium income increased from Rs 88.55 crore in 1956 to Rs 27,461.71 crore in March 2000 and thereafter to 90,759.20 crore in March 2006. Total premium income per employee increased from Rs 0.288 lakhs in 1956 to Rs 80.187 lakhs in 2006. In-force Policies

Total number of in-force policies went up from 56.86 lakhs in 1957 to 1,013.89 lakhs in 2000 and thereafter a huge increase to 1,796.63 lakhs in 2006. The number of in-force policies per branch and division was 0.23 lakhs and 1.72 lakhs in 1957 which has gone upto 0.88 lakhs and 17.79 lakhs respectively, for per branch and divisional office. Claims Settlement

During the year 2005–06 LIC has settled a total of 120.90 lakh claims for Rs 28,512.46 crore. During 2005–06 LIC has settled 115.63 lakhs maturity claims amounting Rs 24,743.42 crore and 5.27 lakh death claims amounting to Rs 3,769.04 crore. This has been possible due to massive computerization, networking, thrust on Customer Relationship Management (CRM), etc. Network of Offices

Office network is an important input for growth in order to reach to the customers for mobilization of business and to take service to the doorsteps of customers. Realizing this LIC moved to build up its office network by opening branch and divisional offices throughout the country. In 1957 LIC started its journey with 33 divisional offices mostly in the metropolitan and urban areas, the number has gone up to 101 and most of these new divisions are in the smaller cities, similarly, the number of branches to start with was 240 in 1957 it increased to 2,048 and most of the new branches are in semi-urban and rural areas. Out of 2,048 branches, 1,248 branch offices of LIC are located in rural areas. Besides 2,048 branches, LIC has opened 24 satellite offices by March 2006 for providing services at the doorstep of the customers. LIC’s strategic planning for market penetration takes into account the segmentation and development of rural and urban market. There is a strong network of agents to cater to the needs of rural people. Massive Use of Information Technology

LIC is one of the organizations in India which has gone for massive use of technology. It has its own Software Development Centre (SDC), engaged in upgrading existing technology and developing new technology. In LIC, all the jobs processed in branch offices have been mechanized, 2,042 branches (out of 2,048) are now connected through wide area network, LIC has its own portal providing various services, including policy status, bonus calculation, loan quotation, list of lapsed policies, A similar portal has been in place for the agents as well. LIC

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has also put in place facilities of internet payments, electronic clearing system, ATMs, etc. LIC has also put in place a massive data warehousing system in house IT system thus providing tremendous support to management decisions and improving service quality with speed. Foreign Operation

In the past nationalization period, LIC has not only expanded its offices and marketing network in India but it has also opened several subsidiaries and branch offices. Branches

LIC has its branch offices at Port Louis (Mauritius), Suva and Laukota (Fiji) and at Wembley (United Kingdom). Subsidiaries and Joint Venture

LIC (International) BSC (C), Bahrain is a subsidiary of the corporation opened in 1989 which operates in the states of Bahrain, Saudi Arabia, Kuwait and United Arab Emirates (UAE) through chief agents and brokers. This company has opened a branch office in Muscat at Oman. A joint venture is being set up by LIC Saudi Arabia. In Nepal—LIC Nepal Ltd. is functioning as a joint venture between LIC of India and M/S Vishal Group of Companies in the Kingdom of Nepal launched in 2001 and in Sri Lanka LIC has established LIC Lanka Ltd. It is a joint venture company between LIC of India and M/S Bartleet Group of Co. Ltd., launched in 2004. LIC (Mauritius) offshore—a joint venture company between LIC of India and GIC of India. Agents and Employees

There has been a substantial increase in the number of agents on role which has increased by about five times between 1957 (207,373) and 2006 (1,052,283). The corporation has launched an innovative scheme called the ‘Urban and Rural Career Agents’ with a view to attract educated youth to take up LIC agencies. By March 2005, there were 25,856 urban career agents and 46,418 rural career agents. Thus LIC has directly provided employment opportunity to millions in addition to providing regular employment which has gone up by more than three times from 30,768 in 1957 to 113,184 in 2006. Investment

Investment of LIC of India before the enactment of IRDA Act 1999 used to be guided by the Insurance Act 1938. According to this Act 25 per cent of the assets were to be invested in government securities and 25 per cent in government and other approved securities. Out of the remaining 50 per cent, 35 per cent could be invested in bonds/stocks and publicly traded securities while the remaining 15 per cent could be invested in other areas. However, this was modified in 1958 and as per modification of Section 27A of Insurance Act, investment norms were laid down. 1. Not less than 20 per cent to be invested in central government securities. 2. Not less than 25 per cent as loans including (1) to be invested in NHB.

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3. Not less than 50 per cent including (2) should be invested in state government securities. 4. Not less than 75 per cent should be invested in socially oriented sector including public sector, cooperatives sector, house building by policyholders, own your own home scheme including (3). During the post-nationalization period investment of LIC has gone up astonishingly merely from Rs 381.90 crore by 31 December 1957 to Rs 524,017.25 crore on 31 March 2006 and emerged as the largest investor in the country (Table 3.6). TABLE 3.6 LIC of India Investment as on 31 March 2006 Investment in India (A) Amount (Rs in crore)

% to Total

Investment Outside India (B) Amount (Rs in crore)

1. Loan 57,534.93 11.00 117.77 2. Stock exc. securities 462,237.61 88.37 793.77 3. Special deposits 0 0.00 0 with central govt. 4. House property 0 0.00 35.58 5. Other investment 3,293.18 0.63 4.41 Total 523,065.72 100.00 951.53 Grand total (In India and Out of India) [G] 4,138,009.5

% to Total

Total (A + B) Amount (Rs in crore)

% to Total

12.37 57,652.00 83.42 463,031.38 0.00 0

11.00 88.36 0.00

3.74 35.58 0.46 3,297.59 100.00 524,017.25

0.0068 0.63 100.00

Source LIC Annual Report 2005–06.

Total investment of LIC stood at Rs 524,017.25 crore, of which Rs 523,065.72 crore, that is, 99.82 per cent was invested in India and Rs 951.53 crore, that is, 0.18 per cent was invested abroad. Investment in Stock Exchange Securities dominated LIC’s investment of the total investment of Rs 462,237.61 crore in India, 88.37 per cent was invested in Stock Exchange Securities. Out of Rs 951.53 crore investment abroad Rs 793.77 crore, that is, 83.42 per cent was invested in Stock Exchange Securities. Second highest component was loan and 11 per cent and 12.37 per cent was invested in India and abroad, respectively. (A more detailed discussion on investment maybe seen in Chapter 5.) Socially Oriented Investment

LIC’s investment in developmental and socially oriented sector has been increasing steadily. Significant amount of investment has gone into electricity, housing, water and sewerage, transport and industrial development. Data for socially oriented investment in December 1957 is not available. However, by March 1970 Rs 513.21 crore, that is, 33.9 per cent of total investment was in socially oriented sector. The socially oriented investment further increased to Rs 358,400.76 crore by March 2006 which was 68.39 per cent of total investment of the corporation.

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Surplus and Taxes Paid to the Government

Performance of LIC also reflected in valuation surplus which increased from Rs 7,613 crore in 2000–01 to Rs 12,463.00 crore. As per the LIC Act 1956, 5 per cent of this surplus goes to the Government of India—which has sharply increased from Rs 383.77 crore in 2000–01 to Rs 621.77 crore in 2005–06. LIC also pays a huge amount of tax which was Rs 3,967.75 crore in 2006 excluding service tax (Table 3.7). TABLE 3.7 Surplus, Share of Government and Taxes Paid by LIC (Rs in crore) Year 2000–01 2001–02 2002–03 2003–04 2004–05 2005–06

Valuation Surplus 7,613 8,667 9,767.00 10,987.60 13,951.69 12,463.00

Government’s Share in Valuation Surplus 383.77 433.25 488.10 548.13 696.60 621.77

Taxes Paid to the Government∗ 709.65 868.17 1,258.62 1,506.28 5,365.16 3,967.75

Source LIC Annual Reports. ∗Does not include service tax. Note

Market Structure—Post-liberalization Period Insurance industry particularly the LIC of India has witnessed significant growth with respect to insurance coverage, premium mobilization and contribution to socio-economic development. LIC launched a wide range of products, providing cover to the most vulnerable section and served the cause of development. However, insurance industry remains primarily a supplydriven industry. Though it has done exceedingly well, much more remained to be done in terms of expansion of market size, consumer service and to provide wider product choice to the customers. Meanwhile, the global economy underwent a radical change in 1990s and a new economic order was established in India along with many countries of the world, with the new economic order supply-driven structure was replaced by the demand-driven market structure through liberalization and entry of private sector players.

Prelude to Reform A new chapter was added to the Indian economy with far-reaching consequences when structural reforms were initiated in 1991 in the aftermath of BOP crisis. Several segments of financial markets were deregulated and opened up to domestic and foreign private investment. However, it took about a decade to liberalize Indian insurance sector due to political sensitivity. Prior to opening up the insurance market lots of public debate was generated. The Government of

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India also appointed two high-powered committees to look into the details and to suggest future course of action for the Indian insurance sector.

Malhotra Committee The Government of India appointed a high-powered committee under the Chairmanship of R N Malhotra, who was earlier the Governor of RBI. The committee released its report in 1994. The terms of reference of the committee was to suggest the structure of insurance industry, to assess the strength and weakness of the insurance companies in terms of creating an efficient and viable insurance industry, to develop instruments for mobilization of financial resources for development, to improve functioning of LIC and GIC, to make recommendations for changing the structure of insurance industry, to make recommendations on regulation and supervision of the insurance sector in India, etc. The committee made several far-reaching recommendations regarding the structure of the insurance industry, regulation, supervision and functioning of LIC and GIC. To improve functioning of LIC, the committee recommended that LIC should be selective in recruiting agents and must provide suitable training after identifying the training needs, Insurance Institute Mumbai should start courses for insurance sector intermediaries, LIC should also recruit Master of Business Administration (MBA) for marketing, claims should be settled within a given time frame. The committee also recommended to improve servicing, product development, pricing, IT, etc. The committee made far reaching recommendation regarding altering the structure of LIC and GIC. It also recommended entry of new players and capital requirement of Rs 100 crore for such players, though lower capital requirements were suggested for co-operative sector’s entry into insurance. The committee also recommended special attention to rural sector.

Insurance Regulatory Act (1999) The Malhotra Committee Report set the tone of change in the Indian insurance sector and deregulation followed subsequently. Indian cabinet approved the Insurance Regulatory Authority (IRA) Bill on 6 March 1999 which was aimed at liberalizing Indian life and general insurance industry. However, due to political instability the bill could not be ratified by the Indian parliament. The bill was subsequently termed as IRDA Act and passed in the Parliament on 7 December 1999. With the passing of the bill the monopoly position of LIC was removed and private companies were allowed to operate in the Indian insurance market. After the IRDA bill was passed in the Parliament, private insurance companies were given licences to operate in the Indian market. Joint ventures between Indian and foreign companies were allowed but FDI was limited to 26 per cent of Rs 100 crore capital of life companies and Rs 200 crore for non-life companies. Indian insurance market witnessed a silent revolution

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with the IRDA in place. IRDA, in the light of with its Mission Statement came out with several guidelines/circulars/orders in the interest of healthy growth of the Indian insurance industry, protection of consumers’ interest and orderly management of insurance companies. Mission Statement of IRDA

In its Annual Report 2000–01 IRDA, stated its Mission Statement, as following: 1. To protect the interest of and secure fair treatment to policyholders. 2. To bring about speedy and orderly growth of the insurance industry (including annuity and superannuation payments), for the benefit of the common man and to provide long-term funds for accelerating growth of the economy. 3. To set, promote, monitor and enforce high standards of integrity, financial soundness, fair dealing and competence of those it regulates. 4. To ensure that insurance customers receive precise, clear and correct information about products and services and make them aware of their responsibilities and duties in this regard. 5. To ensure speedy settlement of genuine claims, to prevent insurance frauds and other malpractices and put in place effective grievance redressal machinery. 6. To promote fairness, transparency and orderly conduct in financial markets dealing with insurance and build a reliable management information system to enforce high standards of financial soundness among market players. 7. To take action where such standards are inadequate or ineffectively enforced. 8. To bring about optimum amount of self-regulation in day-to-day working of the industry consistent with the requirements of prudential IRDA regulations, published in the Gazette of India on 14 July 2000 set the direction for future insurance industry in India. The Act stipulates several provisions in this respect. Protection of Interest of Policyholders

The IRDA Act 1999 mandates the IRDA to protect the interest of policyholders and to regulate promote and ensure orderly growth of the insurance industry. Maintenance of Solvency Margin

As per the provision of the IRDA Act 1999 (and subsequent provision) every life insurer is required to maintain an excess value of his assets over the value of his liabilities of not less than Rs 500 crore (Rs 100 crore in case of a reinsurer) or a sum of equivalent based on a prescribed formula, as determined by regulation not exceeding 5 per cent of mathematical reserve and a percentage not exceeding 1 per cent of the sum at risk for the policies on which the sum at risk is not negative, whichever is highest.

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Rural and Social Sector Business

IRDA Act 1999, stipulated that every insurer after the commencement of the Act is to ensure that a specified percentage of business is done in the rural and social sector. Rural sector was defined where population is not more than 5,000, density is not more than 400 per sq km and at least 75 per cent of male working population is engaged in agriculture (this was subsequently modified marginally). According to this, a life insurer to ensure rural business from 5 per cent in the first financial year to 15 per cent in the fifth year. A social sector, according to the Act includes unorganized sector, informal sector, economically vulnerable or backward classes and other categories of persons both rural and urban with respect to all insurers. Accordingly number of lives to be insured varies from 5,000 in the first financial year to 20,000 in the fifth year. Appointed Actuary

Introduction of appointed actuary system is yet another milestone of the IRDA Act. All life insurance companies must have an appointed actuary. Appointed actuary must be a fellow member of the Actuarial Society of India, should possess a certificate of practice issued by the Actuarial Society of India and must fulfil certain conditions specified in the appointed Actuary Regulations. Actuarial Standard

IRDA issued qualifications of Actuary Regulation and prescribed powers and duties of the appointed actuary. Actuarial Society of India, which was entrusted by IRDA, has come out with a Guidance Note (GN) on appointed actuaries and life insurance covering professional standard, responsibilities of appointed actuary towards maintaining the solvency of the insurer, meeting reasonable expectations of the policyholders and to ensure that the new policyholders are not misled with regard to expectations. Accounting Standard

Regulations have been issued for preparation of financial statements and auditor’s report of insurance companies. The regulations broadly conform to the accounting standards issued by the Institute of Chartered Accountants of India (ICAI). Agents Qualification and Training

IRDA has prescribed minimum qualification and training of agents. Accordingly, an insurance agent should have at least a high school diploma and must undergo certain hours of training from a recognized institution. Entry of Private Life Insurance Companies

With the passing of the insurance bill in the Parliament, several private companies applied for transacting life and non-life business in India. However, very few were issued licences. The

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first Indian private sector life insurance company to be issued a licence was HDFC Standard Life in October 2000. During the financial year 2000–01 seven private sector life insurance companies including HDFC Standard Life Insurance Company Ltd., ICICI Prudential Life Insurance Company Ltd., Birla Sunlife Insurance Company Ltd., Max New York Life Insurance Company Ltd., Kotak Mahindra Old Mutual Life Ins. Ltd., Tata AIG Life Ins. Co. Ltd., and SBI Life Ins. Co. Ltd. were issued licences. In the Financial year 2001–02 four companies, namely, ING Vysya Life Ins. Co.Pvt. Ltd., Bajaj Allianz Life Ins. Co. Ltd., Met Life India Ins. Co. Pvt. Ltd. and AMP Sanmar Life Insurance Company were issued licences, while in the year 2004 and 2005 one each, namely, Sahara India Insurance (February 2004) and Shriram Life Insurance Ltd. (November 2005) was issued licence. Since then 13 private sector companies have been conducting transactions in the Indian life insurance market. By March 2006, there were 15 life insurance companies including LIC of India (Table 3.8). TABLE 3.8 Entry of Private Life Insurance Companies Name of the Insurance Company HDFC Standard Life Ins. Co. Ltd. Max New York Life Ins. Co. Ltd. ICICI Prudential Life Ins. Co. Ltd. Kotak Mahindra Old Mutual Life Ins. Ltd. Birla Sun Life Ins. Co. Ltd. Tata AIG Life Ins. Co. Ltd. SBI Life Ins. Co. Ltd. ING Vysya Life Ins. Co.Pvt. Ltd. Bajaj Allianz Life Ins. Co. Ltd. Met Life India Ins. Co. Pvt. Ltd. Reliance Life (Formerly AMP Sanmar) Aviva Life Ins. Co. India Pvt. Ltd. Sahara India Ins. Co. Ltd. Shriram Life Ins. Co. Ltd.

Date of Reg. 23 October 2000 15 November 2000 24 November 2000 10 January 2001 31 January 2001 12 February 2001 20 March 2001 2 August 2001 3 August 2001 6 August 2001 January 2002 14 May 2002 6 February 2004 17 November 2005

Source IRDA Annual Report (2003–04).

Capital of Life Insurance Companies One of the most debated issue in post-liberalized life insurance industry is the FDI component of capital in the private sector life insurance companies, which at present is 26 per cent of minimum capital of Rs 100 crore. All the Indian companies except Sahara India were promoted as joint ventures with foreign equity participation, Sahara India was promoted as a 100 per cent Indian private sector company. Though initially AMP Sanmar was promoted with foreign equity, it became a wholly owned company after it was acquired by Reliance. As per the existing provision foreign partners can contribute to maximum 26 per cent of capital as FDI (Table 3.9).

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TABLE 3.9 Equity Share Capital of Life Insurance Companies (Rs in crore) Name of the Insurance Company HDFC Standard Life Ins.Co.Ltd. ICICI Prudential Life Ins.Co.Ltd. Max New York Life Ins.Co.Ltd. Om Kotak Life Ins. Co. Ltd. Birla Sun Life Ins. Co.Ltd. Tata AIG Life Ins. Co. Ltd. SBI Life Ins. Co. Ltd. ING Vysya Life Ins. Co. Pvt. Ltd. Met Life India Ins. Co. Pvt. Ltd. Bajaj Allianz Life Ins. Co.Ltd. Reliance Life (Formerly AMP Sanmar) Aviva Life Ins. Co. India Pvt. Ltd. Sahara India Ins. Co. Ltd. Shriram Life Ins. Co. Ltd. Sub Total LIC of India Total

2004–05

2005–06

320.00 620.00 925.00 1,185.00 466.08 557.43 211.76 244.58 350.00 460.00 321.00 447.00 350.00 490.00 325.00 490.00 235.00 235.00 150.07 150.23 217.100 331.00 319.80 458.70 157.00 157.00 – 125.00 4,347.81 5,885.95 5.00 5.00 4,352.81 5,890.95

Foreign Promoter 113.08 308.10 144.93 63.59 119.60 116.22 127.40 127.40 61.10 39.06 0.00 119.26 0.00 32.50 1,355.35 – 1,355.35

Indian Promoter 506.92 876.90 412.50 180.99 340.40 330.78 362.60 362.60 173.90 111.17 331.00 339.44 157.00 92.50 4,530.60 5.00 4,535.60

FDI (%) 18.60 26.00 26.00 26.00 26.00 26.00 26.00 26.00 26.00 26.00 00.00 26.00 00.00 26.00 – – –

Source IRDA Annual Report (2005–06).

Merger and Acquisition in Life Insurance Industry Indian life insurance market has also witnessed first acquisition of an existing company by an Indian corporate. This was the case of AMP Sanmar. AMP Sanmar was promoted by Indian company Sanmar and its Australian partner AMP. However, the partnership could not continue. It was reported that Sanmar wanted to withdraw from the life insurance business in India. Subsequently, Indian Corporate Reliance Capital Limited acquired the entire equity capital of AMP and Sanmar group in AMP Sanmar Life Insurance Co. Ltd. and the name was changed to Reliance Life Insurance Co. Ltd. and fresh certification of incorporation was issued by the Registrar of Companies, Tamil Nadu on 17 January 2006. AMP Sanmar on 4 October 2005 and has been renamed as Reliance Life Insurance Company Ltd. This is the first case of acquisition in the life insurance sector. Company wise equity capital of life insurance companies is shown in Table 3.9. It can be noted that total equity capital of all the companies increased from Rs 2,234.13 crore in 2002–03 to Rs 3,238.71 crore in 2003–04. Contribution of Indian and foreign promoters accounted as Rs 2,461.37 crore and Rs 782.33 crore, respectively.

Other Developments in Post-liberalization Period Liberalization of life insurance market has brought many dimensional changes along with competition, world-class insurance regulation, better protection of consumers, wide range of

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new products, increased awareness among the consumers, compulsory education of sales force, etc. There is also an increased awareness about health insurance and microinsurance and many companies are launching these products. Regulation for Healthy Development

In the post-liberalized era, IRDA attempted to promote a healthy and competitive insurance market by introducing several regulatory measures. Upto March 2004, IRDA issued 33 regulations for this which include appointment of actuary; actuarial report and standard; qualification of actuary; assets liability and solvency margin of insurer; obligation of insurers to rural social sector; advertisement and disclosures; licensing of agents, brokers and corporate agents; investment regulations; protection of policyholders interest, etc. Regulations improve the quality and depth of markets as well as increase competition, which ultimately enhances the value for customers. Thus regulation serves the industry as well as all the stakeholders of the industry. Therefore, regulation should not be seen as a controlling mechanism but as an aid to the development of industry, IRDA regulations serve this purpose. New Products

One of the significant developments in the Indian life insurance market is the widening of the product basket. The new life insurance companies promoted as joint ventures between Indian and foreign companies launched a variety of new products. A whole range of insurance and retirement products, children’s products, investment products, etc. 1. During 2000–01, 20 new products which included term assurance, endowment, whole life money back, single premium bond, endowment, etc. 2. During 2002–03, IRDA cleared 102 products, a large number being unit linked and pension products. 3. During 2003–04, IRDA cleared 105 new products, a large number of new products cleared were endowment and conventional life insurance products. This is a very positive development in life insurance industry in India since it provided a wider scope to the consumers to select a product of choice and need. Moreover, it enabled the life insurance industry to improve its strength to compete with Other Financial Institutions (OFIs). Licenced Life Insurance Agents

Agents play a very important role in life insurance business since they act as linkage between a life insurance company and the buyers of insurance products. Agents play a very crucial role in countries with lower level of education and act as financial advisers and assist the customers to take need-based informed decisions. Therefore, they need to be well trained. IRDA has emphasized on this and introduced minimum hours of compulsory training to agents. Agents

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in India obtain the necessary licence from IRDA to transact insurance business. There has been a substantial increase in the number of agents since IRDA was established in 1999. Number of licences (new and renewal) issued by IRDA till 31 March 2004 was 1,538,672 out of which 816,897 were urban agents and 721,775 were rural agents. Therefore, out of the total agents appointed about 53.09 per cent were urban agents while 47.91 per cent were rural agents. Business Growth during the Post-liberalized Period

Liberalization of the insurance industry leading to entry of private life insurance companies has intensified competition which has helped market expansion in the post-liberalized era. The life insurance market has also become healthier due to a number of regulatory initiatives of IRDA. There is a significant improvement in insurance literacy, information dissemination and informed decision-making by the consumers. Moreover, product diversification has provided a wider choice to the consumers to select need-based products. Increase in the number of trained agents and entry of corporate agents and brokers provided a new impetus to channel management and distribution leading to life insurance penetration in wider segments of the market. All these developments have been reflected in higher sales and better growth of life insurance business. The Indian insurance industry was opened in August 2000 and new registrations were granted on 23 October 2000. Private sector companies have entered the Indian life insurance market in Financial Year 2000–01 but not much contribution was made by them. Further no authentic business data is available for the period 2001–02. Keeping this in view we have examined the post-liberalization business growth during the period 2003–04 to 2004–05. We discuss below some of the important development during this period. Opening of life insurance market provided the much needed boost to business growth in terms of increase in premium and policies. Post-liberalized period also witnessed significant expansion in network and geographical spread. LIC achieved significant growth during the pre-liberalized period and by the end of March 2001, in-force policies serviced by LIC stood at 11.32 crores under the SA of Rs 734,368.08 crore and annual premium received through these policies was to the extent of Rs 36,063.29 crore. However, the entry of private sector induced competition in the market and total premium income jumped to Rs 50,094.46 crore in 2001–02. The growth momentum sustained during subsequent years and total premium income doubled in the next four years from Rs 50,094.46 crore in 2001–02 to Rs 105,875.77 crore in 2005–06. Since opening up of market to the private sector, the Indian life insurance industry entered into a growth trajectory by maintaining undisrupted growth in premium income from 11.28 per cent in 2002–03 to 27.78 per cent in 2005–06. However, this has been possible due to unprecedented growth in the first premium income, particularly in single premium which was 74.11 per cent in 2004–05 and 69.40 per cent in 2005–06 (Table 3.10).

GROWTH

IN

PREMIUM INCOME

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LIFE INSURANCE IN INDIA TABLE 3.10 Premium Underwritten by Life Insurers (Rs in lakh)

Insurers

2001–02

2002–03

2003–04

2004–05

2005–06

A. First year premium LIC 1,958,877.25 1,597,676.15 1,698,929.64 1,165,823.94 1,372,803.17 Private sector 26,850.90 754,772.99 422,309.25 244,070.58 96,568.97 Total 1,985,728.15 1,694,245.12 1,943,000.22 1,588,133.19 2,127,576.16 (33.97) (14.65) (14.68) (–14.68) B. Single premium – – – 899,482.42 1,478,784.14 LIC 272,193.91 134,148.09 Private sector 1,033,630.51 1,750,978.05 Total (69.40) (74.11) C. Renewal premium LIC 3,023,313.69 3,865,172.79 4,617,830.54 5,447,422.62 6,227,635.05 481,386.89 216,293.48 67,962.05 Private sector 403.48 15,337.18 Total 3,023,717.17 3,880,509.97 4,685,792.58 5,663,716.10 6,709,021.94 (18.46) (20.85) (20.75) (28.34) D. Total premium LIC 4,982,190.94 5,462,848.94 6,316,760.00 7,512,728.98 9,079,222.36 772,750.82 1,508,353.79 312,032.63 Private sector 27,254.81 111,906.15 Total 5,009,445.75 5,574,755.09 6,628,792.80 8,285,479.80 10,587,576.65 (27.78) (24.31) (18.91) (11.28) Source IRDA Annual Report for the year 2003–04 and 2005–06. Note First year premium include single premium.

The growth rate in renewal premium declined from 28.34 per cent in 2002–03 to 18.46 per cent in 2005–06. Declining growth rate in renewal premium income was primarily due to high growth rate in single premium business. However, growth in absolute volume of renewal premium income year after year is an indication of increased business conservation ratio as well as improvement in quality of underwriting. Though the high growth rate in first year premium including single premium income was fuelled by growth in sales of unit linked products influenced by upbeat stock market. Continued growth in premium income strongly supported high growth in GDP and domestic savings in India. Real GDP growth in India in 2004–05 and 2005–06 was 7.5 per cent and 8.4 per cent, respectively, while GDS registered a growth rate of 29.1 per cent in 2004–05 (Table 3.11).

Dominant Private Sector Companies During the year 2005–06, total market share of private sector companies accounted for 14.25 per cent. However, only five companies cornered 10.65 per cent. Top five companies in terms

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TABLE 3.11 Company-wise Total Life Insurance Premium (Rs in crore) Insurers LIC

2000–01 34,892.02

2001–02

49,821.91 (42.79) ING Vysya – 4.19 HDFC Std Life 0.002 33.46 BSLI 0.32 28.26 ICICI Prudential 5.97 116.38 Kotak Life – 7.58 Tata AIG∗ – 21.14 SBI Life – 14.69 Bajaj Allianz – 7.14 MNYL 0.16 38.95 Met Life – 0.48 Reliance Life – 0.28 Aviva – – Sahara – – Shriram Life – – Private Sector 6.45 272.55 (4,124.31) Total 34,898.47 50,094.46 (43.54)

2002–03 54,628.49 (9.65) 21.16 148.83 143.92 417.62 40.32 81.21 72.39 69.17 96.59 7.91 6.47 13.47 – – 1,119.06 (310.49) 55,747.55 (11.28)

2003–04

2004–05

2005–06

63,533.43 75,127.29 90,792.22 (16.30) (18.25) (20.85) 88.51 338.86 425.38 297.76 686.63 1,569.91 537.54 915.47 1,259.68 989.28 2,363.82 4,261.05 150.72 466.16 621.85 253.53 497.04 880.19 225.67 601.18 1,075.32 220.80 1,001.68 3,133.58 215.25 413.43 788.13 28.73 81.53 205.99 31.06 106.55 224.21 81.50 253.42 600.27 – 1.74 27.66 – – 10.33 3,120.33 7,727.51 15,083.54 (178.83) (147.65) (95.19) 66,653.75 82,854.80 105,875.76 (19.56) (24.31) (27.78)

Source: Insurance Regulatory and Development Authority (IRDA). 2006. Annual Report 2005–06, Hyderabad. Notes ∗Figures revised for the year 2002–03 and includes the group business. Figures in the bracket represent the growth over the previous year in per cent. – represents business not started. 1 crore = 10 million.

of market share were ICICI Prudential (4.02 per cent), Bajaj Allianz (2.95 per cent), HDFC Standard Life (1.48 per cent), Birla Sunlife Insurance (1.19 per cent) and SBI Life (1.01 per cent).

Growth in New Policies Premium income increases due to increase in sales and there has been a significant increase in sales of life insurance policies since 2001–02. During the four years period, that is, from 2002–03 to 2005–06, new policies sold by life insurance companies increased from 2.54 crore to 3.55 crore. However, growth rates in new policies are not consistent with growth rates in premium income. Growth rates in policies derived out of data in Table 3.12 shows that after 12.8 per cent in 2003–04, it declined to 8.4 per cent in 2004–05 and further increased to 35.3 per cent in 2005–06, while the premium income grew steadily from 18.91 per cent in 2003–04, to 24.31 per cent in 2004–05 and further to 27.78 per cent in 2005–06 (Table 3.11 and 3.12).This is basically due to the changing focus of life insurance companies on high net worth individuals and to sell high SA policies as well as changing preference and general increase in the ability of the customers to go for high SA policies.

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LIFE INSURANCE IN INDIA TABLE 3.12 New Policies Issued by Life Insurers

Year 2002–03 2003–04 2004–05 2005–06

LIC

Private Sector

24,545,580 (96.75) 26,968,069 (94.21) 23,978,132 (91.48) 31,590,707 (89.08)

825,094 (3.25) 1,658,847 (5.79) 2,233,075 (8.52) 3,871,410 (10.92)

Total 25,370,674 (100) 28,626,916 (100) 26,211,198 (100) 35,462,117 (100)

Source IRDA Annual Report for the year 2003–04 and 2005–06.

Market Share (New Business) Before 2000, life insurance market in India was dominated by LIC and its share in the life insurance market was about 98–99 per cent, the rest being managed by postal insurance and state insurance corporation. As such, LIC never had 100 per cent market share. During postliberalization the market share of LIC declined in the expanded market—which is quite natural in a competitive market. However, decline in the market share of any existing company would be reflected more sharply in the New Business market, rather than in total premium. Market share of private sector life insurers increased rapidly from 1.35 per cent in 2001–02 to 35.48 per cent in 2005–06 while in total premium it increased from 0.54 per cent to 14.25 per cent during the same period. By the end of March 2006, market share of private sector in first premium, single premium, renewal premium and total premium was 35.48 per cent, 15.55 per cent, 7.18 per cent and 14.25 per cent, respectively. This indicates the intense nature of growing competition in life insurance market in India (Table 3.13). TABLE 3.13 Market Share of Life Insurers Insurers A. First Year Premium LIC Private sector B. Single Premium LIC Private sector C. Renewal Premium LIC Private sector D. Total Premium LIC Private sector

2001–02 (%)

2002–03 (%)

2003–04 (%)

2004–05 (%)

2005–06 (%)

98.65 1.35

94.30 5.70

87.44 12.56

73.41 26.59

64.52 35.48

– –

– –

– –

87.02 12.98

84.45 15.55

99.99 0.01

99.60 0.40

98.55 1.45

96.18 3.82

92.82 7.18

99.46 0.54

97.99 2.01

95.29 4.71

90.67 9.33

85.75 14.25

Source IRDA Annual Report for the year 2003–04 and 2005–06. Note First year premium includes single premium.

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New Business and Market Share in 2006–07 Detail business information for the year 2006–07 is not available. However, the information about first year premium income including single premium has been released by IRDA (Table 3.14). TABLE 3.14 First Year Premium Underwritten by Life Insurers during 2006–07 Market Share Insurers LIC Private sector Total

Premium 55,934.69 (118.11) 19,471.83 (89.92) 75,406.52 (110.06)

Policies 38,229,292 (21.01) 79,22,274 (104.64) 46,151,566 (30.14)

Premium 74.18 25.82 100

Policies 82.33 17.17 100

Source http://www. irdaindia.org. Note First year premium income includes individual (single and non-single) and group business (single and non-single).

Products Proliferation Opening up the market to private sector has not only fuelled the growth in premium income and selling of life insurance policies, but also widened the product range in the marketplace. Pre-liberalized life insurance market was primarily dominated by endowment type plans but the post-liberalized market witnessed a variety of new plans such as children’s plans, pension and retirement and the unit linked plans. However, the most important was the unit linked plan which became most popular due to customer friendly features such as easy liquidity, flexibility and transparency. Though life market still remains the biggest contributor of premium, the contribution annuity, pension and health insurance is growing. During 2005–06, the contribution of life, annuity, pension and health to first premium income was 73.57 per cent, 4.30 per cent, 22.10 per cent and 0.02 per cent as against 77.27 per cent, 6.7 per cent, 15.55 per cent and 0.47 per cent, respectively, in the previous year. A very positive trend has been observed with respect to pension, which is increasing at a fast rate. Distribution of first premium into linked and non-linked products indicates a trend of consolidation of linked products. Linked products underwritten in 2005–06 was Rs 16,060.67 crore as against Rs 8,247.74 crore, that is, a growth rate of 95 per cent, whereas premium under non-linked products increased to Rs 19,804.33 crore in 2005–06 from Rs 17,069.37 crore, that is, a growth rate of 16 per cent. Further, linked and non-linked business accounted for 44.78 per cent and 55.22 per cent in 2005–06 as against 32.54 per cent and 67.46 per cent, respectively, in 2004–05. There is a growing emphasis on health insurance. A number of life plans were launched with health riders but 2005–06 saw the launch of insurance cover especially for cancer as well as diabetes care. Post-liberalized competition in the life insurance market thus created new markets for new products and offered structured solution to wider need of risk management.

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Benefit Payments During the last five years, there has been a significant increase in life insurance business in India, which has enhanced the benefits payments to the policyholders. According to IRDA Annual Report 2005–06 (p.20) that benefits payments have virtually doubled from Rs 17,484.11 crore in 2001–02 to Rs 35,264.40 crore in 2005–06. It can also be noted that benefits payments more or less remained within the range of 33 per cent to 36 per cent of premium underwritten, but in fact declined since 2003–04 from 36.20 per cent to 33 per cent in 2005–06, which is healthy sign. However, a large amount of such payments are made by LIC. In fact in 2005–06, LIC paid benefits of Rs 33,956.79 crore comprising 37 per cent of premium underwritten while private insurers paid Rs 1,307.61 crore comprising 9 per cent of premium underwritten.

Expenses of the Life Insurers Expense management is a critical issue in life insurance operation, as such expenses should not exceed the prescribed limit. Further, a major expense of life insurance operation is payment of commission which accounts for about 80 per cent of the total operating expenses. It has been noted from the total commission payment as per cent of gross premium has steadily declined from 9.29 per cent in 2003–04 to 2005–06. This has happened due to expansion of alternative channels like Bancassurance, etc. Moreover, increase in sale of single premium policies also impacted commission expenses. In 2005–06, while the industry level operating expense was 8.16 per cent, the same for LIC was 6.65 per cent of gross premium underwritten (as against 8.31 per cent in 2004–05). Operating expense of private insurers, in 2005–06 was 23.72 per cent as against 28.85 per cent in 2004–05. However, the overall trend is an indication of decline in operation’s expenses for the industry (Table 3.15). Evolution of Indian life insurance industry since 1818 in three distinct phases gives us an idea of changing structure of the life insurance market. The first phase starts from 1818 to 1956—which can be further subdivided into a period 1818–1930s and late 1930s to 1956. While the period 1818–1930s can be identified as monopolistic duality among the foreign and Indian companies, the later part of this phase witnessed quite intensive competition among the Indian companies. It can be identified as a market with monopolistic competition in duality. In fact, during the initial period life insurance market was loosely divided into two markets; foreign insurance companies who were basically insuring non-Indians and Indian insurers focussing primarily on Indians. There is even a differentiation in product pricing. There was no regulation of significance before Insurance Act 1938, insurance companies were privately managed and customer’s interest were rarely protected. The second phase (1956–2000–01) of life insurance industry in India was characterized by state monopoly but was regulated better than the earlier phase because of implementation of the Insurance Act, 1938, owing to public accountability of state run LIC of India. Therefore,

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TABLE 3.15 Commission and Operating Expenses of Life Insurers as Per cent of Premium Sl No. 1. First year commission as % first year premium 2. Single premium commission as % of single premium underwritten 3. Renewal commission as % renewal premium underwritten 4. Total commission as % of total premium underwritten 5. Operating expenses as % of gross premium underwritten 6. Commission as % operating expenses

2001–02

2002–03

2003–04

2004–05

2005–06

14.43

17.22

17.78

24.06

22.52

–

–

–

1.54

1.09

5.62

5.80

5.77

5.62

5.45

9.12

9.27

9.29

8.57

8.16

9.43

9.70

9.93

10.22

8.16

97.62

95.86

93.47

83.87

89.94

Source IRDA Annual Report (various issues). Note @ include single premium.

the state monopoly could achieve much better results than the pre-monopoly phase to advance and protect policyholders interest and contribution to nation building. The third phase, which began with deregulation of life insurance industry since 2000 has entered into a phase which can be identified as a perfectly competitive market structure with a number of products but mostly standardized in the light of country’s regulation. There is also better dissemination of information required by the consumers for taking informed decisions. Indian life insurance market thus travelled from loosely regulated non-standardized productbased market to a well-regulated competitive market with virtually standardized life insurance products. However, there is scope for further improvement in life insurance market and to make it customer centric by introducing a competition ‘policy’, ‘ethical standard in selling’, ‘business practices’ and ‘corporate governance’.

Health Insurance Market in India Emerging Concern Health care financing and management has emerged as an important concern particularly in the post-globalized market economy in developing countries. The current concern arises due to the absence of proper delivery of health care services, absence of institutionalized financing mechanism, inability of poor and deprived sections of society to have access to such services and growing ageing causing increased dependency ratio. Restructuring of economy in the post-globalized era, reducing the role of the state as a provider of social goods including health care and growing reliance on market-dictated service benefits had deprived the poor who were unable to purchase such services from private suppliers in the market.

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In the new market environment, while state has been made to play the secondary role, health insurance has assured significant importance and is expected to play a dominant role for health care financing. Health insurance has achieved immense importance in India and is expected to play a very significant role. Health insurance has been defined as the insurance which provides single or multiple payments on the occurrence of certain health-related events. These events can occur more than once (Reekie 2004). This definition provides a direction to various health-related problems which are captured into health insurance policies which include: 1. 2. 3. 4. 5. 6. 7.

Capital disability policies. Permanent health insurance policies. Dreaded disease (critical illness) policies. Long-term care policies. Major medical expenses policies. Hospital cash policies. Ongoing medical expenses policies.

Capital disability policy covers finances of the insured in the event of becoming disabled and benefits are payable either in lump sum or as an income. Under Permanent health insurance policy a regular income is paid to the insured if he/she is fully or partially unable to follow his/ her occupation, the Dreaded Disease policy pays an amount on certain listed diseases when a person is diagnosed to have any of them. Long-term care policy provides financial security against the risk of hospitalization or treatment at home of elderly people. Hospital cash policy provides a certain amount of cash for hospitalization of an insured. Compliment of this policy is the Major Medical Expenses policy. However, an insurance company would operate keeping in view the bottom line and profitability, which can be ensured by minimizing costs. This is done through cost sharing and managed health care. In case of sharing, premium exceeds claims plus costs plus reserves. Management usually applies to disability products and expenses products and in managed health care, the insurer actively participates in prevention, recovery and well-being of policyholders (Reekie 2004). Though both options are there before an insurance company, managed health care is often considered to be a better option due to preventive nature of the system.

Changing Demography of India The concern for health care in India was further added by the fast changing demographic character in India, particularly with regard to ageing. According to revised UN estimates in World Population Prospects (2000), Indian population is likely to increase to 1,531 million in 2050 from 1,017 million in 2000 (Table 3.16), but the number of older people, that is 60 years and above would increase by more than three times from 7.55 per cent to 20.14 per cent during the same period. This would have many fold impact on the economy. The two most

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TABLE 3.16 Projected Changes in Indian Demography (in million) Age Group 0–14 years 15–59 years >= 60 years Total

2000 347 (34.14) 593 (58.31) 77 (7.55) 1,017

2015 345 (27.68) 782 (62.79) 119 (9.56) 1,246

2025 337 (24.63) 865 (63.15) 167 (12.22) 1,369

2030 327 (23.08) 895 (63.16) 195 (13.76) 1,417

2035 313 (21.53) 919 (63.17) 223 (15.30) 1,455

2040 300 (20.20) 937 (63.10) 248 (16.70) 1,485

2050 285 (18.60) 938 (61.26) 308 (20.14) 1,531

Source Population Division, Department of Economic and Social Affairs, United Nations Secretariat ‘World Population Prospects’: the 2002 Revision and World Urbanization Prospects. http//esa.un.org/unpp. Note Figures in bracket show percentage of total population.

significant impacts would be first, the demand for health services particularly for the older people would rise expanding the scope of health insurance market. Second, the increased demand of retirement provision for pensioners and therefore scope for pension business. In fact, the old age dependency ratio will go up from 13 per cent in 2000 to 32.8 per cent in 2005. Therefore, there would be increased demand for old age provisions such as savings and health services. The concern for good health has been growing and the Indian government is also making an effort through increased budgetary allocation. Central government’s plan and non-plan expenditure on health and family welfare has gone up by three times from Rs 1,756 crore in 1995–96 to Rs 7,680 crore in 2004–05. Similarly, combined expenditure of central and state government on health increased from Rs 4,566 crore in 1995–96 to Rs 40,352 crore in 2004–05. However, as a percentage of total expenditure, this allocation has declined from 4.5 per cent to 4.4 per cent and as a percentage of social sector expenditure it has marginally increased from 24.1 per cent to 23 per cent during 1995–96 to 2004–05 (Economic Survey 2004–05, Government of India). National Health Policy (NHP) 2002 aims at achieving an acceptable standard of good health for overall improvement in health services in the country particularly for the underserved and underprivileged section of society which requires increased investment. The NHP envisaged increase in public health investment from current level of 0.9 per cent of GDP to 2 per cent of GDP by 2010. National Common Minimum Programme (NCMP) envisages raising public spending on health to at least 2–3 per cent of GDP with focus on primary health care and specially by stepping up public investment on control of communicable diseases and special attention to health care of the poorer section.

Present Status of Health Care and Financing in India Health care financing and health insurance in India still remained to be poorly developed and in a chaotic state, resulting in deprivation of poor and Socially Vulnerable Sections (SVS) of

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society. According to World Health Organization (WHO 2004), India spends about 5.1 per cent of GDP on health (which is currently 6 per cent of GDP) and 82 per cent of the total health expenditure is spent by private sector and almost all of these are out of pocket expenditures and particularly on curative care. As a result of small public spending, the poor have been deprived of health care benefits in the country.

Present Status of Health Care in India State sponsored health care in India consists of Central Government Health Scheme (CGHS), Employee State Insurance and Voluntary Insurance Schemes like Mediclaim Insurance scheme provided by four subsidiaries of GIC, namely, National Insurance, United India, New India Assurance and Oriental Insurance Company. In addition to the state-owned LIC other private insurance companies also provide health insurance as a rider. The benefits through these schemes mostly goes to the organized sector, and therefore the existing system is vastly inadequate.

Employee State Insurance Scheme (ESIS) The first major initiative for social security in India was launched in 1952 through an Act of Parliament in 1948. ESI includes the organized sector employees out of labour force of 411.5 million (INR 2003), ESI has covered 8 million workers. According to Manpower Profile 2003, ESIS covered about 28 per cent of organized sector workers.

Central Government Health Scheme (CGHS) CGHS is a contributory health scheme launched in 1954 to provide medical coverage to working and retired employees and families. CGHS gets budgetary support from the Government of India. There are currently about 1 million cardholders and the total number of beneficiaries is 4.3 million (Gupta and Trivedi 2005).

Universal Health Insurance (UHI) Scheme for Below Poverty Line (BPL) Families In 2003, the Government of India introduced the UHI for the poor. All the four public sector non-life insurance companies offer this scheme at a premium of Rs 365 a year for an individual or Rs 548 for a family of five. The government provides subsidy of Rs 100 to per BPL family.

Mediclaim Mediclaim was introduced by the four subsidiaries of GIC. Mediclaim launched in 1986 can be purchased for any person between 5 and 70 years of age for a total SA of Rs 5 lakhs. Premium paid under this policy is tax deductible upto a maximum of Rs 10,000.

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Jana Arogya Bima Policy Apart from Mediclaim, the government also introduced a subsidized Health Insurance Scheme called Jana Arogya in 1996, which covers the poor for hospitalization with a 1 per cent to 1.5 per cent premium.

Community-based Health Insurance This is a group scheme launched for people below the poverty line. The scheme was launched in July 2003.

Private Sector Insurance Companies Private sector insurance companies have introduced variants of Mediclaim, which include health insurance policy on the line of Mediclaim providing benefits of hospitalization, personal accident cover, etc.

Critical Illness Policy It is a defined benefit policy and the insurer pays the SA on the diagnosis of 10 critical identified disease.

Hospital Cash Policy Under this policy the insurer pays a fixed amount upto a predetermined limit of each day spent in hospital irrespective of the actual amount spent. The inadequacy of health coverage in India can be gauged from the data in Table 3.15 which shows that little more than 85 million people have been covered by various health insurance schemes which could reach only to an insignificant number of people. This brings us to the fore the role of market and need for more active participation of insurance companies in the health insurance sector.

Health Coverage in India The state-supported social insurance scheme in India is very much fragmented and the nonuniform informal sector is often beyond the reach of a large section of population particularly those in the unorganized sector. With the opening up of the Indian economy through liberalization and structural reforms, economic growth rate is moving up. However, the number of workforce in organized sector is falling and approximately 10 per cent of workforce. According to Anand (2002) there were 397 million labour forces in India out of which 369 million, that is, 93 per cent belonged to the informal sector.

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Though, this segment contributes about 63 per cent of value added to the overall GDP of the country and constitutes about 65 per cent of total employment in urban areas. It remains out of the ambit of formal social security. In view of economic importance, this segment needs to be served with directed initiatives, which will not only be a necessity to provide a fillip to economic growth but will further expand health insurance market.

Health Insurance Market after Deregulation With the deregulation of Indian insurance market, it was expected that health insurance will get a boost. In fact IRDA took a significant step to promote health insurance and made a provision in the Insurance Act, 1938, that preference will be given to register the applicant who agrees to carry on life insurance or non-life business for providing health cover to individual or groups of individuals. In order to protect the interest of policyholders, a provision was made that the rider would not account more than 30 per cent of premium of the basic product. But in some cases of critical illness this can go upto 100 per cent of the premium of basic product. IRDA also framed regulations to facilitate Third Party Administrator (TPA) to provide a linkage between insurance companies and policyholders.

Growth of Health Insurance Business Mediclaim: Premium under Mediclaim has increased substantially from Rs 25 crore in 1996 to Rs 1,370.14 crore in 2003–04, that is, by 18 per cent. This is one of the fastest growing segments of non-life business, next to motor portfolio. According to IRDA Annual Report 2003–04, the public sector non-life insurers accounted for 89.19 per cent of the health premium as against 93.37 per cent in the previous year. Premium underwritten by public sector companies increased to Rs 1,222 crore in 2003–04 from Rs 1,083.29 crore in 2002–03. As against that the health insurance premium of private sector increased to Rs 147.99 crore from Rs 76.88 crore during the same period. The market share of private companies increased from 6.63 per cent in 2002–03 to 10.8 per cent in 2003–04 (Table 3.17). The slow growth rate of health insurance is a cause of concern and even IRDA has focussed on the issue in its Annual Report 2003–04. Accordingly, in order to increase the access of health insurance and to cover a wider section of people there is a necessity for better efforts of coordination between various stakeholders, initiate measures aimed at building confidence among the general public, reduce probability of rejecting genuine claims, standardization of treatment of similar diseases, removal of cost of moral hazards, building up a comprehensive data warehouse to facilitate decisions on pricing of insurance products and hospitalization service. IRDA report further states that insurance companies have no interface with hospital establishments in determining the reasonableness of charges relating to quality of medical care provided, no benchmark and no standard for billing these services, owing to the hidden cost in health care delivery system.

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TABLE 3.17 Health Insurance Coverage in India (in million) Schemes The employees state insurance scheme CGHS Railway health scheme Defence employees Ex-servicemen Mining and plantation Health insurance (public sector—non-life) Health insurance (private sector—non-life) Health insurance and life insurance companies (public and private) State sponsored scheme Employer run facilities/reimbursement scheme of private sector Employer run facilities/reimbursement scheme for public sector Community health scheme Total

Beneficiaries 25.3 4.3 8 6.6 7.5 4 10 0.8 0.23 <0.5 6 <8 3 <85

Source Indrani Gupta and Mayur Trivedi (2005).

Further Steps to Improve Health Insurance According to IRDA (IRDA, Annual Report 2004–05) slow growth of health insurance in India arises due to the lack of regulations in the health sector resulting in exposure of the beneficiaries to various wrong practices present in the system. In order to provide a further boost to the health insurance sector, the Committee on Examination of Regulatory issue appointed by IRDA in 2003 has recommended the following: 1. Registration of stand alone health insurance company with minimum capital of Rs 500 million. 2. Adoption of risk-based capital model for stand alone health insurance companies. 3. Allowing stand alone health insurer to write personal accidents as combined and add on covers. 4. There should be 51 per cent FDI in stand alone health insurance ventures. 5. Continuation of practices of health insurance being written both by life and non-life companies. 6. Agents of life and non-life companies to take agencies of stand alone health insurance companies. Once the stand alone health insurance companies are set up, the growth rate in health insurance sector is expected to be much faster.

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These brief discussions about the present state of health insurance market in terms of reach, product and awareness indicate that there is a necessity for urgent attention to promote a healthy and vibrant health insurance sector in India. There is also tremendous scope for health insurance business if a well-designed financial mechanism is developed. Recent initiative of IRDA to issue comprehensive microinsurance guidelines incorporating product, distribution, administration, regulations, etc., is a very timely step to promote health among the poorer sections of society. However, we need to go beyond the microinsurance products and need to introduce some specific schemes for the vulnerable section. The estimated health insurance potential in terms of coverage of potential is anywhere between 400 and 500 million people (Ahuja 2004). In terms of premium it is estimated that the worth of the health care business in India including service providers, pharmaceuticals and medical devices manufacturers is estimated to be Rs 750 billion (FICCI 2005). However, health insurance business as indicated is just the tip of an iceberg, given the size of the population and potential. Even IRDA has pointed certain necessary steps to improve health insurance market in India. Many eminent experts also pointed out the reasons for cluster growth in health insurance market, in spite of several initiatives by the government and IRDA. In view of the various comments and suggestions the following are very essential to give a boost to the health insurance market in India.

Suitable Product Range To make health insurance more attractive, need-based affordable products need to be designed for various population segments. Many of the existing products do not fulfil this criteria. Product such as Mediclaim and Jan Arogya need to be restructured since they provide reimbursement only for hospitalization, not for outpatients, which is not attractive enough. Moreover, marketing initiatives need to improve.

Uniform Standard Many of the problems particularly at the settlement level arise due to the absence of an uniform code and common standard for treatment process. A common standard for treatment and a uniform format for treatment-related matters needs to be in place, for insurers, TPAs and other parties.

Product Pricing Product pricing is a critical factor for health insurance which includes hospitals and other related services which health insurance policies offer. Since buying capacity differs widely, the pricing should take into account affordability and availability. Moreover, pricing should be fair and proper.

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New Entry Norms In spite of preference given to registration of new companies who offer health insurance, it has not yielded any desired result and none of the internal companies have shown any interest, maybe due to poor performance of existing health insurance business and absence of adequate market-related data. Moreover, capital base of Rs 1 billion might have also discouraged the companies due to prevailing uncertainty. Therefore, a concerted effort to improve database required infrastructure and lowering capital base may be essential.

Fair and Adequate Regulatory Environment Kipp et al. (2005) suggested that it is desirable that every health insurance entity demonstrate its core competencies through application, licensing and ongoing monitoring process. They need to be able to demonstrate several things including: ongoing solvency protection albeit at a lower initial threshold than today for health only company; reasonable rates and underwriting/risk selection practices; administrative capabilities, such as paying claims in a timely manner; data and information reporting capabilities; utilization management; quality measure reporting etc.

Data Network Since health insurance is a risky business there is a possibility of frauds and therefore wellmanaged data ware housing is essential. Industry-wide data network will help the insurers and other stakeholders in respective areas of concern.

Spreading Awareness Since health concerns get lowest priority by the poor who are more concerned for food and shelter, a literacy campaign for health insurance is required to create an awareness. Brief discussions about the present state of health insurance market in terms of reach, product and awareness indicate that there is necessity for urgent attention to promote a healthy and vibrant health insurance sector in India. There is also tremendous scope for health insurance business if a well-designed financial mechanism is developed. Recent initiatives of IRDA to issue comprehensive microinsurance guidelines incorporating product, distribution, administration, regulations, etc., are very timely steps to promote health among the poorer sections of society. However, we need to go beyond microinsurance products and need to introduce some specific schemes for the vulnerable section.

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Pension Reforms and Emerging Annuity Market in India Reform Initiatives There is a growing concern for the problem of ageing population, (over age 60) which according to some estimates, will grow from 76 million in 2000 to more than 218 million by 2030, and mounting cost of the Government Social Security System. Moreover the present system that prevails in India has not been very effective to provide coverage to the population as well as to confront the challenges emerging due to ageing and fiscal constraints. Also there is no formal universal social Security System in India, though, the Pension and Retirement saving system has been quite successful in extending social protection to millions of employees particularly in the organized sector. However the vast unorganized sector remain beyond the ambit of formal social security system. Pension system in most of the organized sector is a Defined Benefit (DB). Under DB plan the employers undertake to pay a defined amount of pension relating to career earnings. The employers bear the market risk. In case the funds perform better than the expected liability, the sponsor shares the benefits but in case the performance is poor than the liability, the sponsor has to increase its contribution to fulfil its defined obligations. However, the system has several inherent limitations and unable to sustain in future due to high cost. ‘The Central government and an increasing number of States, struggling with the mounting cost of pensions for their employees, and exploring reform alternatives.’ Several authors have pointed out many limitations of DB system which seems to be unmanageable, and suggested introduction of Defined Contribution under which the yearly contribution of each employee and employer are specified. No commitments are made about the yearly payment to employees. The amount accumulated in the employees account are converted into an annuity to provide monthly payment to the employee. Risk, under this plan, is solely borne by the employee. A serious debate was going on India to revamp existing Social Security System, and to put in place a well-defined effective mechanism of Social Security. Many experts and various committees have voiced concern about the problems and suggested reforms of existing pension system, particularly by introducing privatizing pension and widening the coverage. Some of the important reports on Indian Pension Reforms are: 1. Project OASIS (Old Age Social & Income Security) by Dave Committee (January 2000) 2. India, The Challenge of Old Age Income Security, by Robert Palacios of The World Bank (April 2001), 3. Pension Reforms in the Unorganized Sector—A Report by The Insurance Regulatory and Development Authority (October 2001), 4. Report of High Level Expert Group on New Pension System (NPS), (Chairman: B K Bhattacharya) Government of India (February 2002), and

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5. Report of the Group to Study the Pension Liabilities of the State Governments, (Chairman: B K Bhattacharya), Reserve Bank of India, October 2003. Analytical observations and recommendations of these committees have contributed important inputs to the new pension system (NPS) of India.

OASIS Recommendations on Reforms The Ministry of Social Justice and Empowerment, Government of India, had set up a Committee on Old Age Social & Income Security (OASIS) in 1998 under the chairmanship Dr S A Dave, which submitted its Repot in January 2000 recommending some drastic steps in the structure of Social Security in India through introduction of privately managed pension system. OASIS has recommended to transform Indian Pension System from defined benefit to fully funded defined contribution system, liberalization of investment and annuitization of pension payments. The thrust of the Committee was to develop an institutional infrastructure through which individual can take care of their own pension requirements, particularly in the unorganized sector. The pension system recommended by the OASIS committee based on Individual Retirement Accounts (IRAs), which is fully portable and to be financed by the employees and the pension account to fully portable. The employees would have an easy access to his/her IRA, which can be operated at any Points of Presence (POP), located all over India including post office, banks, etc. The Committee recommended a flexible contribution system—minimum amount per contribution being Rs 100 and minimum yearly contribution being Rs 500. The Committee suggested that the accumulated amount in the account would purchase annuity from a life insurance company and monthly pension would be paid to the member till the death. The member would be entitled to receive pension on his/her retirement at the age of 60. The tax free limit for accretions into IRA suggested to be maximum Rs 6,000 per annum, premature withdrawal to be taxable, but the amount used for buying annuity should be tax free. Another far reaching suggestion of the Committee is the entry of Private Funds Managers in retirement market in India. As per the recommendation, Pension Funds would be managed by Professional Pension Funds Managers (PFMs) to be selected for the purpose. PFMs would predefine funds styled as Safe Income, Balance Income and Growth Funds. For each type of fund, the Committee has suggested investment limits in Government Paper, Corporate Bonds, Domestic Equity and International Equity. Accordingly a Safe Fund can invest upto 10 per cent in equity, a Balanced Fund can invest upto 30 per cent in equity and a Growth Fund can invest upto 50 per cent in equity, while a Balanced Fund or a Growth Fund can invest upto 10 per cent of its assets in International Equity. The Committee has also suggested Minimum Guarantee for Safe Income Portfolio—fund managers must give guarantee that they would not under perform less than 2 per cent of weighted average return of all managers. The recommendations also included a Government guaranteed additional safety net called Contribution Protection Insurance.

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The IRDA Recommendations of Pension Reforms Insurance Regulatory and Development Authority of India (IRDA) had also submitted a report on pension reform in October 2001. The IRDA report suggested a pension system operating ‘through a mechanism of trustees’. The Pension system envisaged as a purely voluntary one should be voluntary and focussed on the unorganized sector. The new system should cover all irrespective of employment and there should not be mandated minimum annual contribution but each contribution should exceed Rs 100. Collections of contribution will be through Banks, NGOs Asset Management Companies, etc. The report indicated that specially selected Pension Provider (PP) would be allowed to manage pension funds. These PPs can be selected from Mutual Funds, Asset Management Companies, Financial Institutions, Banks. Pension would provide in the form of annuity, through Life Insurance Companies. Regarding investment management the report says ‘the system envisages the pension providers to offer a variety of schemes indicating a product mix between debt and equity’. While the report has not ruled out equity investment it has suggested that ‘the adoption of a strategy of investing at least a part of the funds in index funds’. Regarding tax incentives, the report recommended no suggested favourable tax treatment on terminal benefits. The report also suggested that the Regulation of Pension Funds should be entrusted with Insurance Regulatory Authority of India. The IRDA Report is basically an echo of the OASIS report except in respect of regulation of pension funds, while OASIS report suggested the formation of The Indian Pension Authority, IRDA report desired that regulation should be entrusted with IRDA, focussing on the unorganized sector, developing a voluntary third pillar, privatizing funds management, equity investment and explicitly suggesting investment in Index Funds.

World Bank Suggestions on Pension Reforms The World Bank has studied Indian Pension System and has made several observations about limitations of the present system. And also made some important suggestions about scope and direction of Reforms. The Report talks about a major paradigm shift in the mandatory retirement savings scheme. This shift is carried by establishment of a fully funded defined contribution system in place of Un-funded Defined Benefit Scheme and suggested two cases of Systematic reform for India. According to the Report Pension Reform should aim at: reducing overall contribution rates, eliminating unintended intra-generational redistribution, redistributing to workers with low lifetime incomes, establishing a reasonable replacement rate for an average wage worker payable until death and protected against inflation risk and, minimizing labour market distortions subject to the other objectives having been reached. Reforming EPF System

Reforming the EPF system would constitute the central element in the NPS. It is suggested that withdrawal is to be discouraged. Investment restrictions have to be gradually relaxed,

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competition is to be introduced by allowing private fund managers to operate, management, supervisory and regulatory framework to be redesigned. Systematic Reform

The two cases of Systematic Reforms are Minimum Pension Level, and determination of a Target Replacement Rate for the average worker based on his/her earnings history. There are two ways to determine the Minimum Pension Level either to rely on the existing social assistance scheme to supplement the income of elderly people regardless of past membership in the earning related scheme or to add a Basic Pension that supplemented the pension income of lower income members of the earning related scheme. A Target Replacement Rate can be achieved by introducing a fully funded defined contribution scheme. Extending Coverage of the New System

Several methods have been suggested to extend the coverage of Social Security quickly. Important among them are introducing incentives to attract employers and employees which includes, reducing overall contribution by 4–6 percent, the prospect of increasing yields, etc., to impose a ceiling on the contributions to be made to the earnings related defined contribution scheme at some level that reflected public policy concerns about reasonable consumption during old age. The Report also suggested new employer mandate to extend statutory coverage of the public pension system, to increase the list of the type of establishments that are subject to the EPF Act and to reduce the minimum size of the establishments covered. Tax incentives are suggested to attract long-term contractual savings/pension and annuities. Double taxation should be avoided and the contribution should be taxed only once–either at the beginning or at the end. Civil Servants

The Report also pointed out the problems of maintaining a non-contributory scheme for civil servants was highlighted earlier. In order to prevent the accumulation of further unfunded fiscal liabilities, facilitate labour mobility and apply consistent policy criteria to public and private sector workers, younger civil servants or at least new entrants should be shifted into the reformed basic pension and defined contribution schemes. A useful first step might be to shift the Government Provident Fund contribution to the reformed EPF scheme.

Working Group on Assessment of Pension Liability The Government of India appointed a Working Group (WG) under the Chairmanship of A M Sehgal, Controller General of Accounts, India, (which submitted its report on 25th June, 2001) to assess the Government’s liability arising out of pension payments. The terms of reference of the Committee included estimating likely expenditure on pension payments to

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the government servants in the short/medium-term, and to recommend appropriate formats/ information system to facilitate accurate assessment of the pensioners liability in future. The Working Group has examined the present pension structure of the Government and estimated present and future liability. The Committee noted that over 50 per cent of pension payments of Central Government goes to the Defence employees and at the end of March 1998, there were 5.2 million Central Government employees, while the number of pensioners estimated at 3.5 million which gives an overall dependency ratio of 67 per cent. The pension expenditure of the Government of India (including Posts, Civil, Defense, Railways and Telecom) has gone up by 6 times from Rs 3,272 crore in 1990–91 to Rs 19,446 crore in 1999–2000 and likely to go up to Rs 21,117 crore in 2000–01. As a result of the acceptance of Fifth Pay Commission recommendation, pension liability has gone up by 86 per cent from Rs 11,375 crore in 1997–98 to Rs 21,117 crore in 2000–01. According to the Committee the estimated pension liability of the Government of India would rise, to Rs 29,891 crore in 2009–10 at an inflation rate of 6 per cent per annum and to Rs 33,558 crore at an inflation rate of 10 per cent per annum. Therefore the Working Group ‘recommended a transition to a funded system of pension payments for new government employees and a system of incentives to encourage migration of existing employees to funded system. The fiscal impact can only be mitigated for the incremental liability of new employees with the introduction of a defined contribution system’.

High Level Expert Group on New Pension Scheme of the Central Government The Government of India constituted a High Level Expert Group in June 2001 (Chairman: Shri B K Bhattacharya) to provide a road map for introducing the New Pension Scheme. The Group examined the various aspects of existing pension system and came out with a number of recommendations which includes: A Two Tier Scheme: The Expert Group recommended the introduction of a hybrid Defined Benefit/Defined Contribution for Central Civil Servants in place of unfunded Defined Benefits (DB), Pay As You Go (PAYG) scheme or a pure two-tier scheme Defined Contribution (DC) scheme and suggested introduction of a Two Tier system. The First Tier would act as a Social Security Scheme with mandatory contribution of 10 per cent each on the basic pay and DA by the employees and Government while the Second Tier would promote personal savings. A cap of 5 per cent of pay plus DA was recommended in the case of matching contribution by the Government. The mandatory first tier is a Defined Benefit at 50 per cent of the average emoluments over the last 36 months. The minimum qualifying service will be 20 years and full pension will be payable on superannuation for qualifying service of 33 years. A second exit point can be provided at any age after 50 years, and the full pension or proportionate pension will be payable only from the date of superannuation. The contribution under the Second Tier would be Portable and Tax exempt within the overall ceilings prescribed by the Government on approved saving schemes. In case of

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Second Tier, the amount on retirement could be either taken as a lump sum or converted into annuities at the choice of the individual. The contribution to the second tier would be invested in separate funds with the fund managers investing the contributions as per more liberalized investment guidelines. The Group also recommended Indexation of Inflation up to 5 per cent but did not suggest any wage indexation. Furthermore, the Group recommended the new scheme only to the applicability of the new entrants to the civil service. The Group recommended three separate Pension Funds, each one for Railways, Defence and other Civil ministries, The Committee also recommended periodic actuarial valuation of the Fund, so that regular parametric changes (in benefits, contribution rate, etc) could be undertaken to ensure actuarial viability of the Fund (Balances, Asset and Liability). Other recommendations include setting up of the Investment Committee, Professional Fund Management, under supervision of Investment Committee of Board of Trustees, Board itself and a Pension Development and Regulatory Authority (PDRA). According to the recommendation of the Group the contribution from the second tier would have a separate institutional structure and will be based on investment guidelines that might be more liberal than what was laid down for the first tier. Subsequently, based on the experience gained, individuals might be permitted to exercise their choice of type of fund in which funds can be invested. The Group also recommended constitution of an independent Pension Regulatory Authority which can be called Pension Fund Development and Regulatory Authority (PFRDA) for the pension sector in the country.

Recommendations of the Group to Study the Pension Liabilities of the State Governments On the basis of the decision taken in the Eleventh Conference of State Finance Secretaries held in the Reserve Bank of India (RBI) during January 2003, a Group was constituted by the RBI in February 2003 ‘to study the existing pension scheme of the State Governments and the trends in pension payments, future fiscal implications and liabilities of the existing pension schemes’. The committee was to examine cross-country practices concerning pension reforms and the funding arrangements and the feasibility of introducing necessary modifications in the existing pension schemes and to suggest appropriate mechanisms regarding funding arrangements to meet the growing pension liabilities of the State Governments. The Group has particularly suggested structural and parametric changes which includes the following: Structural Changes: The Group has recommended the introduction of defined contribution pension scheme/s for the new employees of the State Governments in place of the existing non-contributory defined benefit pension scheme and has suggested three alternative pension models namely A pure Defined Contribution(DC) scheme in which

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the new employees and the State Governments each would contribute 10 per cent of the basic pay and dearness allowance to an individual account, A Defined ContributionDefined Benefit (DC-DB) scheme which would be a contributory scheme with guarantee of an appropriate level of pension fixed by individual State Governments and the rate of contribution by the employees and the State Governments could be determined on the basis of actuarial calculations and a Two Tier scheme for the new employees with the defined benefit in the first Tier of DC-DB scheme supplemented by a mandatory Defined Contribution (DC) scheme, wherein both the employees and the State Governments make contributions. The pure DC component could, at the option of the State Government, be merged with tier-II of the proposed Central Government Pension Scheme, which is open to State Governments as well. The Group proposed that the new pension scheme should be made mandatory for all new employees of the State Governments and the date of its applicability may be decided by the respective State Governments. It was suggested that in the States where pay, pension and interest burden have exceeded 90 per cent of State’s total revenue receipts, the new contributory scheme is obligatory for even existing employees with less than 10 years of service. The contributions under the proposed scheme/s and also the earnings from the Pension Funds may be granted Income tax exemption. Parametric Changes: The Group has recommended few parametric changes in order to mitigate the immediate and medium-term effect on State finances which includes: immediate withdrawal of existing scheme of fixing the pension on the basis of only the last one month’s pay, determining the basic pension on the basis of the average pay for a longer period, say for 36 months, doing away with the practice of adding five years on a notional basis. While calculating, the basic pension may be done away with and continuation of the present practice of price indexation, while doing away with wage indexation facility, wherever it exists. The Group also suggested bringing down the maximum permissible commutation amount from 40 per cent of Basic Pension to 33 1/3 per cent, enhancing the present discount rate used while calculating commutation factor linking to the rate of return on General Provident Fund. Other suggestions of the Committee include bringing down the enhanced family pension from the present maximum period of seven years to five years or until the pensioner would have attained the age of 63 years, whichever is earlier. Shifting the pension burden of the future recruits of grant-in-aid institutions (GIA)/Local Bodies (LBs) to the respective institutions/bodies. Further, depending upon their own financial position the GIA institutions and LBs should consider having their own pension scheme/s of a contributory type, or join the Central Government pension scheme. The Group favours reduction in the leave encashment period in a phased manner, with advance intimation to all concerned.

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Dedicated Pension Fund: The Group has recommended the setting up a Dedicated Pension Fund to meet at least partially the pension burden of the existing employees and setting up a ‘Dedicated Pension Fund’ which should be kept completely outside the States’ Consolidated Fund and the Public Account. The individual State Governments should consider having their own separate Pension Funds or Joint Pension Funds for a group of States. The smaller States could either have a Joint Pension Fund or may consider joining the proposed tier-II of the Central Government pension scheme. There could be several Pension Fund Managers (PFMs) for each Fund, subject to the guidelines of the Pension Fund Regulatory and Development Authority (PFRDA). In case of a pure DC scheme, a small portion of the earnings from the Pension Fund may be kept in a separate fund which could be used during periods when the earnings are below a benchmark level. In respect of a pure DC scheme and DC component of a 2 Tier scheme, the State Governments may consider providing investment options to their employees, similar to those available to the Central Government employees. In respect of a DC-DB Scheme or DC-DB component of a 2 Tier Scheme, the Group has suggested the investment pattern and accordingly not less than 25 per cent to be invested in Central Government Securities as defined in Section 2 of the Public Debt Act 1944 (18 of 1944) and/or units of Mutual Funds which have been set up as dedicated funds for investment in Government Securities approved by the SEBI. Not less than 15 per cent in Government Securities as defined in Section 2 of the Public Debt Act 1944 (18 of 1944) created and issued by any State Government and/or units of such Mutual Funds which have been set up as dedicated funds for investment in Government Securities approved by the SEBI. Not more than 40 per cent is to be invested in Bonds/Securities of Deposits of Financial Institutions regulated under Banking Regulation Act or IRDA Act; and not more than 20 per cent (of which investment in equities shall not exceed 10 per cent)-in Bonds/Debt Securities of Companies registered under the Companies Act 1956, with rating by a SEBI approved credit rating agency, of at least investment grade in the previous three years, plus equities/ Index Funds. However, whatever be the structure of New Pension System, it would be essential to extend the scope to cover all categories of workers including home-based, self-employed and women workers, irrespective of the duration of any specific work. It would be also essential keeping in view the prevailing necessity and affordability that the scheme is economically viable and self-financing; the scheme must also have certain amount of flexibility, in its scope and administration. Another area need to be carefully looked into is the transition and operation cost, which can even make very good scheme non-viable. Benefits and service delivery must also be designed in an economical decentralized manner to provide timely cost, effective quality service keeping in view to provide largescale coverage, especially of the self-employed and informal sector workers, many local

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variations could then be considered and developed. The new pension model must induce confidence to the participants among the cross-section of people. It can be observed from the recommendations of the various committees that all of them centered around introducing a defined contribution scheme to be financed by the employees contribution. Most of the Committees/Groups also suggested a Portable Scheme with professional fund management and a part investment in equities with separate regulator for pension fund.

Portable Pension Account The NPS will be portable and the members will have an option to transfer individual pension accounts in case of change of employment or change of location. Collection and transmission of contributions and instructions shall be through points of presence to the CRA. The contribution and accumulation to the NPS will attract tax benefits. It is proposed that there will be Exempt Exempt Taxation (EET), that is, contribution and accumulation will be tax exempted, but benefits will attract tax.

New Pension System (NPS) of India In the Union Budget 2003–04, the Government of India announced the establishment of a New Pension System (NPS) initially to be available to civil servants and other workers. Subsequently, the new system will also be available, on a voluntary basis, to all persons including self-employed professionals and others in the unorganized sector. However, mandatory programmers under the Employee Provident Fund Organization (EPFO) and other Special Provident Funds would continue to operate as per the existing system under the Employee Provident Fund and Miscellaneous Provisions Act, 1952 and other special Acts governing these funds. Individuals however, under these programmes could voluntarily choose to additionally participate in this scheme. According to the Budget announcement, the Government of India introduced a new Defined Contribution Pension Scheme replacing the existing system of Defined Benefit Pension System vide Government of India, Ministry of Finance, Department of Economic Affairs, dated 22 February 2003. The new scheme came into operation with effect from 1 January 2004. The Government of India issued a Press Release on 27 August 2003 on operationalization of the budget announcement 2003–04 to establish a NPS in India, which states that ‘The Government approved on 23 August 2003 the proposal to implement the budget announcement of 2003–04 relating to introducing a new restructured defined contribution pension system for new entrants to Central Government service, except to Armed Forces, in the first stage, replacing the existing system of defined benefit pension system. The suggestions/ recommendations made by the various committees were seriously considered by the Central Government and went ahead with Pension Reform by introducing a new system.

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In December 2003, the Central Government notified the New Pension System (NPS) Rules which replaced the Central Civil Services (Pension) Rules 1972 and the GPF (Central Services) Rules 1960 applicable to central government (civil) employees. The NPS Rules came into effect from 1 January 2004. The Government of India established the Pension Fund Regulatory and Development Authority (PFRDA), on 10 October 2003, as the prudential regulator for the New Pension System (NPS). The PFRDA will adopt multiple strategies to promote the NPS and maximize retirement wealth of the subscribers, and to regulate the NPS for healthy and orderly growth. Subsequent to the announcement of the Central Government about the implementation of the NPS, 19 State Governments namely Andhra Pradesh, Assam, Bihar, Chattisgarh, Delhi, Goa, Gujarat, Haryana, Himachal Pradesh, Jharkhand, Karnataka, Madhya Pradesh, Maharashtra, Manipur, Orissa, Rajasthan, Tamil Nadu, Uttar Pradesh, Uttaranchal have issued notifications to join the new Defined Contribution Pension System for their new employees.

The Salient Features of the New Pension System (NPS) The New Pension System established by Government of India is fully funded Defined Contribution (DC) system having very attractive features and is comparable to any such scheme in the world. We may discuss the salient features of the scheme as below: Mandatory DC System: The new pension system in India is a fully funded Defined Contribution Two Tier system, and would be mandatory for new recruits to the Central Government service except for the recruits to the armed forces who join services after 1st January 2004. The existing provisions of defined benefit pension and GPF would not be available to the new recruits in the Central Government service. Two Tier System: The NPS is based on individual account. The NPS will be a two tier system: Tier-I: Tier I is Mandatory, Non-withdrawable and Tax Deferred Pension Account. Tier-II: Tier II is Voulntary, withdrawable savings account. Contribution: In the new system, NPS contributions and investment returns would be deposited in a non-withdrawable tier-I account. As per the NPS rules, the Government of India will deduct 10 per cent of the salary (Basic+ Dearness Allowance) of its new employees and an identical matching contribution by the Government will be transferred to the pension account of the employees. In addition to the tier-I mandatory pension account, each individual may also have a voluntary tier-II withdrawable account at his option. This option is given as GPF is proposed to be withdrawn for new recruits in Central Government service. Government

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will make no contribution into this account. These assets would be managed through exactly the above procedures. However, the member would be free to withdraw part or all of the ‘second tier’ of his money anytime. Mandatory Annuitization: Individuals can normally exit at the age 60 or at superannuation from tier-I of the pension system. At the exit, the individual would be mandatorily required to invest at least 40 per cent of pension wealth to purchase an annuity (from an IRDA-regulated life insurance company). In case of Government employees the annuity should provide for pension for the lifetime of the employee and his dependent parents and his spouse at the time of retirement. The individual would receive a lump sum of the remaining pension, wealth, which he would be free to utilize in any manner. An individual member of the NPS would have the flexibility to leave the pension system prior to age 60. However, in that case, the mandatory annuitization would be 80 per cent of the pension wealth. Individual Pension Account: Every subscriber will be issued an unique Permanent Retirement Account Number (PRAN) by the Central Record keeping Agency (CRA) which will maintain the functions of recordkeeping, accounting and switching of options by the subscriber. PFRDA has selected National Securities Depository Ltd (NSDL) as the CRA. Multiple Fund Managers: In order to provide wider choice and to introduce competition, there will be multiple fund mangers. The subscriber will have a choice to select from multiple Pension Fund Managers and multiple schemes. There will be no implicit or explicit assurance of benefits except market based guarantee mechanism to be purchased by the subscriber. Multiple Schemes: Under the NPS, the Pension Fund Managers will offer multiple Schemes to the subscribers. Fund Manager will offer three schemes to the government servants namely, Option A, B and C based on the ratio of Fixed Income and Equity. In order to provide wider choice to the subscribers, according to risk tolerance there will be predominant debt-oriented scheme (low risk), predominantly equity oriented scheme (high risk) and balance schemes (medium risk). Switching Facilities: The subscribers to the NPS will be entitled to switch over from one scheme to another scheme as well as from one Fund Manager to another Fund Manager. Portable Pension Account: Under the New Pension System, individual Pension Account will be portable and the members will have the option to transfer individual pension accounts in case of change of employment or change of location.

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Collection: Collection and transmission of contributions and instructions shall be through Points of Presence to the central recordkeeping agency. Taxation: The contribution and accumulation to the NPS will attract tax benefits. It is proposed that there will be Exempt Exempt Taxation (EET), that is, contribution and accumulation will be tax exempt, but benefits will attract tax.

Architecture of the New Pension System (NPS) The Two Tier Defined Contribution NPS will have several entities and is to be regulated by the PFRDA. These entities include subscribers, Central Recording Keeping Agency, Multiple Pension Fund Managers(PFMs), NPS Contribution Accounting Network (NPSCAN), Trustee, Trustee Bank, and above all PFRDA.

Pension Fund Regulatory and Development Authority (PFRDA) The Pension Fund Regulatory and Development Authority (PFRDA) will regulate and develop the pension market in India. PFRDA will develop its own funding stream based on user charges. The roles and responsibility of PFRDA would include to carry out regulatory changes overseeing quality and provision of services of NPSCAN, CRA, PFs Trustee Banks, etc., co-ordinate between CPAO/NIC, monitoring operation of CRA, ensuring smooth implementation of projects contracting with service providers under NPS, conducting routine and system audit, etc. Subscribers (Coverage)

Pending the passing of Pension Bill by the Indian Parliament, the NPS will be open to the employees of the Central and State Government Employees and apply on mandatory basis to all employees joining the services in ministries, non-civil departments, autonomous bodies, grant-in-aid institutions, Union Territories (UTs). The NPS will be available on a voluntary basis to all other citizens of India including self-employed professionals and others in the unorganized sector, after the PFRDA Bill is passed by the Indian Parliament. Point of Presence (POP)

The Pension Fund Regulatory Authority will grant a certificate of registration to permit one or more institutions to act as a Point of Presence or Points of Presence for the purpose of receiving contributions and instructions, transmitting them to the Central Record Keeping Agency and paying out benefits to subscribers in accordance with the regulations made by the Authority

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from time to time in this regard. A point of presence shall function in accordance with the terms of its certificate of registration and the regulations made under this Ordinance. Central Record Keeping Agency (CRA)

The Pension Fund Regulatory Authority will grant a certificate of registration and appoint a Central Record Keeping Agency (CRA). The Central Record Keeping Agency shall be responsible for receiving funds and instructions from subscribers through the points of presence, transmitting such instructions and transferring such funds to pension funds, effecting switching instructions received from subscribers and discharging such other duties and functions, as may be assigned to it under the certificate of registration or as may be determined by regulations. The main functions and responsibilities of CRA will include: Record Keeping, Administration, and Customers Service function for all subscribers of the NPS. Issue of unique Permanent Account Number (PAN) to each subscribers, maintaining a database of all subscribers, and recording transaction relating to each subscribers. CRA will act as an operational interface between PFRDA and other NPS intermediaries such as Pension Funds, Annuity Service Providers (ASPs), Trustee and Trustee Bank. CRA will monitor each subscriber’s contributions and instruction and transmit the information the relevant Pension Fund and scheme on a daily basis. CRA will provide consolidated periodic PAN statements to each subscriber. In addition to the above CRA will provide a number of other Services. Pension Fund Managers (PFMs)

Pension Funds will play a crucial role in NPS by managing investment of retirement savings of the subscribers in various schemes according to the investment management agreement, objects/provision of the Trust deeds and guidelines of PFRDA. They will perform many functions relating to funds management including the following: PFMs will report daily NAV of each scheme to CRA on a regular basis. PFMs will maintain books and records about the operation of funds and submit report on the functioning of the fund to the Board of Trustees and PFRDA. PFMs shall conduct itself and funds management activities according to the Investment Agreement signed with NPS Trustees. Trustees

Under the NPS, a Trust will be appointed by the PFRDA which will be responsible for taking care of funds under the NPS. Trust will perform a large number of functions including the following:

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The Trust will appoint Trustee Bank and hold an account with it. Trustee Bank, would receive Funds from the Government/NPSCAN and send the same to Pension Fund Managers, Annuity Service Providers (ASPs). The Trust will appoint a Custodian for the NPS Trusts—the custodian will provide custodial services for the NPS. The Trust/PFRDA shall appoint independent Auditors. The Trust will take into its custody or under their control all the property of the Pension Funds and hold these in trust for the subscribers. There are many more responsibilities of the trustees. Trustee Bank

The Trustee Bank will maintain the account of the Trustee and will receive credits from the government department or its agencies and transmit the information to the CRA for reconciliation. The Trustee bank shall remit the funds to the Pension Fund Managers, Annuity Service Providers (ASPs). Custodian

The Custodian will provide Custodial Services to the Pension Funds, which will include among others to ensure that benefits due on the holdings are received, provide detailed reports to the PFs, etc. Annuity Service Providers

The role of Annuity Service Providers (ASPs) will be critical in the NPS, since they will offer annuity to the subscribers when members reach superannuation or withdraw pension assets. As per the provision there would be mandatory annuitization, and the members have to purchase annuity from ASPs. The ASPs will offer annuity products to the subscribers, receipt funds from CRA and pay regular monthly annuity.

Operationalization of NPS Pending the passage of Pension Bill by the Indian Parliament, PFRDA has proceeded with partial implementation of NPS in the 1st and 2nd stage. In the 1st Stage NPS will be operational for the Tier-I, non-withdrawable mandatory Pension Funds for all Central Government and Central Autonomous Organisations’ employees kept in a separate accounts under Public Account of India. NPS will also be extended to all State Government/Union Territories (UT) and the State/UTs autonomous organization. The 2nd stage will cover the launching of Tier-II, voluntary savings accounts for employees covered by Tier-I. The 3rd stage will permit voluntary contribution by the citizens of India, particularly in the unorganized sector, but after Pension Bill is passed by the parliament.

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In order to implement NPS, PFRDA has appointed, NPS Trust, CRA, PFMs,Trustee Bank, and Custodian. NPS Trustees: An NPS Trustee has been constituted under the provision of Indian Trusts Act, 1882 to oversee function of various intermediaries. Central Record Keeping Agency (CRA): Through a competitive bidding process PFRDA has appointed the National Securities Depository Ltd (NSDL) as the CRA for NPS. Pension Fund Managers (PFMs): Through a competitive bidding process PFRDA initially selected three sponsors namely Life Insurance Corporation of India (LIC), State Bank of India(SBI) and UTI Asset Management Company (UTI-AMC). As per the condition of bidding, these organizations have incorporated three Pension Funds Companies under the Companies Act 1956. LIC has sponsored LIC Pension Fund Ltd as a public limited company, SBI has sponsored SBI Pension Fund Ltd as a private limited company and UTIAMC has sponsored UTI Retirement Solutions as a public limited company to manage pension funds under the PFRDA architecture. Trustee Bank: Bank of India has been appointed as the Trustee Bank by PFRDA. Bank of India as a custodian Bank shall be responsible for collection and remittance of Pension Fund contribution as per the guidelines of PFRDA/NPS Trustees. Custodian: Stock Holding Corporation of India Ltd. (SHCIL), through a competitive process, has been appointed as the custodian for the NPS to maintain custody of the pension assets.

Investment Management Investment Option

At the initial stage, there will be two investments options available under the NPS. The subscribers shall have the option of selecting one of the two options: 1. Option 1: Investment of funds upto 5 per cent in equity, upto 10 per cent in equity linked Mutual Funds and 85 per cent in Government Bonds and Securities. 2. Option 2: Investment of entire 100 per cent funds in Central Government Bonds/ Securities. With the entire system in place, NPS Trusts has transferred Central Government employee pension funds to three fund manager on 1st April 2008. Funds Management Costs

Cost of Fund Management is the most debated and critical factor in Pension Reforms because cost has a direct impact on the ultimate net wealth of pension funds of the members. Therefore,

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there is always a concern to keep funds management costs at a minimum. PFRDA has been alive to this fact and the NPS has emerged as one of the low-cost systems.

Pension Market Potential Changes in Demographic characteristics, Trend in Savings Market, decline in Public Sector Job and unsustainability of Defined Benefit Pension and increased realization of need for retirement savings, etc., will provide increased momentum to pension market growth in the years to come.

Demographic Trends We have already indicated that demographic characteristics of India have been changing very fast and India is moving towards an Ageing World necessitating tremendous amount of Retirement Support. Data published by National Council of Applied Economic Research (NCAER) and Centre for Monitoring Indian Economy (CMIE) suggests that there are 20.4 million urban households in the income range of Rs 50,000 and higher. Of these about 9 million belong to the formal sector. This segment is expected to grow significantly from 21.85 per cent of the population to about 40 per cent by 2025. This would provide a significant increase in Pension Market. Recent trend in demographic changes indicate that the population in India is estimated to be 1,114 million in 2006, which is expected to grow to 1,411 million in 2026. The elderly population is growing at 3.8 per cent as against over all population growth of 1.8 per cent. Higher growth rate in elderly population is a challenge to social security system in India which is also opening up the huge potential for the pension industry.

Savings Trends and Composition According to a note submitted by FICCI, the percentage of household savings in financial assets has been increasing steadily. It is expected to level off at about 72 per cent from the current level of 60 per cent. Savings in financial assets are mainly in the form of bank deposits. The second most preferred group of financial assets is the pensions and small savings that provide tax benefits like the NSC, NSS, etc. There is also a significant difference in the preferences of the formal and informal sectors when it comes to pension products. This shows that people save in pension products because it is mandatory. There is a considerable difference in the savings of the different income segments. The savings as a percentage of the income of the different segments are as shown in Table 3.18.

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Income Group

Savings as a % of Income

Lower Lower middle Upper Upper middle Upper

0.00 13.22 22.52 33.43 34.16

Source Insurance Regulatory and Development Authority, Report on ‘Pension Reforms in the Unorganised Sector’ New Delhi, 2001 IRDA Report.

FICCI notes further stated that the household savings rate as a percentage of the GDP depends on the dependency ratio. It is likely to increase from the current rate of 24 per cent to about 30.5 per cent by 2020 and subsequently decrease to about 25 per cent. This is because till 2020, the decrease in the young-age dependency more than compensates for the increase in the old-age dependency. After 2020, the effect of the increase in old-age dependency is greater than the effect of the decrease in young-age dependency. Currently significant savings take place in certain segments of the economy. It is skewed towards the upper-middle and the upper segments. Even in this segment it is skewed towards the urban areas. The urban segment constitutes about 25 per cent of the total population, earns about 44 per cent of the total income and contributes to about 49 per cent of the overall savings. The informal segment accounts for about 82.6 per cent of the total population, earns about 67 per cent of the total income and contributes to about 60 per cent of the savings. The Working Group on Household Savings of 11th Five Year Plan estimated a buoyant growth in household savings in India. The Group has estimated that overall domestic savings during 2007–08 to 2011–12 at 9 per cent growth in GDP would be 34.7 per cent as against 29.1 per cent in 2004–05. The over all household savings during the 11th Five Year Plan would increase to 30.1 per cent from 26.8 per cent in 2004–05. House Financial Savings during the 11th plan would be 11.4 per cent as against 10.3 per cent in 2004–05 (Reserve Bank of India Bulletin, May 2007). This positive trend in savings, particularly in household financial saving, would boost pension and retirement savings in India.

Informal Sector In India only 11 per cent of pension market has so far covered and 89 per cent workers are uncovered by any formal social security system. A study conducted by the Ministry of Finance, Government of India and Asian Development Bank estimated that out of 424 million workforce only 52 million has been covered under formal pension system which indicate a huge Pension Market potential, particularly in the unorganized sector.

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FICCI–KPMG Estimates of Pension Market Potential FICCI–KPMG has made an estimate of future pension markets in India. Accordingly the pensions market (which as per Government of India definition includes pension, provident funds, and other small savings like NSC, SSS, etc.) in particular would grow from the current size of about Rs 561 billion to about Rs 1,808 billion by 2025 without any reform, but it would grow faster after reform and market size is expected to be more than double around Rs 4,064 billion in 2025 (Table 3.19). TABLE 3.19 Post-reforms Projections of Contributions under Pillars 2 and 3 (Rs in billion) Contributions Funded Schemes EPF/EPS Of which voluntary Of total contribution GPF PPF Individual pension Group pension Total contribution

2005 296 7.8% 23 86 54 127 603 1,166

2010 461 8.5% 39 133 84 183 708 1,569

2015 696 9.3% 64 201 127 306 824 2,154

2020

2025

1,023 10.1% 103 295 186 513 968 2,986

1,498 11.0% 164 431 272 756 1,108 4,064

Source Pension Reforms–Background and Key Imperatives,: FICCI-KPMG.

This is a non-optimistic scenario whereby the growth would largely be due to the normal growth of the economy in terms of growth in income and population. It does not consider the significant increase in coverage that could arise from reforms in the insurance and pension sectors. The post-reforms market size is expected to be much larger.

Expanding Annuity Market Annuity solves the major problems of post retirement life. According to Brown (2000) ‘A Life Annuity solves the Retiree’s wealth allocation problems and allows her to exchange a stock of wealth for a guaranteed stream of income that will be paid as long as she is alive, and thus removes the risk of outliving. In addition to that, an annuity solves the problems of the lost consumption opportunity. There is a very strong relationship between pension reforms and expansion of annuity market, and annuity has become an integral part of pension reform globally. India has introduced an annuity based pension system as in many other countries which have opted for funded DC system. There is also a debate whether annuity should be mandatory or not in a DC Pension system, and an overwhelming majority of experts opined in favour of mandatory annuitization. Brown (2000) has advanced two important arguments in favour of mandatory annuitization. According

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to him there are two primary benefits of mandatory annuitization: a) the potential to improve annuity market efficiency through the elimination of adverse selection; b) the decreased risk that some retiree will fail to adequately provide for their own consumption at advanced age. Following the school of thoughts of mandatory annuitization India has introduced an annuity based pension system as in many other countries which have opted for funded DC system. NPS has an inbuilt mandatory provision of annuitization of a part of Pension Wealth at the time of retirement or withdrawal. Under the NPS, it is mandatory that 40 per cent of pension wealth will be invested in retirement annuity at the time of superannuation. The annuity policy will be purchased from the Life Insurance Company approved by the Insurance Regulatory and Development Authority (IRDA) creating scope for expansion of annuity business, which further boosts up the pension business. Annuity market in India till recently remained to be under developed and the demand for annuity products remained to be very low, which has surprised many expert like Estelle James (2003). According to her, ‘one would expect that the absence of a social security system that pays a life time income stream, combined with low coverage of formal company schemes would lead to a higher demand among people approaching retirement for annuity products. On the contrary, the demand for annuities in India has been miniscule …in 2000, new annuity business was still only 2.3 per cent in terms of new premiums.’ Low rate of penetration of annuity business till 2000, was primarily due to low rates of participation by the public, a small number of providers and limited product innovation. However the situation has changed now after the liberalization of Insurance industry in India, which encouraged private players in the market, induced competition, spread insurance knowledge and need for retirement products, and launching of new annuity products by many life insurance companies. During recent times there has been a spurt in Pension and General Annuity Business of Life Insurance Companies in India. Data released by IRDA shows that First Year Premium under individual pension and general annuity of life insurance companies in India became more than double from Rs 31,517.2 million in 2004–05 to Rs 209,359.5 million 2006–07 (IRDA Journal, vol. V, No. 7, June 2007). In terms of percentage of total first year premium it went up from 15.05 per cent to 34.08 per cent. This is an indication of growing demand for pension products in India. It is assumed that most of this demand may be coming from the unorganized sector, which is outside the formal pension system primarily covering the organized service sector. Mandatory annuitization of 40 per cent pension wealth under NPS will further boost up the annuity market in India. New Pension System thus, will not only support the growth of pension industry, but also will create an expanded market for annuity business in India.

Informal Sector and Microinsurance Market in India Recent changes in the policy of economic management and acceptance of new economic order providing bigger space for private sector enterprises and initiatives have indirectly reduced the space for government intervention. New age economy led by high-tech information management practices and production system has reduced the scope for unskilled labour, which also restricted the trickledown effect of income distribution. During the past few years, with the

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increased speed of reforms in Indian economy, many of the opportunities that were available to people in the rural areas, informal sector, agricultural sector and other vulnerable groups of the economy has slowly dried up. These developments have promoted severe strain on the basic survival of millions of people in the informal and rural sector. The increased vulnerability has been led by increased degree of social risk impacting social welfare. It is, therefore, necessary that the government and its agencies in cooperation with newly thriving private enterprises look into these problems and come out with a scheme to support the socially vulnerable (SVS) to protect their welfare loss and to improve their economic and social standard of living. India has a large informal sector which absorbs a high percentage of work force and contributes to a substantial part of GDP of the country. Currently, Indian labour force is estimated to be 397 million, out of which 93 per cent or 369 million work in the informal economy. In terms of contribution to the economy about 63 per cent of the value added to the overall GDP of the country can be attributed to the unorganized sector (urban and rural). Further, 35 per cent of the value addition to the GDP attributed to the urban informal sector while 65 per cent of the total employment is attributed to the urban informal sector. However, the huge potential in informal sector mostly remained untapped due to absence of appropriate life and health insurance products which can take care of seasonality of income, infrequent income receipt by the informal sector workers. Keeping in view the peculiar characteristics and problems in the informal sector IRDA has designed microinsurance—for life and non-life insurance. This is an important initiative to provide low-cost insurance products—life and non-life. Microinsurance and microcredit has been quite successful in Bangladesh and in many Latin American countries, for example, Bolivia, Argentina. India provides enough scope for expansion of microinsurance.

Vulnerability and Risk Management The concept of household social vulnerability has been defined as the future loss of the welfare below socially acceptable norms, which depends on characteristics of risks and the ability of the household to respond to it. Ability has been defined as the asset base of the household, outcome has been defined as the benchmark of acceptable level of social welfare, for example, poverty line and vulnerability also got a time horizon.

Poverty as Critical Benchmark Human Development Index (HDI) captures the position of social development and social welfare which includes poverty, demography, education and health published by United Nations Development Programme (UNDP). Latest available data indicates that India ranked 127th among 175 countries with an HDI of 0.590 in 2001. The ranking declined to 124th among 173 countries in 2000. The HDI measures the overall achievement in a country in three basic dimensions of human development, that is, longevity, health and education. India has made significant progress in fighting poverty and during the last two decades the proportion of people living below the poverty line has declined from 51.3 per cent in 1977–78

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to 26.1 per cent in 1999–2000 and in absolute terms the number of people below poverty line declined from 328.9 million to 260.3 million. Yet, as per the 57th NSS round, chronically suffering household (not getting enough during any month of the year) remained 0.5 per cent in rural areas and 0.1 per cent in urban areas. About 70 per cent of the poor live in rural areas.

Lack of Access to Formal Sector Employment As per the result of 55th NSS Round (1999–2000) the rate of growth of employment on current daily status basis declined from 2.7 per cent per annum in 1983–94 to 407 per cent per annum in 1974–2000. It was also pointed out that the absolute number of unemployed increased from 20 million in 1993–94 to 27 million in 1999–2000. It is estimated that currently Indian labour is 397 million and 93 per cent, that is, 369 million is employed in the informal sector, which is characterized by very small entities—family oriented, providing for local markets, low level of labour intensive skill, work under contract or sub contract system and they suffer from exploitation of moneylenders due to formal financial support of the institutions.

Education Education is an important route of social mobility but unfortunately education in India remained to be prerogative of selected few and the poor and particularly those who are in rural areas remained illiterate which obstructed social mobility. Though the rate of literacy has improved to 64.84 per cent in 2001, female literacy is only 54.16 per cent.

Women Though women constitute about 48 per cent of the total population, vulnerability among them is higher than among the male because they have many disadvantages with respect to literacy, labour participation rates and earnings; challenges they face are much more than men.

Natural Disaster Poor households face severe problems due to absence of regular employment, income, literacy and social inequality. The intensity of the problem further aggravates due to natural disasters, droughts, floods, storms, hazardous diseases, catastrophes, etc. The impact and intensity of the risks among the poor, due to the factors stated are immensely devastating. Death, sickness, hunger are predominantly common among the poor in rural and urban areas. Acute financial constraints prohibit the poor to invest in health, spend for emergency life saving treatment and obtain any formal social security measures. The poor also need occasional financial support for births, marriage, death and educational expenses in lump sum without severely affecting future livelihood. It is therefore necessary that the state intervene effectively to design social security for these vulnerable sections through non-conventional mechanism. Since the poor vulnerable section is unable to cope with the risks individually due

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to lack of access to the risk mitigation instrument like finance and insurance, they can however resort to the group mechanism. World Bank has suggested Social Management of Risks (SRM) approach, which considers a broad spectrum of options for risk management ranging from private and informal to public and formal mechanisms. These instruments help households manage risks with interaction and linkages from household up through community, regional, national levels. Financial and insurance instruments are possible components of an integrated SRM strategy. Microfinance and microinsurance are the potential instruments in SRM Strategy.

Microfinance Microfinance Institutes (MFIs) provide strong support and linkages to microinsurance. MFIs mobilize savings from households with fungible reserves and help to grow household assets and provide timely credit to the members. There are several examples of successful microfinance institutions such as Gramin Bank (Bangladesh), Bank Rakyat of Indonesia, Banco Sol in Bolivia and community-based Banks in Latin America. They provide credit finance for economic activities of the members. They are based on the basic principles as Gramin Bank in Bangladesh. 1. Poverty is not created by the poor, but by institutions and policies that surround them, charity is not an answer to poverty. It serves only to perpetuate poverty and create dependency. 2. Gramin system is built on the belief that there is no difference in the ability of a poor person and any other person. 3. Credit delivery system based on the ‘Principle’ that less the person has capacity to pay higher the priority she gets. 4. Poor people always pay back. Sometimes, they may take longer to pay back but repay they will. 5. Women have greater long-term vision and are ready to bring about changes in their lives step by step.

Microinsurance Microinsurance is the most effective instrument of risk mitigation and reducing vulnerability of the poor from impacts of disease, theft disabilities and other losses of life and property. Microinsurance transfer the risks and acts as a risk transfer mechanism. The importance of microinsurance for poverty elimination and risk mitigation of vulnerable group arises because the low income groups, households in informal and rural sector have remained beyond the formal insurance sector. ‘The lack of interest by the formal sector to serve the poor is due to low collateral, higher transaction costs, interest rate restrictions, higher risks, etc.’ This group was excluded due to the absence of regular income and required capacity to finance formal insurance. Microinsurance can empower the group and through them help individual members.

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The groups which are outside the formal economy and lack in access of information and resources to avail formal insurance can avail them through the mechanism of microinsurance. There are several types of microinsurance products which can be offered to the members. 1. 2. 3. 4. 5. 6.

Loan protection insurance. Health and disability insurance. Life savings insurance. Damages, piracy and theft insurance. Environmental risk insurance—floods, earthquakes, droughts, typhoons, hurricanes, etc. Group insurance.

Insurance is a risk-transferring mechanism under which there is a contractual agreement, payment of premium, payment of benefit and a pool of liquid financial resources. While designing a microinsurance, care is to be taken to see that it empowers individuals and groups and insurance transaction minimizes moral hazards risks of adverse selection and reduces transaction costs. Each microinsurance (MI) unit defines its own risks, organizes financing insurance and exercises control over FOFs. Integration of microfinances (MFs) and microinsurance (MI) creates a low-cost well-managed SRM mechanism to manage risk of the vulnerable household. Microinsurance reduces the negative impact of risky credit to clients, provides additional revenue to it which in turn improves financial ability. Microfinance on the other hand provides institutional support to MI. However, integration of MFI and MI is very critical and most observed practice is MFI related MI Life Insurance programme such as FINCA International Uganda, Delta Life Insurance Bangladesh, Card Bank Philippine and SEWA in India. First, financial viability of such arrangement is doubtful with subsidy and donation. Second, insurance is a very technical subject and should be actuarial sound. However, regulatory mechanism of these two types of institutions are quite different. Therefore, independent growth of MFIs with formal strategic relationship seems to be a better arrangement for risk management, mobilizing deposit, providing credit and offering insurance to the group members. While MFIs maybe established by using the existing infrastructure like rural banks. Microinsurance schemes maybe operated by insurance companies but both can function through formal group arrangement, to create individual assets but group liability, group collateral and group insurance for members. Microinsurance is an indicator about the necessity of expanding market base in rural and semi-urban areas as well as to provide insurance cover to the people in informal sector and those belonging to economically vulnerable sections of society has been indicated in the previous section. Further, it is a fact that over 70 per cent of Indians live in rural areas. However, still a vast majority in rural and urban areas remained uninsured particularly those who are in lower income states and could not afford insurance at normal price. Rural penetration of life insurance can be observed from rural share in New Business of the largest life insurer in India, that is, LIC. During 2004–05, the share of rural business policies was 22.97 per cent of policies and 25.16 per cent of SA. Therefore, in order to cover a large

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section of uninsured particularly among the vulnerable section of society a new product ranged at a cheaper price required to be launched, and that ideal product is microinsurance. IRDA has come out with guidelines to promote microinsurance which will cater to diverse life and general insurance needs of the vast section of the society. We shall discuss in brief about the product range suggested by IRDA. IRDA guidelines on Microinsurance: IRDA has issued Insurance Regulatory and Development Authority (Microinsurance) Regulations 2005, which provides the structure of microinsurance products that can be launched by Indian life insurance and general insurance companies. Two types of microinsurance products have been suggested by the regulators, namely, life microinsurance products and general microinsurance products. These products can be launched by a general insurance as well as by any life insurance company subject to fulfilment of certain conditions. The regulation also provided provisions for tie-up between life insurance and general insurance. A life insurer can offer general microproduct provided it has tied up with an insurer carrying general insurance product. Similarly, a general insurance company can offer life microproduct provided it has a tie-up with a life insurance company carrying out life insurance business. A microinsurance product therefore includes both life and general microinsurance products and such plans are to be approved by the regulator. A microinsurance product can be sold by microinsurance agents (including NGO, Self-Help Group (SHG), Microfinance Institution, etc.), corporate agents or brokers. The guidelines also incorporated code of conduct for agents overall commission, underwriting, compliance, etc. Details about microinsurance products are given in the next section.

Impact of an Integrated Scheme Huge Employment Opportunity: Establishment of microcredit institutions such as, Local Area Bank (LAB) and microinsurance will create huge employment opportunity in the rural and urban areas particularly among the educated youth who will be absorbed in LAB and microinsurance activities. This will also provide support for establishment of Microenterprises in the informal sector thus further creating employment and income opportunities in informal and rural sector. Impact on Poverty: Microcredit and Microinsurance would open the avenue to attack the problem of poverty. Social initiatives, group actions, new opportunities for income generation would together help the poor to come out of the poverty cobweb. Savings and Capital Formation: MFIs and Microinsurance will create savings habits among the poor, and economically vulnerable section. It will also help the poor and economically vulnerable section to build up real and financial assets. Successful implementation of the scheme will require building up microinstitutions in finance and institution. Without strong institutional structure, microinstitutions cannot survive. Therefore, there is the need for active coordination and participation of LIC and SBI, other financial institutions, NGOs and selfhelp group.

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Scope for Expansion of Life Insurance Market in India Life insurance business is significantly influenced by the state of economy of a country and major impacting factors are rate of growth of GDP, domestic savings, household financial savings, disposable income growth in working age population, existence of other competing institutions and products in the savings market (banks, mutual funds, pension funds, stock market products, etc.). The size of the life insurance market is also influenced by the rate of growth of population, social security system, health care system, changes in customs and social practices, changes in the attitude, risks, etc. It has been observed that societies in which the standard of living has been steadily improving experience a higher insurance penetration. Market competition exerts a very positive influence in market expansion, higher life insurance penetration as well as higher life insurance density. Recent upsurge in Indian economy particularly since liberalization and market reforms leading to competition has created tremendous opportunities for growth of life insurance. Operation of LIC for the last 50 years has created tremendous amount of understanding and awareness about life insurance, which is considered to be a very positive factor directly providing an opportunity for the life insurance industry to grow further. Moreover, the life insurance penetration and coverage is still very low in India which leaves enough space for growth.

Macro Economy in High Growth Trajectory We have already discussed in detail the changing trend in growth rate of Indian economy, which remained to be buoyant particularly since economic liberalization. Overall GDP growth rate which was 6.1 per cent moved up to 6.9 per cent in 2004–05 and is expected to be 8.1 per cent in 2005–06. The high growth rates in GDP have been reflected in absolute growth in GDP, PDI and per capita income. There has been a significant overall increase in GDP, and by the end of March 2004 GDP at the current market prices stood at Rs 2,516,912 crore. There has also been a steady rise in per capita income from Rs 16,223 in 2000–01 to Rs 19,649 in 2004–05. Like other well-developed economies the service sector has emerged as the leading contributor to the GDP. Growth in service sector was more or less steady since 2000–01 and average service sector growth rate during 1998–99 to 2003–04 it was 7.8 per cent as against 8.6 per cent in 2004–05 and accounted for 57.6 per cent of GDP. Among the service sector industries, financial services has registered a steady growth. Life Insurance, which is an important component of financial service sector also witnessed a significant growth during the last few years.

Upwardly Moving Domestic Savings India is one of the countries in the world which has maintained higher growth rate in domestic savings in spite of economic deregulation and increased consumerism, due to higher propensity

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to save by the household sector. However, this growth rate has slowed down during the last few years, particularly since economic liberalization and basically due to growth in consumer expenditure and reduced rate of return on investment. Moreover, during the last few years, some of the incentives for the HDS were withdrawn, which adversely affected the domestic savings rate. GDS in India steadily increased from 23.4 per cent in 2001–02, 29.1 per cent in 2005–06. It is interesting to note that predominant contributor to GDS is the household sector and the contribution of this sector went up from 21.2 per cent in 2000–01 to 26.8 per cent in 2005–06. Steady growth in economy, expansion of service sector and increase in HDS all contributed significantly to the expansion of the insurance market in India. It can further be noted that HSFA remained more or less steady over 10 per cent and precisely 10.3 per cent as against 11.7 per cent in 2004–05.

Low Level of Penetration and Density but High Growth Rate Though, the share of life fund in household financial assets has gone up during the last decade and the Indian life insurance industry registered better growth rate compared to global growth rate. Yet, total premium volume and global market share remained quite low. Premium volume of life insurance industry in the world at 2.3 per cent growth rate increased from US$ 1,682,743 in 2003 to US$ 1,848,688 in 2004 whereas in India the growth rate was much higher at 10.5 per cent and total premium volume increased from US$ 14,425 to US$ 16,919 during the same period. Low density and penetration are an indication of existence of huge untapped potential for the insurance industry. Insurance density in India was only US$ 19.7 as against world average on US$ 5,115.5 in 2004 and insurance penetration in India was 2.53 as against world average of 4.55 in 2004. Therefore, given the high growth rates in economy, savings and insurance with lower penetration and density, life insurance can grow further to a considerable extent.

High Level Confidence of Investors Another important factor which indicates a positive feature of life insurance growth in India is the confidence and trust in life insurance. Survey of Indian investors by SEBI and NCAER (2000) indicates this. According to this survey (of distribution of households by type of instruments) LIC with 39.21 per cent came third to Recurring Deposits (RDs)/post office with 44.73 per cent, fixed deposits with 76.23 per cent. The percentages of households having LIC policy in rural and urban areas were 32.01 per cent and 57.31 per cent, respectively, (Table 3.20). However, it seems that LIC is more popular among high income groups as indicated in Table 3.21). It can be noted that 93.8 per cent household in the income group above Rs 15,000 had fixed deposits with banks while 74.47 per cent had LIC policies. This shows that life insurance is a preferred instrument of Indian households particularly for high income group.

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LIFE INSURANCE IN INDIA TABLE 3.20 Asset Preference Pattern: Distribution of Households by Type of Instruments

Household UTI Mutual Fixed Particulars Scheme Funds Deposit

Bonds

EPF/PPF

All India Urban Rural

6.21 11.56 4.08

20.92 40.24 13.24

8.45 19.52 4.05

5.45 12.02 2.84

76,23 83.89 73.18

LIC

Chit Funds

RDs/ Post IVP/NSS/ Office NSC Others

39.21 57.31 32.01

5.94 9.51 4.52

44.73 40.77 46.3

27.46 35.96 24.07

8.75 11.85 7.52

Source Survey of Indian Investors, by SEBI-NCAER, June (2000). TABLE 3.21 Distribution of All Households in Instruments by Income Class Household Income

UTI Mutual Fixed Scheme Funds Deposit Bonds EPF/PPF

Upto 2500 2.41 2501–5000 6.43 5001–10,000 19.04 10,001–15,000 31.90 Above 15,000 33.89

1.79 4.34 11.98 17.94 20.69

65.01 3.37 81.33 5.25 88.28 11.10 90.16 16.01 93.80 21.50

6.16 26.45 40.21 37.93 33.26

LIC

Chit RDs/Post IVP/NSS/ Funds Office NSC Others

18.37 3.06 43.32 6.24 68.22 10.02 80.00 13.85 74.47 10.75

42.89 48.11 43.47 41.04 45.36

15.30 30.80 41.91 52.22 54.69

6.09 8.52 13.78 15.39 11.15

Source Survey of Indian Investors, by SEBI-NCAER, June (2000).

Rural Market There also exists tremendous potential of growth in the insurance business, particularly that of life insurance in rural areas due to recent growth and changes in composition and structure of income. Market Information Survey of Household (MISH) released by NCAER shows that estimated household income at the All India level was Rs 122,765 crore in 1999–2000, out of which rural India accounted for 57 per cent, that is, Rs 700,589 crore. Further, at the All India level per household income was estimated to be Rs 70,082 crore. A very significant development in this area is that the percentage of low income household (that is, annual income less than Rs 350,000) in rural areas declined from 65.5 per cent in 1992–93 to 47.9 per cent in 1998–99 while the percentage of high income household (that is, annual income above Rs 140,000) increased from 1.4 per cent to 3 per cent during the same period. Similarly, middle, lower and upper middle market also improved substantially. Income growth and hierarchical improvement of rural household indicates the increased scope of life insurance and health insurance business in rural areas.

Low Level of Coverage A rough estimate of insurable population on the basis of working age population (between 15–49) in 1991 Census shows that there was 492.12 lakhs insurable population,(which however

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has further increased to 1,043.52 lakhs in 2003). However, only around 25 per cent of such population has been covered by LIC. If we add up the coverage by other private sector insurance companies it maybe around 26–27 per cent of insurable population in India. Further, Indian life insurance market is undergoing a transition due to competition, since deregulation in 2000–01. Presently 15 life insurance companies (in 2004–05) and wide network of distribution and product–market campaign has been spreading the message regarding life insurance which will create better understanding and awareness about life insurance leading to higher purchase and penetration.

Forecast of Life Insurance Market The size of a life insurance market is determined by a number of factors but the most important are macro economic factors (such as GDP, savings, disposable income and employment), demographic changes and institutional environment (such as management efficiency in product development and distribution institutionalization of external changes). A number of agencies and individuals have made forecasts about the future growth and size of the life insurance market in India. Though these forecasts differs from each other, which maybe due to the underlying assumptions, a common thread is there, that is, scope for significant expansion of life insurance business in India. Here we may consider few such forecasts.

Confederation of Indian Industry (CII), New Delhi CII has made an attempt to estimate the future market for life insurance in India (CII Expert Group on Insurance Distribution and Intermediaries, September 1999). CII assumptions based on GDP growth rate of 6 per cent for the next five years and 7 per cent thereafter, on the basis of these assumptions CII estimated the life insurance premium growth rates to be between 18 per cent to 20 per cent and 20 per cent to 30 per cent for the pension business. According to the estimate, life insurance market would be worth more than Rs 140,000 crore and pension market of Rs 14,000 crore by 2010.

Monitor Company Monitor Company USA, on behalf of IFC projected Indian life insurance market. According to this projection, the market value of Indian life insurance by the end of 2008 would be Rs 100,000 crore to Rs 120,000 crore. The monitor group further estimated that by the next 10 years, LIC would retain 70–80 per cent market share while new private players will gain 20 per cent to 30 per cent market share, that is, the new entrants will capture Rs 20,000 to Rs 35,000 crore premium. Monitor Group has also estimated future growth of pension market

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and according to this estimate compounded annual growth rate would be approximately 15–17 per cent through 2008, resulting in a market size of Rs 110,000 crore to Rs 130,000 crore in 10 years.

Swiss Re Forecast Swiss Re Economic Research and consulting has made a projection about growth of life and non-life insurance in India. According to this, life insurance penetration would increase to 4.4 per cent and average growth rate would be around 18 per cent during 2004–14. Life insurance premium would increase from Rs 749,971 million to Rs 3,947,899 million in 2014. At constant 2004 prices this would go up from Rs 749,971 million in 2004 to Rs 2,433,546 million in 2014.

National Insurance Academy (NIA) Forecast A recent study of NIA Pune, provided some significant estimates of Indian life insurance market. It has given an estimate of the potential of total life insurance market as well as various important segments such as individual business, pension business and unit linked business. The analysis is based on a longer term historical and structural changes that the industry is expected to witness in the long-term. The forecast is based on various growth rates in line with the assumptions of 11th Five Year Plan. Accordingly, GDP growth rate is assumed to be 9 per cent for the years 2007–10 and 10 per cent for 2011–12, and 11 per cent from 2013 to 2017. GDS growth rate (as per cent to GDP) assumed to be 26 per cent for the years 2007–10 and 28 per cent for 2011–12 and 30 per cent from 2013 to 2017. HDS rate is assumed to be 32 per cent for the years 2007–10 and 33 per cent for 2011–12 and 35 per cent from 2013 to 2017. PDI is assumed to be 9 per cent for the years 2007–10 and 10 per cent for 2011–12 and 11 per cent from 2013 to 2017. On the basis of the above assumptions, NIA has projected the changing trend in life insurance industry in India and estimated growth in life insurance business in by 2017 as shown below.

New Business Premium During recent years the life insurance industry has been growing at more than 30 per cent and has witnessed growth rate as high as 41 per cent during 2005–06. It is expected to grow at a much higher rate in the coming years. The projection for 2007–08 is estimated to be around Rs 115, 000 crore at a growth rate of 60 per cent and expected to reach Rs 164,800 crore in 2010, Rs 241,760 crore in 2012. New Business Premium income is expected to increase from Rs 408,399 crore in 2015 to Rs 535,000 crore in 2017. New Business policies had a 16 per cent growth in 2002, though it slowed down to 11 per cent in 2003 and 13 per cent in 2004 and a negative growth of 8 per cent in 2005. However,

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in 2006, the New Business policies rose to the highest growth of 35 per cent. New Business policies are expected to grow at an average of 15 per cent in the coming years. It has already reached 3 crore in 2006 and is expected to reach 3.8 crore in 2007 and 5 crore in 2010 and 11 crore in 2017. Industry Total Premium Income

In view of the above growth rates in New Business, NIA has projected industry total premium income of Rs 293,561 crore in 2010, which would go up to Rs 761,714 in 2015 and further to Rs 995,242 crore in 2017. The individual segment has seen around 24 per cent growth in the last five years, with maximum growth of 53 per cent in 2002. However, it slowed down to 6 per cent in 2003, but picked up a growth of 12 per cent in 2004, rose to 21 per cent in 2005 and 30 per cent in 2006 and is expected to grow at much higher rates than (30 per cent) in the coming years. The projected individual New Business for the year 2010, at an estimated growth rate of 50 per cent is expected to reach Rs 95,000 crore in 2010, Rs 244,877 crore in 2015 and Rs 320,000 crore in 2017.

Pension Business The pension business has seen a lot of ups and down in the last five years with a high rate of 178 per cent in 2002 and then fell down by negative 30 per cent in the next two years (2003 to 2004) and again picked up with a positive growth of 3 per cent in 2005, and then rose to 68 per cent in 2006. This segment is also expected to grow around 35 per cent in the coming years. According to the projection of NIA, Pension Business expected to touch Rs 55,090 crore in 2010, Rs 147,757 crore in 2015 and Rs 193,187 crore in 2017.

Unit Linked Business From the year 2002 to 2006, unit-linked business has been growing at more than 200 per cent every year. The year 2005 was the most significant year for Unit Linked Insurance Policies (ULIP) with growth as high as 420 per cent and in 2006 the premium doubled with almost 100 per cent growth over the previous year. The year 2007 is also expected to have similar trends. It is estimated that ULIP would touch upon Rs 96,143 crore in 2010. Estimates of various organizations/agencies provide tentative indications about the future life insurance market in India. It can be noted that recent predictions like the ones made by NIA are more optimistic than those made earlier, it is because the recent study could take into consideration the developments in the market in the post-liberalized period. Indian economy is more vibrant now and on a path of sustainable upward growth providing more opportunity

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to financial institutions like life insurance to grow. It seems from recent experience that Indian life insurance has got tremendous potential to grow in future.

Indian Life Insurance in the International Context Globally life insurance industry is undergoing a tremendous transformation and convulsion in the current phase of globalization due to convergence, information explosion, interconnectivity and pressure of empowered customers. However, industry response to such changes are at best minimal. This has been reflected in the growing importance of other savings instruments such as pension funds and mutual funds in the global market. In fact, in terms of asset holdings, in USA, life insurance comes fourth—after pension funds, mutual funds and bank deposits. In India the size of life fund has been growing in the recent period, yet, its share in HDS in 2003–04 was 14.5 per cent as against 40.5 per cent share of bank deposits. Though the share of PF and pension has gradually declined from 22.2 per cent in 1999–2000 to 13 per cent in 2003–04, it is bound to go up with the opening of the pension market to the private sector. It is also expected that in the years to come the rate of growth of the pension market will be faster than that of life insurance. We have earlier noted in Chapter 1 that globalization has significantly influenced the growth rates of the countries which have liberalized their economies and integrated to global market. Reforms and deregulation of the Indian economy has also positively influenced GDP growth rates as well as boosted domestic savings rate. In India insurance industry has been deregulated since 2000 and new private sector life and non-life companies have entered into the Indian insurance market. However, as we have observed in Chapter 2,that though Indian life insurance industry registered a positive growth in terms of absolute business it failed to increase its share in the increased HSFA. In fact its share has declined from 15.5 per cent in 2002–03 to 12.4 per cent in 2004–05, though GDS increased from 26.5 per cent to 29.1 per cent during the same period. Therefore, the pattern of growth of life insurance needs to be examined in the light of globalization in premium income trend. The issue of Indian position in the global marketplace can be discussed in terms of growth rate, market share, penetration density, etc.

Premium Volume India being a vast country has a long record of life insurance business ranked only 18th life business in the world, with a total premium of US$ 16,919 million against the US$ 494,818 million of USA which was number one in ranking in 2004. (Though India has improved its position in the world market from 19th in 2000 with premium income of US$ 7,615 million) However, apart from China (US$ 35,407 million), many emerging and smaller countries were much ahead of India, for example, Taiwan (US$ 33,851 million), South Africa (US$ 24,381 million) (See Table 1.8).

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In terms of market share, though Indian position has improved from 0.5 per cent in 2000 to 0.92 per cent in 2004, countries like China registered better growth than India which had improved its position from 0.79 per cent in 2000 to 1.92 per cent in 2004. Even South Africa had better market share 1.32 per cent in 2004 (Table 3.22). TABLE 3.22 Indian Life Insurance Industry in the Context of World, Emerging Market and Asia Growth Rate Year World

2000 2001 2002 2003 2004 Emerging 2000 market 2001 2002 2003 2004 Asia 2000 2001 2002 2003 2004 India 2000 2001 2002 2003 2004

GDP

Life Premium

GDP

Premium

31,161 30,773 32,256 36,463 40,630

1,521,253 1,439,177 1,536,122 1,682,743 1,848,688 136,974

3.8 1.0 2.1 2.7 4.0

9.1 –1.8 3.0 –0.7 2.03 12.0

8,375 7,833 8,175 9,101 9,965 428 438 475 601 670

141,297 161,932 196,769 227,155 499,531 457,390 475,180 518,051 556,321 7,615 10,504 12,274 14,425 16,919

3.1 1.2 3.1 4.2 5.0 6.4 3.9 4.1 8.5 7.1

8.0 12.7 10.5 7.4 3.0 2.6 2.1 1.9 2.0 21.3 22.5 14.1 8.4 10.5

Market Penetration Density US$ Share (%) % of GDP Per Capita 100 100 100 100 100 9.0

4.88 4.68 4.76 4.59 4.55 1.94

147.2 239.9 235.0 247.3 288.7 16.4

9.82 10.54 11.38 12.29 32.84 31.78 30.93 31.23 30.09 0.5 0.65 0.80 0.81 0.92

2.01 2.25 2.31 2.41 5.96 5.84 5.81 5.74 5.58 1.77 2.40 2.59 2.26 2.53

27.2 30.7 35.7 42.1 138.3 125 128.1 140.1 147.2 7.6 9.1 11.7 12.9 15.7

Source Swiss Re Sigma, (various issues).

During 2000–04, the market share of Asia declined from 32.84 per cent to 30.09 per cent though the share of emerging market increased from 9 per cent to 12.20 per cent. Therefore, India’s growth in terms of market share seems be in line with emerging market trend. Level of GDP has significant influence on the level of life insurance premium volume North America (USA and Canada) with 31.5 per cent of world GDP in 2004 accounted for 28.3 per cent of world’s life insurance premium, whereas Africa with 1.9 per cent of world GDP accounted for 1.4 per cent of world life insurance premium. Other continents like Europe with 35.6 per cent GDP accounted for 37.6 per cent premium, while Asia with 24.5 per cent of world GDP accounted for 30 per cent world premium (Table 3.23). However, India with more than 6 per cent of world GDP accounted for only 0.65 per cent of world market premium.

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TABLE 3.23 Life Insurance Penetration and Density in Some Selected Countries in 2004 (i) Some High GDP Countries of the World

Country

Population (millions)

USA Japan Germany UK France Italy PR China Canada Spain South Korea

292.4 127.1 82.5 59.4 59.9 57.5 1,297.2 31.9 41.3 48.4

Penetration (Premium % of GDP)

Density (in US$)

494,818 386,839 84,535 189,591 128,813 82,083 35,407 29,509 23,592 48,680

4.22 8.26 3.11 8.92 6.38 4.86 2.21 2.97 2.84 6.75

1,692.5 3,044 1,021.3 3,190.4 2,150.2 1,417.2 27.3 926.1 571.9 1,006.8

Premium (in US$ million)

Penetration (Premium % of GDP)

GDP Premium (in US$ billion) (in US$ million) 11,735 4,683 2,707 2,126 2,018 1,678 1,599 994 993 721

(ii) Some Countries Other Than (i)

Country

Population (millions)

India Australia Brazil Netherland Russia Switzerland Belgium Taiwan Indonesia South Africa World

1,079.5 20.0 178.5 16.3 142.9 7.3 10.4 22.6 217.5 44.7 6,342.1

GDP (in US$ billion) 670 616 605 580 578 357 352 306 258 213 4,0630

16,919 25,689 8,199 31,512 3,544 24,067 24,112 33,851 1,626 24,381 1,848,680

2.53 4.17 1.36 5.43 0.61 6.73 6.73 11.06 0.63 11.43 4.55

Density (in US$) 15.7 1,285.1 101.1 1,936.5 24.8 3,275.1 2,291.2 1,494.6 7.5 545.5 291.5

Source Swiss Re, Sigma No. 2/2005.

Growth Rate India has registered a significant growth rate in life premium, though it has witnessed a fluctuating growth rate during 2000–04. It is interesting to note that in spite of fluctuations the highest ever growth rate was 22.5 per cent achieved in 2001. However, this subsequently declined and reached its lowest at 8.4 per cent in 2003 but further regained to 10.5 per cent in 2004. In respect of growth rate, India moved along with the global trend which declined from 9.1 per cent to 2.03 per cent and in emerging market 12 per cent to 7.4 per cent during the same period, in spite of steady growth in GDP during this period.

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Life Insurance Penetration Life insurance penetration is calculated as premium in percentage of GDP and is considered to be an important indicator of life insurance development. The level of economic development and population has very strong influence on the level of development of financial as well as the life insurance market. Indian performance in penetration raises the question of efficiency since it is at a very low level, in global and regional standards. India’s penetration in 2004 was 2.53 per cent, as against world penetration of 4.55 in 2004, Asian life insurance penetration was 5.58, Europe 4.68, North America 4.12 and the lowest was 1.1 in Latin America. Though in general, higher level of GDP is expected to be reflected in higher life insurance penetration, yet at the country level penetration maybe lower than the level of GDP, whereas low GDP countries may have achieved better penetration. For example, countries such as USA, Japan, UK and France had penetration level of 4.22 per cent, 8.26 per cent, 8.92 per cent, 6.38 per cent, respectively, some countries with lower GDP, had better penetration levels, for example, South Africa (11.43 per cent), Taiwan (11.06 per cent), etc. India with reasonably higher level of GDP had low level of penetration 2.5 per cent, (as against world penetration of 4.55 per cent). It can be mentioned here that the level of penetration in a developed country like USA may have penetration lower than the world average due to the fact that other segments such as pension and mutual funds are highly developed and a large amount of savings are directed to these sectors, resulting in lower penetration of life insurance. The data in Table 1.8 indicates that global penetration level during 2000–04 declined from 4.88 to 4.55 whereas the same has increased in emerging markets from 1.94 to 2.41. Further, though it declined in Asia from 5.96 to 5.58 India registered a significant increase from 1.77 to 2.53 during the same period. However, penetration level in India is still much lower compared to UK (8.92), Japan (8.26), France (6.38), Australia (4.17), Taiwan (11.06), South Africa (11.43) and many other countries.

Life Insurance Density It is the other important indicator of development of the life insurance industry. Life insurance density is the premium per capita of a country. However, density is strongly influenced by the size of population of a country. Therefore, a country with higher GDP but with a large population may have low density, for example, China and India. Whereas a country with low population and low GDP may have higher density, for example, Bahamas, Switzerland. In fact, Switzerland has the highest insurance density in the world. The low population and high premium countries have achieved better density such as Switzerland (US$ 3,275.1), UK (US$ 3,190.4), Japan (US$ 3,044), Belgium (US$ 2,291.2), France (US$ 2,150.2) whereas density in highly populated countries like India and China was quite low with US$ 15.7 and US$ 27.3, respectively, in 2004.

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The world density of life insurance increased from US$ 147.2 in 2000 to US$ 288.7 in 2004, while the same during the same period increased at a faster rate in emerging markets by about three times from US$ 16.4 to US$ 42.1. Though density in India increased by little more than two times from US$ 7.6 to US$ 15.7, yet it is much below Asia US$ (147.2) and emerging markets.

India among the Emerging Markets During last few years, the emerging market life insurance industries have been witnessing faster growth than industrialized countries as well as world market. However, high growth in life insurance in emerging markets led to liberalization and economic growth. Emerging market was however dominated by few large economies and out of 33 countries in the emerging market category, top 10 countries together contributed to 87.3 per cent of total emerging market premium. India, with 7.5 per cent premium of emerging markets ranked fifth in 2004. The countries ahead of India were South Korea (21.7 per cent), China (15.7 per cent), Taiwan (15.1 per cent) and South Africa (10.8 per cent) (Table 3.24). TABLE 3.24 Top 10 Emerging Markets in Terms of Life Premiums Life Insurance South Korea China Taiwan South Africa India Hong Kong Brazil Singapore Mexico Malaysia Top 10

2004 Premium Volume (in US$ million) 48,680 35,407 33,851 24,381 16,919 12,969 8,199 6,459 5,213 4,208 196,285

Share of Emerging Markets (%) 21.7 15.7 15.1 10.8 7.5 5.8 3.6 2.9 2.3 1.9 87.3

Source Swiss Re Economic Research and Consulting, Sigma No. 5/2005.

These 33 emerging markets had little more than 12 per cent market share—increased from 9 per cent in 2000 to 12.29 per cent in 2004. However, the emerging market growth rates in premium have declined from 12 per cent in 2000 to 7.4 per cent in 2004, though the absolute volume of life premium increased from US$ 136,974 in 2000 to US$ 227,155. Therefore, decline in growth rate is a matter of concern. India has achieved better growth rates of 10.5 per cent in 2004 as against world growth rate of 2.03 per cent and emerging market growth rate of 7.4 per cent (Table 3.25).

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TABLE 3.25 Emerging Markets—Regional Insurance Premium 2004 in US$ Million Continent Eastern Europe Asia Latin America Africa Middle East

Premium 41,673 229,558 49,323 37,609 11,136

Growth Rate (%) (+5.6) (+9.0) (+10.5) (–1.3) (+18.2)

Source Swiss Re Economic Research and Consulting, Sigma No. 5/2005.

Many countries in emerging markets achieved faster growth than India in life insurance, for example, Taiwan (17.6 per cent), Hong Kong (30.8 per cent), Malaysia (20.1 per cent), Thailand (15.5 per cent) and Vietnam (35.1 per cent) in Asia. Most of the Latin American countries, for example, Brazil (35.1 per cent), Mexico (16 per cent), Argentina (40.9 per cent), Venezuela (18 per cent) has achieved better growth rate. None of the Eastern European countries except Slovenia (38.3 per cent) could achieve better growth rate. Similarly, even the average growth rate during 1999–2004, Indian growth rate of 17.7 per cent was surpassed by many countries including China (27.4 per cent), Hong Kong (22 per cent), Thailand (18.9 per cent), Vietnam (76.9 per cent), Slovenia (19 per cent), Saudi Arabia (45.3 per cent), etc. In respect of penetration and density, India lags behind many emerging marks (Table 3.26). In terms of penetration, India (2.26) lags behind many countries such as South Africa (12.96), Taiwan (8.28), Hong Kong (6.38), Singapore (6.07) and even China (2.30). Low level of penetration as one has discussed elsewhere is probably due to lack of awareness among people about personal risk management and failure on the part of insurance companies. Similarly, in respect of density, India is much behind a large number of emerging markets. India with life insurance density of US$ 12.9 was 22nd among the emerging markets. The countries ahead of India were Hong Kong (US$ 1,483.9), Singapore (US$ 1,300.2), Taiwan (US$ 1,050.1), South Africa (US$ 476.5) and China (US$ 25.1) (Table 3.27). The foregoing analysis of development of life insurance industry in India in terms of growth of premium volume, penetration, density and market share, etc., indicate that India is still lagging behind many emerging markets though recently registered better growth rates than many countries. However vast market potential that exists due to the size of population, significant growth rates in GDP and domestic savings still remain to be untapped. Post-reforms, Indian savings market has been witnessing intense competition from various institutions like Banks, Mutual Funds, Life Insurance companies, etc. The intensity of competition is expected to increase further once the full fledged pension reforms takes place in India. To compete in that market, Indian life insurance industry needs to reinvent itself.

Eastern Europe

Latin America

Asia

South Korea China Taiwan India Hong Kong Singapore∗ Malaysia Thailand Indonesia∗ Philippines∗ Vietnam Brazil Mexico Chile Argentina Venezuela Colombia Russia Poland Czech Republic Hungary Slovenia Slovakia

684,623 52,171 43,236 21,249 15,260 9,696 6,453 5,747 3,381 1,292 904 18,042 12,231 4,026 4,098 2,629 2,336 16,352 7,431 4,393 2,887 1,809 1,488

Total 48,680 35,407 33,851 16,919 12,969 6,459 4,208 3,167 1,626 783 601 8,199 5,213 2,617 1,345 79 645 3,544 2,828 1,720 1,179 531 603

Life 19,944 16,765 9,385 4,330 2,291 3,237 2,245 2,581 1,754 509 302 9,843 7,019 1,410 2,752 2,550 1,691 12,809 4,604 2,673 1,708 1,278 885

3.1 7.1 14.3 10.4 24.2 – 13.5 10.0 – – 26.3 10.8 10.9 8.1 19.9 18.0 1.1 –1.7 7.9 3.7 –0.2 12.6 6.8

3.4 2.9 17.6 10.5 30.8 – 20.1 15.5 – – 35.1 16.0 21.7 9.9 40.9 18.0 1.7 –38.4 11.2 4.6 1.7 38.3 6.4

2.3 17.0 3.7 10.1 –3.5 1.1 2.8 3.9 – – 11.9 6.9 4.1 5.0 11.7 18.0 0.9 17.6 6.0 3.1 –1.4 4.6 7.1

Change (in %) 2004, Local Currency Inflation-adjusted Non-life∗∗ Total Life Non-life∗∗

Premium Volume (in million of US$)

1.2 24.1 17.0 15.8 19.2 12.4 12.1 14.4 13.0 7.9 43.5 8.3 5.6 8.7 4.7 11.2 5.2 17.8 3.9 9.4 6.9 7.9 7.0

–0.3 29.4 19.6 17.7 22.0 10.7 14.9 18.9 16.3 11.2 76.9 19.2 2.9 7.1 3.4 12.2 5.4 6.0 7.3 14.3 7.1 19.0 9.6

5.5 16.0 9.6 10.0 8.3 12.8 7.9 10.1 10.4 3.7 21.6 2.5 7.9 12.3 5.4 11.2 5.1 23.0 2.2 6.9 6.7 4.7 5.4

Annual Change (in %) 1999–2004 Inflation-adjusted Total Life Non-life∗∗

TABLE 3.26 Key Insurance Indicators of Life Insurance in Emerging Economies (in 2004)

148 LIFE INSURANCE IN INDIA

South Africa Morocco Egypt Turkey Iran∗ UAE∗ Saudi Arabia∗ Lebanon Kuwait∗

30,682 1,372 612 4,619 1,880 1,493 1,196 577 393

24,381 323 211 857 153 254 50 180 95

6,301 1,049 400 3,763 1,727 1,239 1,146 397 298

–1.7 –4.8 –3.5 –18.8 18.8 28.8 20.0 7.5 – – – – – – 9.3 27.4 – –

Source Swiss Re Economic Research and Consulting, WIIW. Notes ∗Estimates for 2004, annual growth rates are calculated for the period 1999–2003. ∗∗Non-life premiums include health.

Middle East

Africa

12.3 2.4 14.1 23.3 – – – 2.6 –

3.4 3.2 9.3 7.2 25.8 12.0 6.5 2.6 14.7

2.4 –0.1 14.5 7.8 18.8 9.2 45.3 15.7 24.9

7.9 4.4 7.1 7.0 26.5 12.6 5.6 –1.1 12.2

Indian Life Insurance—Changing Market Structure and Emerging Opportunities 149

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LIFE INSURANCE IN INDIA TABLE 3.27 Life Insurance in Emerging Markets (2004) Population

Asia South Korea 47.9 China 1,292.6 Taiwan 22.5 India 1,049.7 Hong Kong 6.9 Singapore 4.3 Malaysia 24.6 Thailand 63.2 Indonesia 214.4 Philippines 79.8 Vietnam 81.4 Latin America Brazil 176.3 Mexico 102.5 Chile 15.7 Argentina 38.3 Venezuela 25.5 Colombia 44.3 Eastern Europe Russia 143.5 Poland 38.6 Czech Republic 10.2 Hungary 9.9 Slovenia 2.0 Slovakia 5.4 Africa South Africa 43.5 Morocco 30.1 Egypt 67.5 Middle East Turkey 67.9 Iran 66.6 UAE 3.0 Saudi Arabia 22.8 Lebanon 4.5 Kuwait 2.2

GDP

Premium US$

% Change

Market Share

52.9 1,366 292 595 162 92 102 142 209 80 39

41,998 32,442 23,739 13,590 10,117 5,561 3,455 3,222 1,373 702 331

–1.2 31.6 15.2 17.5 20.0 14.1 12.9 17.5 10.4 11.3 115.7

2.51 1.94 1.42 0.81 0.60 0.33 0.21 0.19 0.08 0.04 0.02

873.6 25.1 1,050.1 12.9 1,483.9 1,300.2 139.8 52.0 6.4 8.6 4.1

6.77 2.30 8.28 2.26 6.38 6.09 3.29 2.25 0.66 0.87 0.87

492 620 72 129 85 78

6,306 4,230 2,171 928 65 548

16.6 3.2 8.3 –1.2 7.0 7.4

0.38 0.25 0.13 0.06 0.01 0.02

35.8 41.3 138.3 24.2 2.5 12.4

1.28 0.70 2.61 0.72 0.09 0.70

441 207 85 84 28 32

4,887 2,312 1,424 981 344 465

27.3 9.3 18.9 11.0 13.8 12.0

0.29 0.14 0.09 0.06 0.02 0.03

33.9 59.9 139.4 99.1 173.6 85.8

1.12 1.12 1.72 1.20 1.25 1.38

158 44 80

20,728 361 179

4.1 7.9 11.5

1.24 0.02 0.02

476.5 12.0 2.7

12.96 2.05 0.22

242 135 80 215 19 38

570 127 188 39 139 80

5.4 17.5 4.1 30.2 11.7 23.1

0.03 0.01 0.01 Na 0.01 Na

8.4 1.7 72.5 1.7 31.0 36.9

0.24 0.09 0.26 0.02 0.78 0.23

Source Swiss Re Economic Research and Consulting, Sigma No. 5/2005. Notes Population in million in 2003. GDP—in US$ billion in 2003. Premium in US$ million in 2003. Change—annual change (in per cent) 1998–2003 inflation adjusted.

Density

Penetration

Indian Life Insurance—Changing Market Structure and Emerging Opportunities

151

Annexure 3.A.1 List of whose ‘Controlled Business’ has been vested Insurance Companies in the Life Insurance Corporation of India (a) Indian Insurers Sl No.

Name

1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. 24. 25. 26. 27. 28. 29. 30. 31. 32. 33. 34. 35. 36. 37. 38.

Adarsha Co. Ltd. Ajaj Mutual Bima Corporation Ltd. All India General Ins. Co. Ltd. Andhra Ins. Co. Ltd. Argus Ins. Co. Ltd. Aryan Champion Ins. Co. Ltd. Aryasthan Ins. Co. Ltd. Aryya Ins. Co. Ltd. Asian Ass. Co. Ltd. Asiatic Gov. Security Life & Gen. Ass. Co. Ltd. Associacao Goana de Mutuo Auxilio Ltd. Aundh Mutual Life Ass. Soc. Ltd. Bangalakshmi Ins. Ltd. Behar United Ins. Ltd. Bengal Christian Family Pension Fund Ltd. Bengal Ins. And Real Property Co. Ltd. Bengal Sectt. Co-op. Ins. Soc. Ltd. Bhaskar Ins. Co. Ltd. Bombay Alliance Ass. Co. Ltd. Bombay Co-op. Ins. Society Ltd. Bombay Family Pension Fund of Gov. Servants Bombay Life Ass. Co. Ltd. Bombay Mutual Life Ass. Soc. Ltd. Bombay Postal Employees’ Co-op Ins. Fund Ltd. Bombay Zorastrian Co-op Life Ass. Society Ltd. British India Gen. Ins. Co. Ltd Calcutta Customs Co-op Benefit Soc. Ltd. Calcutta Ins. Ltd. Calcutta Postal and R.M.S. Co-op Mutual Benefit Society Ltd. Canara Mutual Ass. Co. Ltd. Central Mutual Life Ins. Co. Ltd. Central Railway Employees Ass. Fund Ltd. Citizens of India Mutual Ins. Co. Ltd. Commercial Ins. Co. Ltd. Commonwealth Ass. Co. Ltd. Continental Mutual Ass. Co. Ltd. Co-operative Ass. Co. Ltd. Corporation Co-op. Ins.Soc. Ltd. (Table Annexure 3.A.1 Continued)

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(Table Annexure 3.A.1 Continued) Sl No.

Name

39. 40. 41. 42. 43. 44. 45. 46. 47. 48. 49. 50. 51. 52. 53. 54. 55. 56. 57. 58. 59. 60. 61. 62. 63. 64. 65. 66. 67. 68. 69. 70. 71. 72. 73. 74. 75. 76. 77. 78. 79. 80. 81. 82. 83. 84. 85. 86.

Crescent Ins. Co. Ltd. Deepak General Ins. Co. Ltd. Delhi Cloth and Gen. Mills Ins. Co. Ltd. Depositors Benefit Ins. Co. Ltd. Devkaran Nanjee Ins. Co. Ltd. Digvijay Ins. Co. Ltd. Dominion Ins. Co. Ltd. East and West Ins. Co. Ltd. East India Ins. Co. Ltd. Eastern Coop Life Ins. Soc. Ltd. Eastern Life Ass. Co. Ltd. Eastern Mutual Ins. Co. Ltd. Eastern Railwaymen’s Coop Life Ins. Soc. Ltd. Empire of India Life Ass. Co. Ltd. Free India Gen. Ins. Co. Ltd General Ass. Society. Ltd. Goodwill Ass. Co. Ltd. Great Social Life and Gen. Ass. Ltd. Gujarat Parsi Co-op Ins. Soc. Ltd. Happy India Ins. Co. Ltd. Hindu Family Ann. Fund Ltd. Hindu Mutual Life Ass. Ltd. Hindusthan Mutual Ass. Co. Ltd. Hindustan Coop Ins. Soc. Ltd. Hindusthan Ideal Ins. Co. Ltd. Home Security Ass. Co. Ltd. Howrah Ins. Co. Ltd. Hyderabad Co-op. Ins. Soc. Ltd. Ideal Mutual Ins. Co. Ltd. India Life & Gen. Ass. Soc. Ltd. India Orial Ass. Co. Ltd. Indian Circar Ins. Co. Ltd. Indian Economic Ins. Co. Ltd. Indian Globe Ins. Co. Ltd. Indian Mercantile Ins. Co. Ltd. Indian Mutual Ins. Co. Ltd. Indian Mutual Life Assn. Ltd. Indian Posts and Telegraphs Co-op Ins. Society Indian Progressive Ins. Co. Ltd. Industrial and Prudential Ass. Co. Ltd. Insurance of India Ltd. Jayabharat Ins. Co. Ltd. Lakshmi Ins. Co. Ltd. Long Life Ins. Co. Ltd. Madhya Pradesh Mutual Ins. Co.Ltd. Madras Life Ass. Co. Ltd. Maha Gujarat Co-op Ins. Soc. Ltd. Mahabir Ins. Co. Ltd. (Table Annexure 3.A.1 Continued)

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153

(Table Annexure 3.A.1 Continued) Sl No. 87. 88. 89. 90. 91. 92. 93. 94. 95. 96. 97. 98. 99. 100. 101. 102. 103. 104. 105. 106. 107. 108. 109. 110. 111. 112. 113. 114. 115. 116. 117. 118. 119. 120. 121. 122. 123. 124. 125. 126. 127. 128. 129. 130. 131. 132. 133. 134. 135.

Name Mangalore Roman Catholic Pioneer Fund Ltd. Metropolitan Ins. Co. Ltd. Midland Ins. Co. Ltd. Modern Mutual Life Ass. Co. Ltd. Mother India Life Ass. Co. Ltd. Mutual Help Assn. Ltd. Nagpur Pioneer Ins. Co. Ltd. National Indian Life Ins. Co. Ltd. National Star Ass. Co. Ltd. National Ins. Co. Ltd. Neptune Ass. Co. Ltd. New Asiatic Ins. Co. Ltd. New Great Ins. Co. of India Ltd. New Guardian of India Life Ins. Co. Ltd. New India Ass. Co. Ltd. New Ins. Ltd. New Metr. Ins. Co. Ltd. New Swastik Life Ass. Co. Ltd. Oriental Gov. Security Life Ass. Co. Ltd Palladium Ass. Co. Ltd. Peerless Life Ass. Co. Ltd. Pioneer Fire and Gen. Ins. Co. Ltd. Police Coop Life Ins. Soc. Ltd. Policyholders’ Ass. Ltd. Popular Ins. Co. Ltd. Prabartak Ins. Co. Ltd. Premier Life & Gen. Ins. Co. Ltd. Presidency Life Ins. Co. Ltd. Prithvi Ins.Co. Ltd. Punjab National Ins. Co. Ltd. Radical Ins. Co.Ltd. Railway Emplys’ Coop Ins. So. Ltd. Rajasthan Ins. Co. Ltd. Reliance Ass. Soc. Ltd. Ruby General Ins. Co. Ltd. Sahyadri Ins. Co. Ltd. Saraswathi Ins. Co. Ltd. Servants of India Ins. Co. Ltd. South India Coop. Ins. Soc. Ltd. South Indian Teachers Union Protection Fund Ltd. Sterling Gen. Ins. Co. Ltd. Sunlight of India Ins. Co. Ltd. Swadeshi Bima Co. Ltd. Swaraj Life Ins. Co. Ltd. Tarun Ass. Co. Ltd. Tilak Ins. Co. Ltd. Tinnevelley Diocesan Mutual Ins.Co.Ltd. Tropical Ins. Co. Ltd. Trust of India Ass. Co. Ltd. (Table Annexure 3.A.1 Continued)

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(Table Annexure 3.A.1 Continued) Sl No. 136. 137. 138. 139. 140. 141. 142. 143. 144. 145. 146. 147. 148. 149. 150. 151. 152. 153. 154.

Name Union Life & Gen Ins. Co. Ltd. United India Life Ass. Co. Ltd. United Karnatak Ins.Co. Ltd. Universal Fire & Gen. Ins.Co.Ltd. Vanguard Ins.Co. Ltd. Vasant Ins. Co. Ltd. Vikram Gen. Ass. Ltd. Vishal Bharat Bima Co. Ltd. Vishwabharti Ins.Co. Ltd. Warden Ins. Co. Ltd. Western India Life Ins. Co. Ltd. Western Rly.Coop Life Ass. Society Ltd. Western Rly. Zorastrian Coop Death Benefit Assn. Ltd. Yeshwant Mutual Ins. Co. Ltd. Zenith Ass. Co. Ltd. Mackinnon Mackenzie & Company’s Employees Coop Benefit Fund Patiala Ins. Corporation Mysore Govt. Ins. Deptt. Travancore State Ins. Deptt.

(b) Non-Indian Insurers Sl No.

Name

1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16.

Crown Life Ins. Company Sunlife Ass. Company of Canada Jubilee Ins. Co. Ltd. Christian Mutual Ins. Co. Ltd. Eastern Federal Union Ins. Co. Ltd. Indian Life Ass. Co. Ltd. Commercial Union Ass. Co. Ltd. Gresham Life Ass. Soc. Ltd. North British & Mercantile Ins.Co. Ltd. Norwich Union Life Ins. Society Pearl Ass. Co. Ltd. Phoneix Ass. Co. Ltd. Prudential Ass. Co. Ltd. Royal Ins. Co. Ltd. Scottish Union and National Ins. Co. Yorkshire Ins. Co. Ltd.

(c) Provident Societies Sl No. 1. 2. 3.

Name C.M.S. Telugu Church Widows’ Provident Fund Indian Industrial & Provident Ass. Co. Ltd. Jagat Seva Mutual Provident Ins. Co. Ltd. (Table Annexure 3.A.1 Continued)

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155

(Table Annexure 3.A.1 Continued) Sl No. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. 24. 25. 26. 27. 28. 29. 30. 31. 32. 33. 34. 35. 36. 37. 38. 39. 40. 41. 42. 43. 44. 45. 46. 47. 48. 49. 50. 51.

Name Vidya Ranya Commercial & Provident Society Ltd. Chota Nagpur Provident Ins. Co. Ltd. Ministerial Officers Coop Provident Ins. Society Aundh State Provident Ins. Co. Ltd. Bombay Capital Provident Gen. Ins. Co. Ltd. Bombay Provident & Gen Ass. Co. Ltd. Bullion Provident Ins. Co. Ltd. C.A.P. Family Relief Provident Coop Society Ltd. Family Mutual Provident Ins. Co. Ltd. Fortune Provident Ins. Co. Ltd. Gujarat Popular Provident Ins. Society Ltd. Hind Benefit Provident Ins. Society Ltd. Model Provident Ins. Co. Ltd. New Provident Ins. Co.Ltd. Samarth Provident Ins. Co. Ltd. Security Provident Ins.Co. Ltd. Social Service Provident Ins.Co. Ltd. Swadeshi Provident Ins. Co. Ltd. Union Provident Society Ltd. Uplift of India Provident Society Ltd. Western Provident & Gen. Ass. Co.Ltd. Your own Provident Ins.Co. Ltd. Maharashtra Brahman Provident Mandal Ltd. Posts & Telegraphs Mutual Provident Fund Teachers’ Provident Ins. Soc. Ltd. Ahimsa Provident Ass. Ltd. All India National Provident Ins. Co. Ltd. Bharatha Mata Provident Ass. Co. Ltd. Catholic Provident Fund Ltd. Nazareth Indian Christian Provident Insurance Fund New Karnataka Provident Ins. Co. Prithvi Mutual Provident Co.Ltd. United India Provident Ass. Co. Ltd. Vanguard Provident Ass. Co.Ltd. All India & Burmach Provident Fund Bangalore Provident Ins. Corpn. Ltd. Mysore Provident Ins. Co.Ltd. Kranti Provident Ins. Co.Ltd. Kerala Gilt-Edged Sec Prov.Ass.Co. Ltd. Muthu Prov. Ins. Co.Ltd. Vijaya Bharathi Provident Insurance Policemen Provident Ins. Soc. Ltd. Alpha Provident Ins. Co. Ltd. Apollo Provident Ins. Soc. Ltd. Bengal Industrial Prov. Ass. Ltd. Bengal Union Prov. Ins. Co. Ltd. City of Calcutta Prov. Ins. Ltd. Cordial Prov. Ins. Co. Ltd. (Table Annexure 3.A.1 Continued)

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LIFE INSURANCE IN INDIA

Sl No. 52. 53. 54. 55. 56. 57. 58. 59. 60. 61. 62 63. 64. 65. 66. 67. 68. 69. 70. 71. 72. 73. 74. 75.

Name East End Prov. Ass. Ltd. Eastern Rly Employees’s Coop Prov. Ins. Society Ltd. Grand Jubilee Provident Ins. Ltd. Hindustan Std. Prov. Ins. Ltd. Incorporated Prov. Ins. Ltd. Indian Prov. Co. Ltd. Inter Provincial Prov. Soc. Ltd. Janakalyan Mutual Provident Soc. Ltd. Mahaluxmi Prov. Ins. Ltd. Mutual Hindu Family Prov. Fund. National Economic Prov. Ins. Ltd. National Industrial Prov.Co. Ltd. New Bengal Provident Ins. Co. Ltd. Oriental Prov. Ins. Ltd. Provident Union Ins. Co. Ltd. Rly Employees’ Prov. Ins. Society Std. Provident Ins. & Annuity Co.Ltd. Urban Provident Ins. Soc. Ltd. Windsor Provident Ass. Co. Ltd. All India Post Men’s Union Prov. Fund Indian Rly Employees Mutual Prov. Soc. Central Rly Men’s Coop Prov Benefit Society Travancore General Provident Raksha Provident

Source Report on the activities of the Life Insurance Corporation of India during the period 1st September 1956 to 31st December 1957, LIC of India.

Annexure 3.A.2 Life Fund of LIC of India (1957–2005) (in Rupees crores) Year (1)

Life Fund (2)

1957 (16 months) 1958 1959 1960 1961 1963 (15 months) 1964 1965 1966 1967 1968 1969

410.40 447.81 495.29 560.38 631.59 720.70 808.37 901.61 977.56 1,123.90 1,260.06 1,434.47

Growth of Life Fund (%) (3) – 9.22 10.60 13.14 12.71 14.11 12.16 11.53 8.42 14.97 12.11 13.84 (Table Annexure 3.A.2 Continued)

Indian Life Insurance—Changing Market Structure and Emerging Opportunities

157

(Table Annexure 3.A.2 Continued) Year (1) 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

Life Fund (2) 1,611.03 1,825.05 2,066.55 2,358.69 2,704.42 3,033.79 3,440.97 3,952.89 4,500.70 5,116.32 5,818.09 6,641.44 7,562.62 8,631.72 9,800.38 11,191.09 12,665.95 14,502.20 16,631.84 19,568.78 23,471.84 28,400.97 34,691.39 40,998.29 49,665.81 59,978.90 72,780.07 87,759.96 105,832.90 127,389.06 154,043.73 186,024.75 227,008.98 273,004.96 321,753.53 385,639.07

Source LIC of India, Annual Report (various issues). Note

Growth rate calculated from the data in column 2.

Growth of Life Fund (%) (3) 12.31 13.28 13.23 14.14 14.66 12.18 13.42 14.88 13.86 13.68 13.72 14.15 13.87 14.14 13.54 14.19 13.18 14.50 14.68 17.66 19.95 21.00 22.15 18.18 21.14 20.76 21.34 20.58 20.59 20.37 20.92 20.76 22.03 20.26 17.86 19.86

Chapter 4 Product–Market Relationship and Distribution in Convergent Financial Market Convergence in financial services industry has significantly changed the complexion of financial services industry, particularly in terms of product development, service delivery and product distribution. Financial service firms are gradually getting integrated often emerging as financial conglomerate with new types of products, benefits, service delivery systems. Life insurance industry is no exception to this emerging phenomenon of convergence and integration. This has also changed the product–market relationship in the insurance industry. Reforms in social security and pension system, anxiety about risk management for vulnerable sections of society, growing longevity requiring improvement in health management, etc., on one hand extended the scope for market expansion of the life insurance industry and on the other increased the competition for market space and challenges to reach the new markets with appropriate basket of products and package of services. Indian life insurance industry is undergoing the convulsion of change and transformation and need to reposition in the marketplace. Marketing today is not only selling but a combination of product-service-distribution. Successful marketing would therefore call for a strategy, incorporating the aforementioned points. Since product–market relationship is changing at a fast speed, market expectation needs to be the base for any such innovative strategy. Keeping this in view, in this section, we have discussed the following issues: 1. 2. 3. 4.

Convergence in financial services. Changing product–market relationship. An outline of risk management product for economically vulnerable sections. Emerging distribution practices in life insurance.

Product–Market Relationship and Distribution in Convergent Financial Market

5. 6. 7. 8.

159

Strategy for rural market penetration. Focus on consumers interest. Developing marketing strategy through marketing research. A Macro–Micro Model for market management.

Convergence in Financial Services Recent reforms and growing globalization in financial services also produced important phenomenon called integration in financial services, which occurs whenever production or distribution of a financial service traditionally associated with one of the three major financial sectors is by actors from another sector. Terms such as bancassurance, allfinanz, universal banking and financial conglomerates, are all used to convey some notion of integration. The process of integration has opened up avenues of expansion of business, scope for new products. The process of financial services integration has offered tremendous opportunities for launching innovative new products, entering into new areas of business, improving the scale of operation and reducing cost and improving the balance sheets and quality of risk management. However, these are not without any cost and financial institutions need to reposition themselves in the marketplace with new vision, mission and goals. What is more important is to institutionalize the new vision and goal by promoting market friendly organizational culture and a new set of operational rules and management philosophies. This is a challenge for the management of a company. However, transition is not without a cost or pains. However, transitional costs can be reduced and pains can be minimized only by forward looking strategic initiatives. There are several forms of financial services convergence or integration. In a fully integrated form all financial services are produced and distributed by a single entity like corporation. In such a form, a corporation may offer commercial banking, investment banking, insurance and other financial services. However, in most of the cases we find a partial integration offering two to three services like German Banks, which offer universal banking services (commercial banking and investment banking) and also insurance and other services through separate subsidiaries. Other variant of integration is to offer various services under a parent company—services produced by one subsidiary and sold by other for example in France or UK Bank Assurance. For example, in France either Banks promote Insurance Companies or Insurance Companies promote Banks. Such integration are very common in many other countries such as Australia, France, UK and USA. In Australia the four major banks operate in conglomerates in all areas of commercial and investment banking, in life and non-life insurance and in pension (Bain and Harper 1999). In France there is a close link between banks and insurance services, and bancassurance is a major source of income. Most of the life insurance products sold by banks are tax saving simple products. According to Daniel (1999) banks accounted for 61 per cent of total life premium

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and 63 per cent of new premium production in France in 1998. A close tie integration is also observed in the Netherlands where non-life insurance has historically been more prominent than life insurance but this is changing, especially since banks have moved aggressively into life insurance marketing. For 1998, banks accounted for an estimated 75 per cent of new life premium (Harold). In UK life insurance products are being sold by subsidiaries promoted by banks. These subsidiaries sell life insurance products through a number of channels such as direct sales, brokers, representative (agents) or bank branches. Direct sale is quite strong in UK as the distributors like Lloyds TBS transacts about 20 per cent of sales via direct response. In Canada there is a greater integration between banks and insurance since large number of banks have been promoted by insurance companies and a large number of insurance/ companies promoted by banks. The Canadian financial services business is concentrated and becoming more so with consolidation and demutualization, driven by competition. The largest six banks control about 85 per cent of the Canadian bank assets and the largest six insurers, most mutual, control 70 per cent of insurer assets (Harold). Financial services in USA moved towards greater integration particularly after Financial Services Modernization Act (known as Gramm–Leach–Bliley Act) 1999. More and more banks have started selling life insurance products particularly individual annuities and according to some estimates they write nearly 15 per cent of annuity consideration. The trend of global convergence in financial services is gaining momentum in India, particularly after reforms since 1991 removing entry barriers. Early 1990s witnessed the trend in integration when many public sector institutions and banks set up their non-core business, for example IDBI started banks and mutual funds, LIC started mutual funds housing finance, and many banks like SBI entered into mutual funds, housing finance and subsequently life insurance. This trend further gained momentum with opening up of insurance to private sector. Private financial institutions such as HDFC, ICICI entered into insurance business. The process of integration further strengthened with more and more banks taking up insurance selling and with this bancassurance has emerged as an important channel of distribution. With further reforms, the process of integration is expected to move forward by breaking existing obstacles. Financial integration however, has its own pitfalls through negative externalities via systematic risks. It also tends to promote adverse impact on competition. Moreover integration may create regulatory complexities since there are more than one regulator such as RBI for banking, IRDA for insurance, SEBI for securities market and PFRDA for Pension Market. To tackle regulatory problems there is need for a super regulator. Alternatively a strong co-ordination among these regulators through a coordinating mechanism is called for. We have observed in Chapter 1 that the ongoing trend towards globalization and market reforms has blurred the barriers of national economy. This has also altered the inter-sectoral economic relations particularly the financial services sector, which is confronted with competition, economies of scale, mounting service cost reflected in low profit margins. While, technological advancement brought sophistication and speed in service delivery mechanism it also helped in information dissemination and

Product–Market Relationship and Distribution in Convergent Financial Market

161

increased consumer awareness constantly putting pressure on financial service industries such as insurance, banks, securities firm to provide cost-effective desired products and services. This growing phenomenon of intense intra-market competition and consumer power (after translating into consumer activism) forced the financial institutions to look beyond traditional barriers of product–market relationship, distribution matrix and conventional concept of competition. In fact, globalized deregulated financial services industry has witnessed a new set of financial institutions and rules of game, the core of which is integration in service delivery, distribution through greater coordination among institutions such as insurance, banks and securities firms, through convergence in financial services industry, in the newly emerging competition culture. The primary motivating factor influencing financial institutions to converge across the institutions, services and geographical boundaries is to maintain and sustain growth, surplus/profitability in a wider and expanding service market through integration of competencies of different service providers. The convergence that are most visible are: Cross Segment Convergence—occurring across traditional financial service market namely insurance, banks and security firms, intra-segment convergence occurring within the segments itself, namely, insurance, banking and crossgeographic boundary—occurring across the geographical boundary. Although convergence looks simple but integration of institutions linked to a widely varied service market is a complex and difficult process. Therefore, an appropriate model of integration for desired results needs to be designed and implemented. According to Thompson (2001) four major models of convergence are: Distribution Model—under this model financial services firms distribute the products of other firms without surrendering its core competencies. This is a low convergence model which enables, for example, banks to improve its balance sheet by distributing bancassurance. Integrated Alliance Model—a stronger relationship between two types of institutions to distribute products of each other either through a joint venture or an exclusive arrangement among them. While integration is stronger it narrows down the option of wider cooperation among similar institutions. Holding Company Model—is a stronger option for integration than other two models mentioned. Under this model a holding company is formed retaining the ownership of other institutions and individual business operates as subsidiaries. Each subsidiary serves its traditional service segments such as banks and insurance. This is a less complex system of convergence but provides better opportunity for business and risk management by spreading over several markets. Highly Converge Model—in a highly Converge Model a total integration takes place among various services such as insurance, and banking and securities business. These business lines are put under each division and the operation is treated as a single market under single management. The advantage is that this model generates a strong synergy in operation and full service for the client base. However, it is a complex model.

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Convergence and Life Insurance Industry Emerging convergence in financial services has given a new opportunity to expand to the otherwise conservative insurance industry. Insurance companies confronted several obstacles to expand its market with limited basket of products, restricted sales through conventional distribution by tied agents and low return on investment in debt securities. Traditional insurance products characterized by endowments and term assurance had limited appeal among the risk averse investors. However, it seems that the converged financial service industry has broken the barrier to expansion. A new enthusiasm among the insurance service providers is quite visible in a converged financial market where insurance companies, banks and securities firms joined together to expand market base, reduce operating cost, optimizing technology and economies of scale. This new found alliance not only changed the format of business strategies of insurance and banks, but also brought enthusiasm among traditional product manufacturer and distributors. Traditional concept of customer loyalty to institutions disappeared in a competitive market led by return and service quality. But financial service integration seems to have brought them back. Customers are more satisfied to receive a bundle of required service products from a single entity—which has reduced their costs to obtain service as well as closer inter-personal interaction between service providers and customers. Convergence and consolidation of financial services therefore opened the opportunities for insurance particularly life insurance. Life insurance industry needs to be strengthened by adopting an appropriate model of integration, designing and cost reducing; revenue enriching model of distribution and a basket of market-targeted products. Financially, whatever model is adopted the ultimate goal should be value creation for stakeholders, policyholders and others. Several business models have been suggested to create more values in life insurance servicing through product manufacturing, distribution and servicing. One such model is outsourcing several services from a Third Party Administrator (TPA, which allows the insurer to improve scale economy in servicing, distribution and investment management. Disaggregation of various insurance services, what A T Kearney said ‘virtual integration represents a bold approach for life insurance companies in the era of convergence’. By disaggregating the existing business model and focussing on core value creating function, players in the insurance industry can achieve, improve efficiency, a predictable cost structure, new initiatives pursued through redeployment of resources. A strong growth and profit message, improved capture and use of customer data and potential long-term capital relief. Disaggregating of insurance services and cost structure would help a company to think of developing a New Business model to improve the value chain of operation. This would help to decide strategic changes in existing business model as well as to pinpoint the services to be outsourced. However, the New Business model disintegrates several functions and seeking outsourcing would be based on a strategic business purpose, estimated market potential, competition and achieving customer satisfaction. The New Business model to suit the transformed market basically carried out through new products and distribution system—aiming at increasing customers’

Product–Market Relationship and Distribution in Convergent Financial Market

163

base, enhancing profitability through value creation. Therefore, focus is on developing new products, developing alternative line of product distribution and rendering cost-effective customer service.

Changing Product–Market Relationship In a convergent financial market, product–market relationship is undergoing a silent change due to the emergence of multiple financial products often providing similar benefits (Table 4.1). Old value chain of benefits are often unable to retain existing customers and bring new customers. Moreover, new generation consumers of financial product are also impatient and provide more weight to market-related return than safety and security of funds. Therefore, life insurance has been increasingly challenged by mutual funds and pension funds. This has forced the life insurance companies to create new products competitive to investment products of mutual funds and securities relating (bonds and equity) products to improve value of life insurance. Further, the competitive forces of risk management intensified the pressure on life insurance to produce higher financial return and minimize volatility. Insurance products are more versatile than other financial instruments and can also provide economic value of insurance. In the globalized free market economy, volatility and market risks have intensified many folds, the market appetite for new risk insurance products has also increased. Demand for new products has increased the need for new risk protection products and on the other hand enlarged the scope of market expansion. Market is changing and that change is sometimes immediately unidentifiable. Therefore, to keep pace with the changing market and its consumers all financial institutions are coming with several innovative products to attract investors. Product innovation has been quite fast in money and capital market. Since 1970, a number of innovative capital market products such as Money Market Deposit Accounts (MMDAs); Money Market Mutual Funds (MMMFs); securitization of loans; derivative products such as option and futures. Innovation of these new instruments were driven by changes in the capital markets generated by increased competition, financial risks and demands, and supply of risk transfer instruments. However, in life insurance, product innovations have been few and far between. Though, in recent times a number of new products have been introduced by the general insurance industry. In life insurance new products include life securitization, bank funded life insurance, etc. Product creation is also a first step towards creating a market and attracting other market participants to life insurance. For example, unit linked life insurance products have been successful in attracting investors who seek to maximize investment through stock market investment. Indian life insurance products have been traditionally tied to conventional savings related products such as endowment assurance. However, this has been changing fast particularly with the entry of private sector life insurance companies, which have launched unit linked and pension products in a big way.

Total assets, US$ billion (1) Financial assets under management —of which for own risk —of which for risk of policyholders Total premium, US$ billion Business split in % (2) —Savings products with return guarantees (often including mortality protection) (%) —Unit-linked/separate account business (US) (3) (%) —Individual pension products (%) —Group pension products (%) —Risk products (such as term life, disability, critical illness, long-term care) (%) —Other (%) Number of companies –Average premium per company, in US$ million –Median premium per company, in US$ million

225 225 153 72 30 17

1 25 30 28

108 278 29

2,698 1,343 495 14

3 35 31 15

1,123 441 13

Canada

4,159 4,041

US

292

204 931

11

34

25

20

10

190

1,106 890

1,996 1,996

UK

167

118 1,093

1

12

1

20

66

129

1,056 197

1,343 1,253

France

234

106 802

6

5

26

10

53

85

816 27

927 843

Germany

2,534

40 9,675

<1 109 752 280

23

16

23

Na (4)

38

387

Na Na

1,754 1,680

Japan

<1

0

<1

36

64

82

292 124

485 461

Italy

TABLE 4.1 Product–Market Characteristics of Major Global Life Insurance Markets, 2004

Na

Agents –

63

3,175

Source Swiss Re Economic Research and Consulting. Notes 1. Data on assets for Italy are for 2002. 2. US and CA: The business split is based on premiums for life, annuity and disability products, excluding medical expense business. Savings products with return guarantees include traditional and indexed universal life and whole life products. Unit linked business includes variable life and variable universal life in the US and segregated fund universal life in CA. For US, the business split for life products is based on new annualized premiums (Source: LIMRA). Individual pension products include both general and separate account business. 3. The investment risk with these types of products remains with the policyholder. In Europe and Japan, this type of business is termed unit-linked business, while in the US it is called separate account business. 4. Very little individual unit-linked business has been written in Japan. However, variable annuities have become popular in recent years. 5. 2002 for UK, France and Italy. 6. UK: New Business, US and CA: Individual life sales. 7. Ind.: Independent.

258 293 290 506 543 277 –Average number of potential clients per company (population divided by number of companies), in 000s Market share of mutuals, 14 5 14 5 20 21 2003 (5) (%) Largest distribution Ind. agents/ Ind. agents/ Ind. financial Banks (62%) Agents (37%) Banks (60%) channel (in % of direct brokers brokers Advisors premiums) (6) (7) (54%) (51%) (63%) Second largest distribution Own sales Own sales Agents (27%) Agents (16%) Brokers (26%) Agents (28%) channel force (43%) force (31%)

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However, huge untapped potential remained to be tapped, which would provide tremendous scope for growth to the life insurance industry. These are health insurance segments, microinsurance segments of the industry. Before discussing about these segments we would like to focus on traditional life insurance products.

Marketization of Products Life insurance products have intangible embedded value for which there is embedded cost and enlightened customers trying to match both of these. Therefore before the product goes to the market, product manufacturer must pay due attention to this aspect of product pricing and quality, which will enlist maximum marketization of any product. Producing a market-centric product based on certain market-centric observation, product planning and product designing are critical factors to be understood in the futuristic market context thoroughly analyzing the customer’s need, choice and preference. The preference of customers is a changing phenomenon, which strongly influences the changes in the financial market engineered by movement of macro economy. Product planning and designing, therefore call for identifying these changing preferences and understanding customer behaviour. Therefore, developing market-centric or need-based life insurance products include several activities structured into separate but integrated components like market research to identify emerging need, constructing a scenario to understand likely relative demand for other products, designing medium and process delivery, building up necessary distribution capability and an integrated approach to deliver products to the right segment of customers. Though life insurance is basically a PFRM, its appeal differs from country to country, mostly due to the nature of financial market, availability of other financial products, depth of financial market, reforms in the social security market, etc.

Product Preference Customers preference for a life insurance product is a changing phenomenon and is influenced by several factors including stock market movement, interest rates, distribution efficiency and network, etc. Social security reform has further added a new dimension to product preference as annuity is one of the important instruments of DC system. A recent study published by Swiss Re (Sigma No. 1/2006) shows that (in 2004), pension products of life insurance were very popular and out of US$ 495 billion, share of individual and group pension was 35 per cent and 31 per cent, respectively. Even pension products launched by mutual funds and of course pension funds are very popular. Similarly, in Canada out of US$ 30 billion, 25 per cent and 30 per cent premium was cornered by individual pension and group pension, respectively. The same trend was also in UK in popularity of products. UK insurance companies collected US$ 190 billion in 2004, out of which 25 per cent by individual pension products, savings products

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with return guarantee in US, Canada and UK had share of 14 per cent, 17 per cent and 10 per cent, respectively. However, a different preference scenario is noticed in France, Germany and Italy where savings products are more popular, and accounted to 66 per cent, 53 per cent and 64 per cent of total premium. Though global attention is drawn to unit linked insurance, yet they occupy a very small space in the product market. In fact the share of unit linked varied between 3 per cent in USA and 36 per cent in Italy. The share of unit linked products was 1 per cent in Canada, 10 per cent in Germany, 20 per cent in UK and France. It can also be seen that countries with more mature and active stock markets such as USA, Canada and UK had relatively low level of preference for unit linked products.

Products Guarantee Another crucial issue being debated in the life insurance product market is the product guarantee. Product guarantee is an important marketing aid to push a life insurance product in a highly competitive market. However, it has its cost also, because investment earnings are subject to market fluctuation and market risks. Therefore, guarantee often leads to enhancing solvency and other market-related risks for an insurance company. A study of Tillinghost–Towerrin showed that product guarantee in the United States is a key factor for sales advancement in a competitive market. ‘Insurance companies have focussed on guarantees as a way to differentiate themselves in the marketplace and gain access to distribution’. The survey focussed on guarantee of interest rates for Universal Life (UL), Fixed Annuity and Variable Annuity (VA), the survey studied the perceived importance of product guarantees. According to the survey, 83 per cent felt guaranteed death benefits in VA, 75 per cent felt guaranteed living benefits in VA, 65 per cent felt no lapse guarantee for UL, 55 per cent felt guaranteed interest rate for fixed annuity and 37 per cent felt minimum guaranteed interest rate for UL are essential for increasing sales. The result of the survey, indicate the importance of guarantee in life insurance business, even in a developed country. One can imagine how strong an urge for guarantee would be in a country like India with low financial literacy and low per capita income.

Life Insurance Products Life insurance products are unique, complex and contingent financial assets to meet financial risks. They are unique because contracted amount of payment is made only in case of untimely death or at the time of maturity. They are complex because the payment is only in the event of contingency covered under the contract, and a policyholder can make payment of different kinds such as yearly, half yearly, quarterly and monthly or in lump sum for the contracted SA.

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Life insurance products can be classified into three major types, namely, traditional insurance products such as term assurance, endowment insurance, whole life policies and non-traditional products like unit linked policies. In addition to risk coverage, most of the traditional products also contain some savings element; non-traditional products like unit linked policies contain strong investment elements in addition to coverage of risks. We shall discuss basic features of some important types of life insurance products.

Term Assurance Term assurance is one of the very basic life insurance policies, other being the endowment policy. Pure term assurance is a life insurance policy which covers the life in monetary terms in return of payment of premium. There are various types of term assurance policies including the following:

Basic Term Assurance Plans Term assurance provides death cover during a specified term of policy. Policy term can be short (for example, 1 year) to long (for example, 25 years) term SA is paid only on death with the specified period (policy term). Premium can be paid in lump sum, yearly, half yearly or on a monthly basis. There is no provision for loan or Surrender Value (SV) under these types of policies.

Level Term Assurance Under a level term assurance policy, the SA throughout the term of the policy does not change.

Increasing Term Assurance Plan Life insurance cover under this plan goes on increasing periodically over the term in a predetermined rate.

Decreasing Term Assurance The SA decreases with the term of the policy. Normally decreasing term assurance plan is taken out for mortgaged protection, under which outstanding loan amount decreases as time passes as also the SA.

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Renewable Term Assured Policies Under a renewable term assurance plan, a policyholder can renew the policy for a limited number of additional periods but it is subject to a maximum age limit.

Convertible Term Assurance This is a very convenient plan for long-term protection, but is presently unable to pay premiums for whole life or endowment plan. Under a convertible term assurance plan, a policyholder is entitled to exchange the term policy for an endowment insurance or a whole life policy.

Endowment Plans As discussed, term assurance plans are purely risk-oriented plans and payment is made only in the event of death during the term of the policy whereas an endowment assurance policy is an investment-oriented plan which not only pays in the event of death but also in the event of survival at the end of the term. Endowment assurance is a contract underwritten by a life insurance company to pay a fixed term plus accumulated profits that are declared annually provided the premiums have been paid as per contract. Premium under an endowment plan has two elements—mortality element and investment element—hence higher than in term assurance which covers only mortality element. A traditional with profits policy bonus is added to the basic SA. There are three types of bonuses, namely, simple revisionary bonus declared annually as cash value, special bonus guaranteed at the discretion of the life insurance company and terminal bonus which is an additional bonus paid at the end of the policy term. There are various types of endowment policies such as basic endowment plan, money back plan and whole life plan.

Basic Endowment Plan This type of plans provides death benefit for a specified sum during the term of the policy contract. It also pays survival benefits at the end of the policy term in case a policyholder survives. The term of the policy may vary from 3 years to 40 years, and premiums can be paid in lump sum (single premium), annually or monthly. Endowment policies can be with or without profit policies and there is a provision for loan and SV. This plan is very popular in India due to two basic benefits of risk coverage and investment return.

Money Back Plan This is another popular endowment plan because there is an additional advantage of receiving a certain amount of money at periodic intervals during the policy term. Other normal benefits

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of endowment plans such as survival and death benefits are also available to the life assured or legal heir.

Educational Endowment Plan These are plans specially designed to meet the educational expenses of children at a future date. Usually such policies are purchased when the child is young. In case the insured parent dies before the date of maturity the instalment is paid in lump sum or with immediate effect which helps to meet the educational expenses.

Mortgage Repayment Plan These are unit linked endowment policies designed for mortgage repayment. Under such policies there is a guaranteed growth. Growth depends on the performance of funds under such policies.

Whole Life Plans Whole life plans are another type of endowment plans, which cover death for an indefinite period. Whole life plans can be with or without profit. Popular whole life plans are ordinary whole life plans, limited payment whole life plans and anticipated whole life plans. Ordinary Whole Life Plan

This is a continuous premium payment plan. The life assured pays the premium throughout his life. It provides the dual benefits of protection and savings. Under this policy loans and surrender facilities can be availed by the policyholder. Limited Payment Whole Life Plans

Limited payment whole life plan provides the same benefits but premiums are paid for a limited period. Premiums are sufficiently high to cover the risks through limited number of payments but the cover is equal to the SA. Anticipated Whole Life Plans

This is another type of a plan providing protection and savings. Under this plan, life assured receives a fixed sum in a periodic interval on his survival and full SA is paid on death of the policyholder without any deduction. Therefore an anticipated whole life plan takes care of family needs after the death of the life assured as well the interim needs of the life assured himself while he is alive.

Unit Linked Plans ULIP is basically an investment product with attractive benefits to the investors as well as with risk and capital related advantages to a life insurance company. With the dynamic growth capital

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markets and the emergence of stock market-led growth, ULIP has emerged as one of the fast growing life insurance products. Unit linked insurance products were initially launched in Europe—in Netherlands in 1953 and in UK in 1957. Subsequently, these products were launched in USA and Canada in 1970s. In India, it was first launched by the UTI in 1970 followed by LIC of India in 2001. Unit linked plans are combination of an investment fund (like mutual fund) and an insurance policy. Unit linked plans offer a long-term investment option where return is linked to the market performance but at the same time there is no compromise on protection. Premiums received from the customers are utilized for purchasing units at the prevailing prices. The daily unit price is calculated on the basis of the market value of the underlying assets (bonds, equities, government securities, etc.). Premiums paid by the customer, less the charges like management/administrative expenses, are utilized for purchasing units at the prevailing unit price of the day. Premiums are invested on the basis of predetermined option of the customers. Usually several options are there and a customer can select a debt fund or a balanced fund or an equity fund depending on the risk profile. The amount received from a policyholder is invested in the stock market by the insurer in select funds depending on the options of the customers. However, after deducting administrative charges unit linked plan generally provides better return than other types of life insurance policies, because under this type of a plan a large part of funds is invested in equities. There is also flexibility and the assured can choose levels and extent of cover needed, and the ability to pay premium by him/her. There is also an option of switching over from one fund to other if a policyholder feels that a particular fund is not performing satisfactorily. Unit linked policies provide several advantages to life insurance companies and investors. For a life insurance company, for example, solvency requirements for ULIP is much lower than other types of life insurance policies. Moreover, margins from New Business under ULIP is higher but the asset management fee is lower for unit linked policies compared to the participating policies. On the other hand the policyholders return is higher and there is better transparency and option for the policyholders to switch over. Unit linked policy offers risk cover growth option to the policyholders and a risk averse option too, policyholders can opt for a balanced portfolio, a risk-taking policyholder willing to take high risk and higher growth can opt for an equity portfolio on the basis of the risk tolerance limit. ULIP also offers partial withdrawal and surrender facilities. While in a traditional life insurance policy the insurer bears the risk of assured profit, a guarantee in ULIP is that the risk is borne by policyholders asset allocation, in a traditional life insurance policy it is the job of insurer, which means risk of guarantee is borne by the insurer, while in an ULIP the asset allocation risks is transferred to the policyholders. Recently, with the increase in popularity of ULIP, a large number of ULIP products with varying advantages are available in the market. ULIP products can be classified as unit linked, index linked or equity linked. In case of unit linked products funds are invested in equities, bonds, real estate and money market instruments. Index linked funds are invested in equity bond or money market index while equity linked funds are invested only in equities.

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There are wider options to pay premium and accordingly products are classified as single premium products or regular premium products under which premiums are paid monthly, half yearly or yearly.

Size of Unit Linked Market In the late 1990s and early 2000s there has been a steady growth in unit linked products basically due to the growth of bancassurance, the falling interest rates and booming stock market in many advanced economies. Though, unit linked is gradually emerging as a very popular product in western countries, it had a chequered character of growth. According to Swiss Re estimates unit linked assets between 1998 and 2001 increased annually by 18 per cent as against nonlinked assets which increased by 5 per cent. In industrially advanced countries sales of unit linked had a close relationship with stock market movement, for example, in a boom year in stock market in 2000 share of unit linked in total life insurance premium was more than 60 per cent in UK, more than 50 per cent in Italy, over 40 per cent in USA and France. However, the same declined with the end of stock market boom in 2000, with the share of unit linked in total premium decline in 2001. The share of unit linked in total premium came down to little over 50 per cent in UK, 50 per cent in Italy, little over 30 per cent in USA and about 25 per cent in France. However, expansion of global economy by 4 per cent and boom in stock markets globally provided further momentum to growth of unit linked products in 2004. The past glory of unit linked could recover in 2004 and as a result the share of unit linked in total premium income. By 2004, the share of unit linked in total premium of life insurances varied from 3 per cent (in USA) to 36 per cent (in Italy) share of unit linked in total premium in traditional unit linked market like UK and France was 20 per cent in each country. In India, there has been a steady growth in unit linked business since opening up of the market. Total linked business of all the life insurance companies increased from Rs 1,579.42 crore in 2003–04 to Rs 8,247.75 crore in 2004–05, that is, a growth of 422.19 per cent as against growth in non-linked business by 0.029 per cent (that is, growth of non-linked business from Rs 17,064.48 crore in 2004 to Rs 17,069.37 crore in 2003–04. However, investing in unit linked policies calls for better understanding of financial markets, development in stock markets, etc. Since performance of unit linked products to a great extent is linked to capital market. Moreover, cost structure is a bit complicated because life insurance companies impose several charges, such as, mortality charge and front end charge. There is also a recurring charge, which includes administrative charge, investment charge, switch-over cost, etc. There are also exit charges. These charges have significant adverse impact on return from unit linked policies. Therefore, decision to invest in unit linked products needs careful consideration and understanding risk return relationship. However, positive and welcome change has been brought by IRDA guidelines. The salient features of these guidelines are given in the following part of this chapter.

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IRDA Guidelines on Unit Linked Products Through guidelines issued on 12 December 2005 (Annexure 4.A.2) IRDA provides the detailed features of unit linked products which can be launched by life insurance companies in India. The guidelines also described various related issues such as market conduct, disclosure norms, advertisements and ratings of funds. Accordingly, the following are the basic features of a unit linked policy. Premium payment can be made at regular intervals such as yearly and half yearly, under a regular premium contract ULIP and also by a single contribution under a single premium contract. ULIP can be a limited premium payment contract or whole life contract. 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13.

Unit linked policy can be a single premium product or non-single premium product. Minimum policy term should be 5 years. Minimum SA of single premium policy and non-single premium policy. The SA payable on death shall not be reduced at any point of time during the term of the policy. No cover should be intended after the expiry of policy terms. An unit-linked product must have a guaranteed SA payable on death and may have a guaranteed maturity value. Acquired SV of a unit linked policy will be paid after Third Policy Anniversary. A lapsed policy can be revived if it is discontinued after payment of premium for three consecutive years. No loans shall be guaranteed under an unit linked policy. A partial withdrawal is allowed only after Third Policy Anniversary. The unit pricing shall be computed based on whether the company is purchasing or selling the assets. NAV of the fund will be calculated on a daily basis and will be made available to the public through the print media on a daily basis. Premium allocation charges, Fund Management Charge (FMC), policy administration charge, etc., also stipulated in the guidelines.

In addition to ones mentioned, the guidelines also outlined the market conduct norms, disclosure norms, advertisement norms and rating of funds.

Annuity Products The very purpose of a pension plan is to create financial assets which can be utilized after retirement from an active working life and to maintain a reasonable standard of living. Today, the global trend is to create such financial assets through self-contribution instead of depending on the state. Therefore, social security reform has been going on throughout the world by promoting DC system in place of the highly costly DB system supported by the state. Since pay out under a DC system is managed through annuity, it has emerged as a fast expanding market segment

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for life insurance. Under DC pension system individuals contribute to their own retirement benefits upto the date of retirement. Members of such schemes have an option to take some percentage of the contribution in cash while the remaining amount is to be utilized to purchase pension annuity to receive lifelong pension. This pension annuity is to be purchased from a life insurance company. An annuity policy is a contract in which the policyholders pay single premium or a series of premium to a life insurance company, which enables the policyholders to receive a series of periodic payments in future. Policyholders can also opt for death benefit or cash benefit. An annuity is basically a retirement investment instrument in which earnings grow according to the interest earned or according to growth in value of assets of underlying investment. Annuity rate is an important concept which implies the amount of instalment to purchase any type of annuity. The annuity rate is decided by the issuer from time to time on the basis of period of payment, life expectancy, going interest, administrative expenses, etc. Two basic types of annuities are fixed annuity and Variable Annuity. A fixed annuity provides guaranteed interest rate for a fixed period of time. Under fixed annuity an insurer has to pay guaranteed payment even if his/her earnings are less than promised, here the insurers bear the loss. This is very useful for conservative investors. Pay out under annuity begins with retirement. The policyholder gets regular income payments from the insurance company. Income payment may be received for the rest of the life of the insured or for his wife or family. Variable Annuity, on the other hand gives freedom to the policyholder to choose an investment option out of many, depending on his/her need the policyholder can diversify his/her portfolio. Apart from freedom to select an investment, it also provides an opportunity to the customers to balance his/her risk tolerance limit—for example, policyholders with high risk appetite may go for equity, while low risk tolerant policyholders may opt for low risk portfolio, say debt. The rate of return from annuity purchase depends on the performance of money invested in a particular portfolio. VA also offers benefit of averaging costs if regular investment is made. There is also scope for portfolio rebalancing and benefits of riders with low-cost. Annuities can further be classified on the basis of the schedule of payment of annuities, as immediate annuity and deferred annuity. Immediate annuity payment starts immediately after one month from the date of purchase and continues for a specified period, while payment under deferred annuity begins after the deferment period as per the contract which can be either a deferred immediate annuity or a deferred annuity due. There are many types of pension annuities, namely, life annuity, level annuity, escalating annuity, indexed linked annuity, limited price annuity and investment linked annuity which can be on a single life or on joint lives. Salient features of some popular annuity plans are discussed in this chapter. There are a variety of annuity plans such as Single Premium Deferred Annuity (SPDA), Flexible Premium Deferred Annuity (FPDA), Equity Index Annuity (EIA). Under SPDA, policyholders pay multiple premiums on an ongoing basis. We may discuss some important and popular annuity products.

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Level annuity: The most safe is the level annuity and under this plan the annuity provider invests the money in fixed income securities. The annuitant on the other hand receives constant income from the annuity providers. Escalating annuity: This is an extension of level annuity. Under this plan the payment received by an annuitant goes on increasing with the time period. Normally, the initial payment is lower than the annuity received under level annuity investment. Linked annuity: There are unit linked or VA and under such plans returns depend on investment performance. Generally, the premium received by an annuity provider is invested in an equity fund. A part of the investment is often given to the policyholders as bonus. Index linked annuity: Index linked annuity is also an escalating annuity. The annuity provider invests the premium in consumer price indexed linked bonds. Income received from this investment is paid to the policyholders. Return and payment to the policyholders increases with the rise in price index. Limited price index: This is another variant of index linked annuity but price increase is compensated to a limited extent. The return received from this is somewhat in between level annuity and full indexed annuity. Universal Life Insurance: UL insurance is a very popular insurance product particularly in USA and UK because of its flexibility and competitive interest rates. UL policy, like other products, offers life coverage and remains active till a policyholder dies. Death benefits under this policy are available to the beneficiaries after their death. There is usually a provision for minimum and maximum benefit and premium payment is also flexible—yearly, quarterly or half yearly. Cost of such a policy depends on the coverage purchased by a life assured, depending on age, health, riders, etc. Flexibility of premium payment allows policyholders to change the coverage depending on the need of the policyholders. One can select higher coverage in the middle age which will be at higher cost but for a selected period. There is also a provision for reduced payment of premium at a later stage, if the life assured desires so. Basic features of such plans can be: 1. Adjust the level of coverage. 2. Set amount and tuning of premium payment. 3. Use cash value of the policy to meet other financial needs—college education, retirement, etc. 4. Choose investment option. 5. Reduce risk spreading over number of separate ages. 6. Investment.

Capital Market Products Recent financial economy is marked by innovation of financial instruments. These innovations are supply-driven as well as demand-driven—though the primary urge was risk protection.

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Supply-driven innovation reduces the cost, improves the speed of service delivery. However, developments of capital market linked life insurance products are very few. Some of the recently innovated insurance products linked to capital market are catastrophe bonds, catastrophe swaps, industry loss warranties, contingent capital, life securitization and exchange traded options. These instruments help the insurance companies to transfer insurance risks to the capital market. Indian insurance companies can look more closely towards this new development in the capital market. However, the most popular among these new products in the advanced insurance market is life securitization. Life securitization is a new financial product of life insurance under which a life insurance company sells its product to a Special Purpose Vehicle (SPV) to receive expenses, policy acquisition expenses and mortality. The SPV finances purchase of rights through issue of securities in the capital markets. Through life securitization a certain amount of risk is transferred to the capital market and the insurer also receives money to finance business expansion. In USA and UK life securitization is gradually becoming popular among investors.

Microinsurance Product Microinsurance is an indicator about the necessity of expanding market base in rural and semi-urban areas as well as to provide insurance cover to the people in informal sectors and those belonging to economically vulnerable sections of society as indicated in the previous section. It is a fact though that over 70 per cent of Indians live in rural areas. However, still a vast majority of people in rural and urban areas remained uninsured, particularly those who are in lower income states and cannot afford insurance at normal price. Rural penetration of life insurance can be observed from rural share in New Business of the largest life insurer in India, that is, LIC. During 2004–05, the share of rural business policies was 22.97 per cent of policies and 25.16 per cent of SA. Therefore, in order to cover a large section of uninsured, particularly among the vulnerable sections of society, a new product ranged at a cheaper price was required to be launched and that ideal product was ‘microinsurance’. IRDA has come out with guidelines to promote microinsurance which will cater to diverse life and general insurance needs of the vast section of the society. We shall discuss in brief about the product range suggested by IRDA. In addition to the IRDA suggested microinsurance, there is also further scope of an integrated product for vulnerable sections of the society. An outline of such a product is also provided.

Microinsurance Product as per IRDA Guidelines IRDA has issued ‘Insurance Regulatory and Development Authority (Microinsurance) Regulations 2005’. It provides the structure of microinsurance products which can be launched by the Indian life insurance and general insurance companies. Two types of microinsurance products have been suggested by the regulators, namely, life microinsurance products and

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general microinsurance products. These products can be launched by a general insurance as well as by any life insurance company subject to fulfilment of certain conditions. Accordingly, important features of such products are discussed in the following part of the chapter. General Microinsurance Products

General microinsurance product means any health insurance contract, any contract covering belongings, crop insurance, health insurance and personal accident contract either on an individual or on a group basis. Accordingly under microinsurance general microinsurance short-term cover for 1 year can be provided. The salient features of such products have been underlined by IRDA. Dwellings, Contents and Crop Insurance

Dwellings and contents or live stocks or tools, Crop insurance on other named assets for an amount ranging Rs 5,000 to Rs 30,000 for 1 year term to individual or to a group (covering at least 20 members) short-term (1 year). Health Insurance (Individual)

Short-term (1 year) health insurance contract for an individual, the minimum amount being Rs 5,000 and maximum Rs 30,000 for 1 year. The maximum and minimum age can be decided by the insurer. Health Insurance (Family)

Short-term (1 year) health insurance cover for family with minimum and maximum SA from Rs 10,000 to Rs 30,000. Minimum and maximum age at entry to be decided by the insurer. Personal Accident

Personal accident insurance can be provided to per life/earning members of family for a term of 1 year. The minimum and maximum cover under such policy would buy Rs 10,000 and Rs 50,000. The minimum and maximum age at entry varies from 5 years to 70 years.

Life Microinsurance Products Life microinsurance products include term insurance, endowment insurance, contract or health insurance cover with or without accident benefit riders on an individual or on a group basis. IRDA has provided outlines for such products as following: Term Insurance with or without Return of Premium

Under such plans the minimum and maximum cover would be for Rs 5,000 to Rs 50,000, the term being 5 years to 15 years and the minimum and maximum age at entry being 18 years and 60 years.

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Endowment Insurance Contract

Under life microinsurance product, an endowment insurance maybe provided for a minimum amount of Rs 5,000 and maximum cover of Rs 30,000 with minimum and maximum period ranging from 5 years to 15 years. The minimum and maximum age at entry being 18 years to 60 years. Health Insurance (Individual)

Life microinsurance health insurance can be offered to an individual with minimum and maximum cover ranging from 1 year to 7 years for minimum and maximum amount of Rs 5,000 and Rs 30,000. The minimum and maximum age at entry to be decided by the insurers. Health Insurance (Family)

Life microinsurance health insurance can be offered to a family with minimum and maximum cover ranging from 1 year to 7 years for minimum and maximum amount of Rs 10,000 and Rs 30,000. The minimum and maximum age at entry to be decided by the insurers. Accident Benefits as Rider

Life insurer can also provide accident benefits as rider for minimum cover of Rs 10,000 and maximum cover of Rs 50,000 for a period of 5 to 15 years duration. The minimum and maximum age at entry being 18 years to 60 years, respectively. The regulation also provided provision for a tie-up between life insurance and general insurance. A life insurer can offer general microproduct provided it has tie-up with an insurer carrying general insurance products. Similarly, a general insurance company can offer life microproduct provided it has tie-up with a life insurance company carrying out life insurance business. A microinsurance product therefore includes both life and general microinsurance products and such plans are to be approved by the regulator. A microinsurance product can be sold by a microinsurance agent (including NGOs, SHGs, microfinance institution, etc.) corporate agents or brokers. The guidelines also incorporated code of conduct for agents overall commission, underwriting, compliance, etc.

Microinsurance Products Launched by Life Insurance Companies in India Since IRDA issued guidelines on microinsurance many life insurance companies in India have launched microinsurance plans. Most of these policies are savings related and the premium can be paid in a flexible manner—weekly, fortnightly, quarterly, half yearly or on a yearly basis over the term of the policy. Microinsurance policies provide various benefits to the policyholders, namely maturity benefit, death benefit, accidental death and disability benefits. Some of the well-received microinsurance policies launched in India are mentioned in the following part of the chapter.

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LIC of India launched Jeevan Madhur—microinsurance policy with a term of 5 to 15 years, addressing to both savings and risks with minimum and maximum SA of Rs 5,000 and Rs 30,000. A suitable premium payment term can be selected from weekly, fortnightly, quarterly, half yearly or yearly. Tata AIG Life, launched three microinsurance policies, namely, Navakalyan Yojana—a 5 year microinsurance protection plan, Sampoorn Bima Yojana—a microinsurance policy under which 15 years of protection is available by paying a premium of 10 years and Ayushman Yojana—a single premium, 10 years microinsurance protection plan. Birla Sunlife Insurance has also launched microinsurance plans namely, Bima Suraksha Super and Bima Dhan Sanchay for the rural masses. Bima Suraksha Super is a non-participating nonlinked term insurance plan while Bima Dhan Sanchay is a non-participating non-linked term with refund of premium insurance plan. Both the plans offer three options, namely, 5, 10, and 15 year policy tenure. The minimum and maximum SA being Rs 5,000 and Rs 50,000. SBI Life Insurance Grameen Shakti—a group microinsurance policy to provide life insurance protection to the weaker sections of society like people who are funded by microfinancial institutions or NGOs or who avail loan from bank. This is a 5-year or 10-year group master policy, minimum and maximum SA being Rs 5,000 and Rs 50,000. The premium can be paid yearly. There are survival benefits, death benefits, etc. Other life insurance companies also launched microinsurance plans. Microinsurance has tremendous growth potential in India which can be used as an effective instrument for inclusive growth.

An Outline of Risk Management Product for Economically Vulnerable Social risk management, can be implemented as a Group Mechanism (GM) financed by the members. The members of the group will put their savings in a designated fund regularly or in lump sum, they can avail loan when they are in distress. A part of such savings will be transferred to a designated insurance fund as premium which will be used to provide insurance benefits to the members in case of an eventuality. The scheme is built upon savings, credit and insurance to manage risks of vulnerable households through cooperative measures. The scheme is thus an integration scheme of microfinance, microcredit and microinsurance, and can be called as Integrated Scheme of Social Risk Management (ISSRM). ISSRM allows the members to build up financial assets for meeting future liabilities and lump sum expenditure, it allows the members to avail credit for emergency expenses and repay in future through ongoing savings. It also provides the members with life, health and other insurance benefits by paying a small part of their savings as insurance premium. A brief outline of an ISSRM, based on group value and supported by microinsurance, microfinance and microcredit follows.

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The Group: The scheme will be built upon local group dynamics—each village being a Local Group (LG). A LG will be subdivided into sub-local groups with 10 members and will be known as (SLG). The SLGs will be treated as a unit and LG is a combined local unit. Each SLG will be responsible for each member and each LG will be responsible for all the SLGs within it. Membership of SLG is voluntary and will be restricted to people who are below the poverty line, work in informal sectors and other criteria which are to be developed by a national level committee. The responsibility of SLGs will be: 1. 2. 3. 4.

To manage contribution of savings. To manage contribution of premium. To manage repayment of loans. To oversee appropriate use of loans availed by the members.

The LGs will act as the supervisor of SLGs, and will: 5. 6. 7. 8. 9.

Supervise regular contribution by SLGs towards deposits, insurance premium. LGs will act as collateral for loans credit obtained by any SLG. LGs will ensure to arrange repayment. LG will be the primary underwriter for microinsurance—life and health. LGs will facilitate the payment of insurance money to SLGs.

Microinsurance IRDA has already come out with a draft paper on microinsurance with a view to adapting insurance companies to the requirements of the microeconomy, linking them as wholesale institutions to SHGs, upgrading SHGs. The IRDA has proposed ‘life microinsurance product’ and ‘general microinsurance product’ covering health insurance and others such as insurance for hut, livestock and personal accident. Such products will be distributed through microinsurance agents which are NGOs. The scheme proposes minimum cover of Rs 10,000 and for individual cover the group should consist of minimum 10 members and for group cover there should be at least 50 members. The products would be distributed by individual agents, NGOs and SHGs. (A brief outline of such a scheme provided below.)

Micro Credit As we have discussed, microfinance and microcredit have tremendous potential to help the poor to mitigate their vulnerability and act as risk-transferring mechanisms. Presently, the

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network of commercial banking is unable to serve this group of people who do not have real or financial assets. Here, the example of Bangladesh can provide us guidance. Sometime back, it was proposed by the Finance Minister to set up LAB in rural areas combining a cluster of villages. This proposal can be revived and can give effect to setting up of microcredit network throughout the country. However, the LAB project can be a reality only with national level efforts. 1. All the commercial banks—public and private sector—should join to form a National Micro Finance Fund (NMFF) which will provide a part of initial capital of LAB, to form the regulation, delivery system, etc. 2. Private and public sector institutes, NGOs and SHGs can join to set up LAB. 3. LAB will be delivery based institutions catering to the needs of poor, vulnerable, small farmers, artisans and informal sector groups. 4. Groups will be responsible to ensure that deposits are paid by the members and also repaid on time, which would be flexible for loans made by the members. 5. Credit from LAB would be made available for economic activities such as setting up microenterprise, house building and higher education of the members. 6. Rules, regulations and banking practices will be simple and easy to understand by rural people.

Linkages—Macro Effects of Microinstitutions 1. 2. 3. 4.

LAB would be allowed to act as a microinsurance agent. Premium for microinsurance can be channelized through the deposit of the SLGs. Microinsurance institutes can provide insurance cover to the loan granted by LAB. This linkage would strengthen the financial ability of LAB as well as reduce the credit risk. On the other hand microinsurance institute will get agents having linkages with it. It will also ensure regular payment of premium by the policyholders.

Emerging Distribution Practices in Life Insurance We have noted above that financial sector convergence has brought a distinct change in consumers expectations, new product development and product placement. Alternatively, there has been a significant transition in product–market relationship in life insurance. Product distribution is a critical function in management of life insurance business. It is more critical because the product is intangible, investment is for long-term and there are realizable and unrealizable benefits. Therefore, distribution of such a product calls for predistribution planning to establish a linkage between product, quality, product value and behavioural aspects of targeted segments of customers.

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Since, the requirements and expectations of life insurance customers are influenced by their family, educational and financial status, their behaviour also differs. Since there is a wide difference in the expectation and buying behaviour, distribution, planning and strategy must differ to absorb the differentiated buying behaviour. Depending on the buying behaviour and background of the customers, (http://www.managingchange.com/sim/segment.html) life insurance market is often classified as: 1. 2. 3. 4.

Financially unaware. Financially aware. Financially astute. Financially nichers.

Segmentation on the basis of financial understanding and need, will suggest the most appropriate distribution strategy and channel. For example, direct sales force/agents maybe more successful to deal with financially unaware segment of market, while telemarketing, direct sale may help an insurance company to reach the financially aware segment of market. Similarly, brokers, banks and telemarketing maybe used for capturing financial niche market. However, in life insurance distribution, most successful ingredients of success are in relationship and one to one interaction, since trust is the most important factor which dictates purchase. High degree of trust, degree of brand value and product–market knowledge of the distributor (agents/brokers, etc.). Relationship market, therefore, has emerged as an important strategy in modern marketing of financial products, particularly in life insurance, which has great potential to add value to customer buying of a life insurance product. However, relationship marketing can be strengthened largely through one to one sales/purchase and subsequently extended to one to one servicing. Marketing is a composite concept which includes sales and servicing. In fact servicing has a stronger impact on market expansion through relationship building among customers and service providers. Because life insurance contracts extending over a long period ranging from 15 to 20 years, service relationship matters. The degree of quality, speed, cost and care to the existing potential customers, would have immense impact on further sales. Therefore, a composite concept of marketing including bundle of influencing factors such as distribution, relationship and servicing need to be put on place for effectively developing product–market relationship in the marketplace.

The Channels of Distribution There are several channels of distribution for life insurance products such as sales through tied agents, brokers, other intermediaries such as corporate agents and banks. Agents are the oldest and tested distributors of life insurance products, though of late, in the post-convergence period, bancassurance has emerged as a fast growing intermediary in many countries of Europe as in

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India in the aftermath of deregulation of life insurance industry. However, whatever be the accepted channel of distribution the approach must be based onto: 1. 2. 3. 4. 5. 6.

Institutionalize strategic intent of channels. Manage distribution as a business. Create unique and consistent customer experience. Excel in few areas that provide competitive advantage. Make business partnering a core Use the Internet to enhance multichannel distribution.

However, this approach must aim at improving sales management effectiveness, enhancing sales revenue, adding new customers and retention of existing customers. As indicated earlier like other policies in a life insurance, distribution policy should also be customer centric to enhance customer value by selling need-based products at reasonable costs to maximize sales revenue. We may now look into various distribution channels that are being used for distribution of life insurance products.

Tied Agents Tied agents are the major force pushing insurance sales in India and the only intermediary before deregulation of the insurance sector in 2000. Agents are recruited by insurance companies, primarily on the basis of location and they are mostly tied to the nearest branch office. In LIC, there are various types of agents like ordinary agents who work under a supervisor called a development officer, career agents who work directly under a branch manager, and career agents branch and direct agents who are working under the branch manager. Tied agents are the major distribution channel and specialize in distribution to specific customer segments and products, though there is no regulatory requirement. Most of the private sector companies along with alternative channels are focussing on tied agents in India. During 2004–05 the total number of agents on roll in LIC was 1,041,737 out of which 72,274 were urban and rural career agents (LIC Annual Report 2004–05). According to IRDA Annual Report 2003–04, as on 31 March 2004, 933,002 individuals and 2,389 corporate agents have been issued new licences. IRDA has stipulated minimum educational and training requirements for these agents and also issued code of conducts for them.

Insurance Brokers Insurance brokers and independent financial advisors are also a critical link between an insurance company and customers. They provide valuable services to the client by analyzing their needs and assessing the risks. They act in the interest of the customer and they are neither employees nor tied to any insurance company. By 31 March 2004, there were 2,154 insurance brokers.

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Bancassurance Deregulation of insurance sector in India has also witnessed another new channel of distribution, namely, corporate agents. During the financial year 2002–03, IRDA has issued notification on corporate agency regulation allowing banks and other corporate entities to distribute insurance products. This was the beginning of bancassurance in India. Accordingly, a bank can act as an agent of one life insurance and one non-life insurance company. Bancassurance as we have noted earlier is a by-product of financial sector integration and is becoming particularly popular with increased demand for non-conventional (savings products) of life insurance. Bancassurance provides a variety of benefits to customers, insurance companies and banks.

Banks Bancassurance by selling insurance products derives several benefits particularly it helps them to augment revenue, allows them to leverage customer base, expand their own customer base by taking care of a wide range of financial needs of a customer and to achieve economies of scale in operation through integration of financial services.

Insurers Insurance companies also receive tremendous benefits by allowing a bank to sell insurance products. Bancassurance helps an insurance company to reduce its excessive reliance on agents, expand the customer and market base through bank clients. Bancassurance also provides momentum to innovation in product development, enhancing revenue through reduction in sales costs and emerge as near integrated financial service institutions.

Customers Customers also receive several benefits by buying insurance through banks. Distribution/sales cost in respect of bancassurance are relatively lower, customers also receive the benefits of advice when they purchase an insurance policy from his/her banks. Moreover, customers can receive banking services such as ATM, credit card of his/her bank for paying premium. Service relationship and trust between bank and customers further increases the confidence of policyholders. A survey conducted on bancassurance in UK in 2000, shows that the average cost of bancassurance as percentage of premium equivalent for bancassurance was 33 per cent as against 42 per cent for independent financial advisors and 78 per cent of direct sales force Swiss Re (Sigma No. 7/2002). The various approaches of bancassurance are distribution agreement, strategic alliance and joint venture.

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Distribution Agreement

Under this agreement banks sell insurance products on stand alone basis and receive commission, no other relationship like database sharing exists. Strategic Alliance

It is a more integrated relationship under which database of banks used for selling insurance products provides a higher degree of inter-institutional relationship. Joint Venture

Bancassurance may also be in the form of joint ventures by sharing products, database and strategic inputs of both the partners of a joint venture. This is a near close relationship of total integration. A further step towards integration would be promoting a financial conglomerate for a multi-product distribution channel. As a result of multi-dimensional benefits bancassurance has been immensely popular in developed as well as developing life insurance market. In countries like France and Italy, bancassurance has emerged as the largest distribution channel. In the year 2004, bancassurance accounted for 62 per cent to 60 per cent of total premium, respectively, in France and Italy. Bancassurance is also fast catching up in Asia and in many other countries about 40 per cent of new premiums is coming through this channel owing to the convergence in financial services industry. In 2004 the share of bancassurance in China was more than 25 per cent, while that in Singapore was nearly 30 per cent, in Korea it was nearly 40 per cent and in Malaysia over 35 per cent in 2003. In other insurance markets in Asia, bancassurance has emerged as the preferred distribution channel. Bancassurance in India is a recent phenomenon, getting popularized after deregulation and entry of private insurance companies. However, individual agents still remained the most important channel of distribution. During 2003–04, 95.3 per cent of life New Business was underwritten through individual agency business, while only 1.30 per cent of business came through brokers. In case of LIC, 99.78 per cent of New Business was underwritten through individual agents and only 0.11 per cent through banks. However, 10.57 per cent New Business of private life insurance companies came through banks and 60.39 per cent through individual agents (IRDA Annual Report 2003–04). However, some private companies like SBI and Aviva Life have underwritten around 50 per cent New Business through bancassurance. Predominantly higher dependence on bancassurance by private companies is due to the intention of low-cost market penetration. Promoting an efficient agency force, which LIC could manage over 50 years was not possible for them due to cost and time factor. Therefore, alternative channels like bancassurance was the easy and cost-effective way. However, bancassurance in India is becoming a popular and acceptable channel even for the public sector LIC of India. By the end of 31 March 2005, LIC had tied up with 31 banks having 10,175 outlets and corporate agents operating through 1,920 outlets (LIC Annual Reports 2004–05). Though

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bancassurance has entered in the market and is making waves in the urban areas, strategic direction to strengthen this channel through technical expertise and right mix of product and business model is required for effective and faster growth.

Direct Marketing Direct marketing as a distribution channel is also catching up fast due to the spread of distribution network. Entry of bancassurance and brokers in insurance selling also speeded up direct marketing through mailing and other media. Brokers and banks reach to their client group through mailing of products and educational literature. With the strengthening of these channels and spread of insurance education, direct sales are likely to increase further. During 2003–04, while private companies have underwritten 14.37 per cent of their own business, it was only 1.63 per cent of total New Business for the industry (Table 4.2). TABLE 4.2 New (Premium) Business (Life) Underwritten through Various Intermediaries 2003–04 (in per cent of total business) LIC Individual agents Corporate agents Banks Others Brokers Referrals Direct business Total new business (Rs in crore)

Private Sector

Total

99.78

60.39

95.32

0.11 0.09 0.02 0.00 0.00 16,989,2964

10.57 6.86 0.31 7.50 14.37 244,070.58

1.30 0.86 0.05 0.85 1.63 1,943,000.22

Source IRDA, Annual Report 2003–04.

E-commerce Like any other service industry e-commerce is also emerging very fast in life insurance. Websites of insurance companies, payments through Electronic Clearing Service (ECS), credit card, etc., promote e-business in life insurance. Designing an appropriate strategy is a critical factor for success. This strategy must be segment and product oriented, having a high degree of educational element. Lack of awareness about PFRM and availability of appropriate products, often acts as a deterrent to life insurance purchase. Therefore, life insurance companies pay attention to this aspect of distribution in the interest of market creation and expansion. An effective strategy with appropriate product– market mix would enable distribution to achieve distributional objectives.

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Strategy for Rural Market Even after 58 years of Independence it is said that India lives in villages because over 74 per cent of its population lives in villages which consists of more than 740 million people. Therefore, no market can be thought of by excluding this large population. Though there is uneven development in India which exhibits wide regional disparities, the same growth pattern may not continue for long and growth momentum is bound to travel to these villages. There is already an indication of this shift reflected in the increasing purchasing power and consumption in rural areas which provides a huge life insurance market. A part of this growth in savings and consumption needs to be converted into life insurance savings by creating an awareness about the importance and necessity for PFRM through life insurance. The tremendous potential of rural life insurance market has been observed in a study conducted by Marketing and Research Team (MART) sponsored by FORTE (Joshi 2005). The rural folks have a strong saving habit—they save about one-third of their incomes annually across the three income segments studied. It was stunning to learn that respondents, even the ones residing in backward areas were quite conversant with insurance. Almost 93 per cent of the respondents were aware of life insurance and 61 per cent were aware of motor and accident insurance. Around 36 per cent of them had bought some insurance or the other and another 38 per cent of these policyholders had intentions to buy more. A little over half (51 per cent) of all the respondents had the intention to buy insurance products. Out of the nonpolicyholder respondents, 62 per cent intended to buy. If these numbers are extrapolated over the macro level, rural population being 742 million, the potential market could be a mindboggling proportion. The study therefore comments that in rural areas there is ‘Existence of a huge savings market which after potential for expansion of life insurance and awareness level is very high but real purchase is low due to absence of market reach and probably due to lack of financial literacy’. However, in spite of existence of vast potential in rural areas, penetration remained to be very low and is currently hovering around 2.8 per cent of GDP (Joshi 2005). This poor penetration of life insurance in rural areas prompted IRDA to issue guidelines of obligations for life insurance companies to complete specified percentage of business in rural and social sector. The regulation requires insurers to underwrite business based on the year of commencement of their operations. The regulation further provided that in case the first financial year of the insurer is less than 12 months, proportionate percentage or number of lives as the case may be shall be underwritten. In addition, the existing public sector insurance companies are required to ensure that the quantum of insurance business underwritten by them shall not be less than what has been recorded in 2001–02. Indian life insurance companies making efforts to fulfil regulatory obligations and the share of rural business in New Business during 2004–05 was 22.97 per cent of SA and 25.18 per cent of policies. According to IRDA Annual Report 2004–05, ‘Overall, all the life insurers have met their obligations towards the rural sector, however there was a shortfall in number of lives

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covered in the social sector in respect of two insurers’ (in 2003–04). Implicit in this statement is the indication of obligation. However, rural penetration need not be seen as a regulatory obligation but rather as a potential market for the insurance company. Since rural India differs from urban India in several respects such as general literacy, financial literacy, financial infrastructure, skewed pattern of income distribution, concentration of wealth and assets in the hands of few and seasonality of income a distinctly different marketing strategy needs to be placed. Marketing in rural areas is not merely selling—it involves trust building, identification of financial knowledge gap and personalized service content strategy. The approach, the product and the distribution needs to have a different look than that followed for the urban market. Marketing strategies for rural areas must be distinctive to incorporate rural characteristics with respect to reach, reflects and reactions of buyers of insurance. This calls for differentiated distribution approach, knowledge and market technology. Indian rural market is heterogeneous and fragmented in choice, purchasing power and risk tolerance limit spread over a wide geographical dispersion hence, no uniform strategy would work efficiently. Further, economy of choice in the rural areas is strongly influenced by old beliefs of the customers as well as by the trade offs between consumption and savings. Understanding the pattern and rationale of rural market, becomes prerequisite to formalize any strategy of penetration. Therefore, whatever the distribution medium/channel might be, it must be based on the psychology of rural decisionmaking of the potential customers of insurance.

Specialized Products While individual life products have its own appeal amongst large sections of rural population having regular income and capacity to pay premium,there is a need for products which can take into account people having seasonal income. Further, for the low income people low premium risk cover is also required. Life insurance companies need to design life products which can match the buyers choice. Products that are designed for insurance market need to consider the seasonality of income and payment capacity in rural areas. Some products linking premium payment to harvesting seasons, that is, Seasonal Premium Payment (SPP) on regional basis maybe thought of. Some other products linking periodic payout to a festival, cultural or a social function will be attractive as savings instruments for the rural people. Most important characteristics of any rural product would be a bundle of benefits. Research conducted by FORTE also found similar echo about rural product preference. According to ‘FORTE findings’ 78 per cent of respondents prefer various combinations of life insurance such as life + accident, life + loan and life + health + accident. Any specific rural product needs to consider these expectations. Though an extensive rural financial structure has been developed by government agencies, NGOs and panchayat samitis connectivity and interrelationship is quite weak. These organizations have been serving the rural people and established their credibility in rural society.

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These institutions could be successfully utilized for promoting life insurance education and life insurance business in the rural areas. LIC of India has initiated various measures to create and enhance awareness about life insurance in rural areas institutions such as commercial banks, regional rural banks (RRBs), post offices and cooperatives need to be integrated and can be used as distribution outlets by insurance companies. Village Huts which are in action once or twice in a week can also be used as nodal points of sales and insurance education. Internet and computer culture is spreading very fast in rural areas—which is also promoting cybercafes. Local level cable operators are also coming up in semi-rural places. These can be used for educating rural people about distinctive benefits of life insurance which will lead to sales.

Strategies Adopted for Rural Market Penetration LIC of India LIC of India, since its formation has extensively penetrated in rural areas of the country by starting branch offices, recruiting development officers and agents and by implementing rural career agents. LIC has been promoting rural distribution channel with strong local linkages. These rural distributors are capable of educating and motivating rural people about the necessity of life insurance keeping in view local constraints.

Rural Career Agents (RCAs) of LIC This scheme has been introduced through specialized training and financial incentives. On one hand the programme of RCAs created employment opportunities for the educated rural youth on the other hand it helped to promote life insurance consciousness and business for LIC of India. Accordingly, a person aged between 18 and 35 years with minimum qualification of tenth standard can become a RCA after receiving 100 hours of training as stipulated by IRDA. The RCAs are also eligible for incentives in addition to a stipend of Rs 750 per month in the first agency year and 600 per month in the next year. They are also eligible for commission like other agents. These agents are required to do business in rural areas where population of a village is less than 5,000. LIC has also introduced Bima Gram scheme to provide a further thrust on rural business and to help the rural people. Bima Gram, is a rural marketing strategy to penetrate into deep rural sectors for tapping rural business systematically and for more and more coverage in rural areas, especially in villages with population less than 5,000. Under the Bima Gram scheme LIC extends financial support of up to Rs 25,000 to each Bima Gram village for installing hand pumps, etc. LIC has also been focussing on specialized products for rural markets, for example, a separate life insurance plan ‘New Jana Raksha’ has been specially designed keeping in mind the needs of the prospective policyholders of rural areas. The special additional feature of New Jana Raksha plan is that if after at least 2 year’s premium has been paid, even if premium does not get paid

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for any reason full death cover will be continued for a period of 3 years from the first unpaid premium due date. All policies issued under this plan will be covered for accident benefit.

Social Security Schemes LIC has also launched social security schemes such as Janashree Bima Yojana and Shiksha Sahayog Yojana. Janashree Bima Yojana

The scheme was launched on 10 August 2000. The object of the scheme is to provide life insurance protection to the rural and urban poor people living below poverty line and marginally above poverty line. It is a 1-year renewable group insurance scheme. Shiksha Sahayog Yojana

It is a scholarship scheme launched on 31 December 2001 for the benefit of the children whose parents are members of Janashree Bima Yojana. Under this scheme a scholarship is given every quarter per child for a maximum period of 4 years. The benefit is restricted to two children per member (family) only. No premium is charged for the scholarship. Benefits are paid out of the social security fund.

Krishi Shramik Samajik Suraksha Yojana 2001 Khetihar Mazdoor Bima Yojana was announced by the Finance Minister in his budget speech. The name was later changed to Krishi Shramik Samajik Suraksha Yojana 2001. The scheme was launched on 1 July 2001. The object of the scheme is to provide life insurance protection, periodical lump sum survival benefit and pension to the agricultural workers.

Aviva Experiment Aviva Experiment in rural marketing is a part of overall marketing strategy. Aviva life insurance made strategic partnership with MFIs for providing microinsurance through these organizations. Bancassurance strategy of Aviva integrated rural markets. It has three pronged bancassurance approach: 1. Indian banks with extensive reach—national spread. 2. Multinational banks: ABN Amro, Amex-Hi-Net worth customer access. 3. Regional Indian banks: regional/rural banks.

TATA-AIG TATA-AIG rural market strategy focussed on microinsurance programme which includes designing a long-term affordable microinsurance product and specialized promotional activity.

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SBI-Life SBI-Life rural marketing strategy focussed on enlisting Regional Rural Banks (RRBs) of the country, as corporate agents by providing training to employees designated as nodal staff for insurance selling (Krishnamurthy 2003). RRBs to roll out a group annual renewable term insurance plan (Super Suraksha) to the customer by offering life insurance cover upto Rs100,000. The staff would meet groups of rural customers and explain the benefits of life insurance cover and issue a master policy after customers sign a good health declaration. RRBs also provide various other assistance such as claim verification.

E-Choupal Experience of ITC e-choupal is an excellent example of successful rural rooted strategy. ITC e-choupal manned by a sanchalak with the help of a computer and Internet connectivity for procuring agricultural products and providing a variety of services to the villagers has been remarkably successful in business prostration. The strategy is a combination of technology, general information relevant to villagers and business objectives. As a result, there is a sense of ownership of e-choupal among villagers. Rural marketing strategy of life insurance companies also needs to create a sense of involvement through transfer to village and creating ownership among potential policyholders in rural market creating employment opportunity by enlisting insurance advisors from lower strata of society monitoring and mentoring through rural organizations. Multichannel strategy for rural marketing maybe quite effective, but the core of such a multichannel strategy would be need-based sales with care. Any strategy must have short-term and long-term objectives. Today, due to infrastructural deficiency and network constraints rural marketing and business expansion is a costly proposition for insurance companies. However, multi-dimensional competition is also likely to increase channel management cost in saturated urban market in the long run. Moreover, growth is expected to shift to the backward and rural areas in future. Therefore, to take an advantage of this shift and changing scenario one would expect a long-term marketing strategy to be put in place before the rural market becomes a hot pot of competition. What is more important in the emerging market evolution, is innovation in product–market relationship for having a competitive edge.

Focussing on Consumers’ Interest It is the consumers who are the driving force of any industry; they are the engine of growth. But very often this truth is forgotten while emphasizing on marketing, which to many means sales. Sales is only one component of marketing, the other being servicing to the customers. Therefore, no marketing initiative can end with desired results without being evolved around customer servicing, which further centres around customer value enhancement. It is a fact that no service industry can deliver 100 per cent satisfactory services to the customers, but a Minimum Benchmark Service (MBS) to protect the interest of customers with

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enhanced value addition can be thought of and delivered. It is not only necessary but also an essential condition for growth and survival of any life insurance company especially in a competitive environment. But it seems that Indian life insurance is yet to go a long way to design and deliver customer expected service package, though since deregulation a considerable improvement has been observed. A study conducted by FICCI and circulated during its ninth conference on insurance indicated that 30 per cent customers considered that the improvement was ‘high’ 5 per cent ‘low’ and 65 per cent as ‘medium’, indicating the slow pace of changeover. Regarding claim settlement, though 65 per cent of respondents felt that claim settlement has improved since liberalization, 22 per cent felt that still the insurance companies have a long way to go in easing out the procedures of claim settlement. The issue of protection of policyholders was also highlighted in the FICCI survey and the results indicated that 83 per cent respondents (intermediaries and companies) keep the consumers informed about new developments. It was also stated that this is a better way to protect interest of customers while 70 per cent felt that creating consumer cells and 30 per cent felt providing timely investment advice would protect the interest of policyholders. Since, IRDA is concerned about protection of interest of policyholders it has issued Protection of Policyholders Regulation 2002. The regulation is quite comprehensive and covers issues related to sales, insurance proposal, grievance redressal procedures, claims procedures and other important contents of life insurance policy. The regulation aims at improving policyholders servicing by covering insurance intermediaries, policyholders and insurers. The salient features of the regulation are outlined in the following part of the text below: z

z

z

z

z

Point of sales: The guidelines at the point of sales relates to the prospectus which should clearly state the scope of benefits, extent of insurance cover, whether the product is participating or no, warranties, etc. Proposal for insurance: A written proposal to be submitted for insurance cover and the insurer should furnish the acceptance within 30 days free of charge. Grievance redressal procedure: Every insurer puts in place a proper grievance redressal mechanism to address complaints and grievances of policyholders. Matters to be stated in life insurance policy: A life insurance policy document must contain information such as name of the plan and its terms and conditions; participating or nonparticipating; basis of participation such as bonus, deferred bonus, simple or revisionary bonus; date of commencement and date of maturity; terms of premium payments; admission of age; requirements for conversion into paid up, revival, non-forfeiture; nomination; assignment and various clauses like first pregnancy and suicides. Claims procedures: The regulation also provided guidelines on claims settlement. It has also given 15 days time limit to an insurer to call for additional requirements for settlement of claims.

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Policyholders servicing: To provide prompt service to the policyholders, the regulations stipulated 10 days time within which an insurer must reply the receipt of any communication from policyholders in service matters such as change of address, change of nomination, noting assignment, information on status of a policy, disbursal of loans and issuing duplicate policy.

Though policyholders servicing is critically important for any insurance company, it often gets neglected due to excessive importance on sales function. Therefore, this regulation on protection of policyholders’ interest is a step in the right direction and will go a long way to improve policyholders servicing. International Association of Insurance Supervisors (IAIS), has also come out with some core principles to be maintained by its members. Accordingly, the supervisory authority sets minimum requirements for insurers and intermediaries in dealing with consumers in its jurisdiction, including foreign insurers selling products on a cross-border basis. The requirements include provision of timely, complete and relevant information to consumers both before a contract is entered into through to the point at which all obligations under a contract have been satisfied.

Insurance Ombudsman Another important step to protect the interest of policyholders, to improve policyholders servicing and to redress the policyholders’ grievances is the scheme of insurance ombudsman introduced in 1998. Ombudsman are appointed by the governing body of the Insurance Council of India on the recommendation of a committee comprising of the Chairman of IRDA, Chairman LIC and GIC and a representative of the Central Government. Ombudsman are drawn from the insurance industry, civil services, judicial services and are appointed for three years, but can be removed from services on account of misconduct. The insurance ombudsman have two types of powers, namely, conciliation and award making. They receive complaints regarding total or partial repudiation of claims, disputes regarding premium payments, legal construement of policy wordings, delay in claims settlement and policy issue. However, they can exercise power within the contract value not exceeding Rs 20 lakhs. The ombudsman may assist the policyholders and insurers to settle complaints through reconciliation and make recommendations. If not settled through recommendations he passes an award within 3 months of receipt of complaints, which is binding on the part of the insurer. IRDA Annual Report 2003–04 indicates that the complaints made to the ombudsman is on the increase every year. During 2003–04 they received 3,404 complaints pertaining to life insurance in addition to 564 outstanding complaints and total 3,289 complaints were disposed off. However, out of the total 3,289, 1,735 complaints were not entertained, 94 case recommendations were made, in 392 cases awards were given, 339 were dismissed and 684 cases were withdrawn/settlement made and 45 were non-acceptance. The large number of cases is an

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indication of dissatisfactory services to the policyholders and insurance ombudsman scheme serving an useful purpose in redressing the grievances of the policyholders.

Developing Marketing Strategy through Marketing Research One of the essential functions of any manager in a business organization is to take a decision about what to do next. However, this decision can be passive or active. A passive decision maker, very often, likes to guess the future on the basis of past experience and may also act only as and when an emergency arises. But an active manager would think about tomorrow, while taking any decision today. Not only that, he would try anticipating probable changes in future and would take futuristic decisions. Therefore, in a changing world full of uncertainty—what we need is to have an active decision-making environment and the managerial ability to take riskoriented futuristic decisions. But the future is always uncertain and there is always an element of risk—risk of failure. Risks are of different types: risks arise from internal as well as external factors. However, in order to sustain growth, corporates must be able to control, eliminate or minimize the harmful impact of unforeseen risks on business owing to: 1. 2. 3. 4. 5. 6. 7. 8. 9.

Changes in macro economic environment. Changes in regulatory environment. Changes in competition structure. Changes in people’s perception about management style, efficiency, etc. Changes in demand structure. Changes in technology. Changes in resources holding pattern including assets. Changes in institutional factors including culture. Changes in social values, etc.

Identification of the future changes and the nature of risks/threats are essential for efficient management in order to take precautionary measures. Uncertainties are not necessarily always negative and management’s action may lead to regenerate business restructuring and induce innovation in the organization. Therefore, corporates must evolve a mechanism to perceive the emerging business risks to tackle them successfully through a well-defined strategy. Strategic planning therefore becomes an important tool for managing change. However, the backbone of strategic planning is forecasting of change. There are several methods of forecasting which can be divided into three categories, namely, qualitative technologies, time series technique and causal models. Qualitative models are qualitative in nature (such as expert’s opinion) and utilize information about special events. Time series uses historical data to establish a pattern of relationship and to predict future while the causal model attempts to establish cause–effect

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relationship. There are several qualitative or judgemental methods but the most widely used methods are ‘Delphi’ and ‘Scenario’ methods.

Developing a Scenario of Change A ‘scenario’ has been described as a possible future based on a mutually consistent group of determinants, often it is defined as ‘a qualitative or quantitative picture of a given organization or group developed within a framework of a set of specified assumptions’. Further, it has been delineated as ‘a description of a possible future based on a set of mutually consistent elements, within a framework of specified assumptions’. However, scenarios are only a means to an end. They identify the long-term forces, nature of change and consequent events which the long range planning must address. Therefore, the next step would be to start matching limited resources of the organization to the greater challenges of the external environment. Therefore, the scenarios would help the organization to face long-term threats and opportunities. Long-term threats come out of changes in socio-economic and political environment. Therefore, appropriate strategic planning is needed to cope with the challenges thrown up by the structural change. A scenario is a description of future events based on the assessment and vision of the author about the likely changes of various factors. The most likely scenario of progress of events is based on the current trend and not much change is expected to occur. Generally, multiple scenarios are prepared. These scenarios can be positive or negative based on the qualitative assessment and quantitative analysis. Since a business organization works in various markets, the changes in these markets influence the cost and revenue. Therefore, a scenario planning system attempts to define the entire environment in terms of a linked model of the macro economy of relevant markets. The systems of scenario planning are based on the four models, namely, Macro-Economic Model, Market Demand Model, Market Supply Model and Corporate Financial Model. Scenario planning starts with the macro economic assumption as the base case and intuitive view of the factors has effect on business and its financial structure. To start with, business accounting in financial model is prepared which is used as a tool for planning by examining the change from base case. The financial structure is prepared with reference to profit, loss, cash flow, investment inventory capacity and market strategy, and a scenario is developed to see how these variables react to changes. The financial model must be linked with a Macro-Economic Model indicating future macro economic variables such as exchange rates, interest rates, national income, per capita income, consumption, spending and prices to arrive at a probable future scenario. Once the accounting (financial) and macro economic outlines are prepared, both the models are linked by analyzing the future market development. Reliability of future scenario will depend on the predictive ability of the planners mind set, availability of data, knowledge and interpretation skills of financial data in the profit and loss account, balance sheets, etc., are required to develop an accounting model. Deep understanding of various national and international economic and

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financial developments is required to develop future macro economic scenario necessary for strategic planning. Scenario planning needs to involve top level management and the best scenario can be designed by a team of experts. It is always advisable to prepare alternative scenarios. Scenario planning as a qualitative tool often suffers due to incompetence and biased view of planners. However, if it is prepared by a competent team it can be superior than the other two models which rely on analysis of past data. Moreover, structural discontinuity can be more effectively dealt with by this model than by the time series and causal model. Due to the simplicity and strong predictive ability ‘Scenario Planning’ is widely used. Scenario development is a powerful technique widely used by many successful companies such as Shell and Sprint. Scenario is developed to identify issues, promote managerial sensitivity and initiate actions, it is considered to be the key to tackle uncertainties. Thus, ‘scenario development is a means of ensuring efficient and effective, strategically consistent and coherent managerial responses to unexpected though not unanticipated changes’. A scenario must be simple to understand. Simpler scenario can be more effectively utilized for strategic planning. The entire process of scenario planning can be regrouped as: 1. Environmental analysis. 2. Scenario planning. 3. Corporate strategy. Environmental analysis includes scanning of socio-economic and political information (internal and external), to recognize the signs of change on the medium- and long-term horizon. However, special aptitude and expertise are needed to identify the source of information, scanning the data and examining the same. A scenario planning exercise includes the following six steps: 1. 2. 3. 4. 5. 6.

To decide drivers of change. To formulate assumptions. To bring drivers together into a viable framework. To produce initial mini scenarios. To write the scenarios. To identify the issues/points.

To develop a scenario we need to identify the most important internal and external factors (called drivers) based on certain assumptions which will decide the future environment. The key internal factors are resource management style, product distribution, etc., and the key external factors are economic, regulatory, technological, political and competition, etc. The identified drivers of change need to be brought together and grouped into a meaningful

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pattern. To produce initial mini scenarios. These drivers of change need to produce initial mini scenarios and establish connection between them. Produce complementary scenarios by changing assumptions—test the scenario for viability. Thereafter a complete scenario needs to be developed keeping the organizational goal in view.

A Conceptual Framework of Marketing Research Changes in customer’s behaviour, income and earning patterns, size of his needs, etc., have a significant bearing on the success of any marketing operation. Thus, monitoring these changes accurately becomes extremely important. A framework for such a marketing research which includes: laying down the purpose; outlining the process; objectives; scope; taking into consideration the market forces and types of research to be conducted. Analytical ability of the research person makes a qualitative difference in projection of future. The most important function in the whole process of marketing operation is the marketing research. Marketing research is so important because it is the most scientific means by which a company can keep itself informed about the needs and attitudes of its customers and that of its competitors. Thus, marketing research provides a linkage and channel of information flow between the company and its customers. It is important for a company either engaged in manufacturing or providing services to know the underlying motives of purchase of goods by some and rejection by others. It is also necessary to have a system of constant monitoring of change in customers behaviour, income and earning patterns, growth of customers, size, degree of needs and wants, to what extent wants are satisfied or unsatisfied and what economic value the buyer would attach to the goods and services. The answer to this whole range of questions lies in scientifically executed marketing research, which however, depends on the skill and commitment of the researcher and the value of the organization attached to it. Here an attempt has been made to give a framework of marketing research process to achieve the above objectives.

Purpose of Marketing Research The purposes of marketing research can broadly be categorized as (a) to reduce uncertainties involved in decision-making process about specific aspects of marketing, of marketing in particular and (b) to monitor and control the performance of marketing activities.

The Process of Marketing Research There are several processes of marketing research, the important being: exploratory phase, research plan, problem formulation, sources of information (Primary and Secondary), collection of data, analysis of data, summarizing and reporting the results.

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Research Objectives Any research activity must first of all identify the objectives. In life insurance research the following can be the major objectives: total market size, significant segments of markets and market coverage.

Analysis of Characteristics of Markets Customers’ needs and function of services, desirable service features, customers’ practices in seeking services, customers attitudes and activities, competitive conditions, share of markets, service costs and related practices, required commercial conditions, market facilities and competitive conditions. Projection of market (2, 5 or 10 years): Basic growth or decline forces. Identification of top out condition, trends or change in customers, type of new competing services, environmental changes—social, economic, technical, political projection of total market value. Critical factors for successful operations: Nature of the service market (mechanization, range of services to be offered, key functions necessary to operate services, costs, system and related factors, mechanization—existing condition, degree of change. Projection of available share of the market: Projection of market share based on market trend, degree to which competitive strengths and weaknesses may affect positions. Extent to which improved operation contributes to higher market share, development of market share for 5 to 10 year period.

Scope of Marketing Research Research on markets has a wider scope which includes: analyzing market potential for existing products and estimating demand for new products, sales forecasting, characteristics of products market, analyzing sales potentials, studying trends in markets.

Research on Products Acceptance of proposed new products. Customers’ expectation about new products, comparative studies of competitive products and customers dissatisfaction with the products.

Research on Product Promotion Evaluating advertisement effectiveness, analyzing advertisement and selling practices, selecting advertisement media, motivational studies, evaluating proposed sales market.

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Research on Pricing Demand elasticities, cost analysis, margin analysis.

Research on Distribution Direct selling, agent network, wholesale distribution, telephonic and mailing distribution. Relative costs and benefits of the various distribution systems.

Identification of Market Forces Major External Forces Following are the major market forces need to be monitored: Social and Legislative

Consumerism, employee legislation, financial legislation, peer group activities and deregulation. Economic and Political

Inflation levels, currency fluctuation, unemployment and level of wage settlement, government economic policy, return on investment expectation. Competitor Forces and Innovation

New entrants in marketplace, competitors marketing ability, new financial liaison, image in the eyes of the consumers.

Major Internal Forces Financial

Ability to generate funds to finance plans. Relative costs of various funds generation method. Personnel

Numbers, skill and use made communication effectiveness, adaptability and motivation. Services and Technological

Ability to produce and administer new services, rationalization of existing range. Distribution and Network Forces

Size spread type and cost consideration.

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Types of Market Research Two major market methods are research in qualitative and quantitative research.

Qualitative Research Qualitative research provides an understanding of, and an insight into, the process rather than drawing specific conclusion. It is used to provide background information and the basis for an analytical framework; identify and examine behavioural pattern beliefs opinions and motives and explore relationships and attitudes. Sample size is usually small. Two major techniques are ‘interviews’ and ‘group discussions’. Success depends on skill to elicit information, analyze and interpret.

Quantitative Research Concerned with collection analysis and interpretation of data from sample representative of universe. Quantitative research uses three methods, namely, data collection (observation, experiment and surveys), experiments (test marketing, survey-structured questionnaires, sample design—administration), sample-probabilistic basis/judgemental basis. Research models: Computer Model, Decision Tree.

Benefits Market Research Measure changes when applying a given set of variables, providing a more sensitive scaling, enabling inclusion of an ideal factor as measure of change, predict outcome and quantitatively evaluate against other measurable factors.

Strengths and Weaknesses of Market Research Models Both the model of market research have certain strengths and weaknesses. Strength of Qualitative Model

It is relatively fast, can be cheaper as small scale is used. Simple to understand and use. Forerunner to quantitative research. Weaknesses of Qualitative Model

Findings are subjective: Smaller sample size reduces statistical accuracy, greater chances of bias. Strength of Quantitative

High level of accuracy. Provides factual information, more significant results, but significant margin of error.

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Weaknesses of Quantitative Model

It is slower than the Qualitative Model and can be more expensive. It requires technical help. Some risk of bias is there therefore, a short of combination of both would provide better results.

Institutionalizing Market Research Probably the most important prerequisite to institutionalizing market research is the total commitment on the part of top management—this total commitment is reflected in: 1. 2. 3. 4. 5. 6.

The importance of research unit in the organization. Freedom of research unit to conduct its day-to-day work. Status of the person who is assigned the job. Regular interaction on the research findings. Degree of dependence of corporate planner on research units. Degree of integration of strategic planning and market research/forecasting.

Another prerequisite of successful functioning of the research department is nature of hierarchical control. The person responsible for managing the research unit must report directly to the chief executive of the organization—not to anybody else otherwise cross control will hamper the functioning of the research department. India is opening up and competition in the financial is market growing. A wrong decision maybe very costly. Historical perspective of decision-making supported by individual institution may not be very useful. Competitive environment demands quantitative analytical findings. Further, an organization must take care to select appropriate and technically qualified people with superior technical knowledge and training, who can integrate economic and socio-political fundamentals with financial market development to predict future development in a correct manner. It is the analytical ability of the research person which makes qualitative difference in projection of future.

A Macro–Micro Model for Market Management In his classic article ‘Marketing Myopia’ (first published in 1960), Professor Theodore Levitt commented that: every major industry was once a growth industry…in every case the reason growth is threatened, slowed, or stopped, is not because the market is saturated. It is because there has been a failure of Management…the failure is at the Top. The Executives responsible for it, in the last analysis, are those who deal with broad aim and policies. (p. 1)

Professor Levitt cites some interesting examples.

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Railroads are in trouble—they let others take customers away from them because they assume themselves in railroad business rather than in the transportation business. Established companies (in Hollywood) got into trouble not because of TVs inroads but because of their own myopia. Hollywood thought of itself as product oriented rather than customer oriented (providing entertainment). The belief that profits are assured by an expanding and more affluent population is dear to the heart of every industry. An expanding market keeps the manufacturer from having to think very hard or imaginatively. One of the interesting examples of this is provided by the petroleum industry. Professor Levitt has cited many more examples and says: ...the Organization tends to view itself as making things rather than satisfying customers’ needs. Marketing gets treated as a residual activity. Basic question about customers and markets seldom get asked. The latter occupy a step child status. They are recognized as existing, as having to be taken care of, but not work very much real thought or dedicated attention. (p. 5)

What Professor Levitt wrote about 45 years back still remains valid in many industries, particularly in the life insurance industry in India. Life insurance (like Hollywood and railroads) remained basically product oriented rather than customer oriented. Life insurance, primarily remained an ‘insurance provider’ rather than a financial service provider. Efforts have been directed to exchange the products for cash/contractual agreements. Also the ‘population myth’—assuring profits by an expanding market is applicable to life insurance industry. Ever growing population offers an expanding market, assures market expansion without much consideration. But this complacent attitude by insurance companies towards marketing became costly. Today, though the position of life insurance remains high in hierarchal needs, it slipped down in terms of asset holding pattern of domestic savers. In many countries including USA, life insurance comes after pension funds, banks, mutual funds. It is because life insurance failed to emerge as a Composite Financial Services Provider (CFSP), failed to produce revolutionary financial products such as MMMFs, MMDAs and derivatives which have generated new demands and expanded the market by many folds. Today insurance companies are under competitive pressure throughout the world as a large number of customers have been taken away by banks, mutual funds and pension funds who came out with several innovative products offering near similar benefit of insurance products. Similarly, ‘marketing’ in most of the organizations becomes a victim of wrongly perceived thoughts and actions. Two different concepts get intermingled in marketing. First, sales transactions are viewed and projected as marketing. There is no doubt that there are efforts before any sales transaction, but most of the pre-sales activities such as advertising and product placement are over with sales transaction. As Levitt says ‘selling focuses on the needs of the seller, marketing on the needs of the buyer’. Selling is preoccupied with sellers need to convert his products into cash, marketing with the idea of satisfying the needs of the customer by means

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of the product and whole cluster of things associated with, creating, delivering and finally consuming it. Marketing is thus a customer-centric dynamic action programme to expand the existing market space, increase sales and enhance customers value, organizational profits as well as share in the market. Therefore, marketing should not be viewed as a short-term activity aiming at quick profit. Rather, it should be viewed as a long-term investment proposition, which like any other investment would provide continued return market support of the customers. Such a proposition of market goes beyond simple selling and purchasing syndrome, but rests on future sensitivity which includes understanding and identifying: 1. 2. 3. 4.

Near and distant future economy and emerging changes. Changing the perception of needs and demands of New Generation Customers (NGCs). Changes in value proposition, distribution and service ethics. Nature and dimension of discontinuity of existing value chain.

Marketing in a futuristic uncertain market environment is a critical function and the sales transactions become a secondary object of attention and therefore simple salesmanship is unable to market the organization, its philosophy and products. Thus, marketing need not be the salesmanship marketing, success does not depend on salesmanship but on leadership to manage the market. Marketing is a cross functional organizational activity involving understanding changes in customers need, expectation, value, judgement, embedded benefits of the products, utility and price of products, product–market relationship, perceived quality of current and future services in the minds of customers. Marketing is thus what marketing does for customers’ expectations: 1. Understanding the need-nature, durability. 2. Buying desire and capacity to pay to the products they need. 3. Producing need-oriented products, pricing according to embedded benefits, designing cost-effective distribution channel, taking the products or services to the doorsteps of the customers. 4. Providing accurate information about the products to the customers, services that could be availed by them and finally the matching benefits and price reward relationships, etc. If marketing means a strong customer-centric approach—market relationship then becomes the organization structure, operational philosophy and arrangement must evolve around the identifiable (present and future) segments of the customers—which need to be changed along with the customers’ mood and choice. Market is a changing phenomenon and marketing actions must follow the markets. Therefore, marketing needs to adjust, re-adjust keeping in view the changes of the basic characteristics. Globalization has integrated markets, technology and practices, convergence has blurred the traditional institutional boundaries, product characteristics, customer service, etc. Further,

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emerging convergence is helping market consolidation. In the emerging market, characterized by globalization; convergence and connected knowledge economy have promoted well-informed customers who are more demanding and empowered today. They are more quality service conscious and price sensitive. Their loyalty cannot be taken for granted. In a competitive market customers are not supply dependent, they have alternatives before them. Therefore, it is the organizations which have to be adaptive. This adaptability should be the core of any marketing strategy. Emerging market is largely uncertain. Managing this market is a huge task but not that impossible to accomplish. Appropriate marketing strategy can help an organization to manage its market.

Why Market is beyond Marketing Reach We have a huge population which needs life insurance and is capable to afford it. We have a wide network of marketing force—which is ever growing. It is also estimated that a huge part of the insurance market remains to be tapped, as only about 25 per cent of insurable population has so far been insured. In India, there is tremendous confidence in life insurance, yet our performance in the global context remains quite unsatisfactory. There are several reasons for low penetration and low density of life insurance in India. However, some of the most crucial factors seem to be: 1. 2. 3. 4. 5. 6.

Low level of insurance education and awareness. Dearth of customer friendly innovative products. Low level of focus on unit linked and term assurance products. Relatively lower rate of return on investment. Absence of vigorous training and professionalism among sales force. Absence of appropriate marketing strategy.

However, during the last few years, particularly since liberalization some of the aforementioned issues have drawn attention of regulators and life insurance companies. Regulator has focussed on the need for training and development of professionals among sales force. Life companies are also launching new range of products such as unit linked term assurance and pension products. However, these efforts need to be strongly supported by well-integrated strategy to build up and expand life insurance market. However, the most critical factor is understanding the market, alternatively to adopt a customer-centric approach—the need, the choice the preference, the buying capacity, etc., of the customers. Many of these focuses were missing in the supply-driven insurance market prior to the market liberalization. But, in a demand-driven market, marketing strategy needs to evolve around them. In the supply-driven phase of Indian life insurance, marketing used to basically be a sales function, coherent in them was risk avoidance, absence of innovation, absence of futuristic

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approach and absence of vision. However, in the new market dynamics, old fashion sales did not help the companies to sustain growth and exist in the marketplace for a long period. It is therefore necessary to think of marketing in terms of strategy, innovation, speed of delivery and existence of well-informed customers in a competitive marketplace.

Macro–Micro Marketing Strategy We proceed further by accepting that sales is not marketing and sales driven initiatives do not help much to build up any effective marketing strategy and to expand the market base. Marketing is futuristic customer centric and vision driven. Broadly, there are four types of orientations of marketplace, which can be adopted by any company: 1. 2. 3. 4.

Sales driven strategy. Market driven strategy. Customer driven strategy. Market driving strategy.

This is a generic classification of strategy built upon some basic parameters such as marketing strategy, segmentation strategy, market research, price management, product management, sales management and customer service. In a sales driven orientation, the focus is on mass marketing without any serious market segmentation approach and channel management attempts to provide maximum coverage. A market driven orientation adopts differentiation in marketing on the basis of market segmentation—sensing the need of the market, used customer service as a tactical weapon and product development as an incremental innovation. In market driving orientation the firm adopts revolutionizing marketing approach, destroys industry segmentation, senses the evolution of market, etc. In a customer driven orientation market is considered as a single segment, market research in such an orientation focuses on customers’ needs, adopts multiple channels at individual customer levels. Management practices and customer service is considered to be a strategic weapon. Life insurance is a unique intangible product, the market for which is driven by a wide range of factors starting from social attitude, social value, social ethics, income and income distribution, evolving social needs, local system of taxation, existing and evolving social security, etc. It is therefore, necessary that the orientation and marketing strategy captures these issues. With this in view, a different strategy for life insurance market penetration is suggested below which can be called as a Macro–Micro Marketing Strategy for Indian life insurance industry.

Identify the Direction of Market Draw a long-term scenario of macro economy, identify the changes in the dominant factors and locate the medium to long-term direction of various sectors—real and financial.

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1. Relate the medium to long-term changes of real and financial economy with the medium to long-term changes in social economy. 2. Develop the historically noticed mutual relationships between real–financial and social economy and use them. 3. Develop a scientific marketing research technique to identify various segments of the market depending on the geographical location. 4. Discover the potential market through market research. 5. Differentiated segments on the basis of geographical reach. 6. Differentiated segments on the basis of social structure. 7. Differentiated segments on the basis of income class. 8. Differentiated segments on the basis of financial needs and social security. 9. Differentiated segments on the basis of risk-bearing ability. 10. Differentiated segments on the basis of knowledge of financial and insurance products. Market discovery through marketing research will help the company to understand the changing pattern of customers’ choice, preference and understanding—from medium to long-term.

Developing Competition Profile A partially wrong perception about competition prevails, among market participants. LIC used to compete with banks, PF and PPFs, UTI/MFs and other savings institutions. With the entry of private insurers, competition for LIC has increased but the competitive strength of life insurance industry has also improved. Therefore, the Long-term Profile of Competition (LPC) needs to be redesigned with targeted focus and secular growth of savings markets.

Managing Products In the new marketplace, profile of life insurance products must match the expectations of the new generation investors, which would be influenced by changes and development in macro economy, financial market and emerging product characteristics of other competing institutions. Product management thus needs to focus on the following issues: z

z

Developing futuristic products with required embedded benefits. New Generation Products (NGPs) must contain quality to fulfil requirements of NGCS. In a complex competitive situation with hidden uncertainty and risks, the NGPs must be able to provide a wide range of solutions yet simple enough to be understood by the wide range of customers, a large part of whom are financially illiterate.

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The issue of pricing products with a divergent range, in a widely dispersed heterogeneous market is also crucial. Therefore, product pricing should be flexible as far as linked to embedded benefits, alterable depending on the ability and need of the Specific Customers Cluster (SCC).

Designing a Composite Marketing Strategy (CMS) New Generation Customers (NGCs) dominates the new market space which calls for a new approach with differentiated relationship. In such an emerging situation classical market models emphasizing upon sales maximization may not work effectively. Therefore, we need to design CMS integrating the various market elements that have appeared in the market space within a multiproduct and multichoice competitive environment. CMS can be built on the following premises: z z

z

z

z

z

z

Break the macro markets into microsegments following the segmentation rule. Dismantle the established practices of mass market selling products which are basically insensitive to customers. Differentiate Market Relationship (DMR) focussing not only on the buying capacity and economic status but also by considering the Knowledge Need and Awareness (KNA) of customers at individual level. DMR would not sell products but would provide life solution for the strategic needs. NGPs are not to simply buy products but solution for the money’s worth. Marketing strategy was developed as a Package of Life Solution (PLS) but is used as a strategic weapon to create a new dimension of marketing approach, where Distribution and Delivery System (DDS) would play the crucial role. The cost composition and speed of DDS must be linked to Embedded Benefits and Value (EBV) of the products and it’s Realizable Value (RV) which would ultimately provide more to the customers and reduce risks for the management. In the PLS, DDS and EBV environment there will be the necessity to reposition Change Management Practices (CMP). Personalised Product Placing (PPP) in the backdrop of relationship marketing where each and every DDS must develop strong connectivity between the channel and provide customized solutions, selling products and establishing an intrinsic service relationship. Brand management is a critical component of Macro–Micro Marketing Strategy (MMMS), which not only calls for projecting the inherent product quality relative cost, related value of embedded benefits but also an identification of prospective customers’ need and expectation with the product. Branch management, as it happens many times, is not an advertisement in ‘one up’ objective but the projection of truthful and ethical dimension and products and post-sales service having customers as the central point.

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Value received by paying a certain price should be more, similarly extra cost of time and energy related to a buying decision must produce better extra value in terms of service, relationship and customers’ respect. We have attempted here to provide some of the important basic characteristics of MMMS, and many more have been left out. It is possible to quantify the parameters of the strategy and expected value to be received both by the buyers and sellers. Though the model basically emphasized upon the value of relationship, it does borrow from market driven, market driving approach but also differs in many respects. But primarily it is an approach strongly linked to the financial and social economy which is characterized by dynamic and heterogeneous market environment. The success of MMMS would depend on alternate mind set, different from what prevails today, that is, sales led marketing, strong desire and management to implement change and ability to perceive change through research. The MMMS model cannot be implemented by a static management suppressing their inefficiency behind the so-called democratic approach. It can be successful and in a dynamic managerial approach characterized by creative innovation, risk-bearing ability and attitude, and practicing self-accountability.

Annexure 4.A.1 Salient Features of IRDA Life Insurance Products-guidelines for Unit Linked Life Insurance Products (Circular No: 032/Irda/Actl/Dec-2005 Dated: 21/12/05).

Type of Products and Sum Assured Guidelines have indicated about SA of single and non-single premium Single premium products Non-single premium products

Minimum SA 125 per cent of the Single Premium (SP) Minimum SA 0.5 × T × Annualized Premium (AP) or 5 × AP, whichever is higher.

The SA payable on death shall not be reduced at any point of time during the term of the policy except to the extent of the partial withdrawals made during the 2 year period, immediately preceding the death of the life assured. However, on attainment of 60 years of age of the life assured, all partial withdrawals maybe set off against the SA payable on death. No cover should be extended after the expiry of the policy term and only settlement options (which are clearly outlined at the commencement of the contract) maybe allowed.

Minimum Policy Term The minimum policy term shall be 5 years.

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Guarantees on Policy Benefits A linked product must have a guaranteed SA payable on death and may have a guaranteed maturity value.

General Aspects on Guarantees Guarantees provided on death, and/or on maturity shall be reasonable and consistent in relation to the current and long-term interest rate scenario. In this regard, demonstration of proper pricing, including the appropriateness through sensitivity and scenario testing shall be required under the File and Use Procedure for all the guarantees provided.

Surrender Value (SV) When a unit linked life insurance policy acquires a SV, it shall become payable only after the completion of the third policy anniversary. The ‘SV’ or the ‘SV formula’ must be published in the policy document and all other promotional materials of the life insurance contract.

Discontinuance of Due Premiums after Paying at Least Three Consecutive Years If all the due premiums have been paid for at least three consecutive years and subsequent premiums are unpaid, life insurers shall give an opportunity to the policyholder to revive the contract within the limited period allowed for revival as per policy conditions. During this limited period for revival, the insurance cover under the unit linked life insurance contracts shall be continued levying appropriate charges. If by the end of the allowed period for revival, the contract is not revived, the contract shall be terminated by paying the SV. However, the life insurers can offer to continue the insurance cover under such contracts, if opted so by the policyholder, levying appropriate charges until the fund value does not fall below an amount equivalent to 1 full year’s premium. When the fund value reaches an amount equivalent to 1 full year’s premium, the contract shall be terminated by paying the fund value. It is clarified that the intention is to ensure payment of a minimum of 1 full year’s premium to the policyholder.

Discontinuance of Due Premiums within Three Years of Inception of the Policy If all the due premiums have not been paid for at least three consecutive years from inception, the insurance cover under the unit linked life insurance contracts shall cease immediately. Insurers shall give an opportunity to the policyholders to revive within the period allowed for revival as per policy conditions. In case the contract is not revived during this period, the contract shall be terminated and the SV, if any, shall be paid at the end of third policy anniversary or at the end of the period allowed for revival whichever is later.

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Loans No loans shall be granted under linked insurance products.

Top-up Premium A top-up premium is an amount of premium that is paid by the policyholders at irregular intervals besides basic regular premium payments specified in the contract and is treated as a single premium. Top-up premiums can be remitted to the insurer during the period of contract only, where due basic regular premiums are paid up to date and if expressed in the terms and conditions of the contract. At any point of time during the term of the contract, so long as the total amount of top-up premiums remain within the 25 per cent of the total amount of the basic regular premiums paid up to that date, the top-up premium will not be required to have any insurance cover (as required in Table 1.2) and the balance amount of such top-up premiums shall have an insurance cover as specified in Table 1.2 (for single premium contracts) and shall remain constant during the period of the contract. The provisions in this paragraph shall not apply in respect of pensions and annuity business.

Partial Withdrawal The first partial withdrawal is allowed only after third policy anniversary for all regular premium contracts and single premium contracts. Where partial withdrawals have been granted, in case of deaths during the term of the policy, the SA maybe reduced to the extent of the amount of partial withdrawals made during the two-year period immediately preceding the death of the life assured. However, on attainment of 60 years of age by the life assured, all the partial withdrawals maybe set off against the SA payable on death. The provisions in this paragraph shall not apply in respect of pensions and annuity business. For the purpose of partial withdrawals, all top-up premiums whether or not associated with insurance cover shall be treated as single premium; for a top-up premium made during the period of the contract, a lockin period of three years shall apply from the date of payment of that top-up premium (this condition will not apply if the top-up premiums are paid during the last three years of the contract).

Settlement Option There is no objection for an insurer providing to the policyholder settlement options, providing only periodical payments, in the contract so as to avoid the possibility of fluctuations affecting the maturity value. Settlement options should clearly indicate the inherent risk being borne by the policyholder during the period and should be explicitly understood by the policyholder. The period of settlement should not, in any case, be extended beyond a period of five years from the date of maturity. The provisions in this paragraph shall not apply in respect of pensions and annuity business.

Unit Pricing The basic equity principle of unit pricing for any unit linked fund offered by the life insurer shall be: ‘The interests of policyholders who have purchased units in that fund and not involved in a unit transaction

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should be unaffected by that transaction’. The unit pricing shall be computed based on whether the company is purchasing (appropriation price) or selling (expropriation price) the assets in order to meet the day-to-day transactions of unit allocations and unit redemptions, that is, the life insurer shall be required to sell/purchase the assets if unit redemptions/allocations exceed unit allocations/redemptions at the valuation date. The appropriation price shall apply in a situation when the company is required to purchase the assets to allocate the units at the valuation date. This shall be the amount of money that the company should put into the fund in respect of each unit it allocates in order to preserve the interests of the existing policyholders. The expropriation price shall apply in a situation when the company is required to sell assets to redeem the units at the valuation date. This shall be the amount of money that the company should take out of the fund in respect of each unit it cancels in order to preserve the interests of the continuing policyholders. Computation of NAV: When appropriation price is applied: the NAV of a unit linked life insurance product shall be computed as market value of investment held by the fund plus the expenses incurred in the purchase of the assets plus the value of any current assets plus any accrued income net of FMCs less the value of any current liabilities less provisions, if any. This gives the NAV of the fund. Dividing by the number of units existing at the valuation date (before any new units are allocated), gives the unit price of the fund under consideration. When Expropriation price is applied: The NAV of a unit linked life insurance product shall be computed as market value of investment held by the fund less the expenses incurred in the sale of the assets plus the value of any current assets plus any accrued income net of FMCs less the value of any current liabilities less provisions, if any. This gives the NAV of the fund. Dividing by the number of units existing at the valuation date (before any units are redeemed), gives the unit price of the fund under consideration. Uniform cut-off timings for applicability of NAV: The allotment of units to the policyholder should be done only after the receipt of premium proceeds as stated below. Allocations (premium allocations, switch in): In respect of premiums/funds switched received up to 4.15 p.m. by the insurer along with a local cheque or a demand draft payable at par at the place where the premium is received, the closing NAV of the day on which premium is received shall be applicable. In respect of premiums/funds switched received after 4.15 p.m. by the insurer along with a local cheque or a demand draft payable at par at the place where the premium is received, the closing NAV of the next business day shall be applicable. In respect of premiums received with outstation cheques/demand drafts at the place where the premium is received, the closing NAV of the day on which cheques/demand draft is realized shall be applicable. With regard to the above, insurer shall ensure that each and every payment instrument is banked with utmost expedition at the first opportunity, given the constraints of banking hours, prudently utilizing every available banking facility (for example, high value clearing, account transfer, etc.) Any loss in NAV incurred on account of delays, shall be made good by the insurer.

Redemptions In respect of valid applications received (for example, surrender, maturity claim, switch out, etc.) up to 4.15 p.m. by the insurer, the same day’s closing NAV shall be applicable. In respect of valid applications received (for example, surrender, maturity claim, switch, etc.) after 4.15 p.m. by the insurer, the closing

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NAV of the next business day shall be applicable. NAV for each segregated fund provided under unit linked life insurance contracts shall be made available to the public in the print media on a daily basis. Also the NAV shall be displayed in the respective web portals of the life insurer.

Charges The life insurers shall use a uniform definition of charges under all their unit linked life insurance products in order to give a better and clear understanding amongst the insuring public.

Premium Allocation Charge This is a percentage of the premium appropriated towards charges from the premium received. The balance known as allocation rate constitutes that part of premium which is utilized to purchase (investment) units for the policy. The percentage shall be explicitly stated and could vary inter alia by the policy year in which the premium is paid, the premium size, premium payment frequency and the premium type (regular, single or top-up premium). This is a charge levied at the time of receipt of premium. Actuarial funding is adopted, this charge may also include an initial management charge, which is levied on the units created from the first years’ premium for a specified period. (For example, If premium = Rs 1,000 and premium allocation charge is 10 per cent of the premium; then the charge is Rs 100, the balance amount of premium is Rs 900 and is utilized to purchase units.)

Fund Management Charge (FMC) This is a charge levied as a percentage of the value of assets and shall be appropriated by adjusting the NAV. It is a charge levied at the time of computation of NAV, which is usually done on daily basis.(For example, If FMC is 1 per cent per annum; fund as on 31 March 2004 before FMC is Rs 100 and fund after this charge is Rs 99.)

Policy Administration Charge This charge shall represent expenses other than those covered by premium allocation charges and the fund management expenses. This is a charge which maybe expressed as a fixed amount or a percentage of the premium or a percentage of SA. This is a charge levied at the beginning of each policy month from the policy fund by cancelling units for equivalent amount. This charge could be flat throughout the policy term or vary at a predetermined rate. The predetermined rate shall preferably be say an x per cent per annum, where x shall not exceed 5. (For example, Rs 40 per month increased by 2 per cent per annum on every policy anniversary.)

Surrender Charge This is a charge levied on the unit fund at the time of surrender of the contract. This charge is usually expressed either as a percentage of the fund or as a percentage of the annualized premiums (for regular premium contracts).

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Switching Charge This is a charge levied on switching of money from one fund to another available within the product. The charge will be levied at the time of effecting switch and is usually a flat amount per each switch. (For example, Rs 100 per switch.)

Mortality Charge This is the cost of life insurance cover. It is exclusive of any expense loadings levied either by cancellation of units or by debiting the premium but not both. This charge maybe levied at the beginning of each policy month from the fund. The method of computation shall be explicitly specified in the policy document. The mortality charge table shall invariably form a part of the policy document. Mortality rates are guaranteed during the contract period, which are filed with the authority.

Rider Premium Charge This is the premium exclusive of expense loadings levied separately to cover the cost of rider cover levied either by cancellation of units or by debiting the premium but not both. This charge is levied at the beginning of each policy month from the fund.

Partial Withdrawal Charge This is a charge levied on the unit fund at the time of part withdrawal of the fund during the contract period.

Miscellaneous Charge This is a charge levied for any alterations within the contract, such as, increase in SA, premium redirection, change in policy term, etc. The charge is expressed as a flat amount levied by cancellation of units. This charge is levied only at the time of alteration. (For example, Rs 100 for any alteration such as increase in SA, change in premium mode, etc.)

Riders All the riders attached to a unit linked life insurance contract shall be filed separately with the authority. The rider premium shall be exclusive of expense loadings. The expenses shall be explicitly stated and levied separately in a transparent manner to the fund. The rider premium (such as allocation charge and FMC), shall not exceed the actual rider premium filed with the authority. Exposure to money market instruments under all linked products and to equities in respect of group gratuity and group superannuation shall be as per existing investment guidelines prescribed for other products. Sales Illustrations

The Life Insurance Council shall put in place in concurrence with the authority by 31 March 2006 the model/method for the sales illustration which should reflect the effect of charges (in terms of reduction in return) corresponding to the lower and higher investment returns and client specific details such as age, intended premium size, the contract term and SA.

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Furnishing Statements of Accounts Unit statement account shall form a part of the policy document. Unit statement shall make a reference to the terms and conditions applicable under the respective policy document. Unit statement shall be issued on every policy anniversary and also as and when a transaction takes place.

Market Conduct For better understanding of the complexities of unit linked life insurance products, the Life Insurance Council shall put in place, in concurrence with the Authority, by 31 March 2006 the guidelines for the market conduct which should include inter alia the following: Separate training to all the insurance agents/intermediaries before they are authorized to sell unit linked life insurance products. The curriculum for this training should inter alia contain the basic features and inherent risks in these products; periodical in house refresher training to the persons involved in soliciting or procuring the business (agents/intermediaries). The records of such persons (agent/intermediaries), who have undergone this specific training, shall be maintained. Appropriate documentation forms part of the proposal papers to demonstrate informed decision-making on the part of the proponent in deciding a particular insurance product. Provision of the sales illustration statement as prescribed and duly acknowledged by the potential policyholder. Code of conduct to ensure no mis-sale takes place. Education of the policyholders on an ongoing basis, about the features, risk factors, terminology, definitions of charges, etc., under these contracts. Uniform practice for rounding off the unit prices.

Disclosure Norms All life insurers should necessarily and explicitly give information as follows, using the same font size, in all the sales brochures, prospectus of insurance products, in all promotional material and in policy documents: The various funds offered along with the details and objectives of the funds. The minimum and maximum percentage of the investments in different types (such as equities and debts), investment strategy so as to enable the policyholder to make an informed investment decision. ‘No statement of opinion as to the performance of the fund shall be made any where.’ The definition of all applicable charges, method of appropriation of these charges and the quantum of charges that are levied under the terms and conditions of the policy. The maximum limit up to which the insurer reserves the right to increase the charges is subject to prior clearance of the authority. The fundamental attributes and the risk profile (low, medium or high) of different types of investments that are offered under various funds of each unit linked product. On top of each document including the proposal form it is mentioned that, ‘In This Policy, The Investment Risk In Investment Portfolio Is Borne By The Policyholder’. The policyholder should be given the full details, using the same font, related to the investments, as an annual report, covering the fund performance during the preceding financial year in relation to the economic scenario, market developments. etc., which should include particulars such as the investment strategies and risk control measures adopted. The changes in fundamentals, such as interest rates and tax rates affect the investment portfolio. The composition of the fund (debt, equity, etc.), analysis within various classes of investment, investment portfolio details, sectoral exposure of the underlying funds and the ratings of investments are made, analysis according to the duration of the investments held. Performance of the various funds over different periods such as 1 year, 2 years, 3 years, 4 years, 5 years and since inception along with comparative

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benchmark index. All the life insurers are required to issue the periodical statements of accounts to policyholders as stated in paragraph 14 of Part-I.

Rating of Unit Linked Funds The authority suggests that the life insurers should move towards the evaluation of their respective unit linked funds done by an independent rating agency with an objective of providing qualitative information to the policyholder as to the assessment of performance of the various unit linked funds to enable the insuring public to choose the product in an informed manner. This information will provide the prospects a level of comfort on operational practices, fund management quality, organizational strength of life insurers. This maybe initiated by the life insurers on a voluntary basis. (Disclosure Norms, Advertisement, Furnishing Information to IRDA has not been included here)

Annexure 4.A.2 Some Important Features of Microinsurance Regulations, 2005 IRDA issued a notification on 10 November 2005 called Insurance Regulatory and Development Authority (Micro-Insurance) Regulations, 2005, underlying the salient features of microinsurance scheme which can be launched by any insurance company in India and also the regulatory framework. The salient features of the scheme, its administration and regulatory features are stated as follows.

Non-government Organization (NGO) It means a non-profit organization registered as a society under any law and has been working at least for three years with marginalized groups, with proven track record, clearly stated aims and objectives, transparency and accountability as outlined in its memorandum, rules, by-laws or regulations as the case maybe, and demonstrates involvement of committed people.

Self-help Group (SHG) It means any informal group consisting of 10–20 or more persons and has been working for at least three years with marginalized groups, with proven track record, clearly stated aims and objectives, transparency and accountability as outlined in its memorandum, rules, by-laws or regulations, as the case maybe, and demonstrates involvement of committed people.

Microfinance Institution (MFI) It means any institution or entity or association registered under any law for the registration of societies or co-operative societies, as the case maybe, inter alia, for sanctioning loan/finance to its members. ‘microinsurance policy’ means an insurance policy sold under a plan which has been specifically approved by the authority as a microinsurance product. ‘Microinsurance product’ includes a general microinsurance product or life insurance product, proposal form and all marketing materials in respect thereof.

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Tie-up between Life Insurer and Non-life Insurer An insurer carrying on life insurance business may offer life microinsurance products as well as general microinsurance products, as provided herein. Provided that where an insurer carrying on life insurance business offers any general microinsurance products, he shall have a tie-up with an insurer carrying on general insurance business for this purpose, and subject to the provisions of Section 64VB of the Act, the premium attributable to the general microinsurance product maybe collected from the prospect (proposer) by the insurer carrying on life insurance business, either directly or through any of the distributing entities of microinsurance products as specified in Regulation 4, and made over to the insurer carrying on general insurance business. Provided further that in the event of any claim in regard to general microinsurance products, the insurer carrying on life insurance business or the distributing entities of microinsurance products, as the case maybe, as maybe specified in the tie-up referred to in the first provision, shall forward the claim to the insurer carrying on general insurance business and offering all assistance for the expeditious disposal of the claim.

Distribution of Microinsurance Product In addition to an insurance agent or corporate agent or broker licenced under the Act, read with the regulations concerned made by the authority for licensing of individual or corporate agents, or insurance brokers, as the case maybe, microinsurance products maybe distributed to the microinsurance agents. Provided that a microinsurance agent shall not distribute any product other than a microinsurance product.

Appointment of Microinsurance Agents An insurance agent shall be appointed by an insurer by entering into a deed of agreement, which shall clearly specify the terms and conditions of such appointment, including the duties and responsibilities of both the microinsurance agent and the insurer. Provided that before entering into such agreement, the same shall be approved by the head office of the insurer. A microinsurance agent shall not work for more than one insurer carrying on life insurance business and one insurer carrying on general insurance business. The deed of agreement referred to in sub-regulation (1) shall specifically authorize the microinsurance agent to perform one or more of the following additional functions, namely, collection of proposal forms, collection of self-declaration from the proposer that he/she is in good health, collection and remittance of premium distribution of policy documents, maintenance of registers of all those insured and their dependants covered under the microinsurance scheme, together with details of name, sex, age, address, nominees and thumb impression/signature of the policyholder, assistance in the settlement of claims, ensuring nomination to be made by the insured any policy administration service. The microinsurance agent or the insurer shall have the option to terminate the agreement referred to in sub-regulation (1) after giving a notice of three months by the party intended to terminate the agreement. No such notice shall be necessary, where the termination is on account of any misconduct or indiscipline or fraud committed by the microinsurance agent.

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Employment of Specified Persons by Microinsurance Agents A microinsurance agent shall employ specified persons with prior approval of the insurer for the purpose of discharging all or any of the functions stated in Sub-regulations (3) of Regulation 5. Provided that corporate agents and insurance brokers procuring microinsurance business shall continue to be governed by the Insurance Regulatory and Development Authority (Licensing of Corporate Agents) Regulations, 2002 and Insurance Regulatory and Development Authority (Insurance Brokers) Regulations, 2002, as the case maybe.

Code of Conduct of Microinsurance Agents Every microinsurance agent and specified person employed by him shall abide by the code of conduct as laid down in Regulation 8 of the Insurance Regulatory and Development Authority (Licensing of Insurance Agents) Regulations, 2002, and the relevant provisions of Insurance Regulatory and Development Authority (Insurance Advertisements and Disclosure) Regulations, 2000. Provided that the insurer shall ensure compliance of the code of conduct, advertisements and disclosure norms by every microinsurance agent. Any violation by a microinsurance agent of the code of conduct and/or advertisement or disclosure norms as aforesaid shall lead to termination of his appointment, in addition to penal consequences for breach of code of conduct and/or advertisement or disclosure norms pursuant to the provisions of sub-regulation (1).

Filing of Microinsurance Product Design Every insurer shall be subject to the ‘File and use’ procedure with respect to filing of microinsurance products with the authority. Every microinsurance product which is cleared by the authority for the purpose of microinsurance shall prominently carry the caption ‘Microinsurance product’.

Issuance of Microinsurance Policy Contracts Every insurer shall issue insurance contracts to the individual microinsurance policyholders in the vernacular language which is simple and easily understood by the policyholders. Provided that where issuance of policy contracts in the vernacular language is not possible, the insurer shall as far as possible issue a detailed write-up about the policy details in the vernacular language. Every insurer shall issue a insurance contract to the group microinsurance policyholder in an unalterable form along with a schedule showing the details of individuals covered under the group and also issue a separate certificate to each such individual evidencing proof of insurance, containing details of validity period of cover, name of the nominee and addresses of the underwriting office and the servicing office, where both offices are not the same.

Underwriting No insurer shall authorize any microinsurance agent or any other outsider to underwrite any insurance proposal for the purpose of granting insurance cover.

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Capacity Building Every insurer shall impart at least 24 hours of training at its expense through its designated officer(s) in the local vernacular language to all microinsurance agents and their specified persons in the area of insurance selling, policyholder servicing and claims administration.

Remuneration/Commission A microinsurance agent maybe paid, remuneration for all the functions rendered as outlined in Regulation 5 and including commission, by an insurer and that the same shall not exceed the limits as stated below. For Life Insurance Business

Single premium policies—10 per cent of the single premium and Non-single premium policies—20 per cent of the premium for all the years of the premium paying term. For General Insurance Business

Fifteen per cent of the premium, where the agreement between the microinsurance agent and insurer is terminated for any reason, whatsoever, no future commission/remuneration shall be payable, for group insurance products, the insurer may decide the commission subject to the overall limit as specified in sub-regulation (1).

Overall Compliance Every insurer shall ensure that all transactions in connection with microinsurance business are in accordance with the provisions of the Act, the Insurance Regulatory and Development Act (41 of 1999), and the rules and regulations made there under.

Submission of Information Every insurer shall furnish information in respect of microinsurance business in such form and manner and containing such particulars, as maybe required by the authority from time to time.

Obligations to Rural and Social Sectors All microinsurance policies maybe reckoned for the purpose of fulfilment of social obligations by an insurer pursuant to the provisions of the Act and the regulations made there under. Where a microinsurance policy is issued in a rural area and falls under the definition of social sector, such policy may be reckoned for both under rural and social obligations separately.

Chapter 5 Managing Life Insurance Investment Growth induced management of a life insurance company cannot depend only on the ability of savings (premium) mobilization through sale of products and optimizing service satisfaction of customers (policyholders), but also needs high level of efficiency in funds management. Funds management efficiency has become a more critical input of growth due to changing market structure, complexities and sophistication in financial products, and corporate management activism. Moreover, funds mobilized as premium are utilized for payment to policyholders which arises due to death of a policyholder (death benefit) or maturity of policy (survival benefit). Therefore, benefits of policyholders are the liability of a life insurance company. Funds management, virtually the liability management for a life insurance company, which makes the job more complex due to the long-term uncertainties in liabilities. However, efficiency in funds management in a life insurance company like any other institutional investment management institution, calls for a high degree of technical efficiency in market prediction, portfolio designing, asset allocation and strategy formulation, etc. Since product portfolio of life insurance company is quite vast and varied, nature of future liabilities would differ from product to product, which is to be taken care of while designing investment portfolio for matching asset return with projected future liability. Another growing concern of life insurance operation and funds management is the management of risks. Though the sources of risks in an insurance company are spread enterprise wide, investment remains to be the major source of risk. However, this area of concern still remains to be focussed in total management of a company. Mismatch in asset return and projected liability, unethical practices investment, absence of prudent person regulation, lack of concern among top management, etc., and absence of industry risk standard enhances the risk content of enterprise operation. Therefore, in this Chapter we have focussed on some critical issues relating to funds management.

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Strategic issues in investment management in life insurance companies. Investment management in life insurance companies in India. Risk management in life insurance companies—issues and practices. Understanding macro economic indicators for investment management.

Strategic Issues in Investment Management in Life Insurance Companies Introduction Investment management is the most critical area of operation in any financial institution, particularly in any life insurance company, which has to design a number of portfolios keeping in view the different risk levels and a variety of investment objectives implicit in the minds of policyholders. The complexities in investment have further increased due to the extension of the boundary of financial market beyond the domestic market of savings and investment as a result of globalization leading to cross-border activities in savings and investment, free flow of funds, discovery of alternative investment avenues and innovative instruments of investment. While the traditional role of insurance companies as passive investing institutions has been fast changing in the so-called New Economy, supposed to be led by stock market, the predominant role of insurance companies as savings mobilizers and risk-bearing institutions is under threat due to the growing popularity of mutual funds and pension funds. These developments have further added vulnerability to investment management in insurance companies in a liberalized financial and insurance market in India, competition is going to generate volatility and risk in marketplace, increase uncertainties in portfolio performance, market failures and market-related fraudulent activities. However, India has put in place a well-designed regulatory framework to protect the interest of policyholders through operational transparency and prudential norms in respect of investment management. However, efficient investment management requires understanding of potential impact of changes in policy regime, economy and market and operational skills and precision to manage the potential risks. Keeping the aforementioned in view, this book makes an attempt to examine the major issues emanating from complexities of management of insurance funds. Before we proceed further we may look into various critical areas of insurance funds management in the light of a conceptual framework outlined above. Insurance companies are important financial institutions, which play a very significant role in national economy and particularly in the capital market. Life and general insurance companies mobilize savings and invest the same in capital market and assist the process of industrialization and economic development. The contracts sold by life insurance business covers a wide range of people’s needs since a variety of contracts are sold. As such this makes investment operation of a life insurance company a complex and a critical function. The longer the period the higher the

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uncertainty because the investment cycle passes through several phases of economic and stock market cycles.

Product Portfolio As discussed in the Chapter 4, product portfolio of a life insurance company is very complex since it sells products of different duration with varying degrees of embedded value and often with guaranteed return which are exposed to duration mismatch between liability and asset portfolio. Therefore, fund management in a life insurance company needs to consider a multidimensional approach keeping in view the utmost necessity of asset liability matching. It is therefore, very important to understand major products of a life insurance company to decide about investment principle and investment strategy. The objectives of individual savings through insurance and pension plans are quite different. While most of the policyholders buy insurance primarily for the risk cover, with secondary intention for savings benefit, there are some policyholders, who invest in unit linked plans desiring to get more return and unlike others, they are less risk averse. While life insurance schemes are run on the ongoing basis, having continuous funds flow—in and out—which complicates management of funds. A life insurance company should be alive to this reality of different investment objectives and expectations of policyholders needs to move cautiously with appropriate strategy to manage its funds to ensure safety, liquidity and return. Therefore, funds management tends to be the liability management of an insurance company. However, the nature of liabilities differs substantially from plan to plan. Accordingly, the financial assets required to match these liabilities will also differ for endowment plans, money back plans, linked plans and pension plans. Therefore, there should be a clearly structured asset group matching the duration and return of the assets. Required assets projections for future liabilities is a critical investment decision and an important determinant of portfolio asset class. This job needs to be done scientifically with the help of statistical modelling to estimate future trends in macro economy, money market, debt market and equity market. Expertise in forecasting such trends would enable one to assess the future cash flow. However, cash flow management needs to be done keeping in mind the expected cash outflow. Another concern of an insurance company is to comply with the requirements of the regulatory authority. Insurance regulator imposes certain conditions for funds’ investment and these are required to be incorporated in the investment policy. These conditions are basically relating to assets admissibility prudential and exposure norms, solvency margin, etc. These conditions aim at attaining certain objectives, namely, safety, investors expectations and certain broader socio-economic goals of the country say, for example, investment in less risk instruments such as government bonds ensures safety and return while investment in infrastructure ensures achieving socio-economic objective of the National Economic Policy.

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Investment Regulation Investment operation in a life insurance company has to achieve different objectives. Financial assets are purchased from the premium received by a life insurance company and used to cover life funds, to make provision for meeting obligations towards policyholders’ payments such as death benefits, maturity benefits and survival payments and also to manage other liabilities. According to Davis (2000) life insurance company liabilities tended historically to be defined in nominal terms. These nominal liabilities would be arising from term policies (purchased to provide a certain sum in the event of death), whole life policies (term policy with the event of death) and annuities (to give a fixed income for the remainder of the insured life). Therefore, assets are linked to different types of liabilities produced by mortality projection, discontinuity or surrender, interest rates, liquidity, etc. These call for well-perceived investment strategies to manage potential risks and liabilities. However, achieving these objectives is often restrained by several unexpected factors such as market failures, etc. Market failures basically arise from information asymmetry, externalities or monopoly power of a firm. In addition to these, there are also moral hazards and adverse selection by the insurer which adversely alters the desired objectives. Since there is an enormous amount of risk involving policyholders’ money, insurance regulators all over the world attempt to regulate funds management to minimize risks associated with portfolio investment. The primary objective of investment regulation is to ensure that financial objectives of insurance contract is met through creation of appropriate financial assets out of the premium received from the policyholders. Though over regulation, often emerges as a constraint for the fund managers, yet prudential investment regulations are absolutely necessary in the interest of policyholders and the industry. The efficiency in funds lies in the performance within strong regulatory environment. Indian regulatory authority, IRDA has put in place a well conceived regulatory framework for investment management.

Investment Limit As per IRDA Investment Regulation, assets relating to pension business, annuity business and linked life insurance do not form part of controlled funds. The regulation has specified separate investment norms for life insurance, general insurance, unit linked and pension fund. Regulation also states that every insurer shall invest and at all times keep his funds invested in accordance with the regulations.

Life Insurance Controlled Fund The regulation states that every insurer carrying on the business of life insurance shall invest and at all times keep invested his controlled fund in the following manner:

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1. Investment in government securities—25 per cent. 2. Government securities and other approved securities, including above—not less than 50 per cent. 3. Infrastructure and social sector—not less than 15 per cent. 4. Investment in other than approved security—not exceeding 35 per cent.∗ (∗ Others to be governed by Exposure Norms as specified in Regulation 5. Investment in ‘Other than Approved Investment’ (OTAI) can in no case exceed 15 per cent of the fund).

Pension and General Annuity Funds The regulation states that every insurer carrying on the business of life insurance business shall invest and at all times keep invested his controlled fund in the following manner: 1. Funds belonging to pension and general annuity business must be invested in the following manner—government securities—not less than 20 per cent. 2. Government or other approved securities, including the above—not less than 40 per cent. 3. Balanced to be invested in approved investment—not exceeding 60 per cent.

Linked Life Insurance Fund Regulation on investment of unit linked life insurance funds states that ‘Unit linked policies may only be offered where the units are linked to categories of assets which are both marketable and easily realizable’. The regulation states that every insurer carrying on the business of life insurance business shall invest and at all times keep invested his controlled fund in the following manner: 1. Approved investment—not less than 75 per cent. 2. Unapproved investment—not more than 25 per cent.

Exposure Norms Investment regulation has further stipulated the exposure norms of the investee company, entire group of the investee company classified the approved securities and industry sector to which the investee company belongs, as well as defined the approved securities (Annexure 5.A.1).

Investment in Derivatives Another important development relating to investment of life insurance funds is the permission to insurance companies to invest in derivatives in a selected manner for the purpose of hedging.

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IRDA guidelines—INV/GLN/2004–05 (Annexure 5.A.2) on fixed income derivatives states that ‘with a view to enabling insurance companies to hedge their interest rate risk to which they are exposed, to allow insurer carrying on the business of life insurance or general insurance to deal in the following types of fixed income derivatives, instruments’. 1. Forward Rate Agreements (FRAs). 2. Interest Rate Swaps (IRS). 3. Exchange Traded Interest Rate Futures. IRDA guidelines further mentioned about the purpose, types, rate, size tenure of fixed income, derivatives, etc. Purpose

Dealing in above permitted derivatives should be used only for one or more of the following purposes: 1. Hedging interest rate risk of investment in fixed income securities. 2. Hedging for forecasted transactions. Types

FRAs/IRS are permitted in different types of plain vanilla. Options futures such as caps/floors/ collars are not permitted. Benchmark Rate

Rate should necessarily evolve on its own in the market. Participants are free to use any domestic money, debt market rate or interest rate implied in foreign exchange forward markets. Size

No restriction on the minimum or maximum size of notional principal amounts of FRAs/ IRS. Tenure

No restriction on the minimum or maximum tenure of the FRAs/IRS permitted counters. Dealing should be only with one or more counter parties. The guidelines also provided the names of counter parties in OTC transaction, exposure and prudential limit—risk management policy and process, exposure and prudential limit, accounting and measurement, disclosures in financial statement, etc. (For details see Annexure 5.A.2) The guidelines are quite comprehensive and provide an immensely useful instrument to the life insurance companies to manage investment risks.

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Investment Committee The IRDA (Investment) (Amendment) Regulations 2001 also made it mandatory for an insurance company to constitute an investment committee consisting of minimum two nonexecutive directors of the insurers, the principal officer, chief of finance and investment divisions and wherever an actuary is appointed the Appointed Actuary.

Investment Policy Further every insurer shall annually draw up an investment policy and place the Board of Directors for approval. Such a policy will incorporate issues relating to liquidity, prudential norms and exposure limit, and stop loss limit in securities trading. 1. Ensuring an adequate return on policyholders and shareholders funds consistent with protection, safety and liquidity of such funds. 2. Funds shall be invested and continued to be invested in equity shares, preference shares and instruments which enjoy a rating referred to in the Regulations. The investment policy will be approved by the Board and will be implemented by the investment committee. The Board shall review the investment policy and its implementation on an half yearly basis or at such short interval as it may decide. The details of the investment policy and its review as periodically decided by the Board shall be submitted to the authority within 30 days of its decision thereto.

Some Strategic Issues in Investment Management Investment strategies in a life insurance company need to be designed by taking into account the various components of product portfolio, liability and associated risks. Therefore, there maybe a number of strategies instead of one. Different strategies for different funds and for the proportion of financial assets, namely, money market instrument, debt market instrument, equity, etc. Therefore, asset allocation becomes a crucial function for fund managers. Further deciding a risk return contour well in advance is equally important. In the preceding paragraphs we have discussed some of the points which make insurance funds management a complex function due to a variety of investment objectives and different levels of risks, which need to be satisfied by the fund managers. Another problem is multiplicity of time horizon. Most of the insurance contracts are long-term in nature and the portfolios are different in nature. Some of the products even offer guaranteed return and in a long-term volatile market providing guaranteed return calls for extraordinary management skills. Asset Liability Management (ALM) over a long period of time is more difficult than over a short period due to market

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volatility and long-term nature of contracts. All these objectives need to be achieved within the prudent regulatory framework. In a competitive market economy transparency, information dissemination and corporate governance have to be in built in funds management policies and strategies. It is therefore prudent to introduce the concept of portfolio management for managing insurance funds and adopting separate allocation strategies depending on the nature of investment objectives, risk level and market cycles. Some important strategic issues to achieve the aforementioned objectives are discussed in the latter part of the chapter.

Designing Portfolio and Sub-portfolios A life assurer transacting multipurpose business activities and selling a wide range of policies needs to build up separate portfolios as per IRDA guidelines since the investment limit prescribed by IRDA are different for each type of asset. Three broad portfolios for a life insurance company are: 1. Portfolio of controlled fund assets. 2. Portfolio of pension and general annuity assets. 3. Portfolio of unit linked life insurance assets. Controlled fund of any life insurance company consists of assets originating from business transacted in several kinds of policies, namely, endowment, term assurance, sickness insurance, etc., the level of risks and liability of each group of business/asset would differ from each other group. Therefore, it would be prudent to establish few sub-portfolios within the controlled fund portfolio. Though the IRDA has prescribed a single norm for controlled fund investment, effective management would require setting up of fund-specific strategies, sub-portfolio for the controlled fund, etc. Similarly, there should be separate portfolio for pension and annuity as well as for unit linked assets, because of the skill requirement for managing assets of such funds. Concept of competitive performance also calls for establishing objective specific separate portfolios in a multi-dimensional insurance company. Internal competition is an important instrument to improve management efficiency. If the entire fund is pooled together for investment purpose, relative efficiency, relative contribution as well as relative cost funds management can be assessed. Further, policy shortcomings and necessary corrective measures cannot be initiated for rebalancing the portfolio which is an important requirement for taking advantages out of market movement and protecting funds. There it is necessary that separate portfolios, which should be treated as separate accounting units, be set up, independent of each other. This will also allow introduction of earnings-/performance-led reward system.

Investment Policy We have seen that defining the investment policy is an integral part of the process of investment management. The IRDA regulation on investment management states that ‘every insurer shall

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draw up annually an Investment Policy and place the same before its Board of Directors for its approval’. The regulation further states that such a policy be guided by issues such as liquidity, prudential norms, management and market risks, ALM safety and liquidity of funds, etc. However, formulation of investment policy needs to be based on factors such as future liability, the level of risk tolerance of the policyholders and expected return, which however differs among the various types of policies, for example: 1. Pension fund liability would differ from that of unit linked policy fund. 2. The liability with profit policy funds would differ from that of funds without profit. 3. Similarly, the level of risk tolerance of investors in unit linked policies would differ from investors of pension fund. Another compelling factor for a separate investment policy for different kinds of funds is the long-term nature of insurance funds which passes through various phases of business cycle and ultimately influences the return of funds. In a recessionary and depressed market, return from unit linked funds—which invest a high percentage of funds in equity—maybe relatively lower than the return from endowment funds, due to the higher percentage of investment of funds in debt instruments. Therefore, investment policy of unit linked funds should be different from the investment policy of endowment or annuity fund. Asset allocation strategy aimed at maximizing asset return and minimizing asset liability mismatch in the short and long run. Strategic asset allocation takes care of long-term objectives, while tactical asset allocation strategy performs the short-term adjustment.

Asset Allocation Strategy Asset allocation is the most important aspect of an investment decision. Asset allocation means the distribution of funds of a portfolio among different financial instruments such as stocks, bonds and cash keeping in view of the overall investment objective, level of risk tolerance and the time horizon, etc. It encompasses the expected risk-return profile and strategy risk management. Asset allocation strategy is one of the most important sources of performance and there is no substitute for an appropriate strategy of asset allocation. Asset allocation has two dimensions, namely, long-term and short-term. The former is also known as strategic asset allocation and the latter as tactical asset allocation, though the broader goal of the latter is also to maximize long-term returns. Strategic asset allocation allows the fund managers to achieve long-term objectives in relation to investors risk tolerance capacity determined by the risk-return ratio of each class of assets. Tactical asset allocation on the other hand allows the fund managers to improve periodic return by adjusting the portfolio in accordance with the short-term volatility of the market, tough within a long-term perspective. The third variant of strategy called dynamic asset allocation is considered as a series of rolling strategic asset allocation. A fund manager must be well acquainted with these strategies and their operational mechanisms and be capable

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to select an appropriate strategy for a particular fund for better return. Therefore, funds set up with high risk, high return, need to follow tactical asset allocation strategy. Dynamic asset allocation strategy can also be adopted on a specific situation. For an endowment or savings type of funds having guaranteed returns should follow strategic asset allocation with long-term view, investing primarily in fixed income securities in order to match future payment liability. One way is to match the assets with future liability, that is, liability must match with future stream of earnings, which is called duration matching. Under this method duration of liability and the present value of the portfolio must match. Duration matching will reduce interest rate risk and it is also used for immunizing the portfolio. On the other hand, policyholders in unit linked policies are relatively more interested in higher/capital market-related return and willingly to bear more risk. Therefore, in such a fund a large amount is invested in equities. However, better equity returns depend on efficient implementation of tactical allocation strategy based on frequent review, periodic adjustment and aggressive management of a portfolio within the broad objective and policy norms.

Asset Liability Management Asset liability management (ALM) is an extremely important area of investment management, particularly for an insurance company which deals with financial risks of human lives and the small investors. Asset liability can be managed through portfolio immunization as indicated above by using the duration matching method, matching the duration of asset with the duration of liability. Another way to take care of asset liability mismatch is to follow cash matching. This method requires funding the future liability by coupon receipts and redemption of securities. With the discovery of derivatives, particularly the futures, ALM has become easier and cost effective. For an insurance company having substantial amount of investment in bonds and other fixed income securities, bond futures can be effectively utilized for duration matching to manage future mismatch in liability and assets.

Risk Management One of the explicit objective of prudential exposure norms and limits is to minimize investment risks. Investment risks may arise from a variety of factors such as decline in interest rate, default by the creditor, changes in liquidity condition and changes in legal system. (These factors have been discussed in detail in the chapter on Risk Management in Life Insurance.) However, understanding the risk, introduction of prudent person regulation, designing risk-based capital base, etc. (These issues have been discussed in detail in a separate section in this book).

Hedging through Derivative Risk management helps to plan out strategies which maximize benefits and long-term gains by maintaining a healthy cash flow. Shareholders look into the dividend, capital appreciation

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and long-term value optimization of their investment. Therefore, it is the short-term as well as long-term gains, which are to be maximized through investment operation by a manager. However in the process, fund manager experiences a number of adverse factors increasing the risk content of investment operation. There are several mechanisms to handle these risks and one such mechanism is ‘hedging through derivatives’. Derivatives can be used for speculation or for hedging. Speculators can take market opportunities by capturing market movements in order to enhance his profitability, while hedgers take specific exposure in order to stabilize his earnings/cash flow in adverse market movements causing fluctuations in the interest rates. The financial instruments used for hedging are popularly called ‘derivatives’, since they derive their values from some underlying assets such as index or reference rates and they include futures, forward swaps and options. Basically, these instruments can be divided into two categories, namely, forward-based contracts (swaps and futures) and option-based contracts (options, caps and floors). A forward contract is the simplest derivative instrument. It is an agreement to buy or sell a specified asset at a specified date in future at a specified price. All terms are settled at the outset of the deal. If at maturity the spot price is above the exercise price, the contract buyer makes a profit, and conversely, if the spot price is below the exercise price he makes a loss. A contract may also be for future interest rates. If a corporate manager thinks that the future interest rate is likely to increase and he has to borrow a specified amount for development, he can enter into an agreement. This maybe done in order to reduce uncertainties in the delivery of loans and thereby uncertainties in the write-off of loans. Futures

A future contract can be defined as an agreement to buy or sell an asset at a certain time in future at a certain price. It is a firm financial agreement to sell or buy a standardized instrument or commodity at a predetermined price at a predetermined place (stock exchange) at a future date. Swaps

Swaps are over-the-counter arrangements between two parties to exchange (or swap) specified cash flows for certain designated periods during the stated maturity. In its most common form it is exhibited in interest rates. During recent times swaps have been used primarily for hedging. Options

There are two types of options: ‘Call’ and ‘Put’. Buying a ‘Call’ option gives the purchaser the right to buy the underlying assets, whereas purchasing ‘Put’ option offers an opportunity to sell the underlying assets. The key advantage of either option trading is that the buyer can choose whether to exercise the option or not. The option strategy has the immense power of neutralizing risks.

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All derivative instruments mentioned facilitate risk management in the underlying cash market. This risk management is based on the basic premise that two parties participate in an exchange undertaking risks and expected returns. However, risk management style will differ from participant to participant. While one participant may seek protection from volatility, another may prefer profit to volatility. One participant’s loss could be the other one’s gain. Therefore, derivatives themselves can be source risks. These risks can be classified as credit risks (bad debts), market risks (interest rate risks, price risks and underwriting risks) and operational risks (risks related to transactions). However, scientific handling of derivative instruments by experts would reduce the risks and could be effectively used as hedging instruments. For maximum benefits of derivatives, the following points are to be kept in mind: 1. Hedging, when used with other possible options as a risk strategy, can be more effective. 2. Hedging should be investment-specific, that is before hedging the objectives of investment goal and cash flow have to be identified. 3. Hedging may not be very useful for low capital and conservative capital-based companies. 4. Hedging should be company-specific. It is not necessary to follow the competitors in the same industry. Investment goal, peculiarities of capital structure and cash flow may differ from company to company. So what is best for one company may not necessarily be good for another. A fund manager must remember that in an environment of absolute uncertainty, no strategy can be perfect to remove risks altogether. There would be some elements of risks in every corporate action, but derivatives and risk management strategy can certainly improve the allocation of resources and redistribute risks in a better way than it would have been possible with any other risk strategy.

Investment Research Probably the most important area of investment function of any financial institution, particularly any insurance company is the area of investment research. Since a life insurance company manages long-term risks, a long-term perspective is required for effective management of risk return relationship as well as management of asset liability mismatch. A fund manager must have medium to long-term perspectives of economy and market. A fundamentally strong fund manager can take a long-term view. But, a long-term view can only be developed with the help of assessment of a long-term scenario. Therefore, predictive ability of a fund manager is very essential for managing any insurance fund. Moreover, active management and tactical asset allocation strategy cannot be implemented without any strong research back-up. An effective research set-up must include: macro economic research, debt market research, equity research and investment policy research. However, what is more important is to have a research mentality among the people, particularly those who are involved in investment business. This is an

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important area of management success but mostly ignored in the Indian set-up and research culture is vastly missing from corporate canvas.

Corporate Governance Corporate governance in general indicates a mechanism to maximize the wealth of shareholders/ owners, which can be achieved through optimum utilization of resources and maximizing the return on investment by managing business with ethics, transparency and corporate accountability. Since financial institutions play a very important role in economy and influence the life style of people, corporate governance becomes an important area of concern. Corporate governance in insurance companies is further essential, particularly due to the very nature of its operation. However, several measures have been implicit in insurance investment management, leading to introduction of corporate governance, for example, compulsory constitution of investment committee, introduction of prudential norms, statutory submission of statistical information to IRDA, standardization of valuation of assets, etc. However, one area of corporate governance that needs our attention is the adoption and implementation of investment strategies. This is more important with respect to active investment strategy which significantly relies on stock selection and market timing for beating the market. Very often over-diversification adds disproportionate costs to the funds. Lack of technical knowledge often results in poor performance. Similarly, passive management, which aims at achieving investment goal by selecting wrong securities from an index with inflated premium and turns illiquid in future may cost heavily to the investors. Very often stock market activism of fund managers invites trouble for the funds, which needs to be checked in advance. Therefore, corporate governance is essential to manage the fund managers.

Prudent Person Rule Quantitative regulation is normally a regulatory mechanism to put restrictions on investment in assets with high degree of volatility or/and low liquidity. However, this has limited role in ensuring prudence investment management since quantitative restrictions have limited impact on the quality of managerial decision. Therefore, in order to strengthen quantitative restriction, Prudent Person Rule, ‘a concept whereby investments are made in such a way that they are considered to be handled prudently (as some one would do in the conduct of his or her own affairs)’. The aim is to ensure adequate diversification, thus protecting the beneficiaries against insolvency of the sponsor and investment risk (Davis 2000). As such the Prudent Person Rule focuses on the behaviour of the persons involved in investing particularly the fund managers. In this rule the focus is on the external rules, the onus is on internal control and governance structures in which the authority has confidence (Davis 2000). Prudent Person Rule can be effectively implemented by identifying the life of responsibilities, introducing due diligence to the performance of fund managers. Prudent Person Rules have been introduced by many countries including USA, UK, the Netherlands, etc.

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Outsourcing Asset Management In Chapter 4 we have discussed about the ongoing transformation in insurance services and to improve the value creation mentioned about in outsourcing of some services by an insurance company. In the process of virtual integration, a firm should concentrate on core business others being outsourced to specialized agencies. Funds management is a very specialized job and needs experts to understand various facets of assets management. As noted earlier, with diversification of product portfolio and increased complexities in the market; generalists in a life insurance company are unable to handle this job efficiently. Financial assets generated by a life insurance company, primarily belong to the policyholders who deserve best returns on their funds. However, increased competitive pressure, regulatory limits, accounting standards and new class risks, etc., generated tremendous pressure on fund managers. However, competitive pressure has increased tremendously due to aggressive competition from mutual funds, pension funds and other investment products forcing life insurance to launch new products with assured return or promise for better returns. With product proliferation and increased competition in the investment market continuous improvement in skill of asset allocation, portfolio design and investment research are essential for efficient asset management. There is a visible sign of huge growth in life insurance funds and particularly that of unit linked funds in India, which will make funds management really complex and challenging. Therefore, Indian insurers need to think of improving funds management skills and efficiency by many fold or to resort to the support of a third party asset management company.

Investment Management by Life Insurance Companies Investment Operation before Liberalization Investment management is a crucial function of a life insurance company since it invests huge amount of public money and has to create enough financial assets to match its future liabilities. Further, the amount of funds invested by a life insurance company is always under public scrutiny and therefore, funds management governance is also very important. LIC as a public financial institute always managed its investment under strict regulatory norms, government guidelines and well-designed governance system.

Investment Policy Before 2000, LIC was the only insurance company in India, however its investment management was strictly guided by various guidelines such as the Insurance Act, government directives and in-house investment policy approved by the Board. All funds are invested under overall supervision of the investment committee appointed by LIC Board. This investment committee

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constituted by the Board, and the members of the investment committee are drawn from amongst the Board members. Corporations investment is guided by the investment policy adopted by the Parliament way back in 1958. The then Finance Minister Morarji Desai, placed a notification on the table of the Loksabha on 25 August 1958, a notification that made certain provisions of the Insurance Act, 1938 applicable to Life Insurance Corporation of India in accordance with Section 43(2) of LIC Act, 1956. An important Section 27 A of the Insurance Act, as modified was incorporated in the notification, which defined ambit within which the Corporation could operate in the matters of investment (LIC 1991: p.101). Accordingly, LIC investment was broadly divided into three categories namely: 1. Government and approved securities which are generally gilt-edged securities. 2. Investment approved under Section 27(A). 3. Other investment. This section also limited the scope of investment under various categories listed in the previous section. 1. 50 per cent of the funds should be held in government and approved securities. 2. 35 per cent maybe held in approved investment. 3. Not more than 15 per cent can be held as other investment. As mentioned in Tryst with Trust (1991) the basic principles of LIC’s investment policy are summarized as follows: The keynote in the corporation’s investment policy should be that the funds should be invested so as to safeguard and promote to the maximum extent possible, the interest of the policyholders. However, the large interest of the country should not be ignored. The investment should be dispersed over different classes of investment, different industries and different regions. The corporation should take interest in underwriting debentures and shares after careful investigation. The investment policy of the corporation should serve the larger economic and social considerations beneficial to the country. The corporation should act purely as an investor and not assume the role of an operator or speculator and try not to take advantage of temporary fluctuations in the market prices. The corporation should actively examine its investment portfolio from time to time and take such actions as maybe warranted in the circumstances. The corporation should not acquire, control or participate in the management of any concern, in which it has interest as an investor, unless exceptional circumstances are warranted.

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The core of the above is to prudently safeguard investing policyholders money. Public money may be used to serve larger economic and social goal, investing cautiously as an investor, etc. Keeping these in view LIC has been investing its funds mostly in securities with low risk.

Investment of LIC as on 31 March 2001 We have mentioned earlier about the growth of investible funds since 1957. However, a further examination of investment since 2000–01, would reveal the direction of investment of LIC. It is significant to note that LIC started with small investible funds of Rs 38.90 crore at the time of nationalization which went upto Rs 175,014.9 crore in the year of opening of life insurance industry in 2000–01, which indicates that out of the total investment of Rs 175,014.9 crore, Rs 32,155.37 crore (18.37 per cent) was advanced as loan, Rs 140,106 crore (80.05 per cent) was invested in stock exchange securities, Rs 1,862 crore (1.06 per cent) was invested in special deposit scheme of central government and Rs 891.45 crore (0.51 per cent) was invested in ‘other investment’.

Investment in Stock Exchange Securities Since more than 80 per cent of investment was in stock exchange securities it would be interesting to know what constituted this investment. As on 31 March 2001 out of Rs 140,106 crore invested in stock exchange, Rs 85,180.9 crore, that is, 60.80 per cent was invested in Government of India securities Rs 14,374.05 crore, that is, 10.26 per cent was invested in state government securities and Rs 3,502.91 crore, that is, 2.5 per cent in other government guaranteed securities. Therefore, 73.56 per cent of total stock exchange investment was government and government guaranteed securities. Investment in roadways, Port and Railways was Rs 325 crore that is, 0.23 per cent, investment in private sector power generation was Rs 3,796.71 crore, that is, 2.09 per cent, investment in municipality Rs 4.14 crore, investment in shares and units of LIC Mutual Fund (LICMF) was Rs 14,990.63 crore, that is, 10.70 per cent and investment in debentures and bonds was Rs 20,266.54 crore, that is,14.47 per cent. Pattern of investment of LIC as discussed in the earlier part of the chapter indicates the crucial role it played in Indian debt capital and equity market, huge investment of LIC provided the much needed support to the market in terms of growth. LIC has also played an important role in infrastructure development by providing the much needed long-term capital.

Growth of LIC Investment during 2001 to 2006 During the post-liberalization period the size of LIC investment in India had gone up by 2.98 times, that is, from Rs 175,014.9 crore in 2000–01 to Rs 523,065.72 crore in 2005–06. However, total investment of the corporation including investment of Rs 951.53 crore outside India was Rs 524,017.25 crore by 31 March 2006.

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There is also a notable change in the investment portfolio of LIC. It can be noted from Table 5. 1 that share of loan portfolio declined from 18.37 per cent in 2000–01 to 11 per cent in 2005–06. However, the share of stock exchange securities increased substantially from 80.05 per cent to 88.37 per cent during the same period. This is primarily due to the increased opportunities in the stock market and decline in the interest of corporates to debt financing. Removal of restrictions to borrow in the international market by the corporates also reduced their dependence on loan financing and borrowing from banks and OFIs. Moreover, reforms in the Indian stock market provided further opportunities for equity financing to the corporates. All these have influenced the investment pattern of financial institutions such as LIC.

Socially-Oriented Investment of LIC One of the major objectives of nationalization of life insurance companies and formation of LIC was to invest policyholder’s funds efficiently and in the interest of people and the country. This objective has been efficiently served by the corporation by investing a portion of funds in socially-oriented sectors, which includes: 1 2. 3. 4.

Projects/schemes for generation and transmission of power. Housing sector. Water supply and sewerage projects. Development of roads, bridges and road transport.

During the year 2005–06, such investment of LIC was to the extent of Rs 13,850.84 as against Rs 3,488.47 crore, that is, there was an increase of 297 per cent during the 6 years time, which indicates LIC’s thrust on social sector development (Table 5.2).

Investment by Life Insurer during Post-liberalization Period Opening of insurance market and entry of private life insurance companies has not only widened the canvas of life insurance market and taken care of growing insurance needs of the Indian public but it has also given a boost to mobilization of savings and provided added momentum to capital market. Growth in business increased the investment of life insurance industry by many fold. During the post-liberalization period the size of investment of life insurance companies in India increased from Rs 194,009.60 crore in 2000–01 to Rs 487,150.69 crore in 2005–06. While the investment of public sector LIC of India has increased from Rs 193,282.99 crore to Rs 463,771.14 crore, the same for private sector companies increased from Rs 7,266.1 to Rs 23,379.55 crore during the same period. However, LIC still controlled 95.20 per cent of total life insurance investment (Table 5.3).

32,155.37

0.51

1.06

175,014.85 100

891.45

1,862.00

37,734.53

Amount

1.02

0.56

84.14

14.27

Amount

264,366.29 100

2,700.44

1,482.00

80.05 222,449.32

18.37

% to total

source LIC Annual Reports (various issues).

4. Other investment Total

3. Special deposit with Central Government

2. Stock exchange 140,106.03 securities

1. Loan

Amount

2002–03

34,221.99

26,08.39

1,282.00

292,930.86

45,398.64

Amount

54,238.82

Amount

100

0.76

0.37

412,857.16

2,982.64

0.00

575,349.3

Amount

0.72

5,230,657.2

32,931.8

–

0.63

88.37

11.00

% to total

100

2005–06

86.14 4,622,376.1

13.14

% to total

100

2004–05

85.60 355,635.70

13.27

Amount

2003–04

(Rs in crore)

LIFE INSURANCE IN INDIA

2000–01

TABLE 5.1 Investment of Life Insurance Corporation of India (as on 31 March)

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TABLE 5.2 Loans and Debentures Advanced to Various Entities for Infrastructure and Social Purpose (Rs in crore) 2000–01 1. Power 2. Housing (a) Loans to state government for housing schemes (b) Loans to apex co-operative housing finance societies and others (c) Debentures of Housing and Urban Development Corporation (HUDCO), LIC Housing Finance Ltd, HDFC, etc 3. Water supply and sewerage schemes 4. Transport 5. Other infrastructure Total

2005–06

470.82

8,471.90

552.31 1,561.0 –

493.60 45.37 3,925.00

526.82 48.05 329.47 3,488.47

26.16 128.00 760.81 13,850.84

TABLE 5.3 Growth in Investment of Life Insurance Industry (Rs in crore) Year 2000–01 2001–02 2002–03 2003–04 2004–05 2005–06

LIC 193,282.99 245,387.72 258,732.22 347,959.14 418,288.99 463,771.14

Private Sector 726.61 1,400.43 2,351.85 4,665.39 10,162.94 23,379.55

Total 194,009.60 246,788.15 261,084.07 352,624.53 428,451.93 487,150.69

Source IRDA Annual Reports (various issues).

Fund-wise Allocation of Investment Insurance companies come to the market with a variety of plans having different objectives to take care of varied financial needs of the policyholders. Therefore, investment objectives, strategies and composition of funds differ from the basic objective of life insurance plans. Accordingly, investment of life insurance companies has been classified by IRDA as investment of life funds, pension and general annuity funds, group excluding, group pension and annuity fund and unit linked fund. Distribution of total life insurance funds as on 31 March 2006, indicates that investment of life funds, pension and general annuity funds, group excluding group pension and annuity funds, unit linked funds was Rs 397,188.65 crore, Rs 37,264.29 crore, Rs 26,809.62 crore and Rs 25,888.13 crore respectively (Table 5.4).

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LIFE INSURANCE IN INDIA TABLE 5.4 Fund-wise Investment of Life Insurance Companies LIC

A. Life fund 2003–04 304,436.88 2004–05 36,157.64 2005–06 389,447.52 B. Pension and general annuity 2003–04 9,244.06 2004–05 11,462.03 2005–06 36,157.64 C. Group excluding group pension and annuity 2003–04 34,068.32 2004–05 42,639.42 2005–06 26,737.53 D. Unit linked funds 2003–04 209.87 2004–05 2,758.67 2005–06 11,428.45 E. Total (A+B+C+D) 2003–04 347,959.14 (98.68) 2004–05 418,288.99 (97.63) 2005–06 463,771.14 (95.20)

Private Sector

Total

2,872.03 4,790.98 7,741.13

307,308.91 (87.15) 366,219.85 (85.48) 397,188.65 (81.53)

307.77 561.75 1,106.65

9,551.83 (2.71) 12,023.78 (2.81) 37,264.29 (7.65)

7.15 41.43 72.09

34,075.47 (9.66) 42,680.85 (9.96) 26,809.62 (5.50)

1,478.40 4,768.77 14,459.68

1,680.30 (0.48) 7,527.45 (1.76) 25,888.13 (5.31)

4,665.38 (1.38) 10,162.94 (2.37) 23,379.55 (4.80)

352,624.50 (100) 428,451.93 (100) 487,150.69 (100)

Source IRDA (2004–05 and 2005–06). Note Figures in the brackets are the percentage to the respective total.

Further analysis of data in Table 5.4 shows that during the last three years there has been a significant change in the investment profiles and weight of each funds in total investment. It can be noted that the share of the life funds in total investment declined from 87.15 per cent in 2003–04 to 81.53 per cent in 2005–06 while the same for group excluding group pension and annuity declined from 9.66 per cent to 5.50 per cent during the same period. On the other hand there has been significant increase in pension and general annuity as well as unit linked funds. While the former has gone up from 2.71 per cent in 2003–04 to 7.65 per cent in 2005–06, the later increased at a faster rate from 0.48 per cent to 5.31 per cent during the same period. This indicates that there is a growing demand for these two products and the life insurance companies could take the advantage of potential market.

Company-wise Investment Investment of life insurance industry increased at 13.7 per cent to Rs 487,150.69 crore in 2006 as against Rs 428,451.93 crore (Table 5.5). LIC’s share in the industry investment at

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Rs 463,771.14 crore was 95.2 per cent and all private companies together contributed Rs 23,379.55 crore, that is, 4.8 per cent. Among the private companies top five companies together contributed 3.3 per cent. The top five private sector life insurance companies were ICICI Prudential (1.54 per cent), Bajaj Allianz (0.68 per cent), Birla Sunlife (0.48 per cent), SBI Life (0.42 per cent) and Tata AIG (0.25 per cent). TABLE 5.5 Individual Investment of Life Insurance Companies (as on 31 March) Total (All Funds) Insurers Public sector (A) LIC Private sector (B) HDFC Std Life MNYL ICICI Prudential BSLI Tata AIG Kotak Life SBI Life Bajaj Allianz Metlife Reliance Life ING Vysya Aviva Sahara Life Shriram Life Total (B) Total (A+B)

2006

2005

463,771.14

418,288.99

2,596.29 885.85 7,485.50 2,350.85 1,222.35 1,123.82 2,034.98 3,324.36 265.92 352.90 692.36 752.76 161.86 129.75 23,379.55 487,150.69

923.35 478.09 3,474.43 1,295.85 565.05 524.40 1,054.17 762.07 161.66 181.56 319.83 278.93 142.56 10,162.94 428,451.93

Source IRDA Annual Report (2005–06).

Instrument-wise Allocation of Investment We have indicated in Table 5.4 fund-wise allocation of investment by life insurance companies during 2003–04 to 2005–06. A further break-up of such investment according to various financial instruments/sectors is indicated here. However, life insurance companies need to invest according to IRDA guidelines, an investment which specifies and defines various instruments. As per Regulator 3 of IRDA Investment Regulation every life insurance company shall invest and at all times keep invested his controlled fund. Regulation also defines various instruments such as central government securities, state government securities, approved securities and infrastructure sector. Accordingly, government securities as defined in Insurance Act 1938 means security as defined in Public Debt Act 1944, which includes (a) security issued by the central/state government or (b) any other security

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created and issued by the government, for example, 10/7/5 year G-Sec issued by RB on behalf of the central government, Treasury Bills 91/180/364 days, etc. Approved securities as defined in Section 2(9) of the Insuance Act 1938 includes (a) government securities or other securities charged on the revenue of central/state government or (b) security fully guaranteed by central state government, for example, bonds issued by SFC, State Electricity Board (SEB), Land Development Board (LDB), State Development Loans (SDLs), etc. Infrastructure sector includes power sector, road transport system, projects for housing, water supply and sewerage system, irrigation projects, railways, airport or ports, telecommunication, solid wastes management system, industrial parks, etc. Exposure norms include company grants and industry. Approved investment means investment in equity for a company which has paid minimum 4 per cent dividend for the last four years, otherwise Other than Approved Investment (OTAI). Keeping this classification of investment instruments, we may discuss fund-wise pattern of investment of life insurance companies.

Investment of Life Funds Life fund has been invested in central government securities other than the approved securities investment subject to exposure norms, and OTAI. It can be observed from Table 5.5 that in 2005–06, 50.78 per cent life fund (Rs 201,678.32 crore) was invested in central government securities. However, central and state government securities together constituted Rs 245,477.93 crore, that is, 61.8 per cent in 2005–06, as against Rs 209,908.18 crore, that is, 57.32 per cent in 2004–05. Investment infrastructure at Rs 49,638.45 crore increased marginally which was 12.5 per cent in 2005–06 as against 12.43 per cent in 2004–05. On the other hand investment subject to exposure norms including other than approved. Investment declined to 25.7 per cent in 2005–06 from 30.25 per cent in 2004–05. It can also be noted that total life fund as on 31 March 2006, at Rs 397,188.65 crore registered a growth of 8.45 per cent over the previous year. LIC contributed Rs 389,447.52 crore, that is, 98.1 per cent to total life fund investment (Table 5.6).

Pension and General Annuity Fund Pension and general annuity fund investment registered a phenomenal growth of 210 per cent in 2005–06 over the previous years, due to the increased sales of pension products and mobilization of savings since opening up of life insurance to private companies. Most of the life insurance companies including LIC have launched pension and retirement plans, which boasted of pension sales and enhanced investible funds. Instrument-wise distribution of pension fund indicates that investment in central government securities increased from 50.3 per cent in 2004–05 to 52.8 per cent in 2005–06 while the same including central and state government and other approved securities increased from 78 per cent to 79.44 per cent during the same period. Since, pension fund has to fulfil long-term obligation

2006

2005

2006

2005

SG & OAS (Incl. C.G. Sec.) 2006

2005

Infrastructure/ Social Sector 2006

2005

Investment Subject to Exposure Norms (inclusive OTAI) 2006

OTAI 2005

2006

2005

Total (Life Fund) (A)

(Rs in crore)

Source

IRDA Annual Report (2005–06).

Public sector (A) LIC 197,419.39 167,718.86 241,103.52 206,906.87 48,182.22 44,660.40 100,161.78 109,861.60 26,286.06 26,111.98 389,447.5 361,428.87 Private 4,258.93 2,714.53 4,374.41 3,001.31 1,456.23 860.61 1,910.49 929.07 412.50 265.75 7,741.13 4,790.98 sector (B) Total 201,678.32 170,433.39 245,477.93 209,908.18 49,638.45 45,521.01 102,072.27 110,790.66 26,698.56 26,377.73 397,188.65 366,219.85 (A) + (B)

Insurers

Central Government Securities

TABLE 5.6 Fund-wise Pattern of Investment of Life Insurers: Life Fund (as on 31 March)

18,987.86 694.79 19,682.65

2006

2005 5,650.77 399.22 6,049.99

Source IRDA Annual Report (2005–06).

Public sector (A) LIC Private sector (B) Total (A) + (B)

Insurers

Central Government Securities

28,881.26 723.18 29,604.44

2006 9,083.39 414.32 9,497.68

2005

SG & OAS (Incl. C.G.Sec.)

7,276.38 383.46 7,659.84

2006

2,378.66 147.43 2,526.09

2005

Investment Subject to Exposure Norms

2005 36,157.64 11,462.03 1,106.65 5,617.5 37,264.29 12,023.78

2006

Total (Pension Fund) (B)

TABLE 5.7 Fund-wise Pattern of Investment of Life Insurers: Pension and General Annuity Fund (as on 31 March) (Rs in crore)

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with high level of safety about 80 per cent of funds were invested in the more safe government and government guaranteed securities on the other hand investment subject to exposure norms declined marginally from 21 per cent to 20.56 per cent (Table 5.7).

Group Excluding Group Pension and Annuity Group excluding group pension annuity fund witnessed a drastic decline in its size of investment to Rs 26,809.62 crore from Rs 42,680.85 crore in 2004–05, that is, by 37.18 per cent (Table 5.8). This is due to the decline in growth of group business in 2005–06. This decline was led by LIC which witnessed 33.44 per cent fall in group investment in 2005–06 over the previous years. However, private sector registered 132 per cent increase in group investment from Rs 26.97 crore in 2004–05 to Rs 62.55 crore in 2005–06. Instrument-wise distribution of group investment shows that in 2005–06, 62.4 per cent of total investment was in central government securities and state government securities was 79 per cent while 21 per cent was invested in investment subject to exposure norms.

Unit Linked Funds Significant development has taken place in unit linked segment in terms of growth in sales leading to increase in investible funds, favourable macro economic environment, high growth in GDP and the boom in stock market strangely supported the growth in unit linked segment, which has been reflected in growth of investment. Total, unit linked funds in 2004–05 increased from Rs 7,527.45 crore in 2005 to Rs 25,888.13 crore by registering a growth rate of 244 per cent (Table 5.9). This is a very remarkable development in terms of business growth, but more than that it has its own impact on stock market. Because a larger portion of unit linked funds are invested in stock market securities particularly in equity. For example, investment under linked business of LIC in 2005–06 was to the extent of Rs 1,231,528.14 crore. However, Rs 737,001.45 crore, that is, 59.8 per cent of the fund was invested in equity. Industry level data in Table 5.8 shows that 90.4 per cent of the fund was invested in approved investment while 9.6 per cent of the funds were invested in OTAI Huge investment of life insurance industry in equity market has contributed to growth and depth of Indian capital market. Life insurance companies with huge investment in capital market have significantly impacted the depth and market movement. As noted earlier, together they have invested huge amount in debt and equity market and to a great extent influenced the movement of indices. A recent analysis of broking firm CLSA (Economic Times 18 June, 2007) indicates that insurance companies have significantly influenced the market and there was remarkable growth in their buying. CLSA data shows that net purchase of insurance companies in 2006 was US$ 2.7 billion as against US$ 1.5 billion in 2005. In fact insurance companies are emerging as strong players in the Indian stock market. This is an indication of growing importance of life insurance companies in the stock market which is likely to increase in the years to come.

16,665.46 62.55 16,728.01

2006 25,039.54 26.97 25,066.52

2005

Source IRDA Annual Report (2005–06).

Public sector (A) LIC Private sector (B) Total (A+B)

Insurers

Central Government Securities

21,231.45 63.33 21,294.78

2006 33,297.31 33.63 33,330.93

2005

SG & OAS (Incl. C.G. Sec.)

5,506.08 8.77 5,514.85

2006

9,342.11 7.81 9,349.92

2005

Investment Subject to Exposure Norms

(Rs in crore)

2005 26,727.53 42,639.42 72.09 41.43 26,809.62 42,680.85

2006

Total (Group Fund) (C)

TABLE 5.8 Fund-wise Pattern of Investment of Life Insurers: Group Excluding Group Pension and Annuity Fund (as on 31 March)

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TABLE 5.9 Fund-wise Pattern of Investment of Life Insurers: Unit Linked Fund (as on 31 March) (Rs in crore) Approved Investments Insurers Public sector (A) LIC Private sector (B) Total (A+B)

2006 10,269.86 13,131.15 23,401.01

2005

Total 2006

2,547.87 1,158.59 4,183.91 1,328.53 6,731.78 2,487.12

Total (Unit Linked Fund) (D) 2005

2006

2005

210.80 585.86 795.66

11,428.45 14,459.68 25,888.13

2,758.67 4,768.77 7,527.45

Source IRDA Annual Report (2005–06).

Risk Management in Life Insurance—Issues and Practices Introduction During the last few years, one of the major concerns of regulators, managers and customers in the financial services industry is risk management. Though the concern for risk management in financial institutions started in 1984, when R Stucz published his epoch-making article ‘Optional Hedging Policy’ in Journal of Financial and Quantitative Analysis suggesting ‘a viable reason for objective function concavity’. Since then a number of experts highlighted the concern and rationale for risk management. The concept of risk management in insurance industry, such as banks, mutual funds, pension funds and other Financial Entities (FEs) has emerged as the most important area of focus and several initiatives have been taken at the regulatory and enterprise level to identify, measure and manage the risks that are emerging like epidemics all over the world. However, in India this critical issue of life insurance management has not attracted required attention though the economy, financial market and life insurance industry has undergone tremendous transformation. Further, globalization, convergence in financial market as well as market integration enhanced uncertainty and multi-dimensional risks in management of liability. The world around us, of late, has been changing so fast that neither the information system nor the management practices are able to capture the potential trend in the direction of change; there exists uncertainty and inability to initiate proactive action. The major changes that have been noticed include changes in demographic structure impacting the demographic composition leading to increase in longevity, convergence and volatility in financial markets, emergence of complex new products, fast changing computer technology and information system. All these have brought unanticipated changes in financial services. These changes have immense impact on financial institutions like life insurance because new changes are faster and thus have reduced the time space for managerial response, which has also made the future more unpredictable. Increased longevity has necessitated the introduction of new products to match the need of the customers as well as future liability of an insurance company. These changes have made the law of average, nearly redundant.

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Therefore, there is a search for a new model/methodology and management strategies to face the challenges of various types of risks that are being experienced by the insurance companies. These changes have direct and indirect impact on product (liability) and financial assets (assets) portfolio, and very often tend to create mismatch between these portfolios leading to insolvency and risks. Competitive pressure in investment market has often forced many life insurance companies to ignore this aspect of Assets liability management and assets return could not match the accepted product liability. As a result many companies in recent times have gone bankrupt. For example, in USA, 19 companies went bankrupt in 1987, 40 in 1989, 58 in 1991. Similar incidents also took place in other countries. All these led the insurance world to rethink about the necessity of strengthening risk management initiatives. However, risk management is a broad concept encompassing the objectives of risk management, sources of risks, risk management, oversight of implementation of risk policy, etc. Though ideally risk elimination would be the key objective of risk management, in reality it is impossible to eliminate it totally. Therefore, a realistic objective would be to attempt to reduce the intensity of risk, if not total elimination. The central objectives of risk management policy are to maximize the shareholders value and risk adjusted return, and to minimize volatility related to uncertainty.

Risk Management Strategy However, before a risk management mechanism is put in place we need to assess intensity and extent of various external and internal risks, and for this we need to identify an appropriate technique. Very often probability technique is used for this purpose. Once risk assessment is over, the company needs to put in place a well-defined risk management strategy. Risk management strategy needs to be based on overall risk appetite, by taking into account the various sources of risk and their impact on the company strategy and performance. According to Wason (2005) general strategies for managing risks fall into the following categories: 1. Avoid—eliminate, stop, prohibit or sell the risk exposure. 2. Retain—accept and self-insure the risk exposure (that is, by integrating it with other risks or by diversifying risks). 3. Reduce—mitigate or cap portions of risk exposure. 4. Transfer—hedge, securities or outsource the risk exposure. According to Eric Seah (2003) ‘from Life Insurance point of view, risk reduction could involve looking for risks with negative correlation, so that on balance the overall risk is actually diminished’. Seah has further mentioned ‘Life Insurance Companies should remind themselves at all time that it is volatility that can ruin them—in many cases volatility is elusive and is not easy to pin down, in which case we would need to resort to modelling and do some estimates’. A new approach, which is gaining prominence for risk management and development of strategy

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is called Risk Budgeting (RB). RB is a disciplined and structured risk management approach. In RB strategy, goals are established through risk allocation and performance continuously measured against budget risks, that is, goals under RB strategy portfolio are continuously analyzed. According to Rahi (2002) ‘Risk budgeting provides the ability to develop a portfolio that is optimal for a specified risk appetite’. During recent years, a new concept called Enterprise Risk Management (ERM) which is an extension of Financial Risk Management (FRM) is gaining momentum. ERM takes into account non-financial contingencies in addition to financial factors. ERM is a broader concept and takes into account factors such as human resources, distribution channels, corporate governance and technology. ERM is getting popular after the Commission of Sponsoring Organizations of the Treadway Commission’s (COSO) ERM framework was published in 2002. Many organizations are choosing to implement ERM process to ensure that a uniform approach to risk identification, measurement and treatment is utilized across the organization. By adopting this proactive approach of managing risks companies can move from a ‘silo’ management approach to a deeper integration of its various business (AON 2005). However, before any strategic initiatives are taken we need to identify the sources of various risks in life insurance management.

Sources of Risks in Life Insurance Company However, risks in life insurance operation basically associated with multi-dimensional changes in the factors mentioned in the earlier part of the chapter, the major sources of risks of insurance business are related to macro economic factors, pricings, claims, credit spreads and investment market risks. Pricing risks arising from future volatility, mortality risks arising from increased longevity, critical illness risks arising from future guarantee, interest rate risks arising from future reduction of interest rates and low yield in investment, lack of depth due to non-availability of investment products in the market, guarantee of return, inadequacy in reserve/solvency margins, etc. These risks, being experienced by life insurance companies, are often categorized as actuarial risks and systematic risks. Actuarial risks are associated with firms paying too much for the funds it receives or alternatively the risk that a firm is receiving too little for the risk it has agreed to absorb, while systematic risk is the risk of assets and liabilities associated with system factors. Systematic risks are also called market risks. Another significant categorization of risks made by The Working Party on ‘Integrated Risk Management of Financial Services’ (2003) which suggested four types of generic risks based on the basis of consequences: 1. Strategic risk: the risk of making wrong strategic decisions or suffering loss of reputation. 2. Financial risk: default on outstanding debt and loss of value of invested assets. 3. Political risk: risk of legislative changes and government intervention. 4. Operational risk: risk of operating errors and external changes.

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The working party further categorized all types of risks on the basis of the following: 1. Volatility (process) risk: risk caused by pure random fluctuations. 2. Uncertainty (parameter) risk: risk of changing factors in the risk environment leading to changed model parameter. 3. External event risk: highly, infrequent events with dramatic impact. Risk factors can still be categorized into several other forms, depending on the organizational characteristics and management objectives. But the primary risk factors will remain the same. We may therefore, discuss about some of the major sources of risks as below:

Underwriting Risks Underwriting risks is the most crucial function of a life insurance company through which a proposal is converted into an insurance policy. Underwriting involves assessing financial and mortality risks of a policy, which can arise from the underwriting process, pricing products, design of product, personal habit of the policyholders, potential claims, etc. Underwriting requires high level of integrity, knowledge and experience. Assessment of mortality risk is critical since any deviation from expected mortality leads to loss or gain for the insurer. If mortality is higher than expected the insurer will incur loss. However, this risk can be minimized at the level of underwriting.

Asset Liability Risks It arises from mismatch between assets and liability of an insurance company due to fluctuation in interest rates and inflation causing changes in value of assets and liabilities. It also arises from default of borrowers causing a decline in market value of investment assets.

Pricing Risks Pricing risks arise from uncertainty in mortality, leakages, management expenses and income. Though, pricing is a very critical concern for an insurance company, it is often not given enough attention and pricing of a policy is often based on static assumptions of interest rate regime observed in the past. Potential changes in the market and macroenvironment may defy this assumption and generate pricing risks. Therefore, a futuristic basis of interest rate forecasted scientifically needs to be considered while pricing a product.

Systematic Risks Systematic risks also called as market risks arise out of changes in assets and liability due to systematic changes in market factors. Systematic risks maybe hedged but cannot be fully

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diversified. The important market or systematic risks are: interest rate risks, equity and property risks, credit risks, liquidity risks, concentration risks, asset liability management risks, off balance sheet risks, etc.

Credit Risks Credit risks arises due to the unwillingness or inability of a borrower to perform according to the stated obligations, that is, contractual agreement, particularly by the bondholders and loan receivers. Major credit risks are business credit risks, asset credit risks, counter party credit risks and even political risks impacting credit risks. Credit risks are often not transferable.

Liquidity Risks Liquidity risks arise from sudden changes in a situation which causes deviation from planned events, for example, unexpected large claims arising out of unnatural changes such as earthquakes, floods, epidemics, etc., causing large-scale death or sudden withdrawal of funds through surrender of policies. This may cause mismatch between planned liquidity reserved and unexpected demand for liquidity.

Interest Risks However, the most significant among these risk factors is interest rate risks, which arises due to variation in interest rates and therefore, there is a great concern for this. Babbel and Santomero (1996) mentioned that ‘ Insurers are concerned with interest rate risk more than other systematic risk factors, and rightly so. Over the past two decades, it has been the source of much of the fluctuation in the value of fixed income assets, which constitute the majority of their assets’. Interest rate risk primarily affect the liability side, and therefore greater concern for insurers. But other risks like default risk, inflation risk, liquidity risk, etc. have also significant negative impact on assets and thus on liability. However, while it is the crucial Systematic Risk on the Life Insurance Liability side, and of some importance for property/casualty liabilities as well, it is prominent but less dominating on the asset side of the balance sheet. This is because asset values are perceived to be affected not only by general interest level but also by basis of risk, default risk, liquidity risk, inflation risk, prepayment risk, extension risk, sinking fund options, convertibility, real estate and equity risks.

Operational Risk Operational risk is less focussed in risk management scheme. In a well-managed organization operational risk may have a less significant role but it may play a significant role in increasing the risk content of operation. Operational risks are associated with management, human resources,

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system, strategy, etc. Marketing incentives to the sales people may often promote future risks since sales people, namely, agents tend to maximize their own commission instead of focussing on the company’s interest of selling a product mix which would create a situation of steady flow of cash to the organization. Less dynamic management with static view, absence of long-term market and management strategy, problems of record keeping claims settlement, processing, etc., creates operational risks. Absence of dynamic human resource policy may create exit of transprofessionals providing impetus to system failure.

Legal Risks They are associated with financial contracts, frauds, violation of regulation, etc.

Concentration Risks It arises out of large investment in too narrow choices of instruments, industries and regions.

Catastrophe Risks They arise out of rare events resulting into large number of unexpected claims.

Management Risks They arise out of incompetency of management which is unable to predict potential changes and provide necessary direction.

Growth Risks They arise if growth is excessive or not coordinated properly. Excessive growth may lead to poor selection of risk and capital maybe insufficient to cover the risk. Excessive business growth may also lead to undermining and cost overrun, when growth becomes unmanageable.

Miscellaneous Risks They arise from changes in regulatory regime and requirements, taxation, malpractices at operational level and inefficiency in management practices and lack of accountability and fiduciary responsibility. The list of risks given above is not a complete one and can be extended further. However, in reality an organization often focuses on few major risk factors impacting performance and profitability. A survey conducted by Milliman in USA in the first quarter of 2001 on sources, risk management practices, etc., of large life insurance companies noted that 75 per cent

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companies believe that moderate to high risks exposures are due to rating agency actions, equity returns pricing, credit spread, persistency, macro economic factors claim costs and investment market risks.

Risks Measurement However, risk management calls for risk identification and risk measurement. A number of methods have been in use to measure risks in insurance companies. Though, still there is no single best measure like Value at Risk (VaR) which is widely used for the banking industry. It has been indicated that the major sources of risks are basically associated with two types of portfolios, namely, product portfolio and investment portfolio. Insurance company mobilizes funds from policyholders, as such product portfolio is a liability portfolio while investment portfolio is an asset portfolio. Value of these two portfolios must match each other, otherwise mismatch will create imbalance thereby producing risks. Therefore, an insurer has to ensure that these portfolios are prudently managed and liability is arranged through return of asset portfolio. A technique called ALM is used to attain this objective by an insurance company. The technique of ALM has been defined (Conant et al. 1996) as ‘a Management Programme for co-ordinating the financial effects from the Insurer’s portfolio of Product Liabilities on the one hand and its investment portfolio on the other hand. ALM is designed to support an insurer’s strategic objectives concerning Risk, Solvency and Profitability’. ALM is an important tool of risk management in an insurance company which helps to: 1. Managing technical solvency by assessing the cash flow of a company and analysis risks associated with it. 2. Manage systematic or market risks. A financially sound insurance company needs to maintain positive cash flow which is cash inflow > cash outflow. A negative cash inflow, that is, cash inflow < cash outflow, would mean inadequate liquidity to fulfil liability of the company. It would also mean that the company is technically insolvent. A company must be technically solvent to pay for liability out of its earnings from investment portfolio. Therefore, an insurance company would aim at achieving cash flow matching, that is, cash inflow is exactly matching cash outflow. However, growth of a company requires that cash inflow be greater than cash outflow, that is, when it earns surplus or profit. Several techniques have been designed for measuring and managing risks which are basically directed towards understanding and matching liability and assets of an insurance company. These techniques can be broadly indicated as: 1. Portfolio segmentation. 2. Cash Flow Management (CFM). 3. Cash Flow Testing (CFT).

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4. 5. 6. 7. 8. 9. 10. 11.

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Solvency testing. Optimization analysis. Gap analysis—duration and convexity testing. Hedging. Risk-based capital ratios (RBC ratio). Actual and expected experience monitoring (A/E Ratio). Stress testing. Liquidity analysis.

Portfolio Segmentation It is carried out keeping in view the liability and maturity of a product portfolio. Therefore, portfolio segmentation is a method of subdivision of products and assets. On the basis of duration of maturity of a Product Portfolio, a Life Insurance Company can design its asset portfolio in a way that there is no mismatch between cash inflow and cash outflow.

Cash Flow Management (CFM) Product portfolio of an insurance company has substantial amount of cash liability which is often unpredictable. Predictability of cash outflow and cash inflow and matching assets to expected liability will reduce risk to a great extent. Therefore, under this system assets are created as a mirror image of liability and assets and liability match. Therefore, under CFM liabilities are matched with cash flows.

Cash Flow Testing (CFT) An important technique of the Simulation Model used for predicting results is changing various futuristic assumptions. Under CFT analysis, basic asset/liability analysis are undertaken to verify that sufficient reserves are maintained particularly for generated income controls and annuity products. Under CFT techniques, assets are to be equal to reserves. CFT analyzes cash flow with different interest rates scenario and how that affects the expectation of the company and the quantum of risk that a company may face in future.

Gap Analysis It is another widely used method of risk management which evaluates the weighted average maturity of a portfolio and its sensitivity to interest rate change. Gap analysis indicates the mismatch between assets and product portfolio, that is, assets and liability. Normally a maturity gap formula is used to find the mismatch between assets and liability. A desired situation arises when the average maturity of asset portfolio equates to the average maturity of the liability

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portfolio. Maturity gap mismatch arises when the maturity period of one of the two portfolios are either longer or smaller. Gap analysis is carried out through option adjusted duration statistics, which measures the extent of relationship between the change in the interest rate and the change in the market value of a portfolio. This is a technique to measure the sensitivity of interest rate change on portfolio value in market terms. However in practice, duration analysis is used along with convexity statistics, which is a measure indicating stability of the duration statistics. Therefore, duration and convexity refer to the effort to construct asset portfolio that match specified blocks of liabilities in terms of duration and convexity (LOMA). While in convexity analysis, the price sensitivity of duration to a change in the interest rate is monitored, in duration analysis price sensitivity of portfolio or security is examined in return to change in interest rates. Performance attribution test is conducted to find out the risk factors causing losses by comparing the actual performance with predesigned performance. Dynamic Solvency Testing (DST): In a DST, simulation modelling is used to project assets, cash flow and equity to understand financial position and risk of the company under various interest rate scenarios.

Hedging It is an important technique used for portfolio insurance. Portfolio insurance aims at setting limits to potential investment losses and hedging is a strategy to achieve this objective. Financial instruments popularly called as derivatives are used for hedging. These instruments can be divided into two categories, namely, forward-based contracts such as forward, swaps and futures and option-based contracts such as options, caps and floors. IRDA has allowed Indian life insurance companies to use fixed income derivatives, namely, Forward Rate Agreement (FRA), Interest Rate Swaps (IRS) and exchange traded interest rates for hedging interest rate risks.

A/E Ratio Analysis In this method actual experience is compared to plan expectations, budget, pricing, etc., to assess which liability assumptions are met. Further, A/E ratios can be utilized to conduct trend analysis in order to assess future gains, losses and to estimate future risks. Analyzing the trend of A/E ratio can help project future gains or losses.

RBC Ratio/Target This is considered to be an important measure of risks and increasingly being used by the life insurance companies. Risk-based capital is related to solvency margin. Risk-based capital ratio is actual capital to risk-based capital and according to risk-based solvency margin practice a company must maintain a specified ratio. In this analysis ‘the ratio of RBC to adjusted statutory surplus is used as the standard for surplus adequacy related to risk’.

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Stress Testing Stress testing is a popular risk management tool among risk managers, which assess the potential impact of movements of financial variables on portfolio in an unlikely event. Stress testing are two types namely Scenario Test and Sensitivity Analysis. In scenario tests, key financial drivers of a portfolio are identified and scenarios are formulated, then these key drivers are stressed beyond the VaR level. In Sensitivity Analysis the significance of large movements of financial variables impacting the portfolio is assessed.

Liquidity Analysis It is also being frequently used to analyze the intensity of risks, particularly in view of the increased volatility in capital market which often generates liquidity constraints for a company. Liquidity analysis is performed by using ratio of withdrawal to available cash or by using stress test.

Scenario Analysis This is quite a simple but powerful tool for risk management. Economic environment is a dynamic one and is constantly changing, significantly influencing the assets liability of a portfolio. Therefore, assessing the changes under various macro economic assumptions would throw light on the emerging nature of risks and allow the company to make projections on assets, liability, cash flow, etc. In scenario analysis, liabilities and assets of a portfolio are examined under different macro economic assumptions to see the effect of changes on important macro economic variables, on cash flow and on the basis of that different projections are made by the company to assess the intensity of emerging risks. Further, scenario analysis is also used for another risk model called stress testing, which is a process to identify a situation that may arise in future and cause a huge loss. However, stress testing also uses models such as correlations and volatilities.

Total Capital Method Another interesting method for risk assessment and risk management suggested in the report on ‘Integrated Risk Management of Financial Services’ by a Working Party of Dutch Actuaries (July 2003). According to the Working Party, the risk measure is total capital which is required to be able to cover all the risks in aggregation. Total capital includes equity as well as liability component. The report suggested that a system of uniform quantification of heterogeneous risks should be put in place. This uniform risk measure should satisfy following conditions: 1. Consistency between line of business. 2. Consistent choice of time horizon for all risks.

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Economic valuation should be used for risk assessment and capital buffers. Risk classification should be as complete as possible. The approach taken should be transparent. The approach should take into account multiple adverse scenarios. The approach should take into account dependencies between risks.

The working party has also suggested some steps for quantification of risks. 1. Determine the risks included in the model quantification and mention the risk excluded. 2. Determine the amount of prudence one wants to include in the total capital requirement. 3. Based on the previous step, determine the adverse scenarios one wants to include to determine total capital requirement. 4. Quantify the correlation/dependency relations between the risk types and the scenarios. 5. Determine the required total capital for either the individual risk types or the individual scenarios. It may be mentioned here that in order to strengthen the risk management practices insurance supervision is focussing more and more on capital of a insurance company to maintain insurance operation against the benchmark of assured risks in addition to the statutory solvency margin. In USA, risk-based capital laws are now in effect in all states requiring commissioners to take specified actions when a firm’s risk-based capital ratio, defined as the ratio of actual ratio to risk-based capital, falls below a certain threshold (Cummins et al. 1997). Even in Europe, the Solvency project is centred around risk-based capital model. In a capital based solvency system, risk-bearing business will be linked to more risk capital.

Risk Management Practices Risk management mechanism consists of risk management rules and risk management techniques which are used to reduce volatility in cash flow and earnings, and adverse financial effects. Like risk management methods there are a variety of techniques used by the insurance companies to manage risks. According to Babbel and Santomero of Wharton School, ‘it appears that a common practice has evolved such that four elements have become key steps to implementing broad based risk management system’ (pp. 7–8). 1. Standards and reports—setting up underwriting risk classification and review standards and standardization of financial reporting system.

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2. Underwriting authority and limit—to exercise internal control on managers. 3. Investment guidelines and strategies—to exercise control over desired asset liability mismatch. 4. Incentive scheme—to relate compensation to risk and earnings. However, broadly risk management initiatives may be grouped into (a) risk management regulations, (b) risk standard and (c) risk management techniques.

Risk Management Regulations The major initiatives under this are legislations and regulations. Legislation

Legislation provides a broad legal framework under which an insurance company functions. It often prescribes the limits of functional freedom to limit the risk exposure of a company. In India insurance companies are governed by the Insurance Act, 1938 and IRDA Regulation, 2000. Regulation

Legislation provides powers to the regulatory authority, which frames rules and regulations for the industry and the company. Regulators also supervise implementation of various rules/ regulations by the companies. In India, IRDA is the regulator for insurance companies and it has introduced several regulations/guidelines. Companies licenced by IRDA have to comply with these guidelines. IRDA has introduced several regulations/guidelines to control investment activity with the primary objective to ensure safety funds and to reduce future risks involved in investment operation. Important regulations which focus on risk management are The Insurance Regulatory and Development Authority (Investment) (Amendment) Regulations 2001, Guidelines–INV/ GLN/008/2004–2005. Fixed Income Derivatives, and Insurance Regulatory and Development Authority (Assets, Liabilities and Solvency Margin of Insurance) Regulations 2000. These regulations provide a definite direction to the company management to set up a prudential operating environment in the company to mitigate risks.

Risk-based Capital An insurance contract is a commitment by the insurers to fulfil certain obligations. The capability of the insurer to meet these commitments is known as ‘solvency’. Insurance supervision by regulators focuses on this solvency issue. By efficient management of solvency an insurer can manage investment and other risks. There are various types of insurance solvency supervision models. However, two most widely used models are: fixed ratio model and riskbased models.

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In Fixed Ratio models ‘solvency requirements are established as a fixed percentage of the value of a given variable that is assumed to be strongly correlated with a company’s degree of risk exposure’. Countries in the European Union and India, etc., adopted this model. Solvency ratio has been defined as the ratio of the amount of available solvency margin to the amount of required solvency margin. Every insurer has to determine the required solvency margin, available solvency margin and solvency ratio. In a risk-based model ‘all of the risks confronting an insurance undertaking—technical risks, investment risks and other risks including management risk, commercial risks, etc., RBC ratio is considered to be an important indicator of risk measurement’. This method has been adopted by countries such as USA, Japan and Canada. In India ‘Insurance Regulatory and Development Authority (Assets Liabilities, and Solvency Margin of Insurers) Regulation 2000, provided guidelines on determination of solvency margins for life insurance. Accordingly, ‘available solvency margin’ means the excess of value of assets over the value of life insurance liabilities and other liabilities of policyholders and shareholders funds.

Risk Standard Another risk management practice is to implement risk standard for risk management. This standard can be adopted by the industry as a whole. It can also be designed by an individual company. However, it will be better if industry specific risk standard is designed and implemented by all the life insurance companies. Risk standard would incorporate a wide range of activities including risk measurement, management and monitoring. Establishing a risk management culture, creating an environment control to manage risk, sound corporate governance, system of information dissemination and monitoring strengthens the risk management system. A certain system of benchmark or risk standard, further strengthens the system. However, such a risk standard needs to be established for the industry as a whole, which is to be followed by all the players in the industry. Setting up a risk standard for the industry is essential for concerted efforts in risk management and it will be a necessary condition for fund management of a company to follow such a standard. Therefore, a uniform risk standard needs to be introduced through the life insurance industry. This uniform standard may be called Life Insurance Industry Risk Standard (LIIRS) incorporating risk identification, measurement and management, and oversight. Risk management must include the fiduciary responsibility of Board and managers, risk management objectives, responsibilities of various entities, checks and balances and independent risk oversights. The regulator or self-regulatory organization like Insurance Council of India can introduce this standard. We may mention here the important work done by the Risk Standard Working Group (1996), established in April 1996 by 11 prominent experts and fund managers in USA to create a set of risk standards for institutional investment managers and institutional investors. This working

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group released 20 standards in three important areas, namely, management, measurement and oversight of risks. The report emphasized upon clear definition and acknowledgement of responsibilities particularly that of primary fiduciaries (Board of Directors, trustees, plan sponsor supervisors or equivalent) and the manager fiduciary (chief investment officer internal and external investment manager). A summary of the 20 risk standards given in the Annexure. Twenty risk standard that was suggested by the group has been classified as following: Management

1. 2. 3. 4. 5. 6. 7. 8. 9.

Acknowledgment of fiduciary responsibility. Approved written policies, definitions, guidelines and investment documentation. Independent risk oversight checks and balances, written procedures and controls. Clearly defined organizational structure and key roles. Consistent application of risk policies. Adequate education, systems and resources, back-up and disaster recovery plans. Identification and understanding of key risks. Setting risk limits. Routine reporting, exception reporting and escalation procedures.

Measurement

1. 2. 3. 4. 5. 6. 7.

Valuation procedures. Valuation reconciliation, bid/offer adjustments and overrides. Risk measurement and risk/return attribution analysis. Risk-adjusted return measures. Stress testing. Back testing. Assessing model risk.

Oversight

1. 2. 3. 4.

Due diligence, policy compliance and guideline monitoring. Comparison of manager strategies to compensation and investment activity. Independent review of methodologies, models and systems. Review process for new activities.

Risk Management Techniques Having a risk standard, broadly for the industry would establish certain benchmark for each company. While achieving this benchmark would be necessary for the industry, individual company resorted to their own acceptable techniques to reach the industry risk standard. Therefore, individual companies may have their own risk standard in line with common risk standard for the industry, focussing on the techniques most suitable for them.

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However, there is no uniform technique to manage the entire gamut of risks in a life insurance company but there are several methods and developed practices to manage actuarial risks, through pricing system, solvency margin, etc. Recent developments indicates that static assumptions regarding loss distribution failed to manage risks arising out of interest rate volatility. Another risk factor is the incentive given to agents and marketing staff, which encourages them to sell more new policies, replace old polices, and all this increases the overall risks for the company. In areas of systematic risks, top on the list of risk management technique is the ALM because it not only covers interest rate volatility but also non-interest risks arising out of embedded options in the policy. Further, ALM is used to manage product-specific risks as well as company-wide risks. A survey of global consulting firm, Milliman USA, of Risk Management Practices of US Life Insurance companies shows that more than 75 per cent of the companies indicated that they use the following risk management practices: 1. 2. 3. 4. 5. 6. 7. 8.

Risk insurance. Diversification of assets. Diversification of liabilities. Selective underwriting. Continual process improvement. Hedging via capital market. Stochastic pricing. Risk adjusted pricing targets.

Risk Insurance

It is a common practice of life insurance industry to pass a part of their business risk to a reinsurance company which specializes in managing such risks. Under such an arrangement the insurer pays the claims to the insured and recovers its loss or part of it from the reinsurer. Diversification of Assets

Under this technique the fund manager invests in a wide range of financial assets such as debt, equity, derivatives and money market instruments. This is asset allocation. Asset allocation strategy is supported by periodic reallocation/rebalancing in view of changes in market environment and risk-return matrix. Diversification of Liability

Liability diversification is attained through distribution of various types of life insurance products limiting exposure to particular range of products. Liability diversification also attends through repricing of products in view of changes in market return.

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Selective Underwriting

Underwriting is the primary risk management tool. The underwriter assess the implicit risk of any insurance proposal and also determines the premium including extra premium to be charged. Risk is also determined separately for each class of insurance. Underwriter also determines whether the insurer should pass on the risk to the reinsurer or it should be retained with the insurer itself. Risk limits set the maximum exposure to risk factors and risk tolerance of the management. Reinsurance allows risk transfer to another party through reinsurance agreement. Diversification of assets minimizes impact of unsystematic risks on portfolio while diversification of liabilities is achieved by offering diverse products. Hedging in capital markets is aimed at reducing adverse impact of interest rate fluctuation achieved through derivatives—future forwards options and swaps.

Institutionalization of Risk Management Risk management is a philosophy which needs to be accepted by an individual employee of an organization. But this philosophy cannot be imposed and will not work if thrust upon them only through control mechanism. For acceptance of the risk management philosophy, an environmental turnaround is required by promoting a culture of risk management. Individuals throughout the organization must own this philosophy in such a way that they become the owners of risk management. Any avoidance would create leakages thus making the risk management system defective. For effectively institutionalizing the risk management practices and ownership, an organization must relentlessly make effort to: 1. 2. 3. 4.

Create a corporate culture of risk management. Put in place a system of corporate governance to manage risks. Actively pursue the procedures and policies to attain risk management objectives. Put in place a risk management mechanism comprising broadly identified responsibility to implement the system and continuous monitoring the progress. 5. Risk standard.

Culture As mentioned earlier the culture of risk management maybe promoted through voluntary acceptance of the concept or through dissemination of ownership. To facilitate the ownership of risk management, there should be awareness about importance, criticality of the concept and ultimate benefits to the employees and the organization that could be achieved out of implementation of risk management. However, the awareness campaign requires the commitment of the Board and top management of the organization. Sincerity, seriousness and commitment of the top management need to be seen by the other employees down the line.

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Corporate Governance Sound governance system is an important mechanism, which plays a crucial role in promoting transparency and soundness in management of a corporate and thus creates a culture of disclosure, vigilance, accountability and sensitivity about risk management among managers and other employees. Since corporate governance also promotes strategic vision of the organization it also strengthens the organizations risk management strategy. A Report of SEBI Committee on Corporate Governance (Chairman: N R Narayana Murthy) focussed on these aspects. The Committee recommended that: Procedures should be in place to inform the Board members about risk assessment and minimization procedures. These procedures should be periodically reviewed to ensure that executive management controls risks through means of a properly defined framework. Management should place a report before the entire Board of Directors every quarter, documenting the business risks faced by the company, measures to address and minimize such risks and any limitations to the risk-taking capacity of the corporation. This document should be formally approved by the Board. Vision and concern of the Board members help in creating sensitivity to the top management about risk management and necessary internal control and supervision. Concern of the Board also reflected in developing, implementing and monitoring a risk management mechanism as well as fixing individual responsibility. Therefore, the board needs to initiate such practice which in addition to the regulatory requirements will induce voluntary initiatives with a long-term perspective of risk governance. Huerta (2005) in his paper presented at a World Bank Conference mentioned about the Board responsibility of corporate governance and risk management. He suggested that: – An investment regulatory scheme for insurance companies must be adopted that harmonizes with the specific characteristics of the economy, maturity of the financial market, implemented corporate governance measures and existing measures regarding internal control. – Corporate governance standard on investment and comprehensive risk management entail the Board of Directors’ clear and explicit responsibility regarding the approval of policies and procedures on FRM, as well as setting limits on exposure to risks. – The corporate governance standard on investments and comprehensive risk management entails a clear separation of duties, decision-making, interaction and cooperation between the Board of Directors, chief executive officer and other executives; guidelines or principles concerning investments; monitoring the management of assumed risks and the opinion of independent third party.

Policies and Procedures Corporate risk management mechanism calls for a well-meaning long-term policy in the light of corporate vision, mission, goal and various stakeholders’ interest. However, policies need to be effectively supported by well-designed procedures. Procedures are often seen as

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a control mechanism. No doubt controls are required and are essential components of risk policy. However, internal control needs to be seen as an instrument of empowering people and providing them with guidelines to control activities to mitigate various risks. Internal control has many elements. However, according to AMAS (2005), internal control is a process, effected by an entity’s Board of Directors, management and other personnel, designed to provide reasonable assurance regarding achievement in the following categories: 1. Effectiveness and efficiency of operations. 2. Reliability of financial reporting. 3. Compliance with applicable laws and regulators. Effective internal control based on sound procedures ensures risk management through active participation of people at various levels. COSO framework referred to earlier suggested five elements of internal control and operational risk management which include control environment, risk assessment, control activities, information, communication and monitoring. Control Environment

It sets the tone of an organization influencing the control consciousness of its performance. It is the foundation of all other components of internal control, providing discipline and structure. Control Activities

They are the policies and procedures that help ensure that management directives are carried out and help ensure that necessary actions are taken to address risks to achievement of the entities objectives. Risk Assessment

Risks emanating from internal and external sources must be assessed. A precondition to risk assessment is establishment of objectives, linked to different levels and internally consistent. Therefore, an assessment mechanism is a prime consideration in risk management initiatives. Information and Communication

Pertinent information must be identified, captured and communicated in a form and framework that enables people to carry out their responsibility. Monitoring

Internal control system needs to be monitored—a process that assesses the quality of the system’s performance overtime.

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It can be noted that COSO framework on internal control covers almost all aspects of risk management. However, care should be taken to ensure that it does not become merely a control mechanism but an essential component of performance and success of an organization. Therefore, there is a need to launch a programme to educate the people and to create an environment of ownership for risk control mechanism. Institutionalization of risk management practices calls for separating Risk Monitoring (RM) from Operational Function (OF). Therefore, monitoring should be entrusted to the entity not involved in operational matters. Though implementation will be reviewed by a primary fiduciary such as the Board or top management, yet there is a necessity for independent monitoring through designated persons. Many organizations appoint a Chief Risk Officer (CRO) for this purpose and the person appointed as the CRO, is reasonably a senior level executive reporting to the Chief Executive/Board. The CRO should have a proven record and expertise to handle such a job independently and without any inhibition. The CRO would monitor the implementation of risk management, keeping the risk budget and risk policy as a benchmark. He would also keep a watch on the deviation of actual risk from the risk tolerance limit and implementation of risk standard, ALM and risk strategy. CRO functions independently and submits periodic report to the Board either on a quarterly or a half yearly basis, through the chief executive of the organization. However, the success of the CRO system largely depends on real independence. If top management is not very sincere and committed to the cause of risk management, there will never be real independence. According to Holton (2004) independence comprises of the following: 1. Risk managers have reporting lines that are independent from those of risk-taking functions. 2. Except at the highest levels risk takers have no input on the performance reviews. 3. Employees cannot switch from one role to another. Risk takers remain risk takers, risk managers as risk managers. Incentives

These steps are important to create a culture of risk governance and risk management. Risk governance can be established either through ‘risk control’ or through ‘risk reward’. In either of these models, there is a necessity of improving risk knowledge, risk information and competitive risk practices. Genuine risk reporting and starting of risk information will strengthen risk governance. Risk management has its costs as well. Professional training, technology, short-term loss due to rigid implementation of risk policy, etc., may cost in the short-term though the benefits out of risk management practices may accrue in the long-term. However, management must be willing to bear this cost in the long-term interest. Further, the review of risk management practices and risk measurements are required to be conducted at frequent intervals by the primary fiduciary and manager fiduciary. This review should include the policy compliance, due diligence, monitoring investment guidelines, investment strategies, risk limits

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and evaluation of investment models. If required, revision or redesigning of models, strategies, risk limits maybe done within the overall guidelines and parameters of the regulators. However, the goal of risk governance and risk management can be achieved if the top management and Board are actively interested in it. Therefore, risk management should not be thought of only as a regulatory requirement, but an integral part of corporate strategy and a way of corporate life in the interest of all the stakeholders.

Understanding Economic Indicators for Stock Market Investment In every walk of modern life various activities of individuals and organizations are significantly influenced by the changing economic environment. Recent developments in global economy leading to integration of economies have provided tremendous opportunities as well as increased the market risks. In the emerging stock market environment one has to pay greater attention to the state of general economy and important economic factors while making any decision relating to investment management, as the non-economic government intervention, which played a decisive role in a planned economy, is virtually absent in a competitive market economy. Structural changes and reforms have exposed the financial sector in India particularly the financial institutions and non-banking financial intermediates to a challenging situation never experienced before. Due to fast changing environment, decision makers are exposed to greater competition and higher degree of risk and uncertainty. A planned economy, with government intervention and modest regulatory mechanism, provided a deterministic model in the past where freedom of action was limited on the part of investment managers and they could satisfy the investors with a return linked to predetermined rates. This, on one hand reduced the risk of investment decision but on the other restrained the expectations of investing public. This scenario is no more valid in the emerging free market economy where the expectations of the investors have increased. In order to fulfil their growing expectations, investment managers had to venture into new areas and opt for a different composition of financial instruments following a non-traditional approach, which enabled them to earn and pay a competitive rate of return to investors. Since, newer options and actions always combine with a higher degree of uncertainty leading to a greater risk, investment decisions need to be backed by a suitable quantitative analysis which will enable decision makers to reduce the degree of uncertainty in selecting an alternative composition. In a competitive environment, one cannot depend upon intuition for taking decisions. Important features of the competitive economy are that they are more integrated, action oriented and that the macro economic fundamentals exert stronger influence on business actions. Business is a socio-economic political phenomenon and long-term decision cannot be made in isolation. Political factors influence the economic policy of a country. Therefore, understanding the economic factors and estimating the future changes are essential prerequisites

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for effective corporate policy and investment decisions particularly in a service industry, since it has emerged as the engine in growth of a modern economy. Three important policy measures of the government, namely, fiscal policy, monetary policy and general political factors need to be studied more seriously for a likely scenario about the macro economy. We may examine some of the indicators and their likely impact on market and investment decision.

National Accounts Statistics (NAS) National income refers to aggregate income originated from various economic activities in a particular period—normally a year. National income can be obtained from NAS which is an integrated system of statistical statements depicting values of final products originating in different industries and those of incomes generated and outlays expanded in the personal, private as well as public sector. These income and outlay accounts are consolidated sources and use of finance or accumulation accounts and closed with accounts of External transactions (EPW 2004). In order to find out the national income we need to move step by step with calculation of Gross Domestic Product (GDP).

Gross Domestic Product (GDP) Gross Domestic Product measures the output produced by factors of production in domestic economy. GDP is the sum total of monetary value of aggregate economic activities minus intermediate goods. In calculation of GDP, imputed values of own use products and services are considered. GDP is basically a product concept and therefore referred to as GDP at factor cost. In order to avoid double counting, the concept of ‘value added’ is used, which is the increase in value of goods in the process of production. GDP can be measured in terms of factor cost or in terms of market prices. When GDP is calculated at market prices, the value of domestic output also includes indirect taxes on goods and services, whereas GDP at factor costs excludes indirect taxes on goods and services. Therefore, GDP at market prices is higher than GDP at factor costs. We can calculate GDP at market price as well as at factor costs by applying the following formula. GDP at Market Prices = C + I + G

(1)

Where C = Consumption, I = Investment and G = Government spending on goods and services. GDP at Factor Costs = C + I + G – Te

(2)

Where C = Consumption, I = Investment, G = Government spending on goods and services and Te = Indirect Taxes.

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Generally GDP at factor cost is denoted by Y. Therefore, we may represent GDP at factor as Y = GDP at factor costs = C + I + G –Te

(3)

The above method of calculation excludes the presence of foreign sector. But in today’s world no country can survive without exports and imports, irrespective of value and quantity. Therefore, introducing exports X and imports Z, we get Y = C + I + G + (X – Z) – Te This can however be written as Y = C + I + G + NX – Te Where NX = X – Z = Net balance on trade in goods and services.

Gross National Product (GNP) GDP as calculated earlier does not take into account the factor income received from abroad. Therefore, a more appropriate concept is GNP which is GDP plus net factor income received from abroad. Therefore, GNP = GDP + Net factor income received from abroad.

Net National Products (NNPs) GDP and GNP really does not reflect actual national income because during the production process, assets are worn out and require replacement. This is called depreciation or capital consumption. Therefore, in order to represent wearing out of assets during the process of production; provision for Consumption of Fixed Capital (CFC) is made. When this CFC is deducted from GDP and GNP we get Net Domestic Product (NDP) and NNP. NNP is an income concept and includes factor income received from rest of the world. Therefore, NDP = GDP–CFC and NNP = GNP – CFC

(4)

It can be mentioned here that national product and national income is equal to the factor income, hence valued at factor cost. But the expenditure is made at current market price which is factor cost plus indirect taxes minus subsidies. Hence, it is referred to as GDP (GNP, NDP, NNP) at market prices.

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Nominal and Real GNP GNP as indicated is nominal GNP meaning that the same has been calculated at current prices which is not comparable with the GNP of previous years because of changes in price levels. Therefore, for comparison purpose and to get a fair idea about change in GNP it is calculated at a constant price (base year). In order to convert nominal GNP to Real GNP we use GNP deflator. GNP deflator is very useful to arrive at real GNP from nominal GNP. Implicit GNP deflator is an indicator of changing price and changing trend in demand for goods and services. The implicit GNP deflator is calculated by dividing current price GNP by constant price GNP and multiplying the same by 100. Annual change in real GNP indicates the changes in growth rate of economy.

Per Capita GNP Per capita GNP gives us an idea of the standard of living of people and how it is changing. Per capita GNP is calculated by dividing the real GNP by the population of a country. Therefore, Per Capita GNP = total real GNP/total population

Personal Disposable Income (PDI) National accounts also provide two more income concepts which are important to assess the expected demand for services and goods. These are private income and personal income. We can arrive at private income by adding income accruing to private sector from domestic product, interest on public debt current transfer from government administrative department plus net factor income from abroad and other current transfer from the rest of the world. Personal income is arrived at by subtracting savings of private corporate sector, net of retained earnings by foreign companies, corporation tax from private income is a direct taxes paid by household and miscellaneous receipts of government administrative departments deducted from personal income, thereby we arrive at PDI. PDI provides information about changing trends in purchasing power of an individual for products and services.

GDP Estimates in India Central Statistical Organization (CSO), a Government of India organization, is the only official agency which estimates yearly and quarterly GDP. (There are some other private organizations which also do the same.) It can be mentioned here that GDP released by CSO is calculated with the base year 1993–94. National accounts in India provides GDP (GNP, NDP and NNP)

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at factor cost current prices or at current market prices. In real terms, GDP (GNP, NDP and NNP) is calculated at factor 1993–94 prices or at 1993–94 market prices. CSO, releases annual NAS. There are Advance Estimates (AEs), Quick Estimates (QEs) and Revised Estimates. 1. AE of Annual National Income on 7 February. 2. Update of AE on 30 June along with Q4 Estimates. 3. Quick Estimates (QEs) on 31 January next year. CSO releases QEs of national income, consumption expenditure, saving and capital formation for a year after 9/10 months lapse. However, it is the white paper which presents revised estimates of macro economic aggregates for the previous year. In addition to the Quick and Revised Estimates CSO also releases AEs of GDP and NNP as well as GDP and NDP. Normally these are prepared in the middle of the year and released in the next January. However, most importantly from the point of monitoring macro economic development and corporate decision is the quarterly estimates released after every quarter of financial year. Quarterly GDP estimates sectoral growth rates and the first three quarters Q1, Q2, Q3 rates are revised with Q4 rates which are revised with annual estimates.

Interpretation of National Income Data Yearly GDP growth rate indicates the trend in economic growth and national income analysis of individual components of GDP which shows the relative performance and trend in sectoral growth. Quarterly analysis is very useful to identify the emerging macro economic potential—income, expenditure, trade, services, etc. This information can be used for business planning, monitoring short-term business cycle, forecasting stock market movement, etc. By monitoring quarterly GDP deflator one can have a good idea of GDP growth rate. GDP deflator also helps to understand extent of inflation across the economy. Sectoral growth and relative share of various segments provide information regarding emerging direction of macro economy, which would help to identify sectoral GDP, demand and purchasing, and savings power. Therefore, study of national accounts and quarterly growth is very important for planners, economists, investment managers, etc. GNP is an indication of overall health of the economy. The rate of change of GNP indicates the rate of economic growth. Sectoral distribution of GNP shows the share of agricultural, industrial and service sectors in GNP. These sectors can further be subdivided into sub sectors. For example, the industrial sector can be divided into manufacturing, construction, etc. Further division of consumer durables consumer goods, capital goods, intermediary goods, etc. will indicate the relative growth of these industries. For example, industrial growth in late 1980s was led by consumer durable industries which recorded a growth rate of 19.3 per cent against the general growth rate of 9.8 per cent in 1988–89.

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Analysis of national income is very important because it indicates the trend of disposable personal income. An increase in absolute and relative personal income will be an indication of extent of personal savings and consumption. Personal income tax will influence the high rate of disposable income and the rate of personal income tax may reduce the demand for these industries. So, one needs to examine the GNP, national income, disposable income, etc., in real terms by applying GNP deflator. Thus, the growth rate of real GNP is the most important indicator about the direction of the economy.

Money Supply and Monetary Policy Money supply in economy has a broad ramification and significantly influences the nature of the rate of return on investment. Therefore, the nature and direction of money supply in the economy needs careful scrutiny. Money supply in the economy is guided and controlled by the Central Bank (RBI in India) through the monetary policy. One school of thought believes in the expansionist monetary policy through management of interest rate while the other school believes in controlling money supply to check inflation. However, excessive expansion of money supply has ill effects on economy in terms of increase in inflation and interest rates that lead to contraction of investment. On the other hand, contraction of money supply may also lead to a reduction in demand, a fall in the interest rate and ultimately in recession. Therefore, a delicate balance needs to be maintained in the economy. The monetary policy refers to the growth of money supply, level of interest rate and credit condition. The Central Bank (RBI) announce its Annual Monetary Policy indicating its objectives, for example, the Annual Statement for 2004–05 of RBI targeted to ensure the provision of adequate liquidity to meet credit growth and support investment as also export demand in the economy while keeping a very close watch on the movements in the price level. Consistent with the above, while continuing with the status quo, to pursue an interest rate environment that is conducive to maintaining the momentum of growth and macro economic and price stability (Economic Survey 2004–05, Government of India). Monetary policy statement thus provides a direction of the likely initiatives of the RBI in managing money supply and related issues. Therefore, this is a critical management input for designing a business strategy for the corporates.

Definition of Money Empirically money has been defined as ‘Broad Money’ and ‘Narrow Money’ based on the liquidity of assets and as store of value. Further, Money (M) is defined as Currency plus Demand Deposit of Banks (DD) and other Deposits of the RBI (OD) which are in the nature of Demand Deposit and are held by the public (Gupta 1995). Therefore, M = C + DD + OD

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Supply of different types of money has different impacts and it will be useful to define them with reference to RBI definition.

Broad Money (M3) Generally, it refers to money held for transaction purpose and also as a store value. Broad money is a guide to the liquidity trend since it indicates the trend of private sectors preference for liquid assets—which can be easily connected into liquid assets without loss of capital. Broad money consists of currency with the public (C1), aggregate deposit with banks (C2), which can be divided into demand deposit (C2)(a) and time deposit (C2a) and other deposit with RBI (C3). Therefore, Broad Money (M3) = C1 + C2+ C3.

Narrow Money It on the other hand refers to money held for immediate near future, spending on goods and services. Narrow money consists of currency with the public (C1) plus aggregate demand deposit with bank C2(a) plus other deposits with the RBI. Therefore narrow money (M1) is M1 = C1 + C2 (a) + C3 Broad money plays an important role in economy as means of exchange and precautionary demands and therefore is held by personal and non-personal sector. Thus, broad money is an important liquidity measure, since assets consisting of broad money can be easily converted into cash.

Reserve Money In addition to broad money (M3) and narrow money (M1) there is another type of designation for money called reserve money or high-powered money. Reserved money is produced by the government and the RBI and is held by public and banks. Reserve money comprises of currency in circulation, bankers deposit with RBI and other deposits with the RBI. Reserve money is controlled by the central bank of a country, that is, RBI in India. The monetary base, that is, reserve money is high-powered money, which is greatly influenced by the money multiplier, for example, 1 per cent increase in money multiplier may cause 10 per cent increase in money supply.

Monetary Base and Money Multiplier To determine money supply we need to understand monetary base. The monetary base or stock of high-powered money is the quantity of notes and coins in private circulation plus quantity held by the banking system (Begg et al. 1991). Whereas, the money multipliers provide an

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indication on the extent of change in monetary base due to change in quantity of money stock by one unit. In the equation form it is: Money Stock = Money Multiplier × Monetary Base.

Money Multiplier in India Money multiplier is the ratio of broad money to reserve money. The money supply multiplier varies inversely with the policy determined reserve ratio and the current deposit ratio endogenously determined by the public (Economic Survey 2004–05). Money multiplier in India End of March 2002 4.43 End of March 2004 4.59

End of March 2003 4.65 End of March 2005 4.6

Money multiplier which was 4.65 at the end of March 2003, remained at 4.6 during the next two years. Decline was due to the preference of people for deposit rather than cash—which continued during 2004 and 2005. Bank reserves to aggregate deposit significantly influenced money multiplier which declined marginally from 6.9 in March 2004 to 6.7 in March 2005, while currency to aggregate deposit rates remained static at 18.8. Multiplier thus indicates stability in money supply situation achieved through policy determined initiatives.

Sources of Money Supply Data RBI calculates and publishes money supply every month. Broad money (M3) consists of currency with public (C1) aggregate demand and time deposits with banks (C2) and other deposits with RBI (C3) while narrow money consists of currency with public. Aggregate demand deposits with banks and other deposits with RBI. In case of reserve money components instead of ‘currency and public’, currency in circulation (C1) is taken (currency with public is different from currency circulation). The former is arrived at by submitting cash with banks from currency in circulating plus bankers deposit with RBI and other deposit with RBI.

Controlling Money Supply There are several ways that a Central Bank exercises control over money supply—through control over monetary base, directs controls to banks lending and controlling interest rate. Money supply can be controlled through interest rate policy or through money multiplier (which is money supply and monetary base). Money supply influences the position of liquidity in the economy, inflation and interest rate, and would influence the prospects of the aggregate economy. Changes in the bank rate will determine lending and borrowing rates of banks which have far-reaching influences on investment and returns. The recent objective of the

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monetary policy of RBI is to check money supply, contain inflation and to reduce credit to the government. Recent liberalization in the financial sector has also brought about changes in Statutory Liquidity Ratio (SLR) and Cash Reserve Ratio (CRR), which will release more funds to banks for investment. This will also change the demand pattern of banks for short-term funds. Contraction of money supply may adversely affect the growth of GNP. RBI in India is always concerned about controlling money supply to the desired extent—whether it should be 15 per cent or fewer by using money demand function. Monetary base is notes, coins and balance of the commercial bank held by the Central Bank. This is high-powered or reserve money. Since Central Bank holds its liability it can influence the banks lending policy to contract or expand monetary base. If the reserves of the banks are contracted, they will bid for cash and interest will go up, which will be reflected in their lending rates. Central Bank can influence market interest rate through its discount rate which will be reflected in banks lending and deposit rates. The Central Bank can also apply direct control to limit lending of commercial banks through selective credit control, special deposit with the Central Bank etc. In order to increase money supply in the economy, the Central Bank should create reserve money and inject it into the banking system, which allows banks to offer more credit. Supply of credit in turn will reduce interest rates which will stimulate the economy. Money growth thus induces economic growth through multiplier effects. However, GDP increases as long as supply of new money exceeds demand for money. Money multiplier effect starts with creation of new money by banks which is spent thereby GDP increases, money circulation continues and each additional unit of transaction increases GDP till it is fully absorbed in the system. However, unrestrained supply of money through bank lending may slowly lead the interest rates to zero (in a depression situation as in Japan). To reverse the situation government may increase its borrowing or reduce taxation.

Interpretation and Implications of Money Supply As we have noted earlier, money is very important for economic transaction and all types of economic activities. Increased supply of money creates spending power of consumers, creates more demand for goods and services pushing the growth rates and thus GDP and National Income. Demand for labour boosts employment and income. In economic environment, firms issue debt and equity to raise capital because stock market prices rise. However, increase in market price pushes up inflation which reduces purchasing power and restrains consumers’ spending. Conversely, decline in money supply may adversely affect economic growth and push up the economy towards deflation (as in Japan). Interpretation of money supply does help managerial decision-making particularly for the investment decision. Unexpected rise in money supply can push the stock and bond market down. Because when money supply increases too fast RBI will take action to stem the growth and may resort to open market operation and sell its portfolio, withdrawing the money from the banking system which would bring down stock prices.

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Analysis of reserve money provides an indication of emerging liquidity scenario and expected government initiatives. For example, in 2004–05, the government was to cope with excessive growth of reserve money at 18.3 per cent of Rs 674,51 crore in 2003–04. This increase was due to excess of cash balance, flow of foreign funds, etc., in 2004–05. This development forced RBI to sell government securities through repo operations. Therefore, analyzing the trend in reserve money one can expect initiatives likely to be taken by the Central Bank. This will help in building market scenario and designing the investment strategy. Analysis of velocity of money supply provides far-reaching implications for a manager. Velocity of money supply is the turnover of money derived at by dividing GDP (or GNP) by the money supply. Quantity theory of money maintains those prices that are determined by circulation of money. Fisher’s equation MV = PT (M = money supply, V = velocity, P = price level and T = volume of transactions) enables us to trace the link between money supply and price level.

Flow of Fund Analysis Flow of Fund (FoF) accounts in the modern sense represent a systematic record of net transactions involving financial instruments during a given period. Following the system of double entry book used in financial accounting, the transactions between the participants could be treated in quadruple entry form. This method enables us to trace intersectoral funds flow in the economy as well as accuracy in capturing the transactions. Analyzing the FoF accounts, we can have an insight into the functioning of economy in general and the financial sector in particular.

Coverage For FoF accounts, Indian economy is divided into six sectors, namely, banking, Other Financial Institutions (OFIs), Private Corporate Business (PCB), government, rest of the world and household.

Instruments For compiling FOF accounts all the available financial instruments are grouped into 11 categories, namely, currency, deposits, investments (government securities, other securities of government other than small savings, securities of banks, securities of other financial institutions, private corporate securities, foreign securities and other securities), loans and advances, small savings, PFs, life fund, compulsory deposits, trade credit/debt, foreign claims not elsewhere classified and other items not elsewhere classified. The main surplus sector in the system is the household sector, with surplus funds which is borrowed by the government and other sectors.

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However, the surplus household sector is a borrower—borrows money from banks and financial institutions. Even the other sectors may borrow and lend money. A large part of the money from household and government sector is channelized through financial intermediaries such as banks, life insurance, pension funds and companies. These institutions have long-term liabilities and their financial assets are invested keeping in view the long-term maturity to match assets and liabilities. However, they also actively traded in markets which had significant impact on the market particularly the government securities market, which influences the interest rates. From FoF accounts several financial rations can be derived which give an idea of the extent of financial deepening role played by the financial sector and the implicit changes in financial economy.

Finance Ratio (FR) Finance Ratio (FR) is the ratio of total financial claims to the national income, total financial issues (primary and secondary) as a percentage of national income, we get any of the rates of financial development in relation to economic growth.

Financial Intermediation Ratio (FIR) FIR is defined as the ratio of total financial issues to net capital formation and reflects the relation between financial structure and real assets structure.

New Issue Ratio (NIR) NIR is the proportion of primary claims issued by non-financial institutions to net domestic capital formation in economy which indicates the dependence of the non-financial sector on its own funds for financing capital formation.

Intermediation Ratio (IR) Intermediation Ratio (IR) is the ratio between the financial instruments issued by financial institutions and banks on the one hand and by the non-financial institutions on the other hand. This ratio indicates the importance of financial intermediation by bank and other financial institutions.

Implication Broad magnitude of financial flows and their relationships with other macro variables, such as national income, capital formation, financing pattern of different sectors and financial savings of household sector.

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Financial FoFs indicates the changes in financial activities in the economy. For calculation of FoFs, the economy is divided into six sectors, namely, banking, other financial sector, government, private corporate sector, household and the rest of the world. An analysis of financing pattern of different sectors indicate the surplus and deficits of different sectors, flow of loanable funds, etc. Generally, government and private corporate sectors are in deficit and they borrow from the household and the rest of the world. An analysis of financing pattern of private corporate sector shows that deficit of this sector is financed through banking, financial institutions and the household sector. Excess money increases cash holding and the price level. In an inflationary situation, since transaction demands increase, the security owners sell their holdings which cause a fall in security prices and an increase in the interest rate. Higher inflation pushes up the interest rate and thus the demand for credit declines investment activities in economy contracts. An analysis of financial savings of the household sector also indicates the distribution pattern of resources. Government raises resources directly from household (savings) through sales of government securities. An analysis of the FoFs and future estimates would enable one to judge the future aggregate economic condition of various sectors, indebtedness, cost of capital emerging pattern and direction of investment and consumption of economy. This information put together would enable the fund manager to arrive at an expected rate of return on investment.

Inflation and Consumer Price Index (CPI) Inflation refers to sustained increase in the price level or alternatively decrease in the value of money. In economic theory, the inflation is driven by demand and supply. The supply side shocks cause cost push inflation, while demand side shocks cause demand pull inflation. Sustained increase in price level is a cause of concern for all because it affects the purchasing power of money, dampens the spirit of growth, stock market movements, savings, etc. ‘Inflation is a rise in the average price of goods over time. Pure inflation is the special case in which all prices of goods and factors of production are rising at the same percentage rate’ (Begg 1991). Therefore, inflation is the growth in the price level and the rate of inflation = growth of nominal money supply–growth of real money demand. Budget deficit, expansion in money supply, etc., causes price rise and inflation. However, there are other factors which contribute substantially to price rise. An increase in level of demand without a corresponding increase in supply also pushes the price level. Inflation may also be caused by the increase in cost factors (that is, cost push inflation) due to increase in wages, salaries, etc. Inflation may also be profit push (in oligopoly and monopoly), inflation is not necessarily bad for the economy. A low level of inflation, say 1.5 per cent is acceptable. Although, inflation has several negative effects on the economy. It distorts the price mechanisms and thus affects economic growth, it generates uncertainty and thus acts as an enemy of investment and retards the growth of savings. In an inflationary situation, transaction demand increases and security owners sell their holdings leading to fall in security prices and increase in interest

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rates. Inflation reduces profitability by increasing the cost of capital. It also exerts contraction effect on exports. Once domestic price increases, exporters reduce the export volume. Another significant effect of inflation is that it induces investors to go for short-term speculative profits and dampens the long-term investment climate. It has been observed that one of the important factors contributing to lower growth rate is inflation. Inflation can be measured by CPI and Wholesale Price Index (WPI) but it is CPI which is widely used to measure the inflation and price index. CPI is a measure of the prices of fixed basket of goods. In India there are three types of CPI: 1. CPI for Industrial Workers (IWs). 2. CPI for Urban Non-Manual Employees (UNME). 3. CPI for agricultural labourers. In India, Consumer Price Index (IW) is calculated by Labour Bureau, Government of India located at Shimla. Consumer price index numbers for IW (CPI–IW) capture the temporal change in the retail prices of fixed basest of goods and services. This is an important indicator of retail price change. The objective of CPI–IW is to update the base year of the existing services for IWs (Base 1982 = 100) to 2001 = 100. The CPI–IW is mainly used for calculating the allowances being paid to the central and state government employees and also for fixation and revision of minimum wages.

Construction of Indices Three types of indices are constructed: centre specific index, index for housing group and an All India Index. All India Index: The All India Index in the weighted average of the 78 centres’ indices. Steps to Construct

The following steps are involved in collection of dates and updating the CPI (IW). Conduct of income and expenditure survey: The investigators of National Sample Survey Organisation (NSSO) collect income–expenditure date from selected 78 centres spread throughout the country. Security: Data collected by NSSO are scrutinized at two levels. Tabulation of data: Computerized processing of data carried out at Chandigarh—under the estimation procedure suggested by Advisory Committee on Statistics of prices and cost of living. Derivation of weighing diagrams: Weighing diagrams for the purpose of compilation of index number—IW based on the family budget expenditure on consumption expenditure, non-consumption expenditure and capital outlays.

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However, only consumption expenditure is considered for calculating CPI–IW. The consumption groups adopted for CPI–IC, which include: IA—food, IB—pan, supari, tobacco and intoxicants, II—fuel and light, III—house, IV—clothing, bedding and footwear, V—miscellaneous. Food and miscellaneous groups have been further subdivided. Index Formula: The CPI–IW is calculated by following Laspeyres Weighted Average Index formula Im =

EPn Q o × 100 EPo Q o

where QoPo is price relative and denotes the expenditure on an item in the base period.

Wholesale Price Index (WPI) Wholesale Price Index (WPI) is calculated by the office of the Economic Advisor to the Government of India, Ministry of Commerce and Industry. New series of WPI has been introduced, with effect from, 1 April 2000 (with base 1993–94 = 100). The revised series (1993–94) has 435 items for which 1918 quotations are collected. Following Table 5.10 shows the number of items and quotations TABLE 5.10 Items and Quotation for WPI Sl No. Item 1. 2. 3. 4.

Primary articles Fuel, power, light and lubricants Manufactured products All commodities

No. of Items 98 20 334 435

Quotation 455 72 1,391 1,918

Producer Price Index (PPI) in India The Government of India has formed a Working Group (WG) on revision of WPI (1993–94 = 100) under the Chairmanship of Professor Abhijit Sen, Member Planning Commission, is inter alia, looking into feasibility of switching over from WPI to a PPI in India. PPI measures price change from producers’ perspective as against CPI which measures price change from consumer’s perspective. In calculating PPI only basic prices are used, while taxes trade margin and transport costs are excluded. In addition to measuring inflation, PPI can also be used as price deflators in compilation of GDP. PPI measures the price movements of a fixed basket of goods bought and sold by the manufacturers. There is some variation in compilation of PPI in different countries. For example, in UK, there are two series of PPI—output series and input series. PPI output series measures the changes in the prices that producers charge for their goods and it is often called

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Factory Gate Prices (FGPs). There is a PPI input series which measures changes in the prices of inputs such as fuels and materials used for production.

Importance of Consumer Price Index It is often argued that WPI is not a good index to measure inflation and to assess the impact of price rise on the cost of living index and CPI is a better measure for that since it also includes selected service with products. CPI is also a better measure because it takes retail price which consumers actually pay. Therefore, CPI is a better indicator to measure general inflation. During recent times, ‘in sharp contrast to WPI, CPI–IW inflation has been stable and moderate (in India). This is because food items have higher weights in CPI–IW than in WPI and in general the price increase of these items has been moderate in the current year’. The changing trend of CPI (IW), M3, M0 IN during 1990–91 and 2004–05 as shown in Table 5.11. TABLE 5.11 Money Supply and Consumer Price Index in India Money Supply (M3) Year 1990–91 1991–92 1992–93 1993–94 1994–95 1995–96 1996–97 1997–98 1998–99 1999–2000 2001–02 2002–03 2003–04 2004–05

M3

M0

CPI (IW)

15.1 19.3 14.8 18.4 22.4 13.6 16.2 18.0 19.4 14.6 16.8 14.1 14.7 16.6

13.1 13.4 11.3 25.2 22.1 14.9 2.8 13.2 14.5 8.2 8.1 11.4 9.2 18.3

11.6 13.5 9.6 7.5 10.1 10.2 9.4 6.8 13.1 3.4 3.8 4.3 4.0 3.9

Source Handbook of Statistics on the Indian Economy, Reserve Bank of India (2003–04). Notes M0 : Reserve Money; M3 : Broad Money; CPI(IW): Consumer Price Index for IWs.

Implications of Interpretation Price Indices Normally, CPI is well accepted and a widely used measure for industry, stock market analysis and investors. CPI–IW is used for determination of wage, dearness allowances, etc., while the UNME is used for urban non-manual employees. A year on year comparison, though often misleading, provides useful guide to wage negotiation.

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Inflation has adverse effects on stock market index—as inflation erodes real value. When stock market index is divided by the cost of living index an indicator of the real value or purchasing power of stock market portfolio is available (Nelson 1987). It is normal experience that high inflation is followed by high interest rates. Irvin Fisher’s hypothesis say that a 1 per cent increase in inflation will be accompanied by 1 per cent increase in interest rate. It has been observed that countries with high inflation have also experienced high interest rates. It is therefore a fact that an increase in money supply will lead to increase in inflation as well as interest rates.

Interest Rates Interest rates is the cost of borrowing money which varies according to the demand and supply for money. Interest rate is significantly influenced by supply of money and inflation. Inflation also exerts significant influence on real investment and investment timing. It is expected that real investment responds to real interest which is nominal interest minus expected rate of price inflation. Investment activities are basically guided by the net benefits which can be received in future estimated by Net Present Value (NPV) of future returns by means of a Discount Rate which is the opportunity cost of capital, that is, rate of interest. This rate is reflected in NPV. This is a very critical issue for a life insurance company, which needs to maintain regulatory solvency margin at all times. Due to a fall in the interest rate, there will be a strain on the solvency assets and create cash flow problems. Several factors exert influence on interest rates but immediate determinant of interest rate is however, changes in supply of money. Institutionalization of financial market has a very strong impact on the supply and interest rates because financial intermediaries play an active role as mobilizers and suppliers of funds. They can influence relative interest by altering their portfolio of equities and debt.

Motives for Holding Money While discussing money supply we have mentioned that money is a stock concept and holding money has an opportunity cost, that is, the interest given up by holding it. Even then people hold money, because there is some benefit of holding, which motivates to hold money. There are three motives namely: Transaction Motive

For purchasing goods and services. Transaction demand influenced by the length of time between receipts and expenditure and size of receipts and expenditure. It is the M, money which primarily serves the transaction or exchange motives. Precautionary Motive

We are living in an uncertain world and unsure about future demands, receipts and nature of spending. Therefore, certain amount of money will be required for meeting uncertain

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emergencies. This is called a precautionary motive to hold money. It is the broad money which basically serves the precautionary motive. Speculation Motive

The third important motive to hold money is the speculative motive (Keynes) or as many economists say ‘asset motive’. Asset or speculative motive is the characteristic behaviour of risk averse people who prefer low risk low return assets instead of high risk high return assets. They may prefer to hold cash bank deposit or bonds which are low risk assets than investing in high risk high return equities in order to avoid future losses. Therefore, the speculative demand for money varies with anticipated gain or losses and the extent of holding money depends on individual preference for liquidity. From the liquidity preference of all individuals and institutions we can draw a Liquidity Preference Curve (LPC). When we add together all the liquidity preference we get LPC which is called as the ‘Demand for Money Curve’. This curve reflects demand for money balance at each level of interest rate. There is an inverse relationship between securities price (bonds) and interest rates due to liquidity preference. When security prices are high and interest rates are low the speculators will increase money balances to avoid losses, that is, high liquidity preference. When security prices are low and interest rates are high, the speculator will have low liquidity preference low cash balance.

Demand for Money Demand for money is basically determined by key variables such as interest rates, the price level and real income. Here we need to differentiate the real money and the nominal money. The real money is the nominal money divided by the price level. The Central bank of the country (RBI in India) controls the real and nominal money supply. However when the changes in the price levels tend to affect the real money, controlling the real money may become difficult and monetary policy may need to be supported by administrative actions. There is a unique relationship between demand for money, price level, interest rates and income. When prices for goods and services increase, but real income and interest rates remain unchanged, the demand for real money will not be changed but if interest rates increase the demand for real money will reduce, while an increased real income will increase the demand for real money. This however is based on the transaction motives of demand for real money.

Implication of Interpretation of Interest Rates and Demand for Money Money Supply and Interest Rates: There is an inverse relationship between money supply and interest rates. A fall in interest rate increases the demand for money for investment. It will also increase consumption demand. If there is a further rise in money supply, Central Bank needs to increase money demand by reducing rates of interest. Therefore, one can see the close relationship between money supply, interest rates and aggregate demand.

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Interest Rates Differentials: In a marketplace, different assets command different interest rates or offer differential yields. For example, high risk assets (equity) offer higher yield while low risk assets (bonds) offer lower yield. Again low yield assets offer higher interest while high yield assets offer lower yields. Further, long-term marketable security such as gilts offer higher yield than short-term assets like commercial papers, due to risk factors associated with longer tenure. Therefore, uncertainty factors associated with the return of assets have a determining impact on interest rates or yields. If a bond is purchased at a particular price and is held till maturity, one can find yield to maturity expressed as annualized return. However, this may not be for equity assets which pay dividend. Interest Rates and Yields: Interest rates and yields may be referred to as the same thing– percentage increase on money invested or cash payment in future from fixed income securities. However, for investor yield is referred to the return on the investment which may be different from the interest rate in the economy. These securities can be of two types: short-term money market securities like Call Money, Commercial Papers, Certificate of deposits, etc. and interest rate earned on it is called short-term interest or yield. Long-term fixed interest security is called bonds and interest rate earned on it is called long-term interest or long-term yield. By investing in a bond, a bond holder gets interest over the life of the bond which is called yield to maturity, which has two components namely yield during the fixed coupon and difference between the cost of the bond and the final face value payment over the life of the bond. We must remember that the bond price and interest rates move inversely. A rise in long-term interest rate will see a fall in bond price and a fall in interest rate will see a rise in bond price. A significant difference between short-term and long-term security is the stability in value. A short-term security provides stable income over a short period but there is no assurance that it will be the same over a long period. However, value of a long-term security may fluctuate over a short period but it provides long-term assured return. Due to this nature of short and long-term securities, investors generally prefer low-risk long-term securities. The interest rate differentials over long- and short-term is called spread and is used for predicting future rates. As mentioned by Nelson (1987) if the long-term interest rates reflect investors’ collective forecast of where short-term interest rates are headed in future, then the spread between long and short rates should predict the future direction of interest rates. Yield Curve: The yield curve provides a link between short-term and long-term rates of interest of fixed interest long-term securities (say, for example, 5-year bonds and 10-year bonds). This relationship between short rate (r) and long rate R+ on bonds of different maturity is known as term structure of interest rates, which helps in constructing the yield curve. The curve shows important relationship between the interest rate on bond (that is, yield to maturity) and the maturity time. The normal shape of the yield curve is upward sloping which indicates that it flattens with the length of maturity. This also indicates that bonds with longer maturity will command higher price than that with shorter maturity. There maybe downward sloping yield curve and this happens when future short-term rates are expected to be lower than current short-term rates. This happens if the future inflation rates are expected to come down.

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Yield curve also indicates that the authorities by manipulating short rates, may have direct leverage over long rates on government stock. A rise in the short rates may lead, via the term structure and relationship, to a rise in the long rates and fall in the bond price. Therefore, by influencing the long rates through short rates, monetary authority can influence rates of debenture, bonds and equity. Interest rates is an important indicator for security analysis because the rate of return of any investment depends on the existing and future interest rate policy. The lower the interest, lower the cost of capital and better the scope for higher profitability. However, one needs to examine the real rate of interest (difference between nominal rate minus the rate of inflation). In fact, it is the interest rate which is a major determinant of rates of return of investment. Rates of return are composed of pure interest rate, premium for lack of marketability of instrument and risk premium. Pure rates have two components, namely, real and price. Real component of pure rate reflects the expected growth in productivity in economy (GNP) and reluctance to save. The price component of interest rates depends on the expected rate of inflation and premium or lack of marketability. Therefore, the anticipated rates of return depend basically on the rate of return which is the outcome of several factors, namely, GNP, inflation, money supply, etc. Interest rate policy practiced in India as a means of allocation of resources to the priority sector was basically administered. In an emerging free market, interest rate will be decided by supply and demand and lots of attention needs to be given while taking an investment decision. Our competitiveness in the international market will depend, to a great extent, on interest rate policy. The lower the interest, the higher the competitiveness.

Fiscal Policy Government has to spend a huge amount of money on current and capital items and it increases every year. This government expenditure needs to be matched by revenue receipts of the government. Therefore, fiscal policy of a government is the decision on how to spend money and how to raise monetary resources. Generally, the government intends to balance revenue (through taxes) with expenditure. Government also attempts to have a balance between direct and indirect taxes—taxing individuals and companies. Fiscal deficit is therefore the difference between total expenditure and total receipt excluding borrowing. Two important elements of fiscal deficits are the revenue deficit and capital expenditure. Every year the Government of India places its budget before the Parliament, generally in the last week of February, for incurring expenditure for the next financial year. This is a description of financial plans and spending in the next year. Government budget spells out the revenue it will raise for this expenditure on various activities. However, very often revenue receipt falls short of expenditure and the government has to resort to some other means for the expenditure—for example, printing money. If the expenditure is less than the revenue receipts, the budget is a surplus one. On the other hand if the expenditure is higher than the tax revenue the budget is called deficit budget. The budget

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deficit can be shown as Budget deficit = G – NT, where G = government spending, NT = Net taxes (NT = taxes–transfer). Deficit can be financed by printing money or borrowing from RBI. Printing money will increase money supply and fuel inflation. If the government borrows from the market it has to compete with private sector for savings which may help crowding out causing inflation to rise. Government may also follow the stabilization policy to control the level of output so that GNP remains near full employment level. There are three types of deficits namely, fiscal deficit, revenue deficit and primary deficit. 1. Revenue deficit = revenue expenditure–revenue receipts 2. Primary deficit = fiscal deficit–interest payment 3. Fiscal deficit = total expenditure–revenue receipt–recovery of loans–other receipt

Fiscal Deficit and Inflation It is often argued that fiscal deficits leads to inflation because when government borrows from RBI to finance fiscal deficit, money stock increases which leads to inflation. Increased money supply increases the purchasing power of people, the quantity of goods remains the same. This pushes up price levels. However, with the increased money stock spent for other goods there may not be a rise in price level. That means increased money supply matched by increased output may not have inflationary impact.

Fiscal Deficit and Interest Outgo Fiscal deficit may also create a burden on the exchequer because financing deficit by raising debt would increase the burden of interest rate payment.

Government Policy to Reduce Fiscal Deficit Fiscal deficit can be reduced either by reducing government expenditure or by increasing revenue.

Ways to Manage Deficit We need to understand the mechanism of how deficit is made up by the government in order to see the impact of deficit budget on the economy. Deficit is made by four ways, printing money, domestic borrowing, use of foreign exchange reserves and borrowings from abroad. If printing of money exceeds the demand at the current price level, it will lead to inflation and increase the interest rate. Domestic borrowing further creates a strain on the government exchequer by increasing the interest rate burden, thus contracting development activities and capital formation. Foreign borrowing also creates a similar strain and an increase in international debt.

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The use of exchange rate for devaluating the currency does not help much. Recent experiences in India and many developing countries have proved that devaluation by itself does not boost the economy to any significant extent.

Interpretation of Fiscal Policy Implication For policymakers and fund managers, monitoring fiscal policy is very important and an essential aid to design corporate strategy. Deficit is pervasive phenomenon and high fiscal deficits contribute to higher inflation and interest rate and will make capital investment costlier. Higher deficit may force the government to resort to borrowing. This may hamper growth of investment in the economy. Higher deficit may force the government to increase the rates of taxes which may demotivate workers thus restricting growth of output in the economy. Higher deficit forces the government to resort to borrowing which will increase liability and the burden of interest rates. This in turn will force the government to curtail expenditure for development activities and other social sector investment in education, health, etc. Higher persisting deficits are not welcome by fund managers—since inflation and higher interest rates will reduce stock value. Sustained economic growth requires fiscal and monetary stability. High public dent and budgetary deficits generate imbalance and uncertainty and increases risks in decision-making. A study of tax proposals is very important for investment decisions. Though budget proposals on taxation are basically short-term in nature, yet they are most influential for stock markets, particularly in India. Stock markets in India do not absorb important economic news, but are very sensitive to tax proposals, especially those that are short-term in nature. A study of annual plan and pattern of government expenditure would reveal the government priority among various sectors—productive and unproductive. Higher allocation to the productive sector would give a boost to employment and income, and industry and commercial sector of the country through income generation would enhance the purchasing power. A study of government expenditure would further reveal three important areas of resource allocation, namely, consumption expenditure (defence, administration, transfer payment (interest payment, payment of subsidies grants to state/UT and other) and gross capital formation (physical and financial). Subsidies have played an important role in the Indian industrial sector and therefore changes in subsidies need to be studied at least to assess the short-term implications on industry and firms.

Indicators of External Sector Reforms and liberalization in the Indian Economy have opened up many sectors to foreigners and increased FoFs, merchandize and services to and from India. In fact, India is gradually

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emerging as a strong partner of global economic network. Global integration has opened up several opportunities for Indian institutions, entrepreneurs and Indian managers. At the same time it has also increased tremendous amount of risks and uncertainties. Therefore, any development in any other part of the globe, particularly in the countries having strong trade and financial relationship is going to influence the Indian economy through ripple effects. Managers in Indian companies need to understand that these relationships monitor the development of important integrating factors for any future corporate strategies. Therefore, important indicators such as Balance of Payments (BOP), current account, capital accounts and foreign exchange market related to external sectors need to be discussed here.

Balance of Payments (BOP) BOP is a record of all transactions between India and the rest of the world. BOP of a country has two accounts, namely, current account and capital accounts.

Current Account It deals with the international flows of goods and services and other income received from abroad. Current consists of visible and invisible trade. Visible trade has two components—export and imports. The components of invisible trade are: exports and imports of insurance, tourism and technical services. Invisibles have two types of transfers, namely, official transfers such as payment of interests on debt or payments to international organizations and private transfers such as remittances from migrant workers. We often come across the terms trade balance and current balance. Trade balance is the difference between the exports and imports of physical goods, while current balance is the trade balance plus net earnings on invisible trade.

Capital Account Capital account is a record of flow of financial assets and liabilities. It includes direct and portfolio investment, borrowing from banks official debt transactions.

Implications India has come a long way since debt crisis in 1990s forcing structural adjustments and economic reforms. Study of trade accounts provides an idea of direction of foreign trade. A falling trade surplus has adverse implications. Invisibles is another area of significant, importance due to its volatile nature. Repatriated profits depend on the performance of other economies and may not be sustainable. Study of capital account provides an insight into the trend and nature of FoFs. It has severe implications for stock markets. Increased flow of FII funds to stock market increases market

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volatility and may raise the index artificially. Fund managers must monitor this carefully. However, FDI has a long-term positive direct impact on economy since it creates further employment and output. Foreign debt is a cause of concern and needs to be watched carefully. A country must have sufficient import cover, else it may be trapped into foreign exchange crisis. Foreign currency reserve is another area of importance and needs to be monitored.

The External Sector The external sector has its own influence on national income and other domestic sectors in an open economy. This influence is reflected through the country’s trade relation and its strength of export and import. In the overall context, India has a very insignificant presence in world trade, with 0.6 per cent share of the world exports. Exports and imports as percentage of GDP was 7.3 and 8.6 in 1990–91 with trade deficit of 1.2 per cent and current account deficit of 1.1 per cent. The study of the composition of imports and exports would give us an indication of prospective potential industry from investment point of view. For example, export-related imports increased from 15.3 per cent in 1990–91 to 19.5 per cent in 1992–93 indicating a growing emphasis on the export sector. Similarly, the composition of India’s exports would reveal international demand for Indian products. Data indicates that even after successive devaluation, there is not much change in the quantum and composition of Indian exports. A study of trade relation with countries would be helpful to an investment manager. During recent years, Indian trade with Russia declined from 16.1 per cent in 1990–91 to 3.6 per cent in 1992–93. A study of the distribution pattern of Indian exports and imports (countrywide) would be helpful to assess the potential strength of a particular industry and firm in the export market. Exchange rate policy plays an important role in an economy. Freely floating exchange helps the export sector and also encourages foreign investors. However, the strength of the currency in international market depends on the strength of the economy. High growth rate, higher trade surplus, higher employment, etc., strengthen the value of currency. Indian stock markets are basically influenced by speculative activities and mob psychology of a Shakespearean type. Markets usually behave contrary to logic and indication of economic fundamentals. However, this culture has its own meaning, importance and role in a controlled environment. But in a free market economy, financial sector and particularly stock markets are more integrated globally by the industry-wide and economy-wide factors. Therefore, while making an investment decision or taking a decision to reshuffle the portfolio, the changing economic fundamentals must be the guiding light. But in a non-deterministic, non-probabilistic model, future is uncertain and full of risks. However, one can reduce the degree of risks with the help of economic and financial market forecasting. Time has come for the Indian corporate (financial sector) to understand and utilize the immensely beneficial tools of economic forecast.

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Annexure 5.A.1 The IRDA, through its The Insurance Regulatory And Development Authority (Investment) (Amendment) Regulations, 2001 has provided certain stipulations on investment of Insurance Funds. We reproduced some important guidelines pertaining to investment of life insurance funds in the following part of the annexure.

Regulations for Life Business In terms of explanation in Section 27A of the Act, the authority has determined that assets relating to pension business, annuity business and linked life insurance business shall not form part of the controlled fund for the purpose of that section. Without prejudice to Section 27 or Section 27A of the Act—every insurer carrying on the business of life insurance shall invest and at all times keep invested his controlled fund (other than funds relating to pension and general annuity business and unit linked life insurance business) in the following manner: TABLE 5.A.1 Investment of Life Insurance Funds Sl No. Type of Investment

Percentage

(i) (ii)

25% Not less than 50%

(iii) (a)

Government securities Government securities or other approved securities (including (i) above) Approved investments as specified in Schedule I Infrastructure and Social Sector Explanation: For the purpose of this requirement, infrastructure and social sector shall have the meaning as given in regulation 2(h) of Insurance Regulatory and Development Authority (Registration of Indian Insurance Companies) Regulations, 2000 and as defined in the Insurance Regulatory and Development Authority (Obligations of Insurers to Rural and Social Sector) Regulations, 2000 respectively. Others to be governed by exposure norms as specified in regulation 5. Investment in ‘OTAI’ can in no case exceed 15% of the fund

Not less than 15%

Not exceeding 35%

TABLE 5.A.2 Pension and General Annuity Business

Every insurer shall invest and at all times keep invested funds belonging to his pension, business, general annuity business in the following manner: Sl No.

Type of Investment

Percentage

(i) (ii)

Government securities Government securities or other approved securities Balance to be invested in approved investments as specified in Schedule 1 and to be governed by Exposure/Prudential Norms specified in Regulation 5

being not less than 20% (inclusive (i) above, being not less than) 40% Not exceeding 60%

(iii)

Note

For the purposes of this sub-regulation no unapproved investments shall be made.

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Unit Linked Life Insurance Business Every insurer shall invest and at all times keep invested his segregated fund of unit linked life insurance business as per pattern of investment offered to and approved by the policyholders. Unit linked policies may only be offered where the units are linked to categories of assets which are both marketable and easily realizable. However, the total investment in other than approved category of investments shall at no time exceed 25 per cent of the fund.

Reinsurance Business Every reinsurer carrying on reinsurance business in India shall invest and at all times keep invested his total assets in the same manner as set out in sub-regulation (1), until such time separate regulations in this behalf are made by the authority.

Note Every insurer shall endeavour to maintain a proper balance between the investments made in infrastructure sector and those in the social sector. Bonds issued for development of these sectors, duly guaranteed by the government or otherwise rated not less than ‘AA’ by independent, reputed and recognized rating agencies, issued by others would qualify for compliance of this regulation. All investment in assets/instruments, which are capable of being rated as per market practice, be based on rating of such assets/instruments. Rating should be by an independent, reputed and recognized Indian or foreign rating agency. The assets/instruments under consideration for investment, shall be of a grade not less than ‘AA’ of investment grade as per their current rating. In case investments of this grade are not available to meet the investment requirements of the investing insurance company and investment committee of the investing insurance company is fully satisfied about the same, then, for reasons to be recorded in the investment committee’s minutes, the investment committee may approve investment in instruments carrying current rating of not less than +A. Investments in +A to be kept to the minimum. Rating of debt instruments issued by all India financial institutions recognized as such by RBI maybe of ‘AAA’ or equivalent rating. In case investment of this grade is not available to meet the requirements of the investing insurance company and investment committee of the investing insurance company is fully satisfied about the same, then, for reasons to be recorded in the investment committee’s minutes, the investment committee may approve investments in instruments carrying current rating of not less than ‘AA’ or equivalent as rated by an independent, reputed and recognized Indian or foreign rating agency. No investment shall be made in an asset/instrument, which is capable of being rated as per market practice but has not been rated. Investments in equity shares listed on a recognized stock exchange should be made in actively traded and liquid instruments, namely, its trading volume does not fall below 10,000 units in any trading session during the last 12 months or trading value of which exceeds Rs 10 lakh in any trading session during last 12 months.

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Exposure/Prudential Norms Without prejudice to anything contained in sections 27A and 27B of the Act, every insurer shall limit his investments based on the following exposure norms:

Duty to Report Extraordinary Events Affecting the Investment Portfolio Every insurer shall report to the authority forthwith, the effect or the probable effect of any event coming to his knowledge, which could have adverse material impact on the investment portfolio and consequently on the security of policyholder benefits or expectations.

Constitution of Investment Committee Every insurer shall constitute an investment committee which shall consist of minimum two nonexecutive Directors of the insurer, the principal officer, chiefs of finance and investment divisions, and wherever appointed actuary is employed. The decisions taken by the investment committee shall be properly recorded and be open to inspection by the officers of the authority. Every insurer shall annually draw up an investment policy and place the same before its Board of Directors for approval. In framing such a policy, the Board will be guided by issues relating to liquidity, prudential norms, exposure limits, stop loss limits in securities trading, management of all investment and market risks, management of assets liabilities mismatch, investment audits and investment statistics, etc., and the provisions of the Insurance Act, 1938 and Insurance Regulatory and Development Authority (Investment) Regulations, 2000. Ensuring an adequate return on policyholders and shareholders funds consistent with the protection, safety and liquidity of such funds. The funds of the insurer shall be invested and continued to be invested in equity shares, preference shares and instruments which enjoy a rating referred to in the note below Regulation 4 and made by a national/international agency; in the absence of a rating for an asset, the Board shall clearly lay down the norms that will be followed by the investment committee which will ensure that the safety and liquidity of the policyholders’ funds are assured. The investment policy as approved by the Board will be implemented by the investment committee, which shall keep the Board informed periodically about its activities. The Board shall review its investment policy and its implementation on a half-yearly basis or at such short intervals as it may decide and make such modifications in its existing investment policy as are necessary to bring them in tune with the requirements of law and regulations—in regard to protection of policyholders’ interest and pattern of investment laid down. The details of the investment policy or its review as periodically decided by the Board shall be submitted to the authority within 30 days of its decision thereto. The authority may call for further information from time to time from the insurer as it deems necessary and in the interest of policyholders issue such directions to the insurers as it thinks fit.

Limit for Investee Company In the case of Indian Insurance Companies: Exposure at any point of time not to exceed 10% of the subscribed share capital, free reserves and debentures/bonds of the investee company or the 10% of the Insurer’s total assets in case of non-life insurers and 10% of the controlled funds in case of Life insurers, whichever is less. In the case of existing insurers: The limits mentioned above as applicable to the Indian Insurance Companies, shall stand modified as under:a) exposure at any point of time not to exceed 20% of the subscribed share capital, debentures/bonds of the investee company or 5% of the Controlled funds of the life insurer or 10% of the general insurers total assets

Exposure at any point of time not to exceed 10% of the aggregate subscribed share capital, free reserves and debentures of all the group companies in which investments including investments under considerations, have been or proposed to be made by the insurer or the 10% of the total assets in case of Nonlife insurers and 10% of the Controlled Funds in case of Life Insurers whichever is less. The percentage of 10% of the total assets in the case on Nonlife insurers and 10% of the Controlled Fund in case of Life insurers can be raised to 15% in each case subject to specific approval of IRDA.

Investment by the insurer in any industrial sector would not exceed 10% of its total investment exposure to the industrial sector as a whole. (Classification of Industrial sector to be done on the lines of classification in Industries done by CMIE (Centre for Monitoring Indian Economy)

Notes 1. Subject to exposure limits as per Insurance Act, 1938, investment in equity including preference shares, investment in equity convertible part of debentures should not exceed 50 per cent of the above exposure norms as mentioned in Table 5.A.3. A similar 50 per cent of exposure norms limit would also apply to investment in immovable property. 2. Subject to exposure limits mentioned in Table 5.A.3, an insurer shall not have investments of more than 5 per cent in aggregate of its controlled funds in the case of a life insurer or 5 per cent in aggregate of its assets in the case of non-life insurer in the companies belonging to the promoters’ groups. For the purposes of this regulation ‘group’ will have the same meaning as in the MRTP Act, 1969. All investments in this category would specifically be referred to the authority.

(i) All investments in equity/ preference hares of the company (ii) Debentures (Convertible/partly convertible/non-convertible) (iii) Short/Medium/Long-term loans (iv) Any other permitted investments as per the Act/ Regulation

Type of Investment

Limit for the Entire Group to Limit for the Industry Sector to which the Investee Company which the Investee Company Belongs Belongs

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Miscellaneous Valuation of assets and accounting of investments shall be as per the Insurance Regulatory and Development Authority (Preparation of Financial Statements and Auditor’s Report of Insurance Companies) Regulations, 2000. The authority may, by any general or special order, modify or change the application of Regulations (3), (4), (5) and (6) to any insurer either on its own or on an application made to it.

Annexure 5.A.2 An Extract from the IRDA Guidelines (Annexure 11)—Inv/Gln/008/2004–05

Fixed Income Derivatives 1. Background 1.1 In the terms of Regulations 11(1) of IRDA Investment Regulations 2000 (inserted w.e.f. 01–01– 2004], every insurer carrying on the business of Life insurance or General insurance may deal in financial derivatives only to the extent permitted, an in accordance with the guidelines issued by the Authority in this regard. 1.2 The IRDA has decided, with a view to enabling insurance companies to hedge their Interest rate risk to which they are exposed, to allow insurers carrying on the business of life insurance or general insurance (Participants) to deal in the following types of Fixed Income Derivative instruments, to the extent permitted, and in accordance with these guidelines: (i) Forward Rate Agreements (FRAs); (ii) Interest Rate Swaps (IRS); and Exchange Traded Interest Rate Futures.

2. Description of Permitted Fixed Income Derivative Instruments 2.1 Forward Rate Agreement (FRA) 2.1.1 A FRA is a financial contract between two parties to exchange interest payments on a ‘notional principal’ amount on settlement date, for a specified period from start date to maturity date. Accordingly, on the settlement date, cash payments based on contract (fixed) and the settlement rate, are made by the parties to one another. The settlement rate is the agreed benchmark/reference rate prevailing on the settlement date. 2.2 Interest Rate Swaps (IRS) An IRS is a financial contract between two parties exchanging or swapping a stream of interest payments on a ‘notional principal’ amount on multiple occasions during a specified period. Such contracts generally involve exchange of a ‘fixed to floating’, ‘floating to fixed’ or ‘floating to floating’ rates of interest. Accordingly, on each payment date–that occurs during the swap period–cash payments based on fixed/floating and floating rates, are made by the parties to one another.

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2.3 Exchange Traded Interest Rate Futures 2.3.1 An Exchange Traded Interest Rate Future means an interest rate futures contract or a bond futures contract traded on a recognized stock exchange that is approved for the time being by the Authority for the purpose of these guidelines. On the date of issuance of these guidelines, the National Stock Exchange of India and Bombay Stock Exchange (BSE) shall be recognized stock exchanges approved by the Authority for the purpose of these guidelines.

3. Types of FRAs/IRS 3.1 Participants can undertake different types of plain vanilla FRAs/IRS. IRS having explicit/implicit option features such as caps/floors/collars are not permitted.

4. Benchmark Rate 4.1 The benchmark rate should necessarily evolve on its own in the market and require market acceptance. The parties are therefore, free to use any domestic money, debt market rate or interest rates implied in foreign exchange forward markets as benchmark rate for entering into FRAs/IRS, provided methodology of computing the rate is objective, transparent and mutually acceptable to counter-parties.

5. Size 5.1 There will be no restriction on the minimum or maximum size of ‘notional principal’ amounts of FRAs/IRS. Norms with regard to size are expected to emerge in the market with the development of the product.

6. Tenor 6.1 There will be no restriction on the minimum or maximum tenor of the FRAs/IRS.

7. Permitted Purposes of Dealing in Fixed Income Derivatives 7.1 Dealings in the above-enumerated fixed income derivative instruments should be only for one or more of the following permitted purposes: (i) Hedging interest rate risk of investment in fixed income securities (ii) Hedging for forecasted transactions.

8. Description of Permitted Purposes of Dealing in Fixed Income Derivatives 8.1 Hedging Interest Rate Risk of Investments in Fixed Income Securities 8.1.1 This would cover fixed income derivative positions that are designed to offset the potential losses from existing fixed income investments of the participant. For example, a participant

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holding floating rate debt securities stands to lose when interest rates go down; hence, the participant may choose to short an exchange traded interest rate future contract in order to offset this potential loss; or alternatively, the participant may choose to enter into an IRS where under it agrees to receive a fixed rate and pay floating rate over the balance tenor to maturity of the underlying debt portfolio. 8.2 Hedging for Forecasted Transactions 8.2.1 This would cover positions in fixed Income derivative contracts that are designed to mitigate projected loss due to probable change in interest rates on: (i) investment of policy premium income receivable within a period of one year; (ii) reinvestment of maturity proceeds of existing fixed income investments with outstanding term shorter than one year; and (iii) investment of interest income receivable within a period of one year.

9. Permitted Counter Parties in ‘Over the Counter’ Transactions 9.1 Dealings of participants in the above-enumerated fixed income derivative instruments should be only with one or more of the following permitted counter parties: (i) Scheduled Commercial Banks other than Co-operative Banks. (ii) Financial Institutions notified u/s 4A of the Companies Act, 1956. (iii) Insurance companies registered by the Authority under the Insurance Regulatory and Development Authority (Registration of Indian Insurance Companies) Regulations 2000. (iv) Primary Dealers authorized by Reserve Bank of India. (v) Mutual Funds registered wish SEBI. (At present other than Exchange Traded Interest Future in particular FRA and IRS are dealt ‘OTC’)

10. Regulatory Exposure and Prudential Limits 10.1 Counter Party Credit Limits For FRAs and IRS 10.1.1 Participants dealing in FRAs and IRS have to arrive at the credit equivalent amount for the purposes of reckoning exposure to counter-party. For this purpose, participants shall apply the conversion factors to notional principal amounts as per the method of computing credit exposure prescribed in Annexure 1. The exposure should be within sub-limit to be fixed for FRAs/IRS to the counter parties (permitted under these guidelines) by the participants concerned. The exposure on account at FRAs/IRS together with other credit exposures should be within single/group borrower limits as prescribed under the Insurance Regulatory and Development Authority (Investment) Regulations 2000 from time to time. 10.2 Prudential Limit for Aggregate Fixed Income Derivatives Exposure 10.2.1 A participant’s dealings in fixed income derivatives under these guidelines shall in aggregate not exceed on outstanding notional principal amount equivalent to 150 per cent of the book value of the fixed income investments of the participant under the Policyholders Fund and the Shareholders Fund taken together.

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10.3 Internal Risk Management Policy and Processes, Exposure and Prudential Limits 10.3.1 Each participant should, before commencement of dealing in fixed income derivatives, frame detailed risk management policy, including for hedging and its effectiveness, and procedures on use of fixed income derivatives as also detailed guidelines for internal control (including qualification and Capital adequacy of dealers, periodical audit and the like) and prudential limits for dealings in fixed income derivatives, Inter aria, the risk management policy and procedures should address measurement and management of interest rate risk associated with fixed income derivative contracts permitted in these guidelines. 10.3.2 Such policies and guidelines, duly approved by its Board of Directors should be filed with the Authority. Any changes thereafter should require approval of its Board of Directors, and such changes duly approved should be filed with the Authority within 30 days of the change. 10.3.3 Further, before commencement of dealing in fixed income derivatives, each participant should furnish to the Authority a confirmation of their Board of Directors about their satisfaction that adequate risk measurement and management policy and procedures for measurement and management of interest rate risk with fixed income derivative contracts permitted in these guidelines, have been established and are functional. Such confirmation shall be renewed annually by the Board of Directors of the Participant.

11. Accounting and Measurement 11.1 Participants should adopt norms for hedge accounting of fixed income derivatives designated as hedging instrument on the basis of accounting principles set out in Annexure 2, after the approval of their respective Board of Directors in respect of hedging transactions permitted under these guidelines.

12. Disclosures in Financial Statements 12.1 The following should be disclosed by a participant in its Financial Statements: 1. Description of participant’s financial risk management objective and policies, in particular its policy for hedging forecasted transactions. 2. Hedge Accounting policy. 3. The aggregate notional principal of outstanding fixed income derivative contracts. 4. Nature and terms of outstanding fixed income derivative contracts. 5. Quantification of the losses which would be incurred if counter-parties failed to fulfill their obligation under the outstanding fixed income derivative contracts. 6. Value of the total outstanding fixed income derivative instruments; and details of ineffective hedge transactions and management reasons therefore.

Chapter 6 Issues in Life Insurance Governance The most crucial but less discussed issue in Indian life insurance industry is governance. Perhaps the reason lies in the market structure, controlled for a long time by public sector institutions regulated through government guidelines and parliamentary accountability. But liberalization of the insurance industry with the entry of private corporates, the controlling responsibilities have shifted to the IRDA to a great extent. Moreover, in a new market with tremendous freedom of operation in a competing environment, only regulatory control is not enough to provide required transparency and efficiency. Therefore, regulatory control needs to be supplemented by self-control—guiding management transparency and ethical conduct in business. While corporate governance aims at ensuring management efficiency through transparency in operation and optimizing stakeholders interest, a little more care and attention is needed to manage sales of insurance products in an ethical manner to offer need-based products and services to the policyholders. Therefore, ethical practices in selling and servicing has emerged as a major concern in the insurance industry, particularly, in the life insurance industry which is primarily focussing on retail investors from household sector. Keeping in view that the issues in governance are varied and wide having far reaching impact on business and policyholders interest we discussed the following issues: 1. Governance through regulations, supervision and risk capital (Risk-based regulations and supervision). 2. Ethical business practices in life insurance selling. 3. Corporate governance and corporate social responsibility. 4. The role of self regulatory organizations (SRO).

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Governance through Regulations, Supervision and Risk Capital Risk-based Regulations and Supervision A corporate entity is an important instrument of economic change and social progress. A financial institution like a life insurance company plays an immensely important role in national economy and society and they can discharge this role efficiently under a sound governance system. Though, the insurance firms are managed by complying with the legislative and regulatory requirements, it is the efficiency of internal management which matters. However, efficiency of a management does not depend on complying with regulatory requirements only—it is way beyond that. An efficient management is always proactive, futuristic, strategic, innovative and understands the importance of creativity and differentiation. Management efficiency is strongly supported by a number of factors but few very important factors are risk management, corporate governance, well-developed systems and controls, etc. Therefore, the efficiency and soundness of a management virtually depends on the internal governance system. Since the operation of a life insurance company basically deals with managing risks of different categories, here the major management focus and governance systems are centred on risk management. Therefore, the governance system must aim at risk management and risk mitigation. The system of corporate governance and other control mechanism should support the function of risk management.

Supervision and Governance The primary objective of any governance system is to protect and enhance the interest of stakeholders. In case of a life insurance company the major stakeholders are policyholders and shareholders. The governance system is institutionalized and strengthened through regulatory measures introduced by the regulator of the country as well as through mandatory/voluntary measures such as corporate governance and ethical practices. While the regulation and legislative measures are mandatory, corporate governance, ethical practices may or may not be mandatory for a life insurance company. However, they are essentially required instruments of efficiency and performance. But common to all the measures are concerns about various risks implicit in management decisions—and actions. Therefore ‘risks’ are the direct and indirect basis of governance and supervision. In the previous chapter we have discussed in detail about the various kinds of risks and sources. The important risk factors are: 1. Strategic risks: The risk of making wrong strategic decisions or suffering loss of reputation. 2. Financial risk: Default on outstanding debt and loss of value of invested assets. 3. Political risk: Risk of legislative changes and government intervention. 4. Operational risk: Risk of operating errors and external changes.

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When these risk factors are narrowed down in the context of life insurance the risks are: 1. Underwriting risks, asset liability mismatch risks, pricing risks, actuarial risks. 2. Systematic or market risks, credit risks, liquidity risks, interest risks, operational risks, legal risks, concentration risks, catastrophe risks, management risks and growth risks. This list of risks can be extended further because of changing market environment and nature of competition in the marketplace producing unknown uncertainties. Therefore, managing these risks becomes the major concern for an insurance company and a major benchmark of management success. Management and governance, though basically internal to a company, it is directly influenced by the various regulations introduced by regulations, which an insurance company needs to comply with. The regulator on the other hand supervises the business operations of the insurance companies. A common role of an insurance regulator is to stand in the shoes of the customer by analyzing the companies so as to provide some comfort to the consumers that companies are managing their affairs appropriately and therefore the regulators are able to meet their obligations to the customers of the company (Thompson 2001). Regulatory supervision is basically of two types, namely, legislative type and Self Regulatory Organization (SRO) type. However, in reality most of the countries have a combined form of regulatory supervision—regulations supported by SRO norms. In life insurance supervision, the focal point is the solvency management of a company and critical factors are valuation of assets and liability. Supervising through solvency is an important regulatory measure followed by almost all regulators. However, the models may not be the same. Two distinct types of models are: retrospective model and prospective model. In retrospective model historical data is used to calculate and assess the solvency requirements of insurers, while in prospective model historical data is factored into future trends. Further, there are two types of retrospective models, namely, fixed ratio model and risk-based capital model. Fixed Ratio Model

Under fixed ratio models, solvency requirements are established as a fixed percentage of the value of a given variable that is assumed to be strongly correlated to a company’s degree of risk exposure. This variable generally involves a simple function of one or more items on the balance sheet or profit or loss account (Organization for Economic Cooperation and Development [OECD]). It can be mentioned here that fixed ratio models are considered to be narrow in coverage of risk factors. These models are used in Europe, Korea, Mexico, Poland, Switzerland and many other countries. Risk-based Models

Risk-based model is much wider than fixed ratio models so far as coverage of risk factors are concerned. These factors are pricing, provisioning, liquidity, interest rate, credit, management

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risks, etc. The risk-based capital model has several components of risks, namely, asset risks, credit risks, underwriting risks (that is, underwriting loss), off balance sheet risks, etc. Weights are assigned to each component to assess the degree of risks associated with each component and their impact on overall financial strength of the company. Capital adequacy of an insurance company is tested by comparing risk-bearing capital with risk-based capital. The risk-based models were first adopted in USA in 1992 and subsequently adopted by many countries such as Canada and Japan. There is a growing debate on risk-based solvency models. European Union and many other countries are gradually switching over to the risk-based solvency models, since fixed ratio models often fail to capture a large number of sources of risks. Prospective Models

Risk-based and fixed ratio models are called retrospective models based on historical data factored into future prospects to calculate solvency. Future assumptions include changes in market and management due to assumed volatility and uncertainties. These models are being used in Australia, Finland, etc.

Solvency Regulations in India India has adopted the Solvency Model, which may be characterized by Fixed Ratio Models. The IRDA Guidelines ‘The Regulatory and Development Authority (Assets, Liabilities and Solvency Margin of Insurers) Regulations 2000, issued on 14 July 2000 provided the outline of Valuation of Assets and Liabilities and Determination of Solvency Margin. Some important features of this regulation are discussed below.

Values of Assets Method of valuation of assets by a Life Insurance Company would be carried out as per regulations 3 of the Guidelines, which also defined the non-mandated investments, zero value assets and valuation of computer equipments, etc.

Valuation of Liabilities Liabilities of a Life Insurance Company would be assessed by following the ‘Gross Premium Method’. Accordingly the determination of Mathematical Reserves shall take into consideration the nature and terms of the assets representing liabilities and value and there should be prudent provision against effects of possible future changes. Gross Premium method should also discount certain future cash flows at an appropriate interest rates: premium payable, benefits payable, commission and remuneration payable, policy maintenance expenses, allocation of profits to shareholders, etc. The determination of the amount of liability under each policy shall be based on prudent assumptions of all relevant parameters. The value of each such parameter

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shall be based on the insurer’s expected experience and shall include an appropriate margin for adverse deviations that may result in an increase in the amount of mathematical reserves. The guidelines also outlined how policy options to be considered, valuation parameters additional requirements for Linked Business, Additional requirements for provisions, etc. Valuation of liabilities by gross premium method shall consider discounting certain types of future policy cash flows (as per the guidelines) at an appropriate rate of interest. Where a policy provides built-in options, such as conversion or addition of coverage at future date(s) without any evidence of good health, annuity rate guarantees at maturity of contract, etc., the costs of such options shall be estimated and treated as special cash flows in calculating the mathematical reserves.

Valuation Parameters The valuation parameters shall constitute the bases on which the future policy cash flows shall be computed and discounted. Each parameter shall have to be appropriate to the block of business to be valued. The value(s) of the parameter shall be based on the insurer’s experience study, where available. If reliable experience study is not available, the value(s) can be based on the industry study, if available and appropriate. If neither is available, the values may be based on the bases used for pricing the product. In establishing the expected level of any parameter, any likely deterioration in the experience shall be taken into account. The expected level, as determined shall be adjusted by an appropriate Margin for Adverse Deviations (MAD). Mortality rates and Morbidity rates to be used shall be by reference to a published table, unless the insurer has constructed a separate table based on his own experience. Policy maintenance expenses shall depend on the manner, in which they are analyzed by the insurer, namely; fixed expenses and variable expenses. The variable expenses shall be related to Sum Assured (SA) or premiums or benefits or per policy expenses. All expenses shall be increased in future years for inflation, which should be consistent with the valuation rate of interest.

Valuation Rates of Interest It shall not be higher than the rates of interest, for the calculation of the present value of policy cash flows referred above, determined from prudent assessment of the yields from existing assets attributable to blocks of life insurance business, and the yields which the insurer is expected to obtain from the sums invested in the future.

Determination of Solvency Margin Solvency margin is a safety margin which indictes how prepared a firm is to meet unforeseen requirements and it is the amount by which the assets of an insurer exceed its liabilities, and will form part of the insurer’s shareholder funds.

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The IRDA regulations has provided guidance about Calculation of Available Solvency Margin, Solvency Ratio and Determination of Solvency Margin. Available Solvency Margin means the excess of value of assets, over the value of life insurance liabilities and other liabilities of policyholder’s fund and shareholder’s fund. Solvency ratio has been defined as the ratio of the amount of Available Solvency Margin to the amount of Required Solvency Margin. Every insurer shall determine the Required Solvency Margin, the Available Solvency Margin and the Solvency Ratio as specified under Insurance Regulatory and Development Authority (Actuarial Report and Abstract), Regulations, 2000. At present the Life Insurance Companies in India have to maintain a 150 per cent Solvency Margin which includes a 50 per cent additional cushions over and above the norms specified in the regulations. To maintain this solvency ratio, insurance companies are allowed to bring in additional capital. In view of the critical role of life insurance in national economy, capital markets, personal financial risk management and emerging risk profile of Life Insurance management, it is necessary that all aspects of risks associated with life insurance business be considered while determining the solvency and governance. Experience shows that no method other than Risk-based Capital model capture the whole gamut of risks associated with life insurance business.

Business Ethics and Life Insurance Selling: Best Practices and Market Conduct Ethics in Business One of the major concerns of any business in the modern world is the ethics and code of conduct in the marketplace. Industrial revolution, competition and profit motives of business crippled the barriers of right and wrong. Emergence of powerful business corporations in the global market has often reduced the power of individual customers pushing them to accept whatever is being offered by the corporations. This has led to many scandals, unfair trade practices and moral failures. This has brought to the fore the question of ethics in business—a major issue being discussed in academic, business and corporate world. Ethics in business also has serious implications to the question of corporate and state governance because no sound and good governance is possible without ethical business practices. Since modern state and society is significantly supported by the corporates, good governance is impossible without good corporate governance. However, the concept of business ethics is not new—many believe that it is a progression from ethics of economics to ethics of business. In the words of Morgen Witzel (2002) ‘Business Ethics’ is one of the world’s greatest oxymorons like military intelligence or ethical foreign policy. Down through the centuries there have been

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many who believe that business is per se unethical…but equally there has been a countervailing argument that commerce, business, trade and industry by bettering the lot of humanity through increased prosperity, better health and education and so on are in and of themselves morally valid occupations. It follows from this that those occasional (or not so occasional) lapses are the result of moral failings by individuals, not of the system of commerce as a whole. Failures of individuals in business therefore need to be controlled in the best interest of society. While business is a boon to the society, it can also turn out to be destructive either due to group actions or individual actions, unless some ethical standard is maintained to control the destructive tendency. The necessary control can be exercised by state regulation as well as selfregulation through adherence to moral and ethical codes of business. However, self-regulation is more effective within the given framework of state regulation. Because self-regulation allows an individual to apply moral judgement to maintain ethical conducts more scrupulously in the interest of an individual or society and therefore, the necessity of having some code of conduct for the business practices was felt. Witzal has further mentioned that ‘early 20th century saw the development of “Codes of ethic” for many professions, including business’. A large number of authors have suggested a wide variety of code of conduct for business, and we may quote few of them. Witzal has quoted Edward Filene among others who described business ethics in simple words as a business, in order to have right to succeed, must be of real service to the community. Real service in business consists in making or selling merchandize of reliable quality for the practically lowest possible price, provided that merchandize is made and sold under just conditions. The codes of business ethics, though spelt out in a very simple manner, focuses on the core objectives of business, that is, real service to the society. The products and services that are being offered by any business must be of reliable quality and at a just price. However in real life situation there is often departure from the ideal situation as advocated above. There is expectation of abnormal profit, absence of fair pricing and sub standard quality and service. Greed often overtakes fair business practices. Motives to expand the marketing reach and market share overtakes ethical business practices. Many authors have therefore advocated fair business conducts. For example, Jerry White in his book Honesty, Morality and Conscience (1978) has laid down guidelines for conducting business. Five guidelines for conducting business are: 1. ‘Just Weight’, that is, to give full amount/quality for which the customer has paid an amount. 2. Business should be conducted with total honesty—with consumers, employers, employees and customers. 3. Business to be conducted by ‘being the servant’, the value of business is its service. While the customers will decide how well the organization serves and the people in business will do the serving.

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4. People in business will take ‘personal responsibility’ for own actions and decisions. 5. Business must expect only ‘reasonable profits’. The whole focus of while is the service provider and customers. It would be personal responsibility of the service providers to provide required quality services at a price charged for it. Colonel Nimrod McNair in his booklet Ten Global Principles for Business and Professional Success laid down the following principles: 1. 2. 3. 4. 5. 6. 7. 8. 9. 10.

Show proper respect for authority. Have a singleness of purpose. Use effective communication. . Provide proper rest, recreation and reflection. Show respect for the older and more experienced. Show respect for human life, dignity and rights. Maintain a stability of sexes and the family. Demonstrate the proper allocation of resources. Demonstrate honesty and integrity. Maintain the right of ownership of property.

The concern expressed by authors and guidelines provided by them for ethical conduct of business focuses on the issues of ethics, morality and governance. Today corporate governance has emerged as a key issue of business practices, which can be achieved among other things by following ethical business practices. Life insurance industry is no exception to this.

Marketplace Issues With the expansion of market economy and involvement of private enterprises in economic activities market complexities have increased manifold. State regulations have limitations in monitoring and therefore the concept of self-regulation has emerged as an important instrument of control. Various industry associations are actively advocating certain desired conducts for their members in relation to marketplace activities which cover a wide range of issues. Business for Social Responsibility (BSR) (2003) has grouped these activities into six broad categories namely: 1. 2. 3. 4. 5. 6.

Integrity of product manufacturing and quality. Disclosure, labelling and packaging. Marketing and advertising Selling practices. Pricing. Distribution and access.

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While the Regulatory mechanism has been developed to address these issues, various industry associations and non-government agencies have also designed external standards to address these issues. In order to protect the interests of the consumer from unethical practices of companies producing and distributing consumer goods and services many organizations have come up with sets of ethical codes. American Marketing Association (AMA) Code of Ethics

This is a worldwide professional marketers society with more than 45,000 individual members in 92 countries. ‘A key component of AMA’s mission is to advance the science and ethical practice of marketing disciplines.’ The AMA’s code of ethics is designed to guide its members in their professional ethics. Some of the important features of the codes are stated in the following part of the chapter. Marketers Professional Conduct must be guided by: 1. 2. 3. 4.

Basic rule of professional ethics; not knowingly to do harm. Adherence to all applicable laws and regulators. Accurate representation of their education training and experience. The active support, practice and promotion of this code of ethics.

HONESTY AND FAIRNESS Marketers shall uphold and advance the integrity, honour and dignity of the marketing profession by:

1. Being honest in serving consumers, clients, employees, suppliers, distributors and the public. 2. Not knowingly participating in conflict of interest without prior notice to all parties involved. 3. Establishing equitable fee schedules including the payments or receipt of usual, customer or legal compensation for marketing exchange. RIGHTS

AND

DUTIES

OF

PARTIES

IN THE

MARKETING EXCHANGE PROCESS

Participants in the marketing exchange

process should be able to expect that: 1. Products and services offered are safe and fit for their intended use. 2. Communications about offered products and services are not deceptive. 3. All parties are intended to discharge their obligations, financial and otherwise in good faith. 4. Appropriate internal methods exist for equitable adjustment and/or redress of grievances concerning purchase. AMA code also includes the areas of product development and management, promotion, distribution, pricing, marketing research and organizational relationships. In addition to the

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AMA, other international associations which have designed market and ethical conducts include the Canadian Direct Marketing Association (CDMA); Council of Better Business Bureau (BBB), USA; American Marketing Association Code of Ethics for Marketing on the Internet, etc. The primary focus of all these codes is customers and fair business practices by their members and marketers in general.

Ethical Issues in Life Insurance Selling Life insurance industry, throughout the world, has been expanding at a rapid speed and playing a very critical role in the national economy by providing financial solutions to the policyholders, boosting up capital market and committing to economic development. Life insurance offers various types of products—insurance, annuity, pension and health care to millions of people through a variety of distribution channels such as individual sales force, bank assurance and corporate agents. Providing a right product to a customer requires assessment of his needs and future implications. Therefore, agents and other entities involved in selling life insurance products not only need to be knowledgeable and technically qualified but also need to follow ethical standard to protect the interests of the policyholders. Ideally an insurance company, its agents and other distributors should offer ‘need-based’ products to a customer on the basis of financial objectives and insurance needs. They should also follow fair business practices and should not offer any incentives to induce customers to complete any sales transaction. No agent should advice to replace an existing policy or to sell a new one for his own monetary benefits. He should also provide after sales service to the customers to their satisfaction. Insurance companies must also follow ethical standards in pricing their products to match embedded value to the cost of the products; fair advertising and sales materials must contain correct and necessary information to enable the potential investors to take informed decisions. They should also handle customers’ complaints fairly and provide necessary guidance to them. Insurance companies and their distributors should also assist the customers to enhance their economic and financial literacy which would enable them to buy the right products according to their insurance needs and financial objectives. However, the conditions stated in this chapter for fair selling very often do not exist in the life insurance market and there are numerous examples of unfair selling and unethical business practices. The intensity of unethical business practices in life insurance increased significantly due to intense competition—not only competition among insurance companies but also the competition coming from other financial and saving institutions in the financial market aiming at HDS. Cooper (1998) has observed that complaints against insurers all over the world involving allegations of churning, misrepresentation or investment performance that failed to live up to projections have led to a wave of market conduct lawsuits against a number of the industry’s leading companies of the world (and smaller companies as well) which in turn resulted in multimillion dollar settlements by and/or fines against several major life insurers. In addition, while

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a mix of influences has undoubtedly affected life insurance sales, growing sales trends for some companies turned downward when alleged sales abuses came to light in 1993. A study of Million Dollar Round Table (MDRT) in 1995 also observed violations of ethical issues relating to sales of life insurance products. Listed in the descending order for the top ten issues were: 1. False or misleading representation of products or services in marketing advertising or sales efforts. 2. Failure to identify the customer’s needs and recommend products and services that meet those needs. 3. Conflicts between opportunities for personal financial gain (or other personal benefits) and proper performance of one’s responsibilities. 4. Making disparaging remarks about competitors, their products, or their employees or agents. 5. Lack of knowledge or skills to competently perform one’s duties. 6. Misrepresenting or concealing limitations in one’s abilities to provide services. 7. Failure to be objective with others in one’s business dealings. 8. Failure to provide prompt, honest responses to customer inquiries and requests. 9. Failure to provide products and services of the highest quality in the eyes of the customer. 10. Conflicts of interest involving business or financial relationships with customers, suppliers or competitors that influence or appear to influence one’s ability to carry out his or her responsibilities. Thus, it appears that despite the passage of time and efforts by a number of individual companies and professional associations, the key ethical dilemmas facing marketing professionals working in the life insurance business changed little from 1990 to 1995.

Some Examples of Ethical Conduct and Practices in Life Insurance Market The US Market

Concerned with growing unethical practices in life insurance market in USA in November 1994 the Board of Directors of an independent non-profit organization called American Council of Life Insurance (ACLI)—a major trade association—approved in principle programme formulated by its CEO task force on market conduct to recognize insurers certified by a third party for meeting a set of six ethical principles and a code of conduct for the industry. Nearly two years after the market conduct initiative was approved in principle, it was announced in September 1996 that the Insurance Marketing Standards Association (IMSA) officially began operations on 15 November 1996. IMSA consists of more than 200 voluntary members that lead the insurance industry in promoting high ethical standards in the sales of individual life insurance, long-term care

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insurance and annuity products. Ethical market conduct programme of IMSA is a voluntary programme basically focussed on sales and marketing procedures of individually sold life and annuity products. Companies who are members of IMSA require to do more, than just say that they are ethical. IMSA’s rigorous standard requires that a company demonstrate an extra level of commitment to ethical business practices through systematic approach and ongoing reviews of policies and procedures. Qualifications lasts for three years after which a company must requalify under the same process. IMSA emphasizes upon few critical factors such as prompt and courteous communication, transparency, efficient responsive and adequate consumer service, and accountability at all levels. IMSA imposes on its members a set of standards comprising of six key principles. For a company to observe the principles of ethical market conduct it requires to do the following (Atchinson 2004). 1 Conduct business according to high standard of honesty and fairness and to render that service to its customers which, in the same circumstances, it would apply to or demand for itself. 2. Provide competent and customer-focussed sales and service. 3. Engage in active and fair competition. 4. Provide advertising and sales materials that are clear as to purpose and honest and fair as to content. 5. Provide for fair and expeditious handling of customer complaints and disputes. To qualify IMSA’s standard, a company must fulfil 144 separate criteria, undergo rigorous self audit and then undergo a third party assessment approved by IMSA. By 2004, 160 top insurance companies of USA were the members of IMSA—this represented 60 per cent life annuities and long-term care insurance policies written in USA. IMSA works closely with National Association of Insurance Commissioners (NAIC), Government Accountability Office (GAO) and other agencies. IMSA is an example of industry based approach to raise the ethical standard of business; insurance industry in any country can learn from the principles, practices and proactive market standard practices adopted by IMSA. IMSA STANDARD OF BEST PRACTICES

IMSA devised the following standards to promote high standards of ethical market conduct in advertising, sales and service for individual life insurance and annuity products. High standards of honesty and fairness: 1. 2. 3. 4.

Code A: Broadly defined need-based selling. Code B: Compliance with applicable laws and regulations. Code C: Company affirmatively seeks to improve sales and marketing practices. Code D: Ethical principles are reflected in company policies and practices.

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Competent and customer-focussed sales and service: 1. Code A: Distributors are of good character and repute and have qualifications and experience. 2. Code B: Distributors are duly licenced or qualified under state law. 3. Code C: Distributors and employees involved in the sales process are adequately trained. 4. Code D: Distributors are provided with materials in order to gain knowledge of company products and operations. 5. Code E: Distributors and employees involved in the sales process are trained in the need to comply with applicable insurance laws and regulations and the IMSA principles and code. 6. Code F: Distributors are encouraged to participate in periodic continuing education programmes. Active and fair competition: 1. Code A: Compliance with state and federal laws fostering competition. 2. Code B: Replacement of existing policies only after customer need analysis is completed. 3. Code C: Distributors and sales employees refrain from disparaging competitors. Advertising and sales materials are clear as to purpose and honest and fair as to content: 1. Code A: Presentation of sales material in a manner consistent with the customer’s best interests. 2. Code B: Sales materials are clear and understandable. 3. Code C: Compliance with laws related to advertising and sales materials. 4. Code D: Sales illustrations are accurate and fair, with disclosure of guaranteed/nonguaranteed amounts. Fair and expeditious resolution of complaints and disputes: 1. Code A: Complaints are handled according to applicable laws and regulations. 2. Code B: Good faith efforts are made to resolve complaints and disputes without sorting to civil litigation. System of supervision and review: 1. Code A: Company policies and procedures comply with the IMSA principles and code. 2. Code B: Company has adequate system of supervision over distributors and sales employees to monitor compliance with the IMSA principles and code.

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3. Code C: Company conducts training for sales employees and provides instructions on compliance requirements for distributors. 4. Code D: Company audits and monitors sales practices. The UK Market

In order to strengthen the ethical practices in life insurance selling, the Financial Services Authority (FSA), UK issued the regulation of protection products by the FSA which replaced the Life Insurance (Non-Investment Business) Selling Code of Practice from 14 January 2005. This code covers only those kinds of long-term insurance contracts and permanent health insurance which are not ‘qualifying contracts of insurance’ within the terms of Article 3 to the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001. Part I of the code applies to ‘intermediaries’, that is, all those persons selling life insurance who are not subject to FSA rules regulating the selling of life insurance with respect to the business in question. While Part II of the code applies to ‘introducers’, that is, those who merely introduce a prospective policyholder to a life office but take no part in the subsequent selling process. Members of the association have undertaken, as a condition of membership, to enforce the code and to use their best endeavours to ensure that all those involved in selling their policies observe its provisions together with the provisions of the guidance as published and agreed by the association from time to time. LIFE INSURANCE (NON-INVESTMENT BUSINESS) SELLING CODE

OF

PRACTICE

IN

UK

The intermediary shall not—

1. Inform the prospective policyholder that his name has been given by another person unless he is prepared to disclose that person’s name if requested to do so by the prospective policyholder and has that person’s consent to make that disclosure. 2. Make inaccurate or unfair criticisms of any insurers. 3. Attempt to persuade a prospective policyholder to cancel any existing policies unless either these are clearly unsuited to his needs or it is clearly in the consumer’s interests to do so. Explanation of the contract The intermediary shall— 1. Explain all the essential provisions of the contract or contracts which he is recommending so as to ensure that as far as possible the prospective policyholder understands what he is committing himself to. 2. Draw attention to any restrictions applying to the policy. 3. Draw attention to the long-term nature of the policy and where appropriate, to the consequent effects of early discontinuance and surrender. 4. In the case of change to a policy qualifying for tax relief on the premiums, draw attention to the fact that the relief maybe lost as a result of the change.

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Disclosure of underwriting information The intermediary shall in obtaining the completion of the proposal form or any other material— 1. Avoid influencing the proposer and make clear that all the answers or statements are the latter’s own responsibility. 2. Ensure that the consequences of non-disclosure and inaccuracies are pointed out to the proposer by drawing his attention to the relevant statement in the proposal form and by himself explaining them to the proposer. Accounts and financial aspects The intermediary shall— 1. Keep a proper account of all financial transactions with a prospective policyholder which involves the transmission of money with respect to insurance. 2. Acknowledge receipt (which unless the intermediary has been otherwise authorized by the office shall be on his own behalf) of all money received in connection with an insurance policy and shall distinguish the premium from any other payment included in the money. 3. Forward without delay any money received for life insurance. Code for Introducers The introducer shall— 1. Give advice only on those matters in which he is competent and seek assistance from the life office when necessary. 2. At the earliest opportunity call upon a qualified representative from the life office whose contract he wishes to present to the prospective policyholder, to explain the contract to the prospective policyholder. The introducer shall not— 1. Solicit life insurance business outside the terms of his appointment; 2. Attempt to influence the prospective policyholder with regard to completion of the proposal form. Code of Conduct in Singapore Market

It is not only the US and UK markets but smaller markets have also started adopting market conduct codes for selling/distributing life insurance products. Recently Singapore has introduced such market conduct codes. On June 2004, Life Insurance Association, Singapore (L/A) (2005) introduced compulsory minimum standards pertaining to key areas for distributing life insurance products. These standards are applicable to life insurance industry as well as to distributors. These codes are primarily focussed on switching, usage of promotion and twistings.

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Accordingly, enhanced disclosures to the customers are aimed at informing the policyholders of the disadvantages of switching between companies. Insurers will also monitor switching activities in order to ensure that it is not in the interest of the policyholders. In order to exercise effective control over promotional activities road shows and gifts will be discouraged. However, such gifts are to be approved by the insurers. Further, market conduct codes also discourage twisting in the interest of policyholders’ interest. Market Conduct Practices in India

Indian life insurance industry has entered into a new phase of growth after liberalization of the insurance industry and the setting up of the IRDA on 25 October 2000. While liberalization allowed domestic and foreign companies (as joint ventures) to operate in the Indian market, IRDA has been framing various rules and regulations for orderly development of insurance market: to protect the interest and to secure fair treatment to the policyholders; to set, promote, monitor and enforce high standards of integrity and financial soundness; fair dealings and competence of those it regulates; to ensure that insurance customers receive precise, clear and correct information about products and services; to ensure speedy settlement of genuine claims; to prevent insurance frauds and other malpractices; to promote fairness, transparency and orderly conduct in financial markets and to bring about optimum self-regulations. Keeping the above mission in view, IRDA has periodically come out with various guidelines and regulations to protect the interest of investors, introduce sound practices of management of insurance companies and transparency in the marketplace. Some of the important Regulations aiming to introduce good practices in the marketplace are: 1. Insurance Regulatory and Development Authority (Licensing of Insurance Agents) Regulation 2000. 2. IRDA (Licensing of Insurance Agents) (Amendment) Regulation 2002 and Amendment 2002. 3. IRDA (Insurance Advertisements and Disclosure) Regulation 2000. 4. IRDA (Protection of Policyhodlers’ Interest) Regulation 2002 and Amendment in 2002. 5. IRDA (Insurance Brokers) Regulations 2002. 6. IRDA (Licensing of Corporate Agents) Regulations 2002. IRDA Licensing of Insurance Agents Regulation 2000, provided a comprehensive Code of Conduct for the agents, who should identify himself/herself and company he/she belongs to, disseminate requisite information with respect to products, disclose sales commission, indicate premium to be charged, bring to the notice of the insurer any adverse habit or income inconsistency of the prospect, explain the prospect the nature of information required for rendering necessary assistance to the policyholders, etc. There are other points which an

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agent should not do. IRDA has also similar Code of Conduct for corporate agents and also for insurance brokers. Further, only introduction of market conduct practices may not serve the desired purpose. Ethical practices to be institutionalized through rigorous monitoring. This requires regular examination of market conduct by intermediaries such as sales forces and agents. In this regard we may mention about market conduct survey of market conduct exam conducted in the US to find out the adherence to the regulation. Therefore, the post-licensing monitoring needs to be focussed for desired results out of the introduction of code of conduct of agents/brokers. This job maybe taken up by an SRO like Life Insurance Council.

Corporate Governance and Life Insurance Introduction Recent developments in global economy have significantly impacted the structure of domestic economies as well as the market through free flow of enterprise, technology, capital/finance and savings market. This has promoted the emergence of global economy and global market, necessitating rewriting rules of business and competition. Recent trends in disintermediation are led by the emergence of market economy, where the leading role of banks is being replaced by other financial institutions such as mutual funds, pension funds, insurance, investment banking and broking houses. In the new environment the focus is on the capital market led financing instead of bank finance which played a predominant role earlier. Financial institutions, in addition to enhancement of shareholders value have to increase the wealth for the depositors/ investors, who are the core to their business activities. Moreover, activities of financial institutions are widespread and a failure of any one kind of institutions may induce the collapse of the entire economy. Another emerging phenomenon in the new economic order is growing institutionalization of the financial market, which also often reflected in increased management as well as shareholders’ activism. All these phenomena have increased the risk content of management actions and necessitated good governance. Therefore, corporate governance is more crucial for such institutions not only in the interest of shareholders, investors/depositors and other stakeholders but also in the greater interest of the national economy. Economic reforms and opening up of the insurance industry has offered tremendous opportunities for expansion through competition. The decisive impact of competition in the marketplace has been reflected in the growth of life insurance business. Competition has thus been beneficial to the insurance industry through release of market forces. However, market forces cannot operate in regulatory vacuum and regulators play an important role by framing rules of the game by monitoring forces of operation and by inducing the element of competition among the market players. Further, operational efficiency of the individual insurer also depends on the degree of ethical business conduct, transparency and governance system, and therefore sound corporate governance plays a very vital role in good governance and policyholders’ protection.

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Divorce of ownership and control in modern corporations, institutionalization of corporate finance and capital market during recent times has brought to focus the importance of corporate governance for institutional investors such as life insurance companies and pension funds which are dominating the financial economy of a country. Life insurance companies and pension funds together play the most dominant role in savings market and impact the wealth of millions of contributors who save their money with them. Therefore, good corporate governance through efficient financial management has been considered as most crucial in modern economy. Corporate governance is strongly affected by the relationship among the participants in the governance system such as individual shareholders, employees and suppliers. Though, the role and relationship among these participants are focussed through law; regulation and voluntary adaptation in corporate governance mechanism play the most crucial role promoting and protecting the interest of shareholders and policyholders. According to Alexander Dyck (2001) ‘the institutions of corporate governance are those organizations and rules that influence the expected returns to investing and giving authority over ones resources to insiders. Such institutions alter the pay offs to insiders and outsiders, affecting the actions that will be observed and facilitate or constrain the grabbing hands of public and private actors.’

Corporate Governance Defined Corporate governance in general is a mechanism to maximize the wealth of owners which can be achieved by optimum utilization of resources and maximization of return in a given economic environment by managing the organization in more transparent and participating ways. Corporate governance has been seen by many as, ‘a combination of corporate ethics, corporate transparency as well as corporate accountability’. The majority of the definitions articulated in the codes relate corporate governance to ‘control’—of the company, of corporate management, or of company conduct or managerial conduct. Perhaps the simplest and most common definition of this sort is the one provided by the Cadbury Report (UK), which is frequently quoted or paraphrased: ‘Corporate governance is the system by which businesses are directed and controlled’.

OECD Principles of Corporate Governance Organisation of Economic Cooperation and Development (OECD) issued ‘OECD Principles of Corporate Governance’ in 2004, which states that ‘Corporate Governance’ is one key element in improving economic efficiency and growth as well as enhancing investor confidence. Corporate Governance involves a set of relationships between a company’s management, its board, its shareholders and other stakeholders. Corporate Governance also provides the structure through which the objectives of the company are set, and the means of attaining those objectives and monitoring performance are determined.

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According to the Kumar Mangalam Committee, the fundamental objective of corporate governance is enhancement of shareholders’ value keeping in view of the other stakeholders. Since the prime objective of corporate governance is to enhance the wealth of the shareholders and interest of all stakeholders good financial governance is the basis of sound corporate governance. According to Narayana Murthy Committee The term ‘corporate governance’ is susceptible to both broad and narrow definitions. In fact, many of the codes do not even attempt to articulate what is encompassed by the term. The motives for the several corporate governance postulates engaged in these definitions vary, depending on the participant concerned. The focal subjects also vary accordingly. An important point is that corporate governance is a concept, rather than an individual instrument. It includes debate on appropriate management and control structures of a company. Further, it includes the rules relating to the power relations between owners, the Board of Directors, management and last but not least stakeholders such as employees, suppliers, customers and the public at large. However, market relationship depends on socio-economic forces, degree of which varies from country to country, there cannot be a unique model for corporate governance in all the countries. A country has to adopt its own model of corporate governance, depending on the level of expectations of the stakeholders, efficiency of capital market and general economic objective of the country. Therefore, in India we need to promote a corporate governance mechanism keeping in view the uniqueness of Indian stakeholders’ expectations and market system but in the light of good practices that are prevailing in other developed countries. We may quote here some well-known definition—the fundamental objective of corporate governance is the enhancement of shareholders value keeping in view interests of other shareholders. The true purpose of corporate governance is to maximize creation of a company’s total valuation. The social and environmental issues are integrated in a company incorporated in company debate. The aim of ‘good corporate governance’ is to enhance long-term value of the company for its shareholders and all other partners. The enormous significance of corporate governance is clearly evident in this definition, which encompasses all stakeholders. Corporate governance integrates all the participants involved in a process, which is economic and at the same time social. This definition is deliberately broader than the frequently heard narrower interpretation that only takes account of the corporate governance postulates aimed at shareholder’s interests. Studies of corporate governance practices across several countries conducted by the Asian Development Bank (2000), IMF (1999), ‘OECD’ (1999) and the World Bank (1999) reveal that there is no single model of good corporate governance. This is recognized by the OECD Code. The OECD Code also recognizes that different legal systems, institutional frameworks and traditions across countries have led to the development of a range of different approaches to corporate governance. However, common to all good corporate governance regimes is a high degree of priority placed on the interests of shareholders, who place their trust in corporations to use their investment funds wisely and effectively. In addition, best-managed corporations also recognize

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that business ethics and corporate awareness of the environmental and societal interest of the communities within which they operate, can have an impact on the reputation and long-term performance of corporations. Corporate governance is a mechanism requiring to establish a well-integrated governance chain. Alexander Dyck (2001) mentioned six formal governance chains which provide many benefits and strengthen corporate governance. These links are: 1. 2. 3. 4. 5. 6.

Link One: Legal institutions to constrain state. Link Two: Independent boards to constrain insiders. Link Three: Legal institutions to constrain the grabbing hands of insiders. Link Four: Organizations to improve information flows and accountability. Link Five: Firms to improve the flow of information to outside investors. Link Six: Organizations to provide incentives to intermediaries.

Establishing such a governance chain would require a well-designed legal, strategic and operational mechanism to serve the interest of all stakeholders.

Scope of Corporate Governance Corporate governance mechanism to be focussed basically to protect the rights of shareholders and should ensure equitable treatment of all shareholders. Corporate governance should encourage and ensure active cooperation between the corporation and stakeholders to enhance the wealth, jobs and to sustain the financial health of the organization. Corporate governance mechanism must promote a system of transparency and timely disclosure of information regarding performance, financial health, ownership statistics and governance system of the organization. The corporate governance mechanism must ensure independence of the Board and its accountability to the company and stakeholders. 1. Good governance encompasses all aspects—economic, political, administrative, social and the judicial environment. 2. The board must create balance of interest of capital providers with other stakeholders. 3. Role of financial, non-financial, human and social capital must be recognized and create an environment for optimum utilization. 4. Promote culture innovation, creativity and entrepreneurship in the organization. 5. Put in place a more dynamic non-partisan Board with executive and non-executive directors of repute and accountability. 6. Strengthen the Board of Directors—maintain independence of nominee Directors. 7. Promote ethical practices of the Board—since they are engines of growth. 8. Concern about people—their role, innovation and efficiency, improvement and to create an environment of self-actualization. 9. Foster creativity—transparency and build trust in the organization.

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Governance Model Though the objectives are same in all the countries as a mechanism to strengthen corporate accountability in order to enhance shareholders wealth, the approach and instruments are quite different. USA—the country with maximum social respect and responsibilities for corporates, has adopted a soft approach towards corporate governance to minimize the conflict between owners and managers by giving financial incentives (stock options). Stock exchanges (through listing conditions) play an important role in imparting transparency and accountability of the corporate managers. Towards instilling transparency in corporate activities, insider trading has been made illegal and disclosure norms are also made an essential part of the corporate governance in USA. Thus, the approach is basically market oriented in USA. Corporate governance in Germany is not as market driven as in USA but is implemented through interaction and consensus of Management Board and Supervisory Board. In Germany, banks play an important role in the market because of their role as holders of company stocks and providers of long-term finance. The banks are run by ‘Supervisory’ and ‘Management’ Boards. While the Supervisory Board is responsible for ‘the company’s accounts, major capital expenditures, strategic acquisition and closures, dividends and most importantly for appointment to the Management Board, the management Board is responsible for running the Company’. The two-tier board structure institutionalizes some checks and balances. However, in Japan the basic approach has been developed on an obligation to the company, country and family which is implemented through cross holding and networking among group companies. Thus the focus on the board is less significant in Japan. Japanese corporates are more concerned about appreciation of the value of yen, promotion of entrepreneurial and innovative talents of its people for the development of society and how best to hold them accountable.

Instruments of Governance Regulatory mechanism sets the basic framework of corporate governance but it is the commitment and involvement of management which can translate the objectives into practice. The practice of corporate governance can be strengthened through guidance of the Board and other committees such as audit committee, investment committee. While the Board and committees should take keen interest in corporate practices and governance, they should also be supported by the management by providing regular information. Board

The Board of a company plays the most crucial role in translating the corporate governance practices into reality by setting goals and guiding corporate strategy, monitoring performance, potential conflicts, providing suggestions to mitigate them and by ensuring effectiveness of governance practices. However, effectiveness of the Board governance also depends on the composition and independence of the Board. In an insurance company a wide range of activities are performed which require close monitoring by the Board, but the Board should

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specially keep a close watch on the following and the management should periodically submit its report to the Board on the following; capital adequacy, solvency margin, developments in capital market, interest rate scenario and sensitivity analysis, investment strategy, regulatory compliance periodic disclosure, etc. Audit Committee

Audit committee has been described as the watch dog of the corporate governance system. ‘The Audit Committee Acts as the bridge between the Board, the Statutory Auditors and Internal Auditors.’ The Audit Committee performs a wide range of functions related to the financial management of the company—overseeing financial reporting, process of disclosure, and accounting policies and practices. In each of the meetings of the Audit Committee the following items should be placed before it. They are financial results of the company, compliance with regulator, review of findings of internal auditors, control system and lapses in system and procedure, risk management policy. Investment Committee

Investment management is the most crucial function of an insurance company, since it deals with long-term liability and invests in uncertain capital market full of various types of risks as mentioned earlier. Therefore, investment management needs to take into account these uncertainties and risks under a well-governed system and practices. Investment committee should guide to frame investment policy, investment strategy, portfolios, risk management strategy, turnover strategy, etc. Investment committee should be supplied the following information—capital market development, interest rate scenario, changes in investment strategy, changes in portfolio, turnover statistics, health of portfolio including Non-Performing Asset (NPA) investment performance and income.

Implementation of Corporate Governance Three important methods to implement corporate governance are (a) code of best practice, (b) Corporate Governance Committees (CGCs) and (c) Corporate Governance Rating (CGR). Code of Best Practices

Under this system codes for the best practices are set up in writing for important entities who implement corporate governance. ‘Board of Directors’ should retain full and effective control over the company, monitor performance of executive management, clearly accept division of responsibility, balance of power, include non-executive Directors with calibre and all Directors should have access to advice, service and information. Regarding the ‘non-executive Directors’—the majority should be independent of management from any type of business relation, fees should commensurate with duties and performance, they must make independent judgements on strategy, performance, keep appointments and standard of conduct. They should be appointed for a specific period. For the ‘executive

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Directors’ the service contract should be for a specified period, full and clear disclosure of assets, emoluments—pay should be subject to the recommendation of the Remuneration Committee. ‘reporting control Board should make a balanced unbiased assessment of performance, ensure objectives and professional relationship, establish audit committee of non-executive Directors, explain their responsibility and authority and report their business in an ongoing manner. Corporate Governance Committee (CGC)

The purpose of CGC is to develop criteria and recommend to the CEO and other top officials, advise the Board for its composition, procedures and committees, identify and recommend to the Board appropriate candidates who could be nominees for Director in AGMs. CGC is elected annually by majority votes—normally two independent members are appointed and replaced by the Board. There can be a sub-committee to delegate authority. The authority and responsibility of CGC includes the organization, governance system and recommends various committees, composition and function, determination of desired qualification, expertise and character for potential directors, overseeing the performance of the Board, conduct surveys and make suggestions. The committee also evaluates individual member’s performance, submits regular written report to the Board and annually reviews its own performance. The CGC meetings are held at least once a year. It also maintains written minutes. Corporate Governance Ratings (CGRs)

The third important approach to corporate governance is to monitor the company through an external independent monitoring system. The overall perspective is that the shareholders and primary users are institutional investors. Monitoring corporate governance in companies by independent agency, reduce monitoring cost for institutional investors. Rating is done through various models such as agency model, quantitative CGR screening and management dialogue.

Corporate Governance Initiatives in India In India, the concept of corporate governance is a subject recently debated over, though few corporates have been practicing it for some time now. Corporate governance initiatives in India began in 1998 with the publication of Desirable Code of Corporate Governance—a voluntary code introduced by CII which came into prominence thereafter with the Kumar Mangalam Committee report. Kumar Mangalam Committee: The Securities and Exchange Board of India (SEBI constituted a committee under the Chairmanship of Kumar Mangalam Birla to suggest changes in listing agreement to promote corporate governance on 7 May 1999. This committee submitted its report and the same was accepted on 25 January 2000. On the basis of this report, SEBI issued a circular introducing Clause 49 on 21 February 2000.

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Naresh Chandra Committee: In August 2002, the Department of Company Affairs under the ministry of Finance and Company Affairs appointed a high level committee under the Chairmanship of Naresh Chandra, Former Cabinet Secretary of India, ‘to examine the auditor– company relationship, role of independent directors, disciplinary mechanism over auditors in the light of irregulatories committed by companies in India and abroad’. Narayana Murthy Committee: In the light of the recommendations of the earlier committees and experience gathered by analyzing the disclosures made by the companies, SEBI wanted to strengthen the system further and appointed a committee under the Chairmanship of Shri Narayana Murthy with terms of reference. To review the performance of corporate governance and to determine the role of companies in responding to rumours and other price sensitive information circulating in the market, in order to enhance the transparency and integrity of the market. The Committee submitted its final report in December 2003.The SEBI Board approved the recommendations and subsequently issued Clause 49. Kumar Mangalam Committee Report was the first step towards introducing a structured corporate governance approach in India. After adoption of the report by SEBI in January 2005 the SEBI issued a circular introducing Clause 49. The committee has basically followed the market-oriented US approach. The Kumar Mangalam Birla Committee on Corporate Governance focussed on financial reporting and disclosures, implementation of corporate governance requirements, compliance with the Code and SEBI’s experience and rationale for a review of the Code. Regarding the Board of Directors, the committee mentioned that ‘which provides leadership and strategic guidance and exercises control over the company, while remaining at all times accountable to the shareholders. An effective corporate governance system is one, which allows the Board to perform these dual functions efficiently…it is accountable to the shareholders for creating, protecting and enhancing wealth and resources for the company and reporting to them on the performance in a timely and transparent manner’. Thus, Kumar Mangalam Committee has dealt with the composition of the Board (with executive and non-executive directors), independent directors and their independence, the role of nominee Directors, the role of Chairman, etc. The watchdog in the entire system of corporate governance is the audit committee. The audit committee acts as the bridge between the board, the statutory auditors and internal auditors. A wide range of functions have been prescribed for the audit committee—overseeing the company’s financial reporting process and disclosure of its financial information; review of annual financial statements; accounting policies and practices; compliance with stock exchange reviewing the internal control system; reviewing the adequacy of internal audit functions; looking into the reasons for substantial defaults in the payments to the depositors, debentures and shareholders; reviewing the company’s financial and risk management policies, etc. Among others Naresh Chandra Committee Report Disclosure of Contingent Liabilities, definition of Independent Director, etc., many of the suggestions were included in the Narayana Murthy Committee Recommendations.)

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According to Narayana Murthy Committee, the term ‘corporate governance’ is susceptible to both broad and narrow definitions. In fact, many of the codes do not even attempt to articulate what is encompassed by the term. The motives for several corporate governance postulates engaged in these definitions vary, depending on the participant concerned. Accordingly, the focal subjects also vary. The important point is that corporate governance is a concept, rather than an individual instrument. It includes debates on the appropriate management and control structures of a company. Further, it includes rules relating to the power relations between owners; the Board of Directors; management and last but not the least stakeholders such as employees, suppliers, customers and the public at large. Narayana Murthy Committee focussed on the following—review of information by audit committees, disclosure of accounting treatment in audit reports and audit qualifications basis for related party transactions, Board disclosures with respect to risk management, use of proceeds from Initial Public Offerings (IPOs), written code for executive management limits on compensation paid to independent Directors, non-executive Director compensation, definition of independent Directors, internal policy on access audit committees, real time disclosures of critical business events and mechanism for evaluating non-executive board members performance. Here we may refer to some of the mandatory and non-mandatory recommendations of the Narayana Murthy Committee.

Corporate Governance Guidelines of SEBI SEBI had constituted a Committee on Corporate Governance under the Chairmanship of Shri Kumar Mangalam Birla, member, SEBI Board; to promote and raise the standard of corporate governance with respect to listed companies. The SEBI Board in its meeting held on 25 January 2000 considered the recommendation of the committee and decided to make the amendments to the listing agreement in pursuance of the decision of the Board. SEBI issued its guidelines on 8 February 2003. Accordingly, it is advised that a new clause, namely, clause 49, be incorporated in the listing agreement as under. Board of Directors

The company agrees that the Board of Directors of the company shall have an optimum combination of executive and non-executive Directors with not less than 50 per cent of the Board of Directors comprising of non-executive Directors. The number of independent Directors would depend whether the Chairman is executive or non-executive. In case of a non-executive Chairman, at least one-third of the Board should comprise of independent Directors and in case of an Executive Chairman, at least half of the board should comprise of independent Directors. Explanation: For the purpose of this clause the expression ‘independent Directors’ means Directors who apart from receiving Director’s remuneration, do not have any other material

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pecuniary relationship or transactions with the company, its promoters, its management or its subsidiaries, which in judgement of the board may affect independence of judgement of the Director. The company agrees that all pecuniary relationship or transactions of the non-executive Directors vis-à-vis the company should be disclosed in the Annual Report. Audit Committee

1. The company agrees that a qualified and independent audit committee shall be set up and that: (a) The audit committee shall have minimum three members, all being non-executive Directors, with the majority of them being independent, and with at least one Director having financial and accounting knowledge. (b) The Chairman of the committee shall be an independent Director. (c) The Chairman shall be present at Annual General Meeting (AGM) to answer shareholder queries. (d) The audit committee should invite such of the executives, as it considers appropriate (and particularly the head of the finance function) to be present at the meetings of the committee, but on occasions it may also meet without the presence of any executives of the company. The Finance Director, head of internal audit and when required a representative of the external auditor shall be present as invitees for the meetings of the audit committee. (e) The Company Secretary shall act as the secretary to the committee. 2. The audit committee shall meet at least thrice a year. One meeting shall be held before finalization of annual accounts and one every six months. The quorum shall be either two members or one-third of the members of the audit committee, whichever is higher and minimum of two independent Directors. 3. The audit committee shall have powers which should include the following: (a) (b) (c) (d)

To investigate any activity within its terms of reference. To seek information from any employee. To obtain outside legal or other professional advice. To secure attendance of outsiders with relevant expertise, if it considers necessary.

4. The company agrees that the role of the audit committee shall include the following: (a) Oversight of the company’s financial reporting process and the disclosure of its financial information to ensure that the financial statement is correct, sufficient and credible. (b) Recommending the appointment and removal of external auditor, fixation of audit fee and also approval of payment for any other services.

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(c) Reviewing with management the annual financial statements before submission to the board, focussing on: Any changes in accounting policies and practices. Major accounting entries based on exercise of judgement by management. Qualifications in draft audit report. Significant adjustments arising out of audit. The going concern assumption. Compliance with accounting standards. Compliance with stock exchange and legal requirements concerning financial statements Any related party transactions, that is, transactions of the company of material nature, with promoters or the management, their subsidiaries or relatives, etc., that may have potential conflict with the interests of the company at large. (d) Reviewing with the management, external and internal auditors, the adequacy of internal control systems. (e) Reviewing the adequacy of internal audit function, including the structure of the internal audit department, staffing and seniority of the official heading the department, reporting structure coverage and frequency of internal audit. (f) Discussion with internal auditors any significant findings and follow-up there on. (g) Reviewing the findings of any internal investigations by internal auditors into matters where there is a suspected fraud or irregularity or a failure of internal control systems of a material nature and reporting the matter to the board. (h) Discussion with external auditors before the audit commences, the nature and scope of the audit as well as have post-audit discussion to ascertain any area of concern. (i) Reviewing the company’s financial and risk management policies. (j) To look into the reasons for substantial defaults in the payment to the depositors, debenture holders, shareholders (in case of non-payment of declared dividends) and creditors. 5. If the company has set up an audit committee pursuant to provision of the Companies Act, the company agrees that the said audit committee shall have such additional functions features as is contained in the Listing Agreement. Remuneration of Directors

The company agrees that the remuneration of non-executive Directors shall be decided by the Board of Directors. The company further agrees that the following disclosures on the remuneration of Directors shall be made in the section on the corporate governance of the annual report. All elements of remuneration package of all the Directors, that is, salary, benefits, bonuses, stock options, pension, etc. Details of fixed component and performance-linked incentives,

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along with the performance criteria, service contracts, notice period, severance fees, stock option details, if any and whether issued at a discount as well as the period over which accrued and over which exercisable. Board Procedure

The company agrees that the board meeting shall be held at least four times a year, with a maximum time gap of four months between any two meetings. The company further agrees that a Director shall not be a member in more than 10 committees or act as Chairman of more than five committees across all companies in which he is a Director. Furthermore, it should be a mandatory annual requirement for every Director to inform the company about the committee positions he occupies in other companies and notify changes as and when they take place. Management

The company agrees that as part of the Director’s report or as an addition there to, a management discussion and analysis report should form part of the annual report to the shareholders. This management discussion and analysis report should include discussion on the following matters within the limits set by the company’s competitive position: 1. 2. 3. 4. 5. 6. 7. 8.

Industry structure and developments. Opportunities and threats. Segment-wise or product-wise performance. Outlook. Risks and concerns. Internal control systems and their adequacy. Discussion on financial performance with respect to operational performance. Material developments in human resources/industrial relations front, including number of people employed.

Disclosures must be made by the management to the board relating to all material, financial and commercial transactions, where they have personal interest, that may have a potential conflict with the interest of the company at large (for example, dealing in company shares, commercial dealings with bodies which have shareholding of management and their relatives, etc.) Shareholders

The company agrees that in case of the appointment of a new Director or re-appointment of a Director the shareholders must be provided with the following information: 1. A brief resume of the Director. 2. Nature of his expertise in specific functional areas. 3. Names of companies in which the person also holds the directorship and the membership of committees of the Board.

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The company further agrees that information such as quarterly results, presentation made by companies to analysts shall be put on the company’s website, or shall be sent in such a form so as to enable the stock exchange on which the company is listed to put it on its own website. The company further agrees that a board committee under the Chairmanship of a nonexecutive Director shall be formed to specifically look into the redressing of shareholders and investors complaints such as transfer of shares, non-receipt of balance sheet, non-receipt of declared dividends, etc. This Committee shall be designated as ‘Shareholders/Investors Grievance Committee’. The company further agrees that to expedite the process of share transfers the board of the company shall delegate the power of share transfer to an officer or a committee or to the registrar and share transfer agents. The delegated authority shall attend to share transfer formalities at least once in a fortnight. Report on Corporate Governance

The company agrees that there shall be a separate section on corporate governance in the annual reports of the company, with a detailed compliance report on corporate governance. Noncompliance of any mandatory requirement, that is, which is a part of the listing agreement with reasons there of and the extent to which the non-mandatory requirements have been adopted should be specifically highlighted. Compliance

The company agrees that it shall obtain a certificate from the auditors of the company regarding compliance of conditions of corporate governance as stipulated in this clause and annexe the certificate with the Directors’ report, which is sent annually to all the shareholders of the company. The same certificate shall also be sent to the stock exchanges along with the annual returns filed by the company.

Corporate Governance and Life Insurance Companies Insurance companies mobilize funds from the policyholders and invest the same for a long-term horizon which is full of several kinds of risks. Therefore, the basic objective of the management of an insurance company is to ensure safety, security and growth of policyholders fund and the primary objective of corporate governance in an insurance company is to protect the policyholders against insolvency by efficient management of financial, accounting and technical functions. However, financial management in an insurance company is a bit different from other non-insurance financial companies because of a wide range of contract tenures reflected in a complex system of liability. Therefore, policyholders’ protection by providing enough solvency margin confronting the various types of operational risks particularly in the area of finance and investment is the major concern for risk management. A detailed account of such risks has been given in the Chapter 5.

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The major risks which need to be addressed through corporate governance by a life insurance company are basically of two types, namely technical/insurance risk and investment risks, which need to be addressed by an insurance company.

Technical Risk Risk of miscalculating premiums and miscalculating technical provisions and growth risk arising out of excessive growth not matched by sufficient resources or due to wrong selection or wrong pricing of products.

Investment Risk Investment risk is considered to be an important factor contributing to the insolvency of an insurance company. The major sources to investment risk are: depreciation risk—arising out of depreciation value of investment, liquidity risk—arising out of inability of timely encashment of investment, matching risk—arising out of insufficient cover of liability, derivative risk—arising out of off-balance sheet operation, thin market, wrong pricing and credit risk—arising out of reinsurance.

Managing Financial Risks Financial risks in an insurance company can be minimized through well-designed corporate governance practices supported by regulatory and voluntary initiatives, promoting sound financial management practices. The major initiatives are: quantitative restrictions—quantitative limits of investments in various instruments and locations. Prudent person rules—includes investment by persons with good management quality integrity—under well-settled internal control and corporate governance mechanism. Portfolio diversification and locational dispersal of investment. Provisioning for probable investment risk. Accurate valuation and asset accounting—bringing to light the real value of assets, potential loss of value and actual liability of the insurance company. However, governance of investment strategy can also play an important role in efficiency improvement and risk minimization.

Active Investment Strategy Stock selection and market timing irrespective of trading costs form the basis of this strategy. The fund managers aim at beating the market by taking the advantages of market movement. Very often, there is over-diversification which adds disproportionate costs to the fund thereon causing strain on the performance of the funds. Active investing requires reasonable knowledge in market forecasting, macro economic and interest rate forecasting, etc. Very often, fund managers are incapable of that and they maybe unable to get out of the market at an appropriate

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time and land up in trouble with illiquid stocks, depreciation in asset value and fall in NAV. Good governance of active investment strategy are called for.

Strategy of Indexation Indexation is a passive investment strategy aimed at market return by investing in stocks under a particular index. Indexation strategy is cheaper and less technical and selection is comparatively easy. But the initial selection of stocks must be done easily to avoid chronic under performing stocks and stocks with inflated premium. Future potential for growth liquidity must be taken into account. It is often thought that long-term investment goal can be achieved through indexing and the fund managers remain totally passive about the internal dynamics of the stocks. Corporate governance plays an important role to keep the fund manager awake in order to protect the interest of investors.

Strategy of Value Investing Value investing is a painstaking strategy to discover future values of the stocks by analyzing companies. In-depth analysis of companies are undertaken to discover long-term business value and the value of management. Therefore, a close tie is established between the company and fund managers which enables the fund managers to keep themselves informed about the development in the long-term perspective. Value investing thus developed on the relationship. This relationship enables the fund managers to aim at medium to long-term investment growth instead of short-term speculative gain. Regarding risk management, Narayana Murthy Committee states: Procedures should be in place to inform Board members about the risk assessment and minimization procedures. These procedures should be periodically reviewed to ensure that executive management controls risk through means of a properly defined framework. Management should place a report before the entire Board of Directors every quarter documenting the business risks faced by the company, measures to address and minimize such risks, and any limitations to the risk-taking capacity of the corporation. This document should be formally approved by the Board.(Report of the Committee on Corporate Governance, SEBI, Mumbai, 8 February, p.15)

Corporate Governance and Nominee Directors Another area of importance of corporate governance for financial institutions like life insurance companies is the role of nominee Directors. Insurance companies have of late emerged as dominating institutional investors throughout the world. Insurance companies like LIC is one of the largest investors in the Indian corporate and by virtue of its size of investment its Directors are nominated on the Board of many companies. Basically there is no distinction between the

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roles of executive and nominee directors. The nominee Directors should protect the interest of shareholders whom they represent. Indirectly they represent the interest of the policyholders whose money they manage. The nominee Directors are generally freed from accountability of failure for certain acts such as (pollution) control, cheque bouncing, etc. They should basically be active in the Board, they chair the meeting and dominate committees such as Audit Committee, Remuneration Committee and Consumer Affairs committee. They are expected to be actively involved in areas of strategy, evaluating performance of CEOs and other senior officials. The nominee Directors are to ensure that the Board functions in a better manner and ensures that the business is well managed. They are to also watch the ethical management of business and its commitment to growth and social obligations. They must make independent judgement on strategy and performance, keep appointments and standard of conduct.

Prudent Person Rules Efficient management of insurance companies significantly influenced by accounting and actuarial functions calls for efficiency in management of funds, accounting and valuation of assets and pricing of products, provisioning for liabilities, etc., as per the quantitative and qualitative guidelines fixed by the regulators. However, quantitative regulations have a limit to monitor the operations and potential solvency. Therefore, quantitative regulations need to be supplemented by the prudent person rules and internal ethical standard and governance system set up by the insurers. Together these will contribute to the operational transparency and disclosures. However, the insurer, in line with the Regulator, must set up the norms for operational transparency and standard of disclosure, which would enhance the involvement of stakeholders in the organization. Operational transparency disclosure and stakeholders involvement will significantly enhance the value of corporate governance, which in turn will provide protection to policyholders. Therefore, it can be said that efficient financial governance is the basis of sound corporate governance. But regulation alone cannot promote sound corporate governance unless prudent persons rule and strong desire of the management is exhibited in the management practices.

Corporate Social Responsibility (CSR) and Life Insurance The role of corporates in a globalized market economy needs to be redefined, because corporates are gradually occupying a greater space in socio-economic life like never before. The role of the State as a prime supplier of social goods and protector of economic interest of its citizens has diminished significantly with the increased corporate dominance in economy. Therefore, in the new economy corporates are placed with added responsibility to provide social goods and to serve the social purpose of existence of any economic entity. Since, a private corporate is not merely a private entity, it is the society and citizens who contribute and play an important role in setting up and in the growth of a company by providing a large amount of capital as share capital and a market for the products to grow. The company

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in turn needs to keep in view the contribution of the society and is required to return a part of the gains derived by it in order to discharge its social responsibilities. In modern business, corporate, actions have a very wide influence on the society. Corporate policies and actions particularly, have significant economical and ethical impact on its stakeholders—customers, suppliers, analysts, etc. The influence of corporate policies and actions have been extended further and become stronger since the globalization and internationalization of business and expansion of activities of multinational business organizations. Cross-country and cross-culture operation has also necessitated socially restrained and ethically conducted business practices. In view of the changing role and extended corporate activities, CSRs has, of late, emerged as an important issue of consideration and concern. Though CSR is concept specific to social responsibility of corporate business, it is often used as interchangeable with business ethics or corporate governance.

Definition of CSR CSR has a wider connotation and often varies in specifics depending on the operational nature of a company, yet a generalized definition can be thought about CSR in the overall context of socio-economic responsibilities. Since CSR is an international concern, a large number of organizations have created the formats of CSR and defined it accordingly. However, we may indicate few of them to have a better understanding of CSR and how to institutionalize them.

CSR in Green Paper Commission of the European Communities issued a ‘Green Paper’ on 18 July 2001, considered to be one of the most compact policy paper towards promoting CSR, though the paper aimed at ‘Promoting a European framework for Corporate Social Responsibility…as a response to a variety of social, environmental and economic pressures…and aim to send a signal to the various stakeholders with whom they interact employees, shareholders, investors, public authority and NGOs’. The Green Paper further states that ‘Corporate social responsibility is essentially a concept whereby companies decide voluntarily to contribute to a better society and a cleaner environment. This responsibility is expressed towards employees and more generally towards stakeholders effected by business and which in turn can influence its success’.

CSR in BSR According to the Business for Social Responsibility (BSR), CSR is achieving commercial success in ways that honour ethical values and respect people, communities and the natural environment. BSR definition of CSR also focuses on addressing the legal, ethical, commercial and other expectations. This definition of CSR has a wider connotation which integrates business policies with business operations having corporate responsibilities for present and future impact of business decisions.

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Dimension of CSR Corporate Social Responsibility is a multi-dimensional concept which exerts direct and indirect effect on corporate performance. CSR directly influences the performance by promoting better working environment; more committed and involved employees which leads to improved efficiency and productivity of employees. Indirect effect stems from better consumer’s perception leading to expansion of product-market and consumers choice. CSR has further been distinguished as external CSR and internal CSR on the basis of desired CSR approach and initiatives. Green Paper has mentioned about the following. 1. CSR: External dimension 2. CSR: Internal dimension CSR: External Dimension

Corporate Social Responsibility is a concept which goes beyond the operational boundary of the company. External dimension of CSR covers all the stakeholders of the company. Corporate activities are spread over a wider geographic and economic zone, which maybe distinct in potential and opportunities but every corporate has its wider macro-level vision and goal. However, even within a wider macro goal; localized aspirations can be included in its own CSR. Local needs with respect to economic well-being, desire for products and services, health and education can be served directly and indirectly through support to local voluntary agencies or NGOs. Participation in localized community will not only enable the companies to discharge its social responsibility but also expand its product-market base. These can be achieved through support to environmental protection, local employment, education and health care activities. External CSR also includes human rights. Human rights are a very complex issue presenting political, legal and moral dilemmas. However, very often companies are in a fix to separate human rights dimension from government rules and norms. Therefore, many authors have suggested to design codes of conduct for the company, for example, Green Paper has suggested that ‘Codes of Conduct therefore be based on the ILO fundamental conventions as identified in 1998 ILO Declaration on Fundamental Principles and Rights at word and OECD guidelines for multinational enterprises, involving the social partners and those in developing countries covered by them’. The principles of International Labour Organization (ILO), though basically are meant for multinational organizations, however they can be adopted by any local organization by adjusting to local conditions—low regulations and local aspirations. What is fundamental is to respect the fundamentals of basic human rights through corporate initiatives and social policy. External CSR is also relevant to socio-economic development having bearing protection of physical environment. While this is directly related to the product process of manufacturing industry, service industry like life insurance can support protection of physical environment through its socially directed environmental initiatives.

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CSR: Internal Dimension

The internal dimension of CSR is equally important and in fact is the core of the CSR, because it strengthens the external initiatives of CSR. Internal CSR initiatives focus on human resources as its appropriate utilization, safety, health and welfare measures for the employees. Internal initiatives also look into management of change, protection of natural resources and environment, and participation in social development programmes. Human resource related CSR initiatives are quite critical and comprehensive. Critical because human resources are the most important assets of any organization particularly for life insurance which manufactures and sells intangible products and depends heavily on the post-sales service to customers. In fact it is even more important than financial assets, because they are managed by people. Optimization of human resources through training, skill development and by creating required space for selfactualization is considered to be an important responsibility for management. Recruitment and retention are equally important which should be done in a non-partisan manner. According to the Green Paper quoted earlier, ‘Responsible recruitment practices, involving in particular non-discriminatory practices, could facilitate the recruitment of people from ethnic minority, older workers, women and long-term unemployed and people at disadvantage’. Health and safety are also important priority areas of CSR. Appropriate measures in this area are to be taken by a corporate. However, not only the medical facilities but also the arrangement for rest and recreation are essential for improved and better health for an employee. Protection of environment is another important component of CSR and necessary initiatives need to be taken to protect environment and natural resources. Since environment provides the necessary resources, it is an essential duty of a company of any kind to save from degeneration and pollution. Though the companies involved in manufacturing are directly benefited by natural resources, servicing companies like life insurance are also benefited by the contribution of natural resources and environment and thereby need to be concerned about management and investing to protect environment and natural resources. Finally, another crucial component of internal CSR is the policy and programme relating to internalizing external changes. This is because, a company is an economic entity and economic environment is a dynamic phenomenon. Recent world economy and global markets are undergoing unprecedented changes in terms of global movement of goods and services, innovation and transfer of knowledge and skills. Management practices, customers’ expectation and speed of services, etc., are continuously changing. Internal CSR needs to capture these changes and adapt to internalize, otherwise the mismatch between external changes and internal stationary situation will act as a stumbling block to growth and survival. Therefore, change management is a critical consideration for successful implementation of internal CSR. There are a large number of internal issues. However, we have outlined a few components of internal CSR framework, which are very essential and can be implemented by any company along with policy of ethical business practices and corporate governance.

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CSR Standard CSR has emerged as a global movement and a large number of organizations have designed Corporate Social Responsibility Standard (CSRS). These standards help the organization to implement CSR and act as a CSR performance benchmark. We may quote for such standards here to improve our understanding of Global CSR. Inter faith Center on Corporate Responsibility (ICCR) Principles for Global Corporate Responsibility: ICCR has issued a guideline entitled ‘Principles for Global Corporate Responsibility’ which is a collective distillation of the issues of concern for religion-oriented institution investors. These principles cover whole gamut of CSR such as business ethics, human rights community, environment, stakeholders and workplace.

CSR in Insurance Company—AVIVA Example Application of CSR, irrespective of the nature of company has been widely accepted across the industry and across the country. Insurance companies in UK, USA and other developed countries have been implementing CSR in their company. One such example is the CSR Policy and its implementation of AVIVA Life Insurance Company which is quoted frequently for the quality of CSR. The CSR Policy of AVIVA approved its Board in January 2002, states ‘Aviva as a member of the international business community recognizes its Corporate Social Responsibility commitment in its various roles, which includes insurer, investor, employer and consumer.’ THE CSR Policy focussed on Aviva’s commitment to environment, community, workforce, human rights, health safety suppliers customers and standard of business conduct. Regarding implementation of CSR Policy, it states that designing a policy statement may not be difficult but real problem arises relating to the degree of commitment and desire to implement the policy. The question of ownership is very critical. Management commitment must be beyond doubt and all the stakeholders including employees should feel the pulse of commitment of management, which will inspire them to come forward to make CSR a reality. The most crucial aspect of any CSR Policy is the ownership and implementation. For effective implementation of CSR, it should be owned by the top management. While implementation accountability indirectly lies with them, managers must be directly accountable to implement CSR as approved by the Board of the Company. There should be a timeframe, strategy and review mechanism for implementation.

CSR Activities of LIC of India Life Insurance Corporation of India, the largest life insurance company of India, is also concerned about its corporate social responsibilities and focussing on rural development, health, education, etc. As a responsible corporate citizen, LIC of India is fulfilling its social obligations

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through investment in economic development and involvement in various socially oriented projects initiated by the Government of India. To be more actively involved in CSR activities, LIC has established Golden Jubilee Foundation on 20 October, 2006. The main objectives of the Foundation are: relief of poverty or distress, advancement of education, medical relief, and advancement of any other object of general public utility. The Foundation has already supported many Non-Governmental Organizations (NGOs) who are working in remote areas of the country, provided many infrastructure supported educational institutions, public health programme and offered educational scholarships to poor students. CSR is the nascent stage in Indian insurance industry. There is a need for improving the understanding of future social and commercial gains out of a robust CSR system in Life Insurance industry. A well-defined CSR format for Indian life insurance companies will bring much needed clarity. Insurance Council of India can play an important role by developing and ensuring its implementation.

Role of Self Regulatory Organisation (SRO) Importance of SRO A new market structure of life insurance industry with a large number of customers, a few life insurance companies and an evolving regulatory environment has been emerging in India. This is an unknown phenomenon in the Indian life insurance market, since pre-nationalized life insurance market was virtually non-competitive and scantily regulated while post-nationalized market was characterized by state controlled monopoly. It is in the post-liberalization period that Indian market is truly competitive and regulated by a well-designed regulatory mechanism by the IRDA. In a market economy there is always pressure for less regulations or minimum regulations and greater operational freedom for the industry. However, financial services industry, like life insurance, which plays a very critical role in the national economy and influences millions of savers of all kinds needs to be regulated to the desired extent to protect the interest of policyholders as well to promote a healthy environment for the industry to grow with ethical business practices, sound governance and with CSR. Though in the post-liberalized insurance era, IRDA has come out with a large number of regulations to promote a healthy life insurance market, a lot more is required to be done particularly in the area of governance. Moreover, regulation is a costly affair and over-regulation may impede the speed of growth. Therefore, regulators everywhere move cautiously to create a balance between necessary and desirable regulation. Hence, it is difficult to introduce an optimum regulation because the scale of operation and the nature of market environment are continuously changing. There always remains a gap between the measures of statutory regulation and required optimum regulation for efficient market. However, this gap can be minimized through voluntary initiatives of SRO formed by the operating companies. A healthy SRO system not only minimizes the cost of regulation but also creates an opportunity for less

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regulation with greater operational freedom and choice. This also reduces the state intervention through legislative measures in corporate function. Recent trends in financial services industry such as mutual funds and asset management industry shows that there is a growing focus on regulation through industry level SROs. In life insurance also the growing emphasis is to support the regulator by SROs in efficient management of the industry. Indian Regulator, that is, IRDA has taken timely initiative to promote SRO culture through its notification in February 2001, by establishing the Insurance Association of India, under Section 64A of the Insurance Act 1938. In addition to the Insurance Association, an independent Life Insurance Council has also been set up under Section 64C of Insurance Act 1938. Life Insurance Council consists of all the members of Insurance Association. The Life Insurance Council is expected to perform the role of a SRO. The Council shall be responsible to aid, advise and assist insurers for setting up standard of conduct and sound practices to render efficient service to the policyholders. Life insurance council has already taken many important initiatives in the interest of policyholders such as Policyholders Protection Fund issues in market conduct of the insurers and intermediaries. The Life Council has also issued a circular indicating standard and practices for sales illustration in brochures. Initiatives have also been taken to establish a mortality and morbidity bureau. These efforts are a welcome step in the interest of investors. However, there is scope for much more active initiatives in a number of areas.

Experience of Japan In this context we may refer to the various activities carried out by Life Insurance Association of Japan (LIAJ) which started on 7 December 1908 as an incorporated body with the objective to ‘Strive for sound development of the life insurance industry and the maintenance of its reliability’ (LIAJ 2005). The major functions of LIAJ—to undertake research studies in life insurance, maintain public relations relating to life insurance, promoting friendly relations among life insurers and other functions necessary to attain the purpose of the association. As of 1 October 2005, 38 life insurance companies were members of LIAJ. The main activities of the association are: 1. Representing the opinions of life insurance industry through mediation of opinion among the life insurance industry members. 2. Conducting surveys, research and taking statistics: Conduct surveys of domestic and overseas life insurance industry and collect materials, statistics, etc. 3. Educational activities: Conducts education and examination for agents, office personnel, etc. 4. Operate life insurance network centre: Established in May 1986 to expand computer network and to improve policy servicing. 5. Social service: Conduct various types of social service.

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6. Public relation: Provide information to public for informed decisions. 7. Consulting agents: The association functions as consulting agents to deal with enquiry and complaints. 8. Measures against moral hazards: To promote sound operation of life insurance. 9. Others: Among others maintain a library of 25,000 books. Various activities that are being undertaken by LIAJ, not only aim at supporting the cause of industry but also protect the interest of customers through education, training, research and other activities such as dissemination of information, maintenance of computer network. Life Insurance Council of India may follow such an objective-oriented functional approach. Indian life insurance market and regulatory structure, both are in the stage of evolution and Life Council is also a young organization. Regulator and Life Council can move and grow hand in hand and reduce regulatory burden of Regulator. Life Council, in association with IRDA can take initiative to: 1. 2. 3. 4.

Introduce business ethics for life insurance selling and management. Design and introduce corporate governance for life insurance industry. Design and introduce a framework for CSR for life insurance companies. Design and implement a programme for financial literacy and particularly for life insurance literacy. 5. Design and introduce along with Insurance Institute of India—a certification programme for managers of life insurance industry on the life banking exams for bank employees. 6. Initiate in association with LIC Management Development Centre or with reputed university research programmes on life insurance. No industry body can emerge as an effective SRO unless it functions with a futuristic management perspective keeping in view the interest of stakeholders and industry as a whole. Indian life insurance industry in the context of dynamic macro economy maybe very vibrant with potential of significant market expansion and Life Council should take the lead along with IRDA to promote a governance system as the engine of growth.

Annexure 6.A.1 Code of Conduct for Agents According to Insurance Regulatory and Development Authority (Licensing of Insurance Agents) Regulations, 2000, Every person holding a licence, shall adhere to the code of conduct specified below: (1) Every insurance agent shall: (a) Identify himself and the insurance company of whom he is an insurance agent;

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(b) disclose his licence to the prospect on demand; (c) disseminate the requisite information with respect to insurance products offered for sale by his insurer and take into account the needs of the prospect while recommending a specific insurance plan; (d) disclose the scales of commission with respect to the insurance product offered for sale, if asked by the prospect; (e) indicate the premium to be charged by the insurer for the insurance product offered for sale; (f) explain to the prospect the nature of information required in the proposal form by the insurer, and also the importance of disclosure of material information in the purchase of an insurance contract; (g) bring to the notice of the insurer any adverse habits or income inconsistency of the prospect, in the form of a report (called ‘Insurance Agent’s Confidential Report’) along with every proposal submitted to the insurer, and any material fact that may adversely affect the underwriting decision of the insurer as regards acceptance of the proposal, by making all reasonable enquiries about the prospect; (h) inform promptly the prospect about the acceptance or rejection of the proposal by the insurer; (i) obtain the requisite documents at the time of filing the proposal form with the insurer and other documents subsequently asked for by the insurer for completion of the proposal; (j) render necessary assistance to the policyholders or claimants or beneficiaries in complying with the requirements for settlement of claims by the insurer; (k) advise every individual policyholder to effect nomination or assignment or change of address or exercise of options, as the case maybe, and offer necessary assistance in this behalf, wherever necessary. (2) No insurance agent shall: (a) Solicit or procure insurance business without holding a valid licence; (b) induce the prospect to omit any material information in the proposal form; (c) induce the prospect to submit wrong information in the proposal form or documents submitted to the insurer for acceptance of the proposal; (d) behave in a discourteous manner with the prospect; (e) interfere with any proposal introduced by any other insurance agent; (f) offer different rates, advantages, terms and conditions other than those offered by his insurer; (g) demand or receive a share of proceeds from the beneficiary under an insurance contract; (h) force a policyholder to terminate the existing policy and to effect a new proposal from him within three years from the date of such termination; (i) have, in case of a corporate agent, a portfolio of insurance business under which the premium is in excess of 50 per cent of total premium procured, in any year, from one person (who is not an individual) or one organization or one group of organizations;

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(j)

apply for fresh licence to act as an insurance agent, if his licence was earlier cancelled by the designated person, and a period of five years has not elapsed from the date of such cancellation; (k) become or remain a Director of any insurance company. (3) Every insurance agent shall, with a view to conserve the insurance business already procured through him, make every attempt to ensure remittance of the premiums by the policyholders within the stipulated time, by giving notice to the policyholder orally and in writing.

Code of Conduct for Corporate Agents Insurance Regulatory and Development Authority (Licensing of Insurance Agents) Regulations, 2000 (1) Every licenced corporate agent shall abide by the code of conduct specified below: Every corporate agent shall (a) Be responsible for all acts of omission and commission of its corporate insurance executive and every specified person. (b) Ensure that the corporate insurance executive and all specified persons are properly trained, skilled and knowledgeable in the insurance products market. (c) Ensure that the corporate insurance executive and the specified person do not make to the prospect any misrepresentation on policy benefits and returns available under the policy. (d) Ensure that no prospect is forced to buy an insurance product. (e) Give adequate pre-sales and post-sales advice to the insured with respect to the insurance product. (f) Extend all possible help and cooperation to an insured in completion of all formalities and documentation in the event of a claim. (g) Give due publicity to the fact that the corporate agent does not underwrite the risk or act as an insurer. (h) Enter into service level agreements with the insurer in which the duties and responsibilities of both are defined. (2) Every corporate agent or a corporate insurance executive or a specified person shall also follow the code of conduct specified below: (a) Every corporate agent/corporate insurance executive/specified person shall (i) Identify himself and the insurance company of whom he is a representative. (ii) Disclose his licence/certificate to the prospect on demand. (iii) Disseminate the requisite information with respect to insurance products offered for sale by his insurer and take into account the needs of the prospect while recommending a specific insurance plan. (iv) Disclose the scales of commission with respect to the insurance product offered for sale, if asked by the prospect. (v) Indicate the premium to be charged by the insurer for the insurance product offered for sale.

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(vi) Explain to the prospect the nature of information required in the proposal form by the insurer and also the importance of disclosure of material information in the purchase of an insurance contract; (vii) Bring to the notice of the insurer any adverse habits or income inconsistency of the prospect, in the form of a report (called ‘Insurance Agent’s Confidential Report’) along with every proposal submitted to the insurer, and any material fact that may adversely affect the underwriting decision of the insurer as regards acceptance of the proposal, by making all reasonable enquiries about the prospect; (viii)Inform the prospect promptly about the acceptance or rejection of the proposal by the insurer. (ix) Obtain the requisite documents at the time of filing the proposal form with the insurer and other documents subsequently asked for by the insurer for completion of the proposal. (x) Render necessary assistance to the policyholders or claimants or beneficiaries in complying with the requirements for settlement of claims by the insurer. (xi) Advise every individual policyholder to effect nomination or assignment or change of address or exercise of options, as the case maybe and offer necessary assistance in this behalf, wherever necessary. (3) No corporate agent/corporate insurance executive/specified person shall: (a) Solicit or procure insurance business without holding a valid licence/certificate. (b) Induce the prospect to omit any material information in the proposal form. (c) Induce the prospect to submit wrong information in the proposal form or documents submitted to the insurer for acceptance of the proposal. (d) Behave in a discourteous manner with the prospect. (e) Interfere with any proposal introduced by any other specified person or any insurance intermediary. (f) Offer different rates, advantages, terms and conditions other than those offered by his insurer. (g) Demand or receive a share of proceeds from the beneficiary under an insurance contract. (h) Force a policyholder to terminate the existing policy and to effect a new proposal from him within three years from the date of such termination. (i) No corporate agent shall have a portfolio of insurance business from one person or one organization or one group of organizations under which the premium is in excess of 50 per cent of total premium procured in any year. (k) Apply for fresh licence to act as an insurance agent, if his licence was earlier cancelled by the designated person, and a period of five years has not elapsed from the date of such cancellation. (l) Become or remain a Director of any insurance company. (4) Every corporate agent shall, with a view to conserve the insurance business already procured through him, make every attempt to ensure remittance of the premiums by the policyholders within the stipulated time, by giving notice to the policyholder orally and in writing.

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(5) No Director of a company or a partner of a firm or the chief executive or a corporate insurance executive or a specified person shall hold similar position with another corporate agent of any other insurance company.

Code of Conduct for Insurance Brokers According to Insurance Regulatory and Development Authority (Insurance Brokers) Regulations 2002, Insurance Brokers are to observe the following Code of Conduct: (1) Every insurance broker shall follow recognized standards of professional conduct and discharge his functions in the interest of the policyholders. Conduct in matters relating to clients relationship—every insurance broker shall: (a) Conduct dealings with its clients with utmost good faith and integrity at all times. (b) Act with care and diligence. (c) Ensure that the client understands his relationship with the broker and on whose behalf the broker is acting. (d) Treat all information supplied by the prospective clients as completely confidential to themselves and to the insurer(s) to which the business is being offered. (e) Take appropriate steps to maintain the security of confidential documents in their possession. (f) Hold specific authority of client to develop terms. (g) Understand the type of client it is dealing with and the extent of the client’s awareness of risk and insurance. (h) Obtain written mandates from the client to represent the client to the insurer and communicate the grant of a cover to the client after effecting insurance. (i) Obtain written mandate from the client to represent the client to the insurer/reinsurer and confirm cover to the insurer after effecting reinsurance, and submit relevant reinsurance acceptance and placement slips. (j) Avoid conflict of interest. (2) Conduct in matters relating to sales practices—every insurance broker shall: (a) Confirm that it is a member of the Insurance Brokers Association of India or such a body of brokers as approved by the authority which has a memorandum of understanding with the authority. (b) Confirm that he does not employ agents or canvassers to bring in business. (c) Identify himself/herself and explain as soon as possible the degree of choice in the products that are on offer. (d) Ensure that the client understands the type of service it can offer. (e) Ensure that the policy proposed is suitable to the needs of the prospective client. (f) Give advice only on those matters in which it is knowledgeable and seek or recommend other specialists for advice when necessary. (g) Not make inaccurate or unfair criticisms of any insurer or any member of the Insurance Brokers Association of India or member of such body of brokers as approved by the authority.

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(h) Explain why a policy or policies are proposed and provide comparisons in terms of price, cover or service where there is a choice of products. (i) State the period of cover for which the quotation remains valid if the proposed cover is not effected immediately. (j) Explain when and how the premium is payable and how such premium is to be collected, where another party is financing all or part of the premium, full details shall be given to the client including any obligations that the client may owe to that party. (k) Explain the procedures to follow in the event of a loss. (3) Conduct in relation to furnishing of information—every insurance broker shall: (a) Ensure that the consequences of non-disclosure and inaccuracies are pointed out to the prospective client. (b) Avoid influencing the prospective client and make it clear that all the answers or statements given are the latter’s own responsibility. Ask the client to carefully check details of information given in the documents and request the client to make true, fair and complete disclosure where it believes that the client has not done so and in case further disclosure is not forthcoming it should consider declining to act further. (c) Explain to the client the importance of disclosing all subsequent changes that might affect the insurance throughout the duration of the policy. (d) Disclose on behalf of its client all material facts within its knowledge and give a fair presentation of the risk. (4) Conduct in relation to explanation of insurance contract—every insurance broker shall: (a) Provide the list of insurer(s) participating under the insurance contract and advise any subsequent changes thereafter. (b) Explain all the essential provisions of the cover afforded by the policy recommended by him so that, as far as possible, the prospective client understands what is being purchased. (c) Quote terms exactly as provided by insurer. (d) Draw attention to any warranty imposed under the policy, major or unusual restrictions, exclusions under the policy and explain how the contract maybe cancelled. (e) Provide the client with prompt written confirmation that insurance has been effected. If the final policy wording is not included with this confirmation, the same shall be forwarded as soon as possible. (f) Notify changes to the terms and conditions of any insurance contract and give reasonable notice before any changes take effect. (g) Advise its clients of any insurance proposed on their behalf which will be effected with an insurer outside India, where permitted and if appropriate, of the possible risks involved. (5) Conduct in relation to renewal of policies—every insurance broker shall: (a) Ensure that its client is aware of the expiry date of the insurance even if it chooses not to offer further cover to the client. (b) Ensure that renewal notices contain a warning about the duty of disclosure including the necessity to advise changes affecting the policy, which have occurred since the policy inception or the last renewal date.

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(c) Ensure that renewal notices contain a requirement for keeping a record (including copies of letters) of all information supplied to the insurer for the purpose of renewal of the contract. (d) Ensure that the client receives the insurer’s renewal invitation well in time before the expiry date. (6) Conduct in relation to claim by client—every insurance broker shall: (a) Explain to its clients their obligation to notify claims promptly and to disclose all material facts and advise subsequent developments as soon as possible. (b) Request the client to make true, fair and complete disclosure where it believes that the client has not done so. If further disclosure is not forthcoming it shall consider declining to act further for the client. (c) Give prompt advice to the client of any requirements concerning the claim. (d) Forward any information received from the client regarding a claim or an incident that may give rise to a claim without delay, and in any event within three working days. (e) Advise the client without delay of the insurer’s decision or otherwise of a claim; and give all reasonable assistance to the client in pursuing his claim. Provided that the insurance broker shall not take up recovery assignment on a policy contract which has not been serviced through him or should not work as a claims consultant for a policy which has not been serviced through him. (7) Conduct in relation to receipt of complaints—every insurance broker shall: (a) Ensure that letters of instruction, policies and renewal documents contain details of complaints handling procedures. (b) Accept complaints either by phone or in writing. (c) Acknowledge a complaint within 14 days from the receipt of correspondence, advise the member of staff who will be dealing with the complaint and the timetable for dealing with it. (d) Ensure that response letters are sent and inform the complainant of what he may do if he is unhappy with the response. (e) Ensure that complaints are dealt with at a suitably senior level. (f) Have in place a system for recording and monitoring complaints. (8) Conduct in relation to documentation—every insurance broker shall: (a) Ensure that any documents issued comply with all statutory or regulatory requirements from time to time in force. (b) Send policy documentation without avoidable delay. (c) Make available, with policy documentation, advice that the documentation shall be read carefully and retained by the client. (d) Not withhold documentation from its clients without their consent, unless adequate and justifiable reasons are disclosed in writing and without delay to the client. Where documentation is withheld, the client must still receive full details of the insurance contract. (e) Acknowledge receipt of all money received in connection with an insurance policy.

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(f) Ensure that the reply is sent promptly or use its best endeavours to obtain a prompt reply to all correspondence. (g) Ensure that all written terms and conditions are fair in substance and set out, clearly and in plain language the client’s rights and responsibilities. (h) Subject to the payment of any money owed to it, make available to any new insurance broker instructed by the client all documentation to which the client is entitled and which is necessary for the new insurance broker to act on behalf of the client. (9) Conduct in matters relating to advertising every insurance broker shall conform to the relevant provisions of the Insurance Regulatory and Development Authority (Insurance Advertisements and Disclosure) Regulations, 2000, and: (a) Ensure that statements made are not misleading or extravagant. (b) Where appropriate, distinguish between contractual benefits which the insurance policy is bound to provide and non-contractual benefits which maybe provided. (c) Ensure that advertisements shall not be restricted to the policies of one insurer, except where the reasons for such restriction are fully explained with the prior approval of that insurer. (d) Ensure that advertisements contain nothing which is in breach of the law nor omit anything which the law requires. (e) Ensure that advertisement does not encourage or condone defiance or breach of the law. (f) Ensure that advertisements contain nothing which is likely, in the light of generally prevailing standards of decency and propriety, to cause grave or widespread offence or to cause disharmony. (g) Ensure that advertisements are not framed so as to abuse the trust of clients or exploit their lack of experience or knowledge. (h) Ensure that all descriptions, claims and comparisons, which relate to matters of objectively ascertainable facts shall be capable of substantiation. (10) Conduct in matters relating to receipt of remuneration—every insurance broker shall: (a) Disclose whether in addition to the remuneration prescribed under these regulations, he proposes to charge the client, and if so in what manner. (b) Advise the client in writing of the insurance premium and any fees or charges separately and the purpose of any related services. (c) If requested by a client, disclose the amount of remuneration or other remuneration it receives as a result of effecting insurance for that client. This will include any payment received as a result of securing on behalf of the client any service additional to the arrangement of the contract of insurance. (d) Advise its clients, prior to affecting the insurance of their intention to make any deductions from the amount of claim collected for a client, where this is a recognized practice for the type of insurance concerned. (11) Conduct in relation to matters relating to training—every insurance broker shall: (a) See that his/her staff is aware of and adhere to the standards expected of them by this code. (b) Ensure that the staff is competent, suitable and has been given adequate training. (c) Ensure that there is a system in place to monitor the quality of advice given by its staff.

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(d) Ensure that members of the staff are aware of legal requirements including the law of agency affecting their activities and only handle classes of business in which they are competent. (e) Draw the attention of the client to Section 41 of the Act, which prohibits rebating and sharing of commission. (12) Every insurance broker shall display in every office where it is carrying on business and to which the public have accessed a notice to the effect that a copy of the code of conduct is available upon request and that if a member of the public wishes to make a complaint or requires the assistance of the authority in resolving a dispute, he may write to the authority. (13) An insurance broker as defined in these regulations shall not act as an insurance agent of any insurer under Section 42 of the Act. (14) Every insurance broker shall abide by the provisions of the Insurance Act, 1938 (4 of 1938), Insurance Regulatory And Development Authority Act 1999 (41 of 1999), rules and regulations made there under which maybe applicable and relevant to the activities carried on by them as insurance brokers. The Code of Conduct incorporated in the licensing Regulation are quite comprehensive. Scrupulously following these would definitely support an environment of ethical business practices. Other mention on sound business practices in selling can be found in Policyholders Protection Regulation issued by IRDA. It also lays emphasis on fairness in sales. The Regulation states that a person of any insurance product shall clearly state the scope of benefits, the extent of insurance cover and in an explicit manner explain the warranties, exceptions and conditions of the insurance cover and in case of life insurance, whether the product is participating (with profits) or non-participating (without profits). The allowable rider or riders on the product shall be clearly spelt out with regard to their scope of benefits, and in no case the premium relatable to all the riders put together shall exceed 30 per cent of the premium of the main product. However, in spite of several stringent conditions laid down in various regulations by IRDA, there are examples of mis-selling by agents. Sufficient published data is not available to get a clear picture of misselling and unethical market conduct in insurance selling. However, a recent article in Asia Insurance Post, June 2005, the articles mentioned about wrong selling. (a) There is aggressive and wrong selling of insurance by agents of various companies. (b) Unit linked insurance policies were typically being sold wherein there are full disclosures and also the advisors were trying to ride the bull phase of the market. Customers were being shown the upside for the product without guiding them about the possible down sides. The advisors were not revealing the full disclosures on the changes. (c) In the group products mis-selling was more at the pricing level where pricing was done below mortality assumptions for the group and sales force did not believe in giving correct advice. (d) Rising mis-selling in the days of high competition in the liberalized life insurance industry, the lapsation ratio of life insurance policies have remained very high. It has also been reported in the said article that ‘Currently the Indian Insurance regulator is planning to revamp its regulations at least in couple of important areas including the sales of key man policies, unit linked insurance policies, group policies and licensing norms for Corporate Agents’. However, regulation itself cannot stop mis-selling and unethical business practices. There is a need for industry players to enhance surveillance and to put in place a set of best practices to be monitored by the companies and its association. Insurance council can play an important role in this regard.

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(e) Post-examination activities: These exams have enabled the US Regulators to understand the extent of uniform application and adherence to the regulation by various steps and the nature of deviations. Some such exams and surveys would also help to remove abarasions in the practices by the insurers and support the emergence of an ethically conducted life insurance market in India. Here we have basically discussed about ethical practices in selling. But ethical standards have significant implications on other areas of operation such as product development, pricing, disclosures, advertising, investment management and internal marketing of an organization. Therefore, ethical conduct needs to be promoted as the organizational culture and institutionalized through practices at all levels.

Chapter 7 Managing Change and Challenges Our discussions in the previous chapters clearly indicate that an unprecedented wave of change is taking place in the Indian economy, financial markets and particularly in life insurance industry due to strong waves of globalization and reforms in Indian economy. These changes have opened up unfounded opportunities for the life insurance industry and at the same time thrown up immense challenges to manage the changes and to exploit the emerging opportunities. The unprecendented changes in the market have necessitated a different kind of management and a more dynamic management approach for growth. Surviving in the era of intense competition will depend on market-related management practices driven by technology, support and knowledge-based quantitative decision process. Indian life insurance market is experiencing an unexperienced transition in terms of intraand inter-institutional competition, product proliferation, changing consumer preference and activism. In such an evolving market, management practices are very crucial for growth. We have already mentioned about strategies for business growth, product development, distribution, funds management and governance. However, these initiatives could be institutionalized only through proactive strategy and management decision backed by planning and researchbased inputs. Keeping these in view, in this chapter we have discussed in brief few related issues such as: 1. 2. 3. 4.

Nature of changes in marketplace. Role of institutions in change management . Challenges for life insurance industry. Organizational response to change and challenges.

Nature of Changes in Marketplace Change is the most natural and unavoidable phenomenon of life, individual, institutions and society—influenced by the external or internal forces. Activities of any economic institution like a business organization are basically influenced by the cross-currents of national and

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international economic, political and social forces. These forces are changing very fast due to the changes in technology, spread of information and knowledge, mobility of factors of production, new discovery, new equations and associations, etc. Markets for the products are rapidly changing and becoming more and more complex due to growing competition, changing preferences, tastes of consumers, etc. Changes are an integral part of the economic process and all the economic institutions are exposed to them. Changes maybe cyclical or structural. Cyclical changes are temporary alterations and often follow a pattern which has been exhibited before and frequently returning to the prior state or condition, while structural changes are fundamental transformations in market or operation of some activities or institutions from a previous state. These changes very often bring sudden volatility dismantling the existing economic structure. However, there always will be some hidden factors silently initiating the change which may not be very visible. But they can be located by applying analytical parameter core to the organizational business and market. Therefore, there is a need to develop appropriate mechanism through advance planning to locate the factors and nature of change; speed of change and its impact on economy, market and on the organization. If any firm or industry is incapable of realizing the undercurrent of change in economy and unable to readjust its format and functioning it is bound to be thrown out by the new system. Further, the change can be implicit (invisible) or explicit (visible and identifiable). Implicit change may apparently be invisible and unidentifiable but ultimately culminate into visibility. Experts have identified the process of change as a multi-stage phenomenon involving unfreezing, defreezing and refreezing. Unfreezing refers to the removal of resistance to change which requires disturbing the existing equilibrium condition. The existing equilibrium may not be an ideal and optimum situation. The institutions or society might have arrived at the present equilibrium situation out of several mismatches but may not be the one aspired by majority of institutional members because of change in expectation and value system. However, because of the group inertia the minority beneficiary group would build up resistance to change. Therefore, structured measures are necessary to break-up the resistance in order to remove the mismatches and to arrive at a new equilibrium which maybe ideal and optimum in a new situation. Ideal, because it will take care of individual aspiration and optimum, because prevailing mismatches are removed to arrive at the best possible situation. During the last few years, there have been tremendous changes and transformation in the economy particularly with respect to business activities. The ideas of localization of markets are no more an important issue in the age of globalization. This has prompted the business organization for fresh revaluation of its position in the marketplace and to introduce new strategic initiatives to confront the challenges thrown by globalization, competition, information explosion and new service delivery system. The service industry has emerged as the driver of change and leading sector for growth momentum, these changes have been observed more prominently in service industry. Since, the Indian insurance market is getting integrated into the global insurance industry, it is necessary for us to think about the Indian market in the light of emerging trends in global insurance industry and India’s place in it.

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Post-reforms globalized life insurance market is witnessing unprecedented change due to competition which in turn has improved the dissemination of information, increased product launch and enhanced the consumer awareness and demand. A silent revolution in the customers’ behaviour is taking place since insurance sector in India was deregulated and opened to the private sector. Market has suddenly transformed from supply-driven to demand driven. The process of transformation has been further supported by induction of sophisticated technology. The transformation of market has been driven by several social, political, economic and technological factors. Important sociological factors are: Increase in longevity, disappearance of joint family, increase in smaller household, increase in consumerism and weakening family ties. Important politicoeconomic factors are: Emergence of free market economy and decline in the role of state in welfare of citizens, globalization and entry of foreign capital and superior, newer distribution mechanism and expanding product range. Important technological factors are: Increased speed in information dissemination and service delivery, increase in communication bandwidth and reduction in costs. In the emerging market of life insurance, new generation customers, influenced by the above changes are restless having short-term objectives of growth rather than safety and security which were most desired objectives of old generation policyholders.

The changes led by the above factors in the marketplace need to be viewed seriously by a life insurance company and itself needs to change to adjust with market forces. Market does not differentiate anything but performance. Therefore, the companies which have matured over a period in pre-reformer market may suddenly find themselves out of track, if they fail to capture and recognize the changes that are taking place and change themselves continuously. Therefore, change management becomes a critical factor for survival. In the newly adopted market economy in India, the structure and composition of market and its complexion has undergone drastic change. Life insurance industry, which is one of the core segments in Indian financial economy, has also experienced this transformation with the opening up of the market. In a newly evolving market environment sustained growth of a company depends on total involvement of the people, its products, efficiency, loyalty and creating a vision among its employees. These are the issues, which can be successfully tackled through creating brand image as well as successfully implementing internal marketing system.

Role of Institutions in Change Management In the broader socio-economic canvas, institutions play a unique role by integrating the forces of readjustment mechanism. It provides a platform to the individual members of the society to express their potential energies and channelize them to attain their individual and group goal through integration of intellectual capabilities. The goal is a dynamic phenomenon and goes on changing over time due to disturbances created by the discovery of new technology, new resources, knowledge and new realization of the individual and group role in society.

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These factors either jointly or independently influence the individual and group thinking and make them impatient for a change and new equilibrium situation in institutions, because institutions are the platform of intellectual pursuit. Institutions are thus expected to readjust their objectives and priorities in order to accommodate the expectations of their members (majority). Therefore, institutions have to redefine their goals and redesign the action plan to achieve those goals. However, new course of action can be planned only after identification of expectations and direction of change called for. Survival and sustenance of growth of any institution (social, economic, political) basically depends on its ability to respond to the expectation of its members and quick readjustment of its structural policy. Economic institutions such as business or service organizations are the socio-economic intermediary in any society and act as a crucial linkage between individual expectations and social objectives. However, very often the priorities of any organization may differ, some organizations may scrupulously pursue the goal of profit maximization without giving importance on equity factor, while the individual expectation and social goal may be growth with equity. In such a situation, organizations fail to identify themselves with individual expectations and social goals. Further, conflict may arise due to difference in individual and institution expectation of objectives, style and strategy. While a flexible, transparent and objective environment creates opportunities for self-expression, a regimented environment may hinder growth of an individual and thus of an organization. To resolve these types of conflict and mismatches the organization needs to modify the objectives and functional structure to create confidence in the minds of people. Since, organizational growth and survival depends on these people who have built them, therefore, organizations need to create and maintain an environment conducive to self-expression and self-actualization of its people under the broader socio-economic conditions. Therefore, the organization needs to change its structures of objectives, relationships and operations to remain true to perform its organizational role as a socio-economic intermediary. Our analysis in the previous chapters indicate that there is a tremendous potential of life insurance in India but we are lagging much behind the many emerging markets like China which started from a lower bottom line in life insurance market. An impatient analysis would indicate that crux of the problems is the absence of a growth agenda, strong entrepreneurial push and vision-oriented management action. India has been successfully able to come out of Hindu growth rate, thanks to the vision and mission of the present leadership who have embarked upon liberalization and new growth strategy, providing regenerated momentum to world economy clearing the path of flow of savings and capital to the Indian market.

Outcome of Change and Market Evolution Constant changes are taking place in society, economy and in insurance industry. These changes are to be institutionalized for further growth and expansion of life insurance industry. However, changes have thrown up multiple and multi-dimensional challenges in the area of product–market relationship, management assets and liability, promoting ethical practices and

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governance, enhancing customers’ value and creating an environment for excellence and selfactualization for internal stakeholders. However, we may have discussed about few critical issues to be dealt with at the organizational level, leaving wider policy issues to the policymakers and planners in the country. Immediate attention is required to increase the coverage and penetration level through a wide range of actions in the areas of strategic business planning, product innovation, management accountability, efficiency in investment management, technology management, HR management, service quality management, improvement in disclosures and corporate governance.

Promoting Life Insurance Literacy Since economic and financial literacy is very low in India, insurance companies need to create an environment of understanding about the real benefit and strength of insurance products by disseminating information and educating public about the relative benefits and strengths of life insurance. Life insurance competes with other savings products from mutual funds, bank and government. Since Indian market is led by personalized selling and brand name of LIC, there is limited awareness about insurance among the investing public. In order to promote a demand-led market, insurance companies need to undertake educative campaign for mass information, knowledge and informed decision-making.

Differentiated Focus on Diverse Market Segment Life insurance market is unique and consists of unlimited critical factors with varying degrees of choice led by concern about savings risks, old age, health, disposable income, seasonality in income, prioritization of consumption, etc. Therefore, market segmentation is a key concern for any insurance company and medium to long-term forecasting of changes in specific segment would be a very challenging task. In order to increase penetration level, marketing efforts need to be directed through market segmentation approach based on rural and urban market, high end and low end market, saving substitute market, health insurance market, pension and retirement market, etc. Till recently insurance products were not fully segment directed. Uniform marketing strategy was adopted for all types of products. However, in recent times segment-specific products and marketing strategies are being designed. A more scientific approach is however required through development of distinct products and specialized training to sell them.

Developing Need-based Product Life insurance products are unique in character and contain several embedded benefits of different order of value. Products are expected to serve the emerging needs of the customers which are dynamic in nature. Understanding these emerging needs are crucial to design new products. Since, today’s financial markets offer various alternatives to life insurance. Life insurance

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products are not merely an instrument of savings mobilization but they are packages of desired embedded value of the emerging class of customers. Therefore, insurance companies need to come out with innovation products after in-depth market research. Therefore, time relevant and customer need-based products are to be developed in the background of cost and embedded benefits. It has been observed throughout the world that investors are moving away from insurance market to pension, mutual funds and other investment market for better and short-term return. Therefore, there is an urgent need for developing ‘composite products’ providing insurance and investment benefits products in addition to pension products, health insurance, term assurance investment product (unit linked insurance).

Just Pricing the Products Pricing is a critical factor for any insurance product and in the fast changing insurance market fixing ‘right’ or ‘just’ price would be an important challenge because of the influence of many factors in price determination. Product choice is changing with the changes in socio-economic environment. Pension and annuity market is emerging as a very important segment. Mortality experience is undergoing a fast change due to changes in longevity. Financial markets are getting more complex with increased uncertainties and unpredictability in return. Competing alternative products affecting the policy termination involving unforeseen increase in expenses. Unpredictability in long-term inflation and real interest rates. Scientific pricing therefore calls for more segmented, more frequent, mortality investigation, in-depth research on business cycle and more scientific forecasting of interest rates and impact of market fluctuations on market return.

Protecting the Mortality Shocks Another critical yet not so much discussed challenge is the emerging mortality shock as referred by Swiss Re, arising out of natural calamities such as earthquakes, floods, volcanoes, chemical plants; epidemics such as SARS, HIV and AIDS. These killer happenings may destroy the little benefits due to improvement in mortality. Risks arising out of these unexpected developments are huge and unpredictable. These are the costly but critical challenges, which need industry level initiatives. Serious research needs to be undertaken for rationale prediction of such happenings which maybe used by insurers while pricing the risks. The efficiency of an insurance company to manage such risks would be a deciding factor of growth and survival.

Demand Pull Distribution One of the critical areas of concern for life insurance industry is how to reach effectively to potential customers. Marketing strategies followed by most of the companies are merely ‘market push’; rather than ‘demand pull’. This is really thrusting upon a particular product through agents, banks and brokers, without taking into consideration the choice and needs of the customers.

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Efficient distribution does not only concern about product push but also contains customers need. Therefore, product distribution is thought to be beyond the selling and must be aimed at building a sustainable relationship based on costs and needs. Though there are mediums such as agents, banks and brokers, there is a need to innovate and develop alternative cost-effective channels depending on the product character and market segments. Though India has a population of over 1.045 billion, disposable and per capita income is very low, which makes marginal utility of money very high and safety of funds a major concern for the majority of people who have low level of general and financial literacy. All these call for innovation of suitable distribution channels. Though Bancassurance is a low-cost channel, it can reach only a few segments. We need to develop low-cost personalized selling mechanism, probably by inducting huge reserves of unemployed youth. Segmentation of market, designing segment orient products call for specialized distribution channel. At present the product–market relationship is dominated by personalized selling of monopolist product brand.

Managing Customers’ Choice Managing customers’ choice and demand would be a critical task before the insurance companies. Insurance companies need to focus on customers’ value, cost-effective quality to customer service. Sales is a single transaction, but servicing is a continuous business in an insurance company. It is this service function which is very important and needs to be provided with efficiency. However, this calls for a long-term perspective under a well-designed long-term plan. Customers value management—building customer’s value and securing customer loyalty, customer service is not merely a function but a philosophy. Providing quality customer service by segmenting the market, creating products that are both appealing and actuarially sound, developing appropriate marketing campaign, lowering acquisition costs and creating customer loyalty culture. Customer value management calls for effective implementation of Customer Relationship Management (CRM) through integration into business planning.

Investment Management Investment management is one of the three important functions of an insurance company and management efficiency is judged by funds management performance particularly in a highly volatile, complex and inefficient capital market like India. Market is influenced by many types of interventions which also makes funds management a difficult task. However, promoting a culture of competency and knowledge-based system, would enable the insurance companies to overcome market-related risks. Funds management is a futuristic function, success depends on high level analytical power, forecasting ability and technical knowledge to perceive and monitor macro-financial changes and impact thereof. Future fund management will merely depend on knowledge in economic–statistical–financial analysis and adopting appropriate technology for forecasting,

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risk management, etc. New instruments like derivatives would be widely used for hedging and ALM. Risk management is the core concern for fund managers in an insurance company. Proliferation of new instruments in the market has increased volatility and keen competition increases the market risk. Regulation may provide flexibility in choosing assets pattern but that would also impose strict compliance norms for accountability in investment decisions. The focus area in future will be risk assessment, risk management and research to be undertaken with all seriousness by the insurance corporation.

Optimization of Technology Efficiency New economy and emerging markets are characterized by technology impulse and managing these impulses are considered to be an important challenge and organizational success. Technology has widespread influence and is being used for product development, distribution, servicing and for other management functions. Investment in technology has increased substantially in all types of companies but what is often missing is replacement and opportunity cost of such investments and utilization of technology. Further, often there is no proper assessment of actual return being received out of technology investment. Since any investment is judged by its medium to long-term return, optimization of technology efficiency is an important management consideration. A suitable mechanism of value addition from technology implementation is called for.

Management of Human Capital Real asset of a company is not money but the human capital, which needs better attention. In a competitive market environment there is a need for paying more attention to manage human resources not the lip service to human resource development. Therefore, one of the most critical management initiatives is to design and implement a mechanism to create conditions for optimum utilization of human resources. Such a mechanism must be able to promote an environment for innovation and self-actualization for people. For this, an organization should first, assess the value of human capital, identify the organizational requirement, remove the mismatch between knowledge and job, encourage the creative thinking of people and remove the obstacles on growth and external intervention. In a free market economy, internal knowledge market also needs to be kept intervention free. Since organizational growth and sustainability to a great extent depend on the human capital management one must evolve an objective base ‘Human Capital Care’ policy to optimize maximum return. Other important element must include patronizing and supporting creative people and creative thinking introducing quality consciousness and performance-based reward.

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Knowledge Management Continuous innovation in financial services have been creating an ever growing demand for new skills to suit the organizational requirements in the changing environment. New knowledge and technology has made yesterday’s expertise totally obsolete and there is no room for precedent oriented management decision or purely perception-based management system. Today’s hard reality demands knowledge-based management and decision supported by facts and research findings. However, knowledge-based management can be promoted by building up a knowledge bank through efficient talent management practices. Therefore, talent management is a critical task for any enlightened organization, which requires focussing on removing knowledge mismatch and putting in place a long-term policy of recruitment and retention. Organizational culture also plays an important role in knowledge-based management system, where employment is a brand and employees have got sufficient opportunity for self-actualization. Knowledge management has strategic significance. In order to derive best business value from the knowledge-based assets, experts have suggested five knowledge-centred strategies. 1. Knowledge-based business strategy—knowledge creation, renewal, sharing, etc. 2. Intellectual asset management strategy—enterprise level management of specific intellectual assets, patents, technology, operational and management practices, etc. 3. Personal knowledge strategy—personal responsibility for knowledge-related investments, innovation, competitiveness, etc. 4. Knowledge creation strategy—organizational learning, applied research, etc. 5. Knowledge transfer strategy—transfer knowledge to appropriate area of action. Success of organizational strategies depends to a great extent on effective knowledge management strategy.

Managing Training Activities Training and learning activities occupy a greater space in the activities of insurance companies. Learning in future will also not be the same and will follow a different objective through different methods. I visualize that the future belongs to e-learning which is going to emerge as a critical determinant of sustainable growth because e-learning will provide smart, fast and effective training at a low-cost. Training needs to focus on strategy building and quantitative decisionmaking. To build up skill to knowledge-based selling, managing and servicing. Training must be able to enhance productivity and skill of cost and risk management. Moreover training should enable to enhance sensitivity, accountability, killer instinct and competitive skills among the managers.

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To achieve the above, there is a need to reorient the outlook of top management about the trainers who are usually thought to be theoretical. Today’s management calls for appropriate implementation of theory by trained managers who are equipped to translate knowledge into practice. Therefore, creating an appropriate training atmosphere will be a real challenge for the insurance companies.

Managing Research Activities Future functioning of an insurance company will be significantly influenced by quality research inputs. Data management and interpretation of data will be required for policy planning, marketing, analysis of customer’s satisfaction, human resource development, funds management, actuarial–mortality investigation, cost management, etc. Working of an insurance company covers a wide area of socio-economic and financial market. To take corporate decisions, to have a strategic planning framework a sound database and easy to use analytical tools would be required and a team of hard-core research professionals. Research must focus on marketing and distribution, customer’s satisfaction and value addition, human resource development, funds management actuarial aspects such as mortality investigation, cost management and impact of technological utilization. However, it is a pity that scant attention has been given to research and research-based decisions in India. Sound research-based data and data-based futuristic decision would add the competitive edge in decision-making. Having such a research team and technology would make a difference.

Optimizing Benefits of Regulation and Self-regulation In a market economy, regulatory regime plays a crucial role in promoting enterprising freedom, expanding product base and making the customers’ concerned about his/her freedom and rights. At the same time, customers become more vulnerable and less protective due to unethical pricing and underlying potential for fraud. Therefore regulations and Regulatory Authority play a very vital role in protecting the customer’s interest, creating space for healthy growth of industry and developing an environment for market signal. In future, insurance regulatory challenges will shift from product design to market practices including sales process, need-based selling and prevention of unfair practices. Distribution polarization and code of conduct, corporate governance in investment decision and funds management, asset protection and ALM, mergers, liquidation rehabilitation of insurance companies. Regulation through regulatory authority has an element of control and free market sometimes rejects the policing attitudes of a Regulator. This type of regulation also increases the cost of regulation. Regulators throughout the world are therefore encouraging self-regulation through code of good conduct under the regulatory umbrella. Section 64 of Insurance Act provides formation of Insurance Council to advise IRDA on admissible expense ratio, developing sound practices and code of conduct, monitoring unhealthy practices, licensing of agents, etc.

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Many of the norms and practices designed today are likely to undergo changes with the increase in enormous market complexity in a post-WTO global environment. More competition, more demand for information dissemination, more demand for products, more returns and pressure on cost and margins. All these factors will enlarge the scope and responsibility of SRO.

Improving Governance Efficiency Governance is an evolving issue which includes important issues such as corporate governance, ethical business practices and CSR. The concept of governance is an emerging phenomenon in India which has attracted attention of corporates in recent times due to several corporate debacles. While regulation creates checks and balances for an organization, corporate governance aims at institutionalizing transparency and ethical business practices through compliance and disclosures. This becomes more important for a life insurance company because the stakeholders, particularly the policyholders are widely dispersed, often indifferent and ignorant about the practices and performance of the company. Therefore, there is a need for developing a standard for governance for life insurance companies—which must include general standard and specific standard for pricing, distribution, funds management, servicing, etc. IRDA may take some initiatives to put in place governance standards for insurance companies.

Organizational Response to Challenges Organizations which are established, develop, grow and sustain in a society. It is the society which supplies the inputs and consumes the outputs. Therefore, organizational growth transformation and sustaining the transformation or change must be society oriented. Living in isolation is totally ruled out. Management must fully perceive the societal role of an organization in the right context taking into account the aspirations of the majority, which of course is very difficult in a heterogeneous and vulnerable society, like India. Organizations have to exist under complex pressures and pulls generated internally and externally. Indian society at this juncture is under tremendous pressure of transformation. What seems right for today may not be acceptable tomorrow or the day after tomorrow. Therefore, a genuine visionary approach must be taken to design any plan for organizational change. In a rapidly changing world today is not the answer, it is tomorrow or beyond that which matters. Thinking change is one thing but making it happen is another ball game. Very often we talk about change but do not initiate necessary actions to change. It is so, because change is a painful process, it costs and moreover the change manager has to walk through an uncertain path full of risks. Therefore, to make change happen we need to draw a time bound action plan with a given outline of responsibility and accountability because success of the action plan for change depends to a great extent on the time factor. If the action plan is not taken at the appropriate moment the process may not bring desired results and maybe a very costly affair. Changes are continuous, therefore in order to avoid threats and pressure exerted by internal and external

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forces it is necessary to identify implicit changes in a proactive manner and to initiate measures for structural change. There are external and internal forces which may necessitate the management to initiate structured measures to change the organizational perspectives. There maybe a new discovery of input-product relationship owing to innovations, there maybe contraction or expansion of product or input markets or development of supplementary or complementary goods or new socio-political tension and altering the existing product–profit relationship—whatever maybe the need for change, cause–effect relationship must be identified before the measures for change are initiated—and appropriate short medium and long-term strategies are to be formulated keeping in view the external and internal forces of changes. The entrepreneur or management (top management) has to examine critically the question of change. Is it necessary to disturb the existing equilibrium condition through structured measures? Is the readjustment in organizational objectives, structure of relationship, etc., necessary for growth and survival? Is it necessary to alter the present relationship between organization and society? These are basic questions which need to be addressed from the short, medium and long-term perspectives. The action plan for change must be able to identify the beneficiary group—internal and external. Who are beneficiaries? Small minority of promoters or large majority of employees and consumers (users) of products (services). This question has vital importance because it will decide the structural relationship, degree of involvement of internal population who are the ultimate carriers of change. If the aim is to create better conditions for self-expression and self-actualization of internal population and enhanced opportunities for advancement as well as to improve the product quality (services) for the mass of consumers then the organization can expect spontaneous involvement of internal population in the scheme of change. On the other hand, if the internal population visualizes that change neither brings any gain to them nor to the society as a whole, they may resist the change and create stumbling blocks leading to disastrous results. Growth minus equity may not be acceptable to them. Wholehearted participation of internal population in the process of change would strengthen intellectual integrity and increase operational efficiency which would lead to organizational growth, increased productivity and profitability. The external forces maybe many but they are the most critical factors to be identified for timely action. Changes in market conditions (consumers expectations) technological innovations and development in socio-economic front maybe closely and constantly monitored. Unless care is taken to monitor the development of these factors, timely action for organizational readjustment maybe impossible. Therefore, management must have visionary outlook and be competent enough to develop a ‘time frame of change’. Developments in USSR and other East European countries are the testimony of management failure to monitor latest internal and also external pressure and to initiate timely action for change. However, there cannot be anything like spot decision for change. Time frame should be well designed and must be built on quality data crystallized through scientific processing. As we

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have already mentioned that there should be well-organized machinery to monitor internal and external development and on the basis of that scientific processing forecasting model maybe developed. On the basis of forecasting, time for initiating change can be found. Long range planning model maybe useful for this purpose.

Identifying Change Agents Having a desire to change and drawing an action plan may not necessarily bring change and to make it happen we need a band of change agents. The next question is who manages the change and who are the change agents? The answer is ‘everybody’ from the organization. Very often misleading ideas are thrown about the agent of change and many times either top management or consultants (internal or external) are only treated as the managers of change. Change no doubt can be initiated by top management and undoubtedly it is the commitment of top management to change which sets the ball rolling but external or outside experts can only fill the knowledge gap between an organization and outside world. Change must be managed by people of the organization who belong to it. Degree of top management’s commitment will determine the quality of change and entrepreneurial outlook of the people (including top management) will decide the extent of success. While autocratic and elitist outlook will isolate the people and contribute to mismanagement, the egalitarian perception of top management will create an environment for involvement of the people, thereby hastening the process of change. Organizational actions and behaviour of top management should be more transparent and be able to convince people about their commitment. Management must have sufficient confidence in its own people and enough opportunity must be created for their forthcoming involvement. Once the commitment and confidence of top management is conveyed to the people, their potential entrepreneurial ability such as innovation, risk-taking, involvement in the job and learning spirit will surface and they will act as managers of change. Because economic men are to some extent self-advancement oriented and once they see some opportunity for self-advancement in the changed situation, they will make full attempt to take the changing process to its culmination. Therefore, managing change is not the job of any expert or top management alone. It is the responsibility of all but only those with entrepreneurial ability will come forward. However, the quality of management of change will depend on the degree of commitment of top management and the quality and transparency of their decisions.

Promoting Culture of Internal Marketing The concept of Internal Marketing is an offshoot service marketing in view of emerging competition, dissemination of market and product related knowledge and informed decisionmaking by the ever growing sophisticated customers. Customer satisfaction is the key to product marketing and growth, which cannot merely depend on the small marketing team.

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Service marketing therefore has emerged as a key element in modern marketing initiatives of any organization, particularly the organizations selling intangible products. The role of internal people thus merged as crucial component of marketing and organizations are making efforts to increase involvement of employees including non-marketing employees through various means like attracting talented people, providing avenues of growth, enhancing skills and competitive ability through internal and external training. Non-marketing employees thus act as complementary to sales or marketing people. According to Ballantyne (2000) ‘Internal Marketing is a strategy for developing relationships between staff across internal organizational boundaries.’ Internal Marketing thus strengthens the process of integration and enhances the understanding of employees of the vision, mission and the goal of the organization. This enables the organization to pursue an united initiative to achieve better growth through service conscious marketing drive. Internal Marketing is a structured initiative and therefore it must be an integral part of corporate strategy. However the organization, its philosophy, long-term growth objective and core benefits to employees through organizational growth is to be sold to employees first. The enlightened employees will emerge as skilled and informed service providers, providing boost to external marketing. Internal marketing is thus an important corporate strategy of modern business.

Promoting the Creative Managers There is an ever growing need for management restructuring to achieve change objectives based on business and societal goal. Balancing these goals and achieving commercial objectives call for high degree of managerial entrepreneurship. Therefore, managers need to transform themselves into entrepreneurs to initiate proactive action with a futuristic view. They must be capable of institutionalizing the knowledge available in the organization in an efficient and transparent manner not only to create an organizational environment in order to induce entrepreneurship but also self-actualization of its people. Supporting creativity and creative managers is also very important to create an environment of innovative thinking. One must remember that innovation in methods, process and delivery of services are crucial factors for growth. However, such creative people are few and are different from the masses. Top management must single them out to support their creativity and innovative management thoughts. It is suggested that a conducive organizational environment, maybe developed through structured initiatives as mentioned below: 1. Clearly define the organizational goal and objectives and broadly spell out the role of each section of employees. 2. Open the organizational practices to all sections of employees and treat the members of the staff as equally responsible and important partners in success or failure.

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3. Open the direct channel of communication; remove the hierarchy and other barriers to communication. 4. Allow dissent and encourage constructive criticism regarding organizational practices, functioning and management type and be fair and impartial to all. 5. Allow people to come out with alternatives in the interest of organizational growth. 6. Identify people who challenge the organizational culture, institutionalize management practices and style of functioning but at the same time have the ability to come out with alternatives in the best interest of the organization. 7. Identify creative people, be fair and extend all freedom to them. Provide protection and encourage them to think and innovate. 8. Treat the creative people (irrespective of age, qualification and organizational position) as the most valuable assets of the organization. Take them out from routine jobs and entrust them with impossible and challenging tasks. 9. Extend them all that can be offered to think creatively and innovate without external and internal hindrances. 10. Acknowledge the importance of creative people and their innovation in the organization. 11. Reward the creativity and innovation suitably to motivate further.

Inducing the Managerial Accountability An organization can sustain its growth and remain distinct in a competitive market if it can evolve a system of involvement, ownership and accountability of its managers. Some of the successful practices of performing organizations and performing managers are benchmarking contributions of a particular position. Therefore, while selecting a manager for a particular position, the company opens the opportunity before a number of efficient and competent managers, who come up with the ideas of contribution, agenda of action for their position. The top management then selects the best one on the basis of the background and assured agenda of contribution. The contribution of the selected manager is then monitored on a scientific basis within a given time frame for example, three months or six months, to show their performance. In case they fail to perform as per the assured agenda, the manager maybe changed and the position maybe offered to the second best. This system also generates strategic inputs because when a number of managers compete for a particular position and submit their agenda of action, new thoughts, new ideas come up, which can be the basis for future strategic initiatives and action plans for the organization. This system provides an environment of transparency, acknowledgement of efficiency and reward for performance and job satisfaction to the manager. This also induces the manager to be more accountable to his/her job, responsible to the organization and thus improves the environment of internal marketing.

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Along with the management’s efforts, personnel training policies, well-designed framework of planning and control system must be put in place to support the motivated employees and to perform in an efficient and transparent way which will enhance the relationship between customers and service providers. These strategic initiatives need to be supported tactically by selling the concept to the employees in the organization, why servicing is a critical factor for strengthening external marketing, the value of relationship management and how this will finally strengthen external marketing initiatives which are keys to the growth of the organization.

Management Style to Manage Change Management style plays a critical role in promoting internal marketing. Rigidly hierarchical top–down system acts as a retarding factor,while encouragement of bottom–up system and a fine balancing of top–down and bottom–up system would enhance participation at all levels and support promotion of internal marketing. Management is an integrated approach and preferably should be based on a bottom–up approach which involves all the layers in the organization. This is quite different from the top–down method, where decisions are taken at the top and left to the middle and lower level employees to be implemented. In this method the sensitivity of employees are often not finding a place which may come in the way of transferring the ownership of management decision. However, a bottom–up approach creates more involvement in change management and creates an avenue for smooth transfer of ownership of management decision. Therefore, a proactive organization in the marketplace should focus less on the hierarchical structure but more on operational efficiency, capabilities and management intelligence. However, it is often difficult to initiate because organizational structure in India closely imitates the social structure which is hierarchical in nature. This is also an obstacle to move towards knowledge orientation; what western management could do due to less hierarchical social structure. However, if Indian insurance industry or for that matter any company is to compete with global players, it needs to refocus on organization building based primarily on ability, intention and knowledge. Few companies particularly in the IT sector could manage to promote institutional structure responding to the market signal and succeed globally. Life insurance industry can learn from them.

Glossary

Accidental Death Benefit: Benefit paid to the beneficiary under an insurance policy in the event of accidental death of the assured. Accumulation Value: Generally used under an universal life policy to indicate total of all premium credit to the assured life’s account plus interest received for investment of fund less loans, surrender and other expenses incurred. Actuary: A professional with expertise in technical aspects of life insurance and pension, whose primary responsibility is to assess present and future liability of life insurance/pension plans. They evaluate the reserve of insurance/pension funds, conduct the valuation and determine financial risks and solvency of the company. Actuarial Surplus: The difference between actuarial value of assets and actuarial liabilities. ADR (American Depository Receipt): Indian or any foreign company can raise money by issuing ADR which is traded in the US stock exchange. Agent: Agents play a very crucial role in selling life insurance. An agent may be an independent person hired by a life insurance company who sells policies and is paid commission or may be paid a salary by the company. Age Limits: Insurance companies stipulate minimum and maximum ages below and above which they will not entertain any proposal or may not renew any lapsed policy. Amount at Risk: Means the difference between face value and cash value of a whole life policy. While the net amount at risk declined, the policy reserves increases along with the cash value, during the policy period. Annuity: It is a financial contract between a life insurance company and an annuity policyholder under which the company pays a series of payments, during the lifetime of a policyholder. Payment under an annuity policy can be fixed or variable, paid on a monthly/quarterly/half yearly or annual basis.

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Annuitant: A person who receives payment under an annuity policy. Annuitization: The conversion of the balance under an annuity contract to income plans. Annuity Certain: It is an insurance contract under which, annuity payment is made for a certain number of years. Annuity Consideration: The amount of payment made by an annuitant for an annuity policy. Annuity Rate: The present value of unit of payments payable to an annuitant calculated on the basis of mortality and return on investment. These plans provide pension to an annuitant or his/her spouse. Arbitrage: A trading strategy of buying securities and selling them simultaneously at a profit. Assignment: Transfer of rights and benefits of life insurance/annual policy by the policyholder to another person. Assets: Indicates the property owned by a life insurance company or pension funds including stocks and bonds and accounted in respect with solvency and liability to pay claims. Asset Allocation: Asset allocation refers to diversification of portfolios among different asset classes in order to maximize return and to minimize risks. Actuarial Liability: It is an amount calculated on the basis of certain actuarial assumptions that represent the present value of future benefits payable under an insurance or pension plan. Back Dating: Refers to a procedure to make effective date of a life insurance policy earlier than the date of application to avail benefits of lower age by a life assured. Beneficiary: The person or entity such as trust or corporate named in the policy to receive the proceeds under the policy in case of death of the life assured. Basis Point: Basis Point is one hundredth of one percent, used in measuring interest rates, yield on investment, cost management fees for funds management, etc. Bear Market: Refers to prolonged retreat in stock market when prices of stocks go down month to month. Beta: Used to measure stock price volatility in relation to overall market. A stock with beta of 1.00 will tend to move in tune with the market movement. A stock with beta higher than 1.00 will be more volatile and a stock with beta below 1.00 will be less volatile. Business Insurance: Policies issued to key employees to provide coverage of benefits to indemnify a business for the loss of services.

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Book Value: Value of assets included in the balance sheet of a company. The book value is the net value of an organization arrived at by subtracting its liabilities from its assets. Bonds: Bonds are fixed income securities also known as debt instruments created to raise capital. Under most of the bonds, issuers pay fixed amount of interest to the investors. Broker: A person involved in sale and purchase of assets as an intermediary between a seller and a purchaser. Bonus: Bonus is the additional amount paid with profit policies by a life insurance company. Amount of bonus depends on the surplus/profit made by the company. CAGR: Compound Annual Growth Rate. Capital Gains: It is an increase in value of investment. Capital Asset Pricing Model (CAPM): CAPM is a theory which shows the relationship between risks and returns of an investment portfolio. Cash Balance Pension: It is a hybrid defined benefit pension plan with some features of defined contribution plan. The plan sponsor takes the investment decision, who bears the risks. A hypothetical account is used for each participant. Cash Flow: Refers to the amount of money a company receives. The money received after deducting the amount spent. Cash Surrender Value: Under this provision a life assured can surrender his policy for cash value which arrived on the basis of premium paid. Consequently upon surrender, the policy contract is terminated. Chartered Life Underwriter (CLU): A designation given by American College of Life Underwriters on completion of a series of examination. Coefficient of Variation: A measure of dispersion defined as standard deviation divided by the expected value. Compounding: Compounding is a powerful tool to measure the exponential growth in value of an investment which includes interest earnings—current and previous payment of interest. Consumer Price Index (CPI): CPI measures the changes in consumer prices and thus indicates the trend in inflation. CPI is based on the prices of a basket of goods and services and changes all measures with reference to base prices. Commercial Papers: Unsecured, short-term promissory note issued mainly by companies on discount basis.

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Conditional Vesting: Entitlement to the benefits of a scheme on a conditional basis whether or not the member remains an active member of the scheme. Contracting Out: The use of a pension scheme which meets certain conditions to provide benefits in place of another (generally a state) scheme. Convertible Bond: It is a kind of bond which can be converted to shares of the same company. Convertible Policy: A life insurance policy that can be changed to another form of policy, for example, term assurance policy can be converted into endowment policy. Convertible Term Assurance: Under this a term insurance policy can be converted into a whole life or endowment policy without further medical examination. Convertible Whole Life Policy: A policy which combines whole life and endowment policy. It provides maximum risk and with very low premium. It provides rights to convert the policy into endowment assurance at a later stage after commencement. Credit Risk: Risk that arises out of default of counterparty payments. Critical Illness: Under critical illness policy, the policyholder receives a lump sum amount from the life insurer on the basis of diagnosis of life-threatening illness. Coupon Equivalent Yield (CEY): CEY is the effective interest rate earned on bond investment. Coupon Rate: The stated interest rate on a bond. Current Yield: It refers to the prevailing interest rate which the investors are entitled to get from investment in bonds and other fixed income securities. Days of Grace: As per the condition of a life insurance policy, the policyholders are expected to pay premium on a due date. However, a period of 15–30 days is given as grace to make the payment. Death Benefit: This refers to the amount payable in the event of death of the policyholder, whose life has been insured. Debt to Equity Ratio: An important ratio to understand the worth of a company. This ratio is derived by dividing the company’s debt by equity. Decreasing Term: Refers to the term assurance policy in which the insurance cover is reduced by a specified amount each year bringing to zero at the end of the term of the policy. Deferred Annuity: Under this plan of annuity, payments begin at a future point of time. Deferred Period: Period between the date of subscription and payment of pension under an insurance cum pension plan.

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Deferred Vesting: This is a form of vested benefits under a life policy, commenced after fulfilment of certain conditions usually at a certain age or after specified years of payment of premium. Defined Benefit: Refers to the traditional pension plans that pay a guaranteed annual/monthly benefit to the member on his/her retirement. The benefits formula is basically based on factors like number of years of service. The value of pension is defined as a percentage of final salary. Defined Contribution: Refers to the pension plans which do not guarantee any fixed benefits but only the amount of contribution. The benefit payments depend on the contribution and earnings over time. Dependency Ratio: Refers to the ratio of non-active population to the active population. Derivative Instruments: A financial derivative is a financial instrument with a value depending on the value of some other underlying financial instrument. Discounting: The process of finding the present value of a series of future cash flow. Dividend Yield: This refers to the dividend under a stock as a percentage of the stock prices. Diversification: Refers to the investment strategy under which investment is made into various financial instruments including stocks, bonds, real estate, money market, etc. Domestic Output: Output produced by the resident enterprises of a country. Double Indemnity: Refers to payment of twice the basic benefits to a life assured under some specified circumstances such as death. Double Protection: Coverage of twice the basic benefits to a life assured from a specified risk like accidental death. Earning Per Share (EPS): Refers to the earnings of a company net of taxes and preference shares dividend divided by the outstanding shares. Earning Yields: Refers to yearly earnings per share (EPS) in relation to share prices, arrived at dividing the EPS by stock prices. EBITDA: EBITDA stands for Earning Before Interest, Tax, Depreciation and Amortization. Economic Moat: Refers to the unique competitive advantage of company’s difficulty to copy others. Effective Rate of Interest: The percentage rate of return on annual basis. Effective Yield: Refers to the annual rate of return including periodic interest rate from a bond investment.

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Embedded Value: A process of appraisal of value of life insurance assets of a company. It represents value of future profit steam of the existing assets of the company along with value of shareholders assets. Endowment Insurance: Refers to the life insurance policy under which the amount is paid to a policyholder if he/she survives the tenure of the policy or to the beneficiary if the life assured dies before the term. Enterprise Value: Refers to the total economic value of a company. Enterprise value is calculated by adding market capitalization to total debt and subtracting the cash. Expected Mortality: Refers to the expected incidence of death in a group during a given period at any specified age. Extra Premium: An additional premium charged to standard premium under a contract to cover an extra risk. Face Amount: The amount stated in the face of a life insurance policy and will be paid in case of death of a life assured; the additional benefits are not stated on the face of the policy. Face amount is the sum assured. Fair Value: The price at which asset changes hands between a seller and buyer. FED: The Federal Reserve. The US Federal Reserve which manages interest rates in USA exercises significant influence over movement in world stock market. Fiduciary: Refers to the relationship of confidence and trust between a person and an organization which exercises controls over assets of pension plans/life insurance assets. Financial Intermediation: Indicates transactions of financial institutions in financial market to acquire financial assets incurring liabilities in its own amount. Financial Gearing: Refers to the impact on profit of a company caused by fixed and variable interest borrowing. Forward Contract: Refers to an agreement between two parties to exchange an asset at a specified future date for a specified price. Fully Funded: Refers to a pension scheme which has enough assets to pay all current and future liabilities. Fundamental Analysis: Refers to the analysis of value of shares, future profits, dividend, etc., based on accounting statements, economic and market information. Funds Flow Statement: A statement showing flow of funds of a business firm over a period of time.

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Futures: Futures are financial contracts between a buyer and a seller with an obligation to buy and sell assets at an agreed price at a future date set out in the contract. Generally Accepted Accounting Principles (GAAP): This is a common set of accounting procedures and standards. Global Depository Receipts (GDRs): These are receipts for shares in foreign companies traded in capital markets GDR. GDRs allow companies in USA, Europe and Asia to offer shares in many global markets. Group Life Insurance: Life insurance cover to a group of people under one policy. The group should be already in existence. Group Contract: Refers to the life insurance contract that covers a group of lives. Group Superannuation: Refers to the superannuation scheme offered to a group of employees. Guaranteed Insurance Sum (GIS): The minimum insurance amount which a policy or scheme of insurance should provide as one of the conditions. Growth Fund: Funds that invest in growth stocks. Growth stocks are growing companies with potential of future earnings. Mutual funds, ULIP generally launch growth funds. Hedging: A mechanism to protect the value of a portfolio against changes in market prices in future. High Yield Bond: Refers to junk bond characterized by lower rating and higher possibility of default. HTML: Hyper Text Mark up Language. Human Life Value: Refers to a method used to assess life insurance needs of a person by considering his/her income, expenses future earnings and depreciation, etc., in monetary terms. Immediate Annuity: Refers to the annuity plan under which the annuitant starts receiving annuity payment in the first month after the purchase of the annuity plan. Immediate Vesting: Under a retirement plan of this kind the employee benefits begin as soon as he/she purchases the plan. Impaired Risk: When insurable risk is below the standard risks, then a life assured carries the impaired risk. Insurance Technical Reserve: Technical reserve of a life insurance company consists of a reserve against outstanding risks with respect to life policies.

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In-force Policies: A life insurance policy remains in-force, when premiums are being paid by the due date or the entire amount of premiums has been paid. Insurance: An arrangement for payment of a sum (known as sum assured) as compensation for theft, damage or loss, etc., in return for a payment of a small sum known as premium. Index: Index is the arithmetic average of prices of a basket of goods and services. The prices are weighed to begin with a base price. Index value changes with fluctuation in prices of commodities and services included in the basket. Insurance Regulatory and Development Authority (IRDA): It is the insurance sector regulator in India. IPO: Initial Public Offer. Index Fund: A fund that invests in a particular index such as Nifty. Insiders Trading: Refers to buying and selling particular stocks by using inside information of the company. Internal Rate of Return: The rate of discount at which net present value (NPV) of an investment is zero. Inflation: Refers to a situation of general price. Inflation is a political and economic concern. Intrinsic value: Refers to the present value of the stream of benefits expected out of the investment. Insurable Interest: An insurance contract is valid if he/she has insurable interest, insurable interest arises when a person applying for an insurance policy and the person taking financial benefits would suffer financially and emotionally in the event of any unwanted happenings. Insolvency: The inability of a firm to pay debt obligation. Insured: A person whose life has been covered by insurance. Keyman (Employee) Insurance: Life insurance on the life of a key employee, whose loss of life would cause financial loss to the company. Lapsed Policy: A policy which has been terminated due to non-payment of premium. Lapse Ratio: Refers to the ratio of lapsed policies to the in-force policy in a given period. Level Premium: Level premium refers to the rate of premium which remains the same throughout the contract of policy.

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LIBOR: The London Inter Bank Offering Rate. Life Fund: The fund which a life insurance company maintains for meeting claims under the life insurance policies that it has on its books. Life Expectancy: The average period for which a person is expected to live in future. Expressed for a person aged X. Life Assured: A person whose life has been assured under an individual life policy. Life Insurance: A contract between a life insurance company and life assured under which the life assured or his/her beneficiary recovered a stipulated amount on the expiry of the policy term or death of the life assured. In general it is a system of pooling resources through contribution of a large number of policyholders and is distributed among the large number of policyholders who purchased policies. Liquidity: An asset which is actively traded and quickly converted into cash for example a stock of a listed company with good performance which has been listed in a stock exchange. Market Price: Refers to the price which a buyer pays to the seller to acquire an asset. Market Capitalization: Total money value of all outstanding shares computed as shares multiplied by the current market price per share. Maturity Value: An insurance policy matures when the period stipulated in the contract expires and amount written in the policy becomes payable. When the life assured survives at the end of the policy period with respect to endowment policy and receives an amount; that is the maturity value of the policy. Money Back Policy: Refers to the policies which pay back a stipulated amount periodically to the life assured and balance amount on maturity. Money Market: Financial market for short-term financial instruments such as call/notice/term money, repo/reverse repo, commercial papers, certificate of deposit and bills rediscounting. Moral Hazards: Moral hazards are risks that affect the insurance companies to accept the risks. Mortgage: Refers to the pledge of a specified asset as security for a loan. Mortality Table: Refers to the statistical table containing death rates at various ages. Multiple Protection Policy: Refers to the life insurance policy providing benefits of term insurance and whole life policy.

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Mutual Funds: A mutual fund mobilizes money by selling units and investing the same in various capital market instruments such as stocks, bonds and other instruments like gold. Mutual funds can be open ended or close ended. Mutual Office: Refers to a life insurance company that does not have any shareholders. NASDAQ (National Association of Securities Dealers Automated Quotations): NASDAQ is an association of brokers and dealers in the OTC securities business created in 1938. Natural Premium: Mortality cost of life insurance for a duration of 1 year. Net Asset Value (NAV): NAV is calculated by adding the value of investment in a fund and dividing the same by number of outstanding units. Net Present Value (NPV): NPV refers to the present value of benefits minus present cost of purchase of an investment asset. Nomination: Refers to the provision in a life insurance policy which grants rights to receive policy benefits by the nominated person in case of death of the life assured. Similar concepts are also available for other areas, for example, banks, shares, etc. Non Forfeiture Provision: A provision in life policy whereby an insurer cannot forfeit all premiums under a lapsed policy. Non-Participating Policies: These are policies which do not grant any right to share profit/ surplus by any life assured. Nominal Interest: Interest rate expressed in money terms. Non-Participating Policy: Refers to the Policy which does not receive any Bonus. Non-Standard Life: In case of standard life policies are granted at a normal premium but in case of non-standard life extra premium over and above standard premium are payable by life assured. Occupational Schemes: Refers to the schemes organized by an employer or a group of employers to provide benefits to its employees. Option: Option is a right guaranteed by a life insurance contract to a life assured like increasing level of sickness or death benefits without further evidence. Opportunity Costs: The rate of return that can be earned by investing in an alternative avenue of investment. OYRGTA: Stands for One Year Renewable Group Term Assurance which offers different payment rates to different groups depending on the mortality.

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Paid up Policy: It refers to the life insurance policy, which may arise due to the contractual nature of payment of premium, the expiry of premium payment period or due to the non-payment of premium by the policyholders. In case of non-payment of premium by the policyholders the policy benefits under the contract would be reduced. Pay As You Go (PAYG): Refers to the system of pension under which pension benefits are paid out of the revenue without any liability funding. P/E Ratio: Price-Earnings Ratio which is arrived by dividing market price per share by earnings per share. Personal Disposable Income (PDI): Personal income is derived by deducting savings of private corporate and corporate taxes from private income. Personal disposable income is derived by deducting direct taxes paid by the household and miscellaneous receipts of the government from personal income. Pension Fund: Refers to an independent legal entity formed by pooling resources through contribution of members. Pension fund money is invested in financial assets as per the regulations framed by pension fund regulators. Premium: When one person buys a life insurance policy he/she has to pay lump sum amount or periodically, that is, half yearly/quarterly or monthly a stipulated amount to the insurer. This payment is called as premium. Premium Back Term Insurance: Refers to the term insurance policy which refunds all the premium in case the life assured survives at the end of the policy terms, while the total sum assured is payable to the beneficiaries in case life assured dies during the policy terms. Policy Conditions: In a life insurance contract certain conditions are stipulated which cover definitions, guarantees, options, exclusions, etc. Pure Endowment: Refers to the endowment contract under which benefits are payable if the life assured survives till the date of maturity. Purchasing Power Parity (PPP): PPPs are the rates of conversion of currencies which equals purchasing powers of different currencies. Reinstatement: Refers to restoration of a life insurance policy by paying premium other requirements if any, after the policy has lapsed. Reinsurance: It is a risk management mechanism of a life insurance company under which the original insurer transfers a part or full risk to one or more reinsurance companies. Repo Market: A market in which a holder of gilt or other securities can sell to another party with an agreement to repurchase them at an agreed price at a specified date.

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Reversionary Bonus: Refers to payment of bonus which will enhance policy benefits in future. Generally regular bonuses are reversionary in nature. Rider: An add on benefit available to a policyholder on option along with original policy benefits. Risk Premium: Refers to a premium that covers a specific risk. Rural Sector: According to the IRDA definition any place under the latest population census of India considered as rural having population not more than 5,000, a density of population not more than 4,000 per sq. kilometer and at least 75 per cent of male working population is engaged in agriculture. Salary Saving Schemes (SSS): Refers to a form of arrangement with an employer under which employees can pay their life insurance premium through deduction in salary. Single Premium Policy: A form of payment system under which the policyholders make lump sum one time payment of premium to purchase a life insurance policy. Standard Risk: Refers to the average risk on which the rate of premium is based. Securitization of Risks: Refers to a mechanism under which an insurance risk is diversified by using capital market. For this an insurance company raised money through capital market to cover risks. Solvency Margin: Refers to the amount by which the assets of an insurer exceed the liability which is available to cover its required solvency margin. It also refers to the capital base and is defined as surplus assets over liabilities. An insurance company must maintain minimum solvency margin. Solvency Ratio: Refers to the ratio of the amount of available solvency margin to the amount of required solvency margin. Available solvency margin refers to the surplus of value of assets over value of liability. Statutory Reserve: Refers to the mathematical reserve published by a life insurance company in IRDA returns. Sum Assured (SA): Refers to the amount stated in the policy contract. This is the only benefit paid to the policyholders without profit contract under endowment, pure endowment, term assurance or whole life contract. However, in case of with profit policy the amount of bonus is added to the SA. Sum at Risk: Refers to the amount which is the difference between the sum assured and the reserve for a policy.

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Surrender: Surrender occurs when a policyholder ceases paying premium as per the life insurance contract. Surrender Value (SV): The amount paid by a life insurance company to a policyholder for a surrendered policy. Term Assurance: A form of life insurance policy under which the life insurance company pays a stated benefit if the policyholder dies within a certain period. On surviving the policy terms, the policyholder does not get anything. Treasury Bill: A form of government bill usually issued with a 182 days or 91 days or 30 days term. Underwriting: Refers to the process of identifying and classification of risks under a life insurance policy. Universal Life Insurance: It is a kind of policy having facility of premium payment flexibility. Policyholders may change the death benefits and change the timing and amount of premium payment on fulfilment of certain requirements. Variable Annuity: Annuity benefit payment which varies from year to year depending on the value of portfolio of securities. Vesting: Refers to the attainment of rights to receive the benefits. Valuation: Refers to the assessment of life insurance policy reserve. Whole Life Policy: Life insurance policy if kept in force, benefit payments are made upon the death of the policyholders. Waiver of Premium: Refers to the condition in the life insurance contract under which a life insurance company can waive unpaid premium.

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Index

American Marketing Association (AMA), 303 annuity market emergence, 112 expansion, 129 annuity plans, 173 asset management, 232 institutional investors, 18 insurance companies, 20 asset preference pattern, 138 bancassurance, 184 bank assurance, changes, 28 banking sector, India, 38 BRIC, real GDP growth, 35 capital inflows, impact, 6 capital market development, 15 importance, 31 products, 176 reforms, 52 regulation, 50–52 transformation, 47 trends, 46 Central Government Health Scheme (CGHS), 106 challenges, organizational response, 353 change agents, identification, 355 change management, 358 role of institutions, 345 changes, marketplace, 343–45 Chief Risk Officer (CRO), 263 code of conduct agents, 333 corporate agents, 335 insurance brokers, 339–342

Commission of Sponsoring Organizations of the Treadway Commission (COSO), 247 Committee on Examination of Regulatory Issue, recommendations, 109 community-based health insurance, 107 Composite Financial Services Provider (CFSP), 202 Composite Marketing Strategy (CMS), 207 Consumer Price Index (CPI), 275, 278 contractual savings, 14, 38, 45 convergence and life insurance industry, 162 financial services, 159, 160, 161, 163 models, 161 convergent financial market, 159–209 corporate agents, 185 corporate debt markets, 55–56 corporate governance, 231 and life insurance, 311–26 definition, 312 implementation, 316 in India, 317 OECD principles, 312 scope, 314 SEBI guidelines, 319 corporate risk management, policies and procedures, 263 corporate sector savings, 45 Corporate Social Responsibility (CSR) and life insurance, 326, 332 definition, 327 dimension, 328 Critical Illness Policy, 107 debt market developments, 55 Defined Benefit (DB), limitations, 112

Index demand for money, 280 demographic characteristics, India, 104, 127 derivatives market, 57 development financial institutions, 40 development of insurance market, impact of macro economy, 60 distribution channel, changes, 28 domestic savings, growth, 135 economic environment, India, 31 economic liberalization, 2 emerging countries, life premium market, 146 emerging financial markets, 36 emerging macro economy, India, 31, 33 emerging market economies, 25 emerging markets benefits, 21 market share, 146 regional insurance premium, 147 Employee State Insurance Scheme (ESIS), 106 employment, growth, 130 Enterprise Risk Management (ERM), 249 exchange rate policy, 288 exports, growth, 12 external sector, 288 finance sector, nationalization, 83 financial assets savings, 45 financial globalization, 5, 7 financial institutions assets, 40, 41–42 role, 36 financial integration, pitfalls, 160 financial intermediaries, role, 2 financial liberalization foreign investment, 5 international capital flows, 5 financial markets deregulation, 91 role, 2 structure, 38 financial policies, 2 financial sector reforms, 32, 38, 50 financial services, 33 financial services integration, 70, 71 fiscal policy, 284–86 fixed income derivatives, 292 Flow of Fund (FOF), 275

379

foreign institutional investment, 57 foreign investment flow, 13 formal sector employment, lack of access, 132 Global Financial Stability Report, 6–7, 18 global insurance industry, developments, 28 global integration, 285 global life insurance industry, structural changes, 28 global life insurance market, emerging trends, 22 globalization and economic growth, 8 and financial market liberalization, 30 future prospects, 72 impact, 32 India, 9, 10 reforms, 11 governance efficiency, improvement, 353 governance model, 315 governance through regulations, supervision and risk capital, 296–300 governance, instruments, 315 government securities, India, 56 Gramin Bank, 133 Gross Domestic Product (GDP), 2, 265 Gross Development Savings and Life insurance, relations, 62, 63–64 growth, 32 high growth rates, 136 sectoral contribution, 33 Gross Domestic Savings (GDS), 44, 137 Gross National Product (GNP), 266 growth rates, changing trends, 35 health care, in India, 104–11 private sector, 107 health insurance awareness creation, 111 definition, 104 in India, 103–11 policies, 104, 107 product pricing, 110 Hospital Cash Policy, 107 household assets, distribution, 16 household sector savings, 44–49 human capital, management, 350 Human Development Index (HDI), 131 imports and exports, composition, 288

380

LIFE INSURANCE IN INDIA

India balance of payments, 13 characteristics of reforms, 9 economic reforms, 10 emerging macro economy, 33 growth rate in life premium, 144 merchandize trade, 12 mutual fund industry, 39 per capita income, 33 savings market, 43–46 Indian insurance industry, 40 Indian life insurance changes in market structure, 75 international context, 142 Indian pension reforms, reports, 112 indices, 278 institutional investment, 18 in emerging markets, 19 trends, 51 Insurance Act 1912, 77, 78 Insurance Act 1938, 79 insurance agents, 184 insurance and economic growth, interrelationship, 59 insurance brokers, 183 insurance companies, risk transfer, 17 insurance industry, tariffs and entry barriers, 26–27 insurance market evolution, 346 liberalization, 2 regulation, 96 insurance ombudsman, 193 Insurance Regulatory Act 1999, 91–94 Insurance Regulatory and Development Authority (IRDA), mission statement, 92 Insurance Regulatory and Development Authority (Microinsurance) Regulations 2005, 177 insurance services, information acquisition, 17 insurance, concept, 133 Integrated Scheme of Social Risk Management (ISSRM), 179–81 integration, financial services, 160 interest rates, 281 internal control, 264 internal marketing culture, 355 international trade, 4 intra-market competition, 162 investment by LIC, 236

company-wise investment, 240 fund-wise investment, 241, 242, 244, 245 instrument-wise allocation of investment, 241 investment of life funds, 240 investment policy, 232–34 LIC investment in India, 239 management, 351 post-liberalization period, 235 investment committee, 289 investment institutions, India, 40 investment management by life insurance companies, 232–45 strategic issues, 225 investment policy, 226 investment regulation, 222–25 investment research, 230 IRDA guidelines, 291 IRDA Licensing of Insurance Agents Regulation 2000, 310 IRDA life insurance products, salient features, 208–15 Jana Arogya Bima Policy, 107 knowledge management, 351 Kumar Mangalam Committee, 317 labour migration, 4 life business, regulation, 289 life insurance, 14 and e-commerce, 186 and population growth, 70 as financial intermediary, 15 confidence in, 137 deficiencies, 83 density, 145 distribution practices, 182 ethics in business, 300, 304 examples of ethical conduct, 305–11 globalization, 20 growth, 61, 97, 137, 144 impact of inflation, 60, 66 impact of price, 60 in emerging economies, 148–49, 150 in India, 58, 75 market share, 100, 101 market structure, 75, 83 mobilization of savings, 15

Index penetration, 60, 144, 145 private sector, 98 product portfolio, 221 reasons for low penetration, India, 204 regulation, 77 risk management, 246 rural market penetration, 189–91 life insurance business, growth, 80, 81 life insurance companies asset allocation, 17 equity share capital, 95 support to market, 16 Life Insurance Corporation (LIC) of India controlled business, 151–56 life fund, 157–58 life insurance demand, determinants, 59 life insurance developments, post-liberalization, 95 life insurance funds, independence of, 62 life insurance governance, 295–342 life insurance industry change and challenges, 343–58 global transformation, 141 India, 142 merger and acquisition, 95 nationalization, 83 phases, 76, 102 transformation, 73 life insurance investment management, 220–94 life insurance literacy promotion, 347 changes, 72 classification, 183 expansion, 136 forecasts, 139–42 growth, 84–90 market characteristics, 164–65 life insurance penetration, regional variation, 23, 24 life insurance premium, growth, 22 life insurance product types endowment plans, 169 term assurance, 169 unit linked plans, 171–75 life insurance products distribution, 181 marketing, 166 life microinsurance products, 177–79

381

macro economy, India, 58 macro economic variable, growth in India, 61 Malhotra Committee, recommendations, 91 managerial accountability, 357 market capitalization, 54 market forces, identification, 199 market management model, 201 market regulation, 77 market share life insurance density, 23, 24 regional variation, 23, 24, 142 market structure concept, 75 post-liberalization, 90 marketing research, 194, 197, 200, 201 marketing strategy development, 194 marketing, 202 concept, 182 macro–micro marketing strategy, 205 marketplace activities, categories, 302 markets, characteristics, 198 mediclaim, 106 merger and acquisition, 28 microcredit, 180 microcredit institutions, establishment, 134 microinsurance, 133, 180 IRDA guidelines, 135 support from Microfinance Institutes (MFIs), 133 microinsurance market, India, 130 microinsurance products, 176 Microinsurance Regulations, 2005, features, 215–18 Million Dollar Round Table (MDRT), 305 Minimum Benchmark Service (MBS), 192 monetary policy, 269 money supply, 269, 272–75 money, definition, 269 mutual funds, 53 Narayana Murthy Committee, 319 Naresh Chandra Committee, 318 National Accounts Statistics (NAS), 265 National Common Minimum Programme, 105 national economy, impacts of liberalization, 11 National Health Policy 2002, 105 national income data, 268 Net National Product (NNP), 266 New Business, 140

382

LIFE INSURANCE IN INDIA

New Generation Customers (NGCs), 203 New Pension System (NPS), 120–26 New Pension System, operationalization, 125 Old Age Social and Income Security, 113 Pearson’s correlation matrix, 63 pension and provident funds, 40 pension business, 141 Pension Fund Regulatory and Development Authority (PFRDA), 123 pension liabilities of state governments, recommendations, 117 pension market potential, 127–30 FICCI–KPMG estimates, 129 pension reforms, 114–15 pension scheme, recommendations of high level expert group, 116 pension system, 112 personal disposable income (PDI), 66, 267 savings and life insurance premium, 69 Producer Price Index (PPI), 277 product guarantee, importance, 167 product–market relationship, 158–208 Protection of Policyholders Regulation 2002, 192 Prudent Person Rules, 231, 326 real sector reforms, 31 regional variation life insurance density, 23, 24 market share, 23, 24 regulation and self-regulation, benefits, 352 reinsurance business, 288 research activities, management, 352 resource mobilization trends, 51 Risk Budgeting (RB), 247 risk management, 247–64

categories, 248 competitive forces, 163 institutionalization, 260 practices, 255–60 strategy, 247 risks categories, 248 measurement, 251–55 sources, 247–51 savings trends, 126 scenario, 195, 196 SEBI Committee on Corporate Governance, recommendations, 261 secondary market development, 53 Self Regulatory Organization (SRO), 331 service sector, growth, 135 Social Management of Risks (SMR), 133 solvency regulations, India, 298 Specific Customers Cluster (SCC), 207 stock exchanges, India, 54 stock markets developments, 8 investment, 264 technology efficiency, optimization, 350 trade reforms, impact, 11 training activities, management, 352 unit linked life insurance business, 141, 288 unit linked plans, IRDSA guidelines, 173 Universal Health Insurance (UHI), 106 Universal Life Insurance, features, 175 Wholesale Price Index (WPI), 277 Working Group on Assessment of Pension Liability, 115

About the Author

H Sadhak is a graduate in Economics (Hons) (Calcutta University), postgraduate in Economics (Kalyani University) and holds PhD in Industrial Finance (Poona University) and Diploma in Operation Research for Management (Bombay University). He has got rich and varied experience in the financial services industry—Life Insurance, Pension Fund, Mutual Funds and Banking and also in teaching and research. Currently Dr Sadhak is the Chief Executive Officer, LIC Pension Fund Ltd, promoted by LIC of India and appointed as Fund Manager by the Pension Fund Regulatory and Development Authority (PFRDA), to manage pension funds under New Pension System (NPS). Prior to this, he has worked with Life Insurance Corporation of India, the largest life insurance company in India as an Executive Director. He was also with LIC Mutual Fund for 10 years and managed various operation including funds management. He had handled various assignments including investment in LIC Mutual Funds for 10 years. Before joining LIC, Dr Sadhak worked as an officer with Union Bank of India and as a lecturer in Economics. He has been associated with many high-powered committees of the Government of India, namely, sub-group of Household Savings 11th Five Year Plan, sub-group of Household Savings 10th Five Year Plan; Technical Advisory Group on Real Estate Price Index, Ministry of Finance, Government of India; Working Group of Fifth Economic Census; Central Statistical Organization (CSO), Government of India; Working Group on Insurance, National Statistics Commission, Committee on Household Savings, Reserve Bank of India. He was also the Convenor of Research and Statistics Committee of Association of Mutual Funds in India (AMFI). His earlier books Mutual Funds in India—Marketing Strategies and Investment Practices, Impact of Incentives on Industrial Development of Backward Regions and Role of Entrepreneurs in Backward Areas have been highly appreciated. He has contributed a large number of articles on finance, mutual funds, industrial development, life insurance, mutual funds and management in leading economic/professional journals and dailies in India and abroad. He has received several national awards for his research/contributions and attended several national and international seminars and conference as a speaker.