Impact of Liberlisation On The Insurance Industry

IMPACT OF LIBERALISATION ON THE INSURANCE INDUSTRY.
CHAPTER 1
INTRODUCTION
Insurance sector reform has become one of the most contentious issues
in Indias economic reform process. Unlike in the banking sector, which has
seen both greater competition and a better regulatory framework since the
submission of the report by the first Narasimham Committee in 1992, the
insurance sector continues to defy and stall the course of financial reforms in
India. It continues to be dominated by the two hedgemons, Life Insurance
Corporation of India (LIC) and the General Insurance Corporation of India
(GIC), and is marked by the absence of a credible regulatory authority.
The first sign of government concern about the state of the insurance
industry was revealed in the early nineties, when an expert committee was set
up under the chairmanship of late R.N.Malhotra. The Malhotra Committee,
which submitted its report in January 1994, made some far reaching
recommendations which, if implemented, could change the structure of the
insurance industry. The Committee urged the insurance companies to abstain
from indiscriminate recruitment of agents, and stressed on the desirability of
better training facilities, and a closer link between the emolument of the agents
and the management and the quantity and quality of business growth. It also
emphasised the need for a more dynamic management of the portfolios of these
companies, and proposed that a greater fraction of the funds available with the
insurance companies be invested in non-government securities. But, most
importantly, the Committee recommended that the insurance industry be opened
up to private firms, subject to the conditions that a private insurer should have a
minimum paid up capital of Rs. 100 crore, and that the promoters stake in the
otherwise widely held company should not be less than 26 per cent and not
more than 40 per cent. Finally, the Committee proposed that the liberalised
insurance industry be regulated by an autonomous and financially independent
regulatory authority like the Securities and Exchange Board of India (SEBI).
Subsequent to the submission of its report by the Malhotra Committee,
there were several abortive attempts to introduce the Insurance Regulatory
Authority (IRA) Bill in the Parliament. While several political parties were
against the very idea of allowing private firms to enter the insurance industry,
others were unsure about the extent of the stake that foreign investors/firms
should be allowed to have in the post-liberalisation insurance companies.
However, it was evident that there was broad support in favour of liberalisation
of the industry, and that the bone of contention was essentially the stake that
foreign entities was to be allowed in the Indian insurance companies. In
November 1998, the central Cabinet approved the Bill which envisaged a
ceiling of 40 per cent for non-Indian stakeholders: 26 per cent for foreign
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collaborators of Indian promoters, and 14 per cent for non-resident Indians

(NRIs), overseas corporate bodies (OCBs) and foreign institutional investors
(FIIs). However, in view of the widespread resentment about the 40 per cent
ceiling among political parties, the Bill was referred to the standing committee
on finance. The committee has since recommended that each private company
be allowed to enter only one of the three areas of businesslife insurance,
general or non-life insurance, and reinsurance and that the overall ceiling for
foreign stakeholders in these companies be lowered to 26 per cent from the
proposed 40 per cent. The committee has also recommended that the minimum
paid up share capital of the new insurance companies be raised to Rs. 200 crore,
double the amount proposed by the Malhotra Committee. The redrafted Bill,
which was scheduled to be introduced in the Parliament during the budget
session of 1999, is yet to see the light of the day.
The liberalisation of the insurance industry in India has thus emerged as
the litmus test for the ability and the willingness of a central government to push
through market friendly economic reforms. At the same time, the governments
action in this sphere of economic activity is being viewed by some others as the
indicator of the extent to which the government is willing to accommodate the
dictates of the International Monetary Fund and the United States. The
consequence has been politicisation of the reform of the insurance sector, and
analyses of possible post-liberalisation scenarios have given way to jingoism
and doublespeak.
The insurance industry is a key component of the financial
infrastructure of an economy, and its viability and strengths have far reaching
consequences for not only its money and capital markets,1 but also for its real
sector. For example, if households are unable to hedge their potential losses of
wealth, assets and labour and non-labour endowments with insurance contracts,
many or all of them will have to save much more to provide for events that
might occur in the future, events that would be inimical to their interests. If a
significant proportion of the households behave in such a fashion, the growth of
demand for industrial products would be adversely affected, thereby reining in
industrial and GDP growth. Similarly, if firms are unable to hedge against bad
events like fire and on the- job injury of a large number of labourers, the
expected payoffs from a number of their projects, after factoring in the expected
losses on account of such bad events, might be negative. In such an event, the
private investment would be adversely affected, and certain potentially
hazardous activities like mining and freight transfers might not attract any
private investment. It is not surprising, therefore, that economists have long
argued that insurance facility is necessary to ensure the completeness of a
market.
However, while insurance companies provide hedging opportunities
to households and the corporate sector by selling them de facto American put
options that can be exercised in the event of a calamity, they themselves remain
2
vulnerable to risks that are associated with risk management. Further, owing to
changes in the nature of their products, they are increasingly becoming
vulnerable to the risk that is usually associated with banks and non-bank
financial intermediaries, namely, mismatch of assets and liabilities. While not a
significant amount has been written about the experiences of the emerging
markets, the US experience suggests that even in a developed financial markets
with provisions for supervision, insurance companies can become insolvent
and/or face runs. Since the viability of insurance companies is a necessary
condition for the emergence of a robust insurance industry, it would be
imprudent to ignore the impact that market forces might have on the aforesaid
viability.
This paper will trace, in brief, the experience of the US insurance
industry over the decades. First, it will introduce the readers to the
organisational forms that dominate the structures of the life and non-life
insurance companies. Next, it will highlight the factors that most affect the
health of these companies, and the role that regulations might play in
determining the eventual outcome. Finally, in the light of the above discussion,
it will provide a backdrop for a more meaningful discussion about the
liberalisation of the insurance sector in India.
CONCEPT OF INSURANCE
In our daily lives, there is a risk involved when there is uncertainty.
Instinct of security against such risks is one of the basic driving force for
determining the attitude of human beings. You must as a sequel of this quest, the
concept of insurance has been born for security. Urge to provide insurance and
protection against loss of life and property, you must have been promoted to do
some sort of people willing to sacrifice the cooperation of the population, to
achieve security. In this sense, the story of insurance is probably as old as the
story
of
mankind.
Life insurance, against the risk of premature death of its members to earn
income, especially to provide protection to home. Life insurance is also modern,
provides protection against the risk of (health insurance) and disease and
disability (i.e. risk of outliving source of income) of such risks, such as livingrelated and other longevity. The product is to provide a longevity annuity and
pension (insurance against old age). Non-life insurance provides protection
against accident liability, property damage, and other theft. Compared to the life
insurance contract, non-life insurance contract, the duration, but typically
shorter. In the bundle, is peculiar of life insurance coverage risks and Ministry
together. To provide both life insurance and investment protection.
Insurance is good news on the business problem. Insurance, which provides
short and long-distance relief. Short-term relief, by distributing the loss among
large numbers of people through the medium of Risukubeara specialty, such as
the Insurance Company, and is intended to protect the insured from loss of life
and property. Therefore, to enable business people to face the unexpected loss
of, he need to worry about the possibility of loss is not available. The object for
which long-term growth of the country's economic and industrial investment of
funds by insurance companies with a huge organizational and commercial
industry to be able to use.
CHAPTER 2
EVOLUTION OF THE INSURANCE INDUSTRY
Pre-Liberalisation
The Indian Insurance Industry is as old as it is in any other part of the world.
There were a number of foreign and Indian insurers operating in the Indian
market. Regulations were passed to regulate the Indian insurers but not the
foreign companies providing insurance services in India. However these
legislations became insignificant with time and the Government nationalized
the sector in 1956 by combining about 250 Indian life insurance companies to
form a single firm- the Life Insurance Corporation (LIC) of India who was the
sole provider. Thus the industry was transformed from a competitive one to a
highly regulated monopoly. The reasons behind the nationalisation decision
included the Governments need to channel more resources towards national
development programmes, to increase insurance market penetration through
nationalisation and to protect the interests of the policy holders from failures
which were the result of mismanagement. It was also felt that the
nationalisation of this sector would lead to more effective mobilisation of funds
to enable capital to be allocated to development projects.
With the Government of India implementing the New Industrial Policy in
FY91, under which the Indian economy was opened up to foreign investment,
sectors such as banking and finance were reformed. The liberalisation of the
Indian economy also forced policymakers to review the policies governing the
Indian Life insurance industry. In Apr 93, the government of India appointed
the Malhotra Committee on Reforms in the Insurance Sector. The Committee,
which submitted its report in Jan 94, recommended that the insurance sector in
India be opened up to private players. It was felt that customer service,
insurance coverage and allocation of resources needed to be improved within
the industry. Also more innovative products were needed to suit varied
customer needs and to change the attitude of people towards insurance.
Opening up the insurance sector resulted in the passage of two legislatures.
These were the Insurance Regulatory and Development Authority (IRDA) Act
in FY99, which would make IRDA the statutory regulatory body and
amendment of the LIC and GIC Acts, which would end their respective
5
monopolies. With the passage of the IRDA Act the Indian Life insurance
industry was liberalized in FY00 with the aim of increasing competition in the
industry and to tap the vast potential it provided.
Post Liberalisation
Since opening up the sector, the Life insurance market in India witnessed
dynamic changes including the entry of a number of global life insurers that led
to increased competition in the Indian Life insurance market. As a result, first
year premium (single as well as regular) in the life insurance industry (LIC as
well as private players) registered significant growth in the last eight years
(FY02-FY09); from Rs 198.6 bn in FY02 to Rs 871.08 bn in FY09. Intense
competition has also forced the life insurance industry to improve its
underwriting and risk management abilities that has greatly benefitted the
policyholders. Moreover, customers today are more conscious of the need for
risk mitigation and greater security for the future such as retirement plans. Life
insurance companies have been quick to recognize the larger need for
structured retirement plans and have leveraged their abilities of long-term fund
management towards building this segment.
1) Number of Private Players:

The number of private life insurers has more than doubled from 10 in
FY01 to 21 in FY08 with expansion of existing as well as new players
6
continuing to rise. By the end of Mar 08, there were eighteen life
insurance companies operating in India. Subsequently, Aegon Religare
Life Insurance Company Limited, Canara HSBC Oriental Bank of
Commerce Life Insurance Co. Ltd and DLF Pramerica Life Insurance
Company Limited were given Certificate of Registration by the
Authority. The number of offices of the Life insurers has also increased
dramatically during the year FY08 from 5,373 at the beginning of the
year to 8,913 by the end of the year, showing a growth of over 65%. A
major portion of this expansion was in the private sector whose offices
more than doubled from 3,072 to 6,391. LICs offices increased at a
more modest 10% from 2,301 offices to 2,522.
2) Unit-Linked Insurance Plans:
In the life insurance segment, various unit linked insurance plans
(ULIPs) have been introduced by private players, which helped them to
compete against LIC and also create a clientele comprising of
individuals who are willing to opt for these plans for purely investment
purposes. Since these unit link plans have been developed keeping in
mind the various investment needs of the consumers, these products have
become very popular. Since liberalisation, the growing popularity of
ULIPs has been a key factor behind the growth in private sector life
insurers. In fact, more than half of the premium income of private
companies in the life insurance segment is contributed by these unitlinked plans. Even today, unit linked insurance products continue to
dominate most private players portfolio and the proportion of business
coming from ULIPs remains large. From a growth rate of 82.3% (y-o-y)
in total private life insurance business in FY06, ULIPs registered a
growth rate of 90.3% (y-o-y) in FY08. Traditional policies like term
products and endowment based products form a relatively small
proportion and remains small.
3) Innovative Distribution Channels:

Innovation in distribution channels has also played a major role in
pushing products into markets that were initially uncovered. All the
companies have indulged themselves in appointing and training advisors
for better productivity. Public sector giant SBI Life has developed an
interactive website and a toll free helpline to match the marketing might
of private players. These changes have led to marked improvement in the
response and turnaround time in policy documentation, first policy
receipt, final maturity payment and settlement of claims by companies.
The companies have also discovered innovative ways to better the
services provided by them by outsourcing some of the processes and
services.
4) Competition:
To counter competition from the private players, LIC has also expanded
its product portfolio and has added a number of new products in its
basket such as Jeevan Anurag and Jeevan Nidhi insurance policies.
Unit linked products were also a major contributor to LIC business
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portfolio, growing by 29.76% (y-o-y) in FY06 while non-linked products

grew by 70.24% (y-o-y) during the same year. However, since then, this
scenario has improved with LIC making stronger strides in the sale of
ULIPs to counter stiff competition posed by the private players. As a
result, y-o-y growth rates of ULIPs in LICs portfolio increased to
46.31% and 62.31% in FY07 and FY08 respectively, while the growth
rate of non-linked products moderated from 53.69% (y-o-y) to 37.69%
(y-o-y) in FY07 and FY08 respectively. Besides making rapid strides in
the ULIP segment, a well-established brand and distribution network
continues to aid LIC in retaining a dominant share in the Indian Life
insurance market today.
5) Insurance Penetration:
Expansion of business by private life insurance players in uncovered
market has been the main reason behind Indias increased insurance
penetration. Through the development and effective use of new
distribution channels (eg. bancassurance), Life insurance players have
been able to target previously uncovered markets. This in turn has
contributed to an increase in the level of penetration. Total Life insurance
penetration (premiums as a percentage of GDP) in India was 1.5% in
1990 and was not much higher by the middle of the decade. However,
Life insurance penetration in India improved since liberalisation in 2000.
From 2.15% in 2001, Insurance penetration rose to 2.59% in 2002 before
declining to 2.26% in 2003. Life insurance penetration rose yet again to
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2.53% in 2004 and remained at the same level in the subsequent year. A
milestone occurred in 2006 when Indias insurance penetration nearly
doubled to 4.10% before declining marginally to 4.00% in 2007.
However, when compared to other countries, the life insurance market in
India is significantly under- penetrated. India continues to remain way
behind (as on 2007) industrialized nations like UK (12.60%),
Switzerland (5.70%), France (7.30%), South Korea (8.20%) and Japan
(7.50%).
The level of penetration which is the measure of premiums as a

percentage of a countrys GDP in life insurance has a strong positive
correlation to income levels. India, with its huge middle class
households, exhibits untapped potential for the insurance industry.
Saturation of markets in many developed economies has made the Indian
market even more attractive for global insurance majors. Thus India
continues to be an attractive market for most insurance players both
domestic and foreign.
6) Insurance Density:
Per capita income of consumers plays a vital role in determining the
amount an average consumer spends on insurance. By this measure,
India is among the lowest-spending nations in the world in respect of
purchasing insurance. However, spending on insurance is on a growth
trajectory in India. Indias improving economic fundamentals was a key
10
support factor for faster growth in per capita income in recent years,
which translated into stronger demand and spending for and on insurance
products. From spending a mere US$ 9.1 on insurance in 2001, spending
rose consistently over the next six years to touch a high of US$ 40.4.
This 2007 level of spending, while higher than its neighbours (Sri Lanka
US$ 10.2, Pakistan US$ 2.6 and Bangladesh US$ 1.9), continues to
remain far behind most industrial nations like the US (US$ 1,922.0), UK
(US$ 5,730.5), Japan (US$ 2,583.9) and South Korea (US$ 1,656.6) and
just behind China (US$ 44.2). One factor that has been slowing down the
improvement of insurance density is Indias relatively high population
growth rate, which has averaged 1.7% over the past ten years.
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CHAPTER 3
NEED FOR LIBERALISATION IN INSURANCE
SECTOR
The point that India is a jumbo-sized opportunity for life
insurance need hardly be belaboured. Here is a nation of a billion people, of
whom merely 100 million people are insured. And, significantly, even those
who do have insurance are grossly underinsured. The emerging middle class
population, growing affluence and the absence of a social security system
combine to make India one of the worlds most attractive life insurance markets.
No matter how you look at it whether in terms of life insurance premiums as a
percentage of GDP or premium per capita the market is under penetrated and
people are under-insured.
In a country where there is high unemployment and where social security
systems are absent, life insurance offers the basic cover against lifes
uncertainties. India has traditionally been a savings-oriented country and
insurance plays a critical role in the development of the Indian economy. The
role of insurance in the economy is vital as it is able to mobilize premium
payments into long-term investible funds. As such, it is a key sector for
development.
A brief history
For 43 long years the government-owned Life Insurance Corporation of
India (LIC) held a monopoly. It is only at the dawn of the twenty-first century
that the sector was finally deregulated. Reforms were initiated with the passage
of the Insurance Regulatory and Development Authority Bill in Parliament in
December 1999. The IRDA since its incorporation as a statutory body in April
12
2000 has regulated the opening up of the insurance sector, which has seen 13
life and an equal number of non-life private companies launch their operations
in India.
In India, the decision to liberalize was not easily implemented since there
was resistance to privatization. After all, this would mean:
Ending the government monopoly on mobilizing large-scale funds
LIC, a successful life insurance company, would face the heat;
The foreign insurance companies would come marching in.
That was not all. There were other concerns too. Would new market entrants
hire away all the best employees of LIC? Would the world-renowned foreign
insurers that would enter the market lure current and future Indian
policyholders? How would the citizens of India benefit from liberalization?
What would be the impact on Indias capital markets?
13
CHAPTER 4
BENEFITS OF LIBERALISATION IN INSURANCE
SECTOR
Opening up the sector has transformed the landscape. The Indian

regulator has done a commendable job in liberalizing the market and putting in
place rules of the game to effectively monitor the entry and progress of the new
entrants.
Domestic liberalization and introducing the monopoly providers to
competition has been a part of this story. The positive change brought by
deregulation is inestimable. Even so, some benefits are immediately apparent
1) Real life insurance:
Historically, life insurance has been sold in India as an investment tool.
Attracted by the prospect of reasonable returns and tax savings, people put away
some money into life insurance. Protection against risk which represents the
true value of life insurance did not quite enter the frame. Until the entry of
private life insurance companies. For instance, Max New York Life introduced
the Whole Life product in the Indian marketplace in the belief that a good life
insurance product offers the right balance between protection and savings.
2) Product range:
14
The basket of products available to the customer has grown in the deregulated
environment that permits the introduction of the product.
3) Comprehensive risk coverage:
Deregulation has enabled people in India to cover a larger variety of risks.
Earlier people had no option but to buy pre-packaged life insurance products,
which lacked flexibility. Customization, however, has been one of the key
advantages of privatization. Riders have added value to the customers life
insurance needs. Max New York Life was the first company to offer base
products and riders.
4) Customization:
In earlier days, customers could only buy limited pre-packaged products pushed
by agents chasing quick sales. Today customers have access to more and better
products that suit their specific needs and a new breed of insurance advisors has
taken birth. These agent advisors build enduring relationships with their clients
and help them better understand the value of life
insurance and sell customized solutions in a needs-based manner. This higher
quality of sales interaction has been among the key benefits of privatization.
5) Market awareness:
The money that private life insurance companies have spent on establishing
their brands has helped create
awareness about life insurance. Today life insurance brands compete with other
financial services and manufacturing brands for
marketing space.
6) Rapid progress :
In most other markets that opened their economies, new entrants in life
insurance have taken 10 to 12 years to secure a market
share of 10 per cent. In India, however, the progress of private life insurers has
been considerably more dynamic. In less than five years since deregulation,
private life insurance companies have secured 25 per cent of the market share
from LIC. Further the private sector insurers have achieved year-on-year growth
of more than 60 per cent. In the number of new policies too the market
shares achieved by the new players is quite impressive.
In the short period following liberalization, the new private sector insurers
have together introduced more that 200 state-of-the-art products giving the
15
customers a very wide choice indeed. It is this new dynamism that has caused
insurance penetration togrow to 2.2 per cent during the years following
liberalization.
Indeed, life insurance is a very large financial service, a valuable medium
of long-term savings and growing at 24 per cent CAGR.
In addition to the benefits to customers of finding products to meet their
needs, the insurance sector has also created
sizeable job opportunities. Professionalization of insurance selling and new
marketing concepts introduced by foreign players has meant that many more
people are taking to insurance. There are today in India a million insurance
agents and another 200,000 employees.
The introduction of competition from foreign insurers has also served to
wake up the large State-owned company, the Life Insurance Company of India
or LIC. LIC has shaken off slumber, upgraded its systems, embraced actuarial
prudence, and introduced more modern products and withdrawn products that
had inherent guarantees in them.
Foreign participation has created benefits not only for the new entrants, but
also for the players already in the market. While the initial concerns were
focused on how domestic insurers would lose their 100 per cent of the pie, the
market has actually become more like a seven-layer cake. Even with a reduced
market share, the actual number of policyholders has greatly increased.
7) Leveraging globalization:
Recognition of the benefits of foreign participation to the Indian economy

and consumers is at the heart of the Indian Finance Ministry and IRDAs
support for a proposal now before the Indian Parliament to increase the foreign
investment limit in the insurance sector from 26 per cent to 49 per cent. This
increase will allow insurance companies to absorb new capital, which will
facilitate industry expansion, the deployment of technical competencies, and the
inflow of the latest products and services.
The restrictive era in foreign investment policy was consistent with a high
level of trade protection and wave of economic nationalism that perceived
foreign investment to mean a loss of sovereignty and foreign acquisitions. India
has put that era firmly
MULTIPLE BENEFITS:
India has traditionally been a savings-oriented country and insurance plays
a critical role in the development of the Indian economy. As one of the three
16
pillars of financial systems, insurance serves a distinctive role in managing risk,

providing for financial security, and mobilizing capital for investment.
The role of insurance in the economy is vital as it is able to mobilize
premium payments into ready capital. As such, it is a key sector for
development and a key area for attention for trade liberalization/negotiations. In
the Doha round, countries have an opportunity to capture the benefits of
liberalizing insurance and other financial services sectors. Perhaps the same
questions, which preceded the insurance sector opening in India, are being
asked in other world capitals. The questions are important and valid. The
evidence for liberalization and the benefits to your citizens are tangible and
positive.
Our experience in India is a significant case in point. The World Banks

2001 report on Global economic prospects for developing countries indicates
that liberalization of services could provide as much as $6 trillion in additional
income in the developing world between 20052015.
Services underpin economic development efforts because more efficient

provision of services in finance, telecommunications, transportation and
professional business services would have broad linkage effects that make entire
economies more efficient and globally competitive.
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CHAPTER 5
ORGANISATIONAL STRUCTURES & THEIR
IMPLICATIONS
Insurance companies can be broadly divided into four categories:

stock companies, mutual companies, reciprocal exchanges, and Llyods
companies. The former two are the dominant forms of organisational structures
in the US insurance industry. A stock company is one that initially raises capital
by issue of shares, like a bank or a non-bank financial institution, and
subsequently generates more funds for investment by selling insurance contracts
to policyholders. In other words, there are three sets of stakeholders in a stock
insurance company, namely, the shareholders, the managers and the
policyholders. A mutual company, on the other hand, raises funds only by
selling policies such that the policyholders are also part owners of the
companies. Hence, a mutual company has only two groups of stakeholders,
namely, the policyholder cum part owners and the managers.
As in any organisation, the objectives of the owners, managers and
policyholders are significantly different, giving rise to conflicts of interest or
agency problems (Jensen and Meckling, 1976). Specifically, owners and
managers are often more keen to undertake risky activities than are the
policyholders, largely because the former have limited liability such that, in
the event of an unfavourable outcome, the policyholders will have to bear the
lions share of the loss. However, it is unlikely that in a company the risk
appetite of the owners and the managers will be similar, and this provides the
owners with a rationale to monitor the managers.
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In principle, both the shareholders in a stock company and the

policyholder-owners in a mutual company have it in their interest to monitor
the managers. But whereas stockholders can exit a company easily by selling its
shares in the secondary market, thereby paving the way for a take-over, the
policyholder-owners find it more difficult to exit because they then have to
incur the informational cost of associating themselves with another (viable)
company. In other words, the threat of exit by owners, and the associated threat
of overhaul of the incumbent management by the new owners, is more credible
for stock insurance companies than for mutual insurance companies. Hence,
policyholder-owners of mutual companies are likely to allow the managers of
these companies less operational flexibility than the flexibility of the managers
in stock insurance companies. As a consequence, the mutual insurance
companies are likely to be more conservative with respect to risk taking than the
stock companies.
Alternatively, if an insurance company writes lines of business that do
not require a significant amount of managerial discretion, then it might be
profitable for the company to adopt the mutual ownership structure and thereby
eliminate the agency conflicts that can potentially arise between the owners and
the policyholders. For example, if a life insurance company writes only straight
life policies that do not have an investment component, then the company will
not require deft treasury/portfolio management on a day-to-day basis. It can
simply invest the collected premium in government bonds, highly rated
corporate securities, and blue chip equities, and manage actuarial risk through
risk-pooling. In other words, the discretion required on the part of its managers
to efficiently run the company is minimal. Hence, it will be efficient for such a
company to adopt the mutual ownership structure and concentrate on protecting
the interests of its policy holder owners.
19
THE IMPACT OF REGULATION

While portfolio and cost management are important determinants of
the viability of insurance companies, the US experience indicates that the nature
and extent of regulation too plays a key role in determining the viability of these
companies. The insurance industry in the US has historically been one of the
most regulated financial industries. The nature of regulation of life insurance
companies, however, has differed significantly from the nature of regulation of
property-liability companies. Regulation of the former has typically emphasised
asset quality, while the regulation of the latter has largely concerned itself with
policyholders welfare.
Although the regulations governing asset quality of American life
insurance companies vary across the states, often the regulations of New York
State act as the binding set of regulations. The attraction of the New York
insurance market is its large size, and in order to sell policies in that state an
insurance company has to comply in substance with New Yorks laws and
regulations, even if it is domiciled in some other state. Indeed, New Yorks
insurance regulatory laws have had significant effect on the portfolio
composition of the life insurance companies.
The aforementioned regulations have restricted investment in equities
and mortgages which are perceived to be high risk-high gain financial
securities. As mentioned above, life insurance companies were able to
circumvent the problem by introducing separate accounts, initially only for
group pension plans and later also for individual plans. However, equities and
other high risk-high return assets still account for a small part of the industrys
asset portfolio. At the end of 1990, separate accounts accounted for USD 160
billion, i.e., about 11 per cent of the industrys assets. Of this, less than half was
held in the form of equities, and the rest in the form of bonds, mortgages, real
estate and other assets.
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The regulations of New York and other states have also had impact
on the quality of bonds held by the life insurance companies. New Yorks
insurance regulatory laws require that life insurance companies ensure that, for
all bonds purchased by them, the companies issuing the bonds have had enough
earnings to meet debt obligations for the previous five years. The bond-issuing
companies are also required to have net earnings 25 per cent in excess of the
annual fixed charges, and they should not be in default with respect to either
principal or interest payments. Further, regulation of various states impose
quantitative restrictions on the amount of risky bonds that can be purchased
by the insurance companies. For example, in June 1987, New York imposed a
20 per cent limit on the high-risk bonds issued by companies for financing
leveraged buyouts. In June 1991, this regulation was extended to all private
placements and medium grade bonds and, effective 1992, inside limits of 10
per cent, 3 per cent and 1 per cent were imposed on three categories of lowgrade bonds.
Finally, regulations of all states subject the life insurance asset
portfolios to the Mandatory Security Valuation Reserve (MSVR) requirement.
According to this requirement, which came into effect in June 1990, life
insurance companies are required to make mandatory provisions for all
corporate securities. The minimum provisioning, for A-rated and higher quality
bonds, is 0.1 per cent of par value, and the maximum provisioning of 5 per cent
is required for Caa-rated (or equivalent) and lower quality bonds. If the issuer of
a bond goes into default, the relevant loss is adjusted against the MSVR account
rather than against the companys surplus.
The consequence of these regulations has been a significant
increase in the life insurance companies appetite for government securities,
securities issued by government agencies, and mortgage-backed securities.
Indeed, the proportion of assets held in the form of government securities
increased significantly from less than 3 per cent in 1977 to about 12.8 per cent
in 1990, and these treasury securities accounted for 24 per cent of the industrys
bond portfolio. At the same time, at the end of 1990, the insurance companies
held only 6 per cent of their general accounts in the form of junk bonds (rated
B or lower). The total junk bond exposure of the life insurance industry stood at
about USD 60-70 billion, about 5 per cent of the industrys total asset base.
The life insurance industry has clearly benefited from the regulatory
restrictions imposed upon it by the state governments. The regulations have
protected their asset quality and, at the same time, they have been accorded
some flexibility and opportunities for yield enhancement in the form of
separate accounts The experience of the property-liability insurance industry,
on the other hand, is mixed at best. Political correctness on the part of the states
lawmakers have led to regulation of premia on workers compensation and auto
insurance policies in a large number of states. Their actions find support from a
section of the literature on insurance markets which argues that insurance
21
companies indulge in retroactive loss loading, thereby passing on the cost of

their past errors to the policyholders. Thus vindicated, state legislative bodies
also make it difficult for insurance companies to exit the markets for the
politicised lines, even if the companies feel that they are not earning a fair
rate of return in these markets. Often, an insurance company is forced to write
policies in unprofitable lines of business, in order to retain the right to write
policies in other lines of business.
Further, the non-life industry has suffered significantly as a
consequence of changing legal ethos. In the recent past, the US courts have
retroactively granted citizen-policyholders coverage against hazards, like those
from use of asbestos, that were not factored into the actual insurance contract.
As a consequence, the premia actually earned by the property liability
companies fell short of the fair prices of these contracts, and hence these
companies had to bear huge losses on account of these policies.
However, while politics and changing ethos might together have
dealt an unfair blow to the non-life insurance companies, the importance of
regulation cannot be overemphasised. The cyclical nature of the property
liability firms profitability requires that they be monitored/regulated such that
they are not in default during the unfavourable phases of the cycle. The
property-liability cycle is typically initiated by an exogenous shock which
increases the industrys profits. The higher profits enable the companies to
underwrite more policies at a lower price. During this phase, the insurance
market is believed to be soft. The decrease in price during thesoft phase, in
turn, reduces the profitability of the companies, and initiates the downturn in the
cycle leading to the hard phase. Hard markets are characterised by higher
prices and reduced volumes. Once the higher prices restore the industrys
profitability, the market softens again and the cycle starts again.
In order to prevent widespread insolvency among property-liability
companies, presumably during the soft phases, the National Association of
Insurance Commissioners (NAIC) evaluates the financial condition of each
property-liability company annually, using 11 financial ratios. If a company fails
to meet the minimum acceptable mark for 4 or more of these ratios then they are
singled out for special regulatory scrutiny. As a consequence, the asset quality
of property-liability companies has not been significantly affected by
proliferation of risky assets like junk bonds. Indeed, as of 1989, junk bonds
represented only 1.5 per cent of the industrys bond portfolio or 3.4 per cent of
its equity. It has been argued that the property-liability insurance industry in the
US is much more vulnerable to fraud and non treasury related mismanagement
than insolvency/bankruptcy on account of bad assets. During the late 1980s, for
example, many of the large multistate insolvencies were a consequence of the
refusal by reinsurers to honour reinsurance contracts on grounds of fraudulent
activities on the part of the ceding companies.
22
SUMMING UP : POINTERS FOR INDIAN

POLICYMAKERS
A significant part of the activities of the insurance industry of an

economy entails mobilisation of domestic savings and its subsequent disbursal
to investors. At the same time, however, they guaranty minimum payoffs to both
individuals and companies by way of the put-like insurance contracts. As
discussed above, these contracts can significantly affect behaviour of economic
agents and, in general, are perceived to lead to better outcomes/equilibria for
economies. Herein lies the importance of the viability of insurance companies:
insolvency/bankruptcy of an insurance company can be fast transformed into a
systemic problem in two different ways. The part of the systemic crisis that can
be attributed to the quasi-bank like function of a section of the insurance
industry is easily understood. However, even if an insurance company does not
default on its credit and investment related obligations, and merely reneges on
its insurance obligations, the adverse impact of such default on the economy
and the society at large can be quite devastating. For example, it is not difficult
to imagine the closure of a company that had not made provisions for damages
on account of (say) product related liability because it had believed that it was
protected from such damages by an insurance policy. The consequent
insolvency of the company can affect a number of banks and other companies
adversely, and a systemic problem will be precipitated. In other words, the
insurance industry in any country should be subjected to regulations that are
at least as stringent as, and perhaps more stringent than those governing the
activities of other financial organisations.
It is evident from the above discussion that decisions about what
23
constitutes acceptable portfolio quality, and the extent of price regulation hold
the key to insurance regulation in a post-liberalisation insurance market. As the
US experience suggests, insurance companies are usually subjected to stringent
asset quality norms. Indeed, while a part of their portfolio might comprise of
equity, mortgages and other relatively risky securities, much of their portfolio is
made up of bonds and liquid (and highly rated) mortgage backed securities. An
Indian insurance company, on the other hand, is constrained by the fact that the
market for fixed income securities is very illiquid such that only gilts and AAA
and AA+ rated corporate bonds have liquid markets. At the same time, absence
of a market for liquid mortgage backed securities denies these companies the
opportunity to enhance the yield on their investment without significantly
adding to portfolio risk. This might not pose a problem in the absence of
competition, especially if the government helps to increase the returns to the
policyholders by way of tax breaks, but might pose a serious problem if
liberalisation leads to price competition among a large number of insurance
companies.
It might be argued that if the insurance and pension fund industries
are liberalised, and if the fund managers of all these companies indulge in active
portfolio management, the liquidity of the bond market will increase
significantly. Such increase in liquidity across the board would enable the fund
managers to invest in investment grade bonds of lower rating and thereby add to
the average yield of their investment without adding significantly to their
portfolio risk. The problem, however, is that till the imperfect character of the
bond market is removed to a significant extent, the insurance companies might
either have to operate with thinner margins or remain exposed to unacceptably
high levels of liquidity risk. It might, therefore, be prudent for the policymakers
to impose stringent capital and reserve norms on the insurance companies, in
order to ensure their viability in the short to medium run.
Subsequent to liberalisation, the Indian insurance industry might
also be at the receiving end of regulations governing insurance prices/premia.
Specifically, there might be highly politicised interventions in the markets for
workers compensation and medical insurance. The government might also be
under pressure to regulate the prices of infrastructure related lines like freight
and marine insurance. In principle, the risks associated with such liability
insurance policies may be hedged by way of reinsurance. But if the reinsurers
price the risks accurately and the Indian insurance companies are forced to
underprice the risks, the margins of the insurance companies will be affected
adversely, thereby reducing their long term viability. In view of these political
and financial realities, it might be better to subsidise the policyholders of
politically sensitive lines directly or indirectly through tax benefits, if at all,
rather than distort the pricing of the risks themselves.
At the end of the day, it has to be realised that while competition
24
enhances the efficiency of market participants, the process of creative

destruction, which ensures the sustenance and enhancement of efficiency, is
not strictly applicable to the financial markets. Hence, while exit is perhaps the
most efficient option for insolvent firms in many markets, insolvency of
financial intermediaries calls for government action and usually affects the
governments budgetary positions adversely. At the same time, other things
remaining the same, the risk of insolvency is perhaps higher for insurance
companies than for other financial intermediaries because of the option-like
nature of their liabilities. Therefore, competition in the insurance industry has to
be tempered with appropriate prudential norms, regular monitoring and other
regulations, thereby making the robustness of the industry (in India) critically
dependent on the organisation (and efficiency) of and regulatory powers
accorded to the proposed Insurance Regulatory Authority. Preventing a malady,
as conventional wisdom goes, is better than trying to cure it once the disease has
set in.
25
CHAPTER 6
NEW DIMENSIONS OF LIBERLISATION OF
INSURANCE INDUSTRY
The world has become a global village. The Liberalisation, Privatization
and Globalisation (LPG) wave has sweeped across the global economies. The
two pillars of India's economic policy before 1991 have been protection and
public sector.
Thus the New Economic Policy 1991 was a departure from the regulated
planned economic tradition to that of LPG movement. After nearly a decade of
intense debate a consensus developed in India for ending the public sector
monopoly in insurance and opens the industry to private sector participants
subject to suitable prudential regulation.
Today, to the credit of combined efforts of both the regulator and industry
players, benefits of insurance are widely acknowledged, public confidence in
the industry has been very much restored and the industry has become more
dynamic. Following the recent reform in the insurance sector, Indian insurance
industry is moving ahead.
The main element in the reform process was the opening up of the
insurance industry in 2000 with foreign direct investment permitted up to 26 per
cent of equity. With this change global insurers have rushed into the country to
capture the market. The reforms have two objectives.
One to capture a vast untapped population under suitable insurance cover.
The second, to create a more efficient and competitive insurance industry and
elevate the performance of insurance companies.
26
The Insurance Regulatory and Development Authority (IRDA) since its

incorporation as a statutory body in April 2000 has regulated the opening of
insurance sector which has seen 15 life and 23 non life private companies
launch their operations in India In the post liberalization phase, insurance
industry has witnessed beneficial effects of competition.
The market for pension product is developing and there is a unit linked
insurance plan generated by private players. Opening of the insurance market to
private and foreign players and a conversion of a monopolistic market to a
liberalized one has transformed the insurance industry in India.
Best international practices in service and operational efficiency through use of
latest technologies, need based schemes etc. are available to customer. The
credit for enlarging the insurance sector goes to both the public and private
sector.
While the private sector has come up with aggressive marketing strategy to
establish their presence, the public sector has in turn redrawn its priorities and
revamped their marketing strategies to reach out to greater mass of people It is
in this backdrop of liberalisation of insurance sector the paper has analysed the
new dimensions post liberalisation like raising of foreign direct limit, micro
insurance in rural market, bancassurance, reinsurance and alternate risk transfer
(ATR).
1) The Need For Raising FDI limit:

Reforms in Insurance sector was started in India way back in 1993 as a part
of overall financial reforms. The main idea was to make insurance industry
vibrant and dynamic so that it can support the growth process leading to overall
economic growth of the country in post liberalization era. At present the foreign
direct investment in insurance sector is permitted up to 26 per cent of equity.
Higher amount of Foreign Direct Investment (FDI) in insurance sector would
increase penetration of insurance in India as existing companies will try to
expand their reach and new companies making entry into the market will work
for their space in the market. Higher amount of FDI is likely to enrich the
business by bringing world class business practices and process. Simultaneously
it would help expand distribution capabilities. It is proposed therefore to raise
FDI limit from existing 26% to 49%. This will help the insurance industry in the
following ways.
1. Higher FDI in insurance sector can give much needed capital for growth
of insurance sector which in turn will help in the long term economic
development.
27
2. Ambitious infrastructure projects of Government can get stable long term

source of funds.
3. Higher amount of FDI in insurance would increase penetration of
insurance in India which is low compared to global average.
4. An increase in FDI in insurance will benefit the economy as people will
invest in long term fund which will increased the growth of economy.
5. Insurance in India is mainly confined to urban sector Vast potentials are
lying untapped in rural India. For accessing into these areas new approach
is necessary in the matter of product design, pricing and product delivery
mechanism. As far as rural health is concerned there are many new
entrants waiting for making entry into the market, considering huge
potential. Private players may tap these potentials. Thus raising of FDI
limit in insurance sector will strengthen the market and thus lead to the
economic growth of the country.
2) Micro Insurance in Rural Market of India:

World's poor are entrapped in a vicious cycle of poverty. The vicious cycle
of low income - low savings low investments. To break this vicious cycle the
Government of India (GOI) and Non Government Organizations (NGOS) have
started the micro insurance schemes in India. The Indian rural market with its
enormous size, demand base, variety, and divergent customs offers great
opportunities to marketers.
With the rural population having increased to about 75% of the total population
the demand for products and services has increased in rural areas but the supply
and penetration is almost nonexistent. The insurance sector has not made much
headway in the rural sector.
The insurance market in India was liberalized in the year 2000 but has not
expanded much in real terms beyond the urban domains. It is a common belief
amongst the insurance companies that it is expensive to do business in rural
areas.
There are many challenges in providing micro insurance to rural population
since low income people are susceptible to risks. Commercial insurers have
largely stayed away from the low income market mainly because of high cost
and small premiums. In rural areas infrastructure is lacking and literacy levels
are low.
The rural market is also characterized by inadequate and inappropriate services,
inadequate information and communication gaps. These are the precise reasons
for low demand for insurance in spite of strong need. Micro insurance may
provide an innovative way to fight poverty and is different from insurance in
28
general as it is a low value product. Micro insurance requires an intermediary

between the customer and the insurance company.
The intermediary could be a non Government Organization (NGOS) or micro
finance institution (MFIS). In the micro insurance the target market is specified
low income communities. Policies are classically sold to a cluster which pools
together its risk and prepaid contributions. Premiums paid are normally small
and paid frequently suiting the paying capacity of these communities.
Thus the rural poor who are low income people are protected against health risk
(death, disability, illness, injury, hospitalization) and property risk (damage, loss
of crop/ livestock, cattle, theft,) which take place due to natural calamities such
as drought, flooding, tremor, devastating disease, death and widowhood.
Thus micro insurance is the use of insurance as an economic instrument at the
'micro' (i.e. smaller than national) level of society. It refers to providing cover
for insurable risks of micro entrepreneurs, small and landless farmers, women
and low income people through recognized, semiformal and informal
institutions.
India has a special Microinsurance Act that regulates the suppliers through its
special agency for insurance regulation- the IRDA. Under this Act the insurance
companies are obliged to conduct a certain percentage of their business in rural
areas or with marginalised groups. Micro Finance has provided the institutional
areas on which structure of micro insurance could be built in rural areas.
3) Schemes of Micro-Insurance:
1. The Personal Accident Insurance Scheme (PAIS) which is being provided
along with the Kisan Credit Card (KCC) and Rashtriya Krishi Bima
Yojana (RKBY) for insuring crops are the only risk mitigation
mechanism available to rural households.
2. Many State Governments are offering Health Insurance facilities to the
rural poor which have also generated considerable acceptance and
awareness about insurance products in the rural areas.
3. In October 2004 the RBI permitted Regional Rural Banks (RRBs) to take
on insurance business as a "Corporate agent". RRBs have several
branches is rural areas & they can play an important role.
4. In IRDA regulations have certain most innovative features in legally
recognizing NGOS, MFIs (Micro Finance Institutions) and SHGs as
"micro insurance agents". This has the potential of significantly
increasing rural insurance dispersion.
5. A lot of commercial banks have united foreign insurance policies. Thus
banking outlets and Co-operative societies could provide the needed
29
outreach to provide micro insurance facilities without any further adding

to business costs.
6. The GOI has also launched its new Social Security initiative - Aam Admi
Bima Yojana ( Common Person's Insurance Programme) for poor families
that do not own agricultural land. It extends death and disability coverage
to an estimated 15 million rural and landless households. Under this
programmes the State and the Union governments are expected to bear
the premium of Rs. 200 for every policy holder who is insured to the
extent of Rs. 50,000 in case of natural death and 75,000 in case of an
accident. A number of micro insurance schemes are state led. Many
others are partnership between private insurance companies and
microfinance institutions. In such a partnership the microfinance
institutions assume the role of an agent and distributes the product of the
insurance company to its clients. This helps the insurance company to
reach difficult markets cheaply. The insurance company benefits from the
trust relationship the local microfinance institution has established with
the target population.
4) Reinsurance:
The term 'reinsurance' stands for the practice whereby a reinsurer, in return of
premium paid to it, indemnifies another insurer for a portion or all of the
liability taken up by the latter due to a policy of insurance that it has issued.
This latter party is called the 'reinsured'. Reinsurance is a type of risk
management involving transfer of risk from insurer to reinsurer.
It works like this- the insurer gives the reinsurer a portion of premium it collects
from the insured and in return is covered for losses above a particular limit. A
reinsurer enters into a reinsurance agreement for a very specific reason- either
the nature of risk insured or the business strategies of the insurer or other
reasons.
It is an independent contract between the reinsurer and the insurer and the
original insurer is not a part of the contract. If the claimant is an individual or
even a group of individuals an insurance company will find it, relatively easy to
cover the claims. But if there are a huge number of claims at the same time and
loss is massive and wide spread this may not be possible. It is in this context
that reinsurance plays an important part in determining the success of the
insurance business.
Reinsurance primary deals with risks that are not predictable and cause the
greatest exposure for the insurance company. A single insurer will not be able to
bear the damaging financial impact of such losses. Therefore an unbearable loss
is broken down into bearable units by risk transfers.
30
An insurance company limits the amount of risk it takes depending on the

reinsurance terms along with factors like the worth of its assets, trend of
inflation in the economy, a price of the insurance products and the type of risk.
The reinsurance business hinges on successful partnerships. As the Indian
market grows the regulator and the players are expected to realize the
advantages of the reinsurer as a partner rather than as a means of risk reduction.
If an insurance company relied too heavily on a weak reinsurer it will be unable
to meet heavy losses since the reinsurer itself might be insolvent.
This could also result in lower sales of the insurance products as the customers
might settle for investing in other options such as government securities and
fixed deposits. Insurance companies should be prudent enough to arrange for
insurance with stronger companies. They must also harness the power of the
technology to upgrade reinsurance.
5) Merits of Reinsurance:
1. Reinsurance safeguards capital and reinforces stability. In a highly
volatile market it may sometimes be hard to correctly price new products
because of inadequate information. Incorrect pricing could lead to
unanticipated claims that the insurance company cannot meet. If there
were not reinsurance the insurance company would have to settle these
claims out of its own capital therefore reinsurance helps to protect the
solvency of the insurance company.
2. Reinsurance enables the insurer to take up large claims and expand
capacity. In India regulations restricts the insurer from risking more than
10 percent of its surplus on any one risk. Reinsurance provides the
insurance with ability to cover large individual risks and guarantees
timely settlement of the claim.
3. Reinsurance helps insurance company to upgrade itself and insurance
company can benefit immensely by tying up with a successful reinsurer.
The reinsurer can provide important underwriting training and skill
development and share expertise gained from other countries. Since the
success of reinsurer is linked to the profits of the insurance company it
is in the best interest of the reinsurer to measure that the company is
sound. The reinsurer can also contribute to designing the product, pricing
and marketing new products. It can also offer back office support such as
faster claims processing and automation of operations.
4. The insurance buyers are now much more aware of the way the market
works. Increasingly they are demanding high quality insurance products
31
and are conscious of the fact that reinsurance is an important criterion to

be considered while selecting an insurance policy.
6) Regulation Regarding Reinsurance in India:

Given the importance of reinsurance there are several guidelines laid down by
Insurance Regulatory Development Authority of India (IRDA) to ensure fair
play. Some of these are as follows.
1. Every insurer should retain risk proportionate to its financial strength and
business volume.
2. Certain percentage of the sum assured on each policy by an insurance
company is to be reinsured with the National Reinsurer. National
reinsurer has been made compulsory only in the non life sector.
3. The reinsurance programme will begin at the start of each financial year
and has to be submitted to the IRDA forty five days before the start of the
financial year.
4. Insurers must place their reinsurance business, in excess of limits defined
outside India with only those reinsurers who have a rating of at least BBB
standard and Poor (S & P) for the preceding five years. This limit has
been derived from India's own Sovereign rating, which currently stands at
BBB.
5. Private life insurance companies cannot enter into reinsurance with their
promoter company or its associates though the LIC can continue to
reinsure its policies with GIC.
The objective of these regulations is to expand retention within India, ensure the
best protection for the reinsurance costs incurred and simplify administration.
7) Bancassurance:
One of the more recent examples of financial diversification is 'bancassurance'
the term given to the distribution of insurance products through branches or
other distribution channels of banks.
In India the concept of bancassurance appears to be gaining ground quite
rapidly both through commission based arrangements and joint ventures
between banks and insurance companies. There are costs associated with setting
up a successful bancassurance network. The proper training of bank personnel
to understand the market insurance schemes is vital to the success of these
ventures.
32
There is also a need to invest extensively in IT and other support systems that
would provide an integrated backup for banking and insurance services.
Regulatory issues need to be addressed comprehensively and sorted out
particularly with respect to competition and market structure problems. Given
these changes bancassurance and collaboration between banks and insurers has
a long way to go in India.
8) Alternative Risk transfer:

Despite the total transformation of Insurance sector after the liberalisation
Indian insurance has been still behind in comparison with the world wide
insurance development which has brought the convergence of insurance markets
with money markets and capital markets.
The service sectors like banking and insurance have adopted a new mechanism
called Alternative Risk Transfer (ART) to meet the incidence of costly insurance
losses which cannot be covered by the traditional insurance & reinsurance. Thus
bankers and investors have adopted alternative risk transfer for their success and
survival.
The earthquake, hurricane, Tsunami and other natural disasters and their ever
increasing exposures have brought some revolution and breakthrough in the
traditional or conventional insurance and reinsurance practices. The ART
products are Insurance derivatives which involve transfer of property and
casualty risk through the issuance of derivative instruments.
Another is Insurance securitisation which involves the process of transfer of
property and casualty risks from one party (the issuer) to another party (the
investors). The ART products have not found significant place in Indian
insurance industries. At present Indian general insurers do not find any much
difficulty for reinsurance for protection against large loss arising out of any
single events.
With the increasing operations of MNCs in this sector and full-fledged
operation of bancassurance by general insurance companies and introduction of
credit insurance by state owned company like New India Assurance Company
and prospects of agriculture insurance in India there will be need for more ART
products in the near future.
Further recent IRDA regulations on solvency margins for insurers and reinsurers
rising market expectations for more efficient risk financing programmes
development of Indian capital market and replacement of FERA by FEMA are
all inducing factors for insurers, re-insurers, investors and bankers to make a
proper use of essential ART products to transfer insurance risks from insurance
market to capital markets.
33
CHAPTER 7
LIBERLISATION OF INDIAN INSURANCE INDUSTRY
IN INDIA MALHOTRA COMMITTEE
The Government of India in1993 set up a high powered committee by

R. N. Malhotra, former Governor Reserve Bank of India, to examine the
structure of insurance industry and recommend changes to make it more
efficient.
The Committee recommended the liberalisation of the Indian
Insurance market, indicating that the market should be opened to private sector
competition and ultimately to foreign private sector competition.
The Malhotra Committee was set up with the objective of
complementing the reforms initiated in the financial sector. The reforms were
aimed at creating a more efficient and competitive financial system suitable for
the requirements of the economy keeping in mind the structural changes
currently underway and recognizing that insurance is an important part of the
overall financial system where it was necessary to address the need for similar
reforms...
The purpose of the committee are as follows:
1) To create an efficient and viable insurance industry, to have a wide
coverage of insurance services.
2) To have a variety of insurance products with high quality of service.
3) To develop an effective instrument for mobilization of financial resources
for development.
34
4) To make recommendation for changing the structure of the insurance

industry.
5) To recommend on regulation and supervision of the insurance sector in
India.
6) To recommend on the role and functioning of surveyors, intermediaries
like agents etc in the insurance sector.
In 1994, the committee submitted the report and some of the key
recommendations included :
1) Structure :
Government stake in the insurance Companies to be brought down to
50%.
Government should take over the holdings of GIC and its subsidiaries so
that these subsidiaries can act as independent corporations.
All the insurance companies should be given greater freedom to operate.
2) Competition :
Private Companies with a minimum paid up capital of Rs. 1bn should be
allowed to enter the industry.
No company should deal in both Life and General Insurance through a
single entity.
Foreign companies may be allowed to enter the industry in collaboration
with the domestic companies.
Postal Life Insurance should be allowed to operate in the rural market.
Only one State Level Life Insurance Company should be allowed to
operate i each state.
3) Regulatory Body:
The Insurance Act should be changed.
An Insurance Regulatory body should be set up.
Controller of Insurance (Currently a part from the Finance Ministry)
should be made independent.
4) Investments :
35
Mandatory Investments of LIC Life Fund in government securities to be

reduced from 75% to 50%.
GIC and its subsidiaries are not to hold more than 5% in any company
(Their current holdings to be brought down to this level over a period of
time)
5) Customer Service:
LIC should pay interest on delays in payments beyond 30 days.
Insurance companies must be encouraged to set up unit linked pensions
plans.
Computerisation of operations and updating of technology to be carried
out in the insurance industry. The committee emphasized that in order to
improve the customer services and increase the coverage of the insurance,
industry should be opened up to competition.
But at the same time, the committee felt the need to exercise caution as any
failure on the part of new players could ruin the public confidence in the
industry. Hence, it was decided to allow competition in a limited way by
stipulating the minimum capital requirement of Rs. 100 crores. The committee
felt the need to provide greater autonomy to insurance companies in order to
improve their performance and enable them to act as independent companies
with economic motives. For this purpose, it had proposed setting up an
independent regulatory body.
36
CHAPTER 8
INSURANCE REGULATORY AND DEVELOPMENT
AUTHORITY (IRDA) ACT 1999
On the basis of the recommendations of Malhotra committee, the

Government constituted an interim insurance Regulatory Authority. IRA bill
was introduced in Parliament in 1996. The bill was retitled as insurance
regulatory and development authority and introduced again in 1999 along with
three schedule containing amendments to the insurance Act 1938, LIC Act 1956
and GIC Act 1972 and was passed.
Insurance sector was opened up for competition from Indian private
insurance companies with the enactment of Insurance Regulatory and
Development Authority Act, 1999 (IRDA Act). As per the provisions of IRDA
Act, 1999, Insurance Regulatory and Development Authority (IRDA) was
established on 19th April 2000 to protect the interests of holder of insurance
policy and to regulate, promote and ensure orderly growth of the insurance
industry. IRDA Act 1999 paved the way for the entry of private players into the
insurance market which was hitherto the exclusive privilege of public sector
insurance companies / corporations. Under the new dispensation Indian
insurance companies in private sector were permitted to operate in India with
the following conditions :
Company is formed and registered under the Companies Act, 1956
37
The aggregate holdings of equity shares by a foreign company, either by

itself or through its subsidiary companies or its nominees, do not exceed
26%, paid up equity capital of such Indian insurance company;
The company`s sole purpose is to carry on life insurance business or

general insurance business or reinsurance business.
The minimum paid up equity capital for life or general insurance business
is Rs.100 crores.
The minimum paid up equity capital for carrying on reinsurance business
has been prescribed as Rs. 200 crores.
The Authority notified 27 Regulations on various issues which include
Registration of Insurers, Regulation on insurance agents, solvency Margin, Reinsurance, Obligation of Insurers to Rural and Social Sector, Investment and
Accounting Procedure, Protection of policy holders` interest etc. Applications
were invited by the Authority with effect from 15 th August, 2000 for issue of the
Certificate of Registration to both life and non-life insurers. The Authority has
its Head Quarter at Hyderabad.
38
INSURANCE COMPANIES :
IRDA has so far granted registration to 12 private life insurance
companies and 9 general insurance companies. If the existing public sector
insurance companies are included, there are currently 13 insurance companies
in the left side and 13 companies operating in general insurance business.
General Insurance Corporation has been approved as the Indian reinsurer for
underwriting only reinsurance business. Particulars of the life insurance
companies and general insurance companies including their web address are
given below:
LIFE INSURERS
Websites
Public Sector
Life Insurance Corporation of India
www.licindia.com
Private Sector
Allianz
Bajaj
Life
Insurance
Company Limited
Birla Sun-Life Insurance Company
Limited
HDFC Standard Life Insurance Co.
Limited
ICICI Prudential Life Insurance Co.
Limited
ING Vysya Life Insurance Company
www.allianzbajaj.com
www.birlasunlife.com
www.hdfcinsurance.com
www.iciciprulife.com
www.ingvysyalife.com
39
Limited
Max New York Life Insurance Co. www.maxnewyorklife.com
Limited
MetLife Insurance Company Limited www.metlife.com
Om Kotak Mahindra Life Insurance www.omkotakmahindra.com
Co. Ltd.
SBI Life Insurance Company Limited www.sbilife.co.in
TATA AIG Life Insurance Company www.tata-aig.com
Limited
AMP Sanmar Assurance Company www.ampsanmar.com
Limited
Dabur CGU Life Insurance Co. Pvt. www.avivaindia.com
Ltd.
GENERAL INSURERS
WEBSITES
Public Sector
National Insurance Company Limited www.nationalinsuranceindia.com
New India Assurance Company www.niacl.com
Limited
Oriental Insurance Company Limited www.orientalinsurance.nic.in
United India Insurance Company www.uiic.co.in
Limited
Private Sector
Bajaj Allianz General Insurance Co. www.bajajallianz.co.in
Limited
ICICI Lombard General Co. Ltd.
www.icicilombard.com
IFFCO-Tokio General Insurance Co.
Ltd.
Reliance General Insurance Co.
Limited
Royal Sundaram Alliance Insurance
Co. Ltd.
TATA AIG General Insurance Co.
www.itgi.co.in
www.ril.com
www.royalsun.com
www.tata-aig.com
40
Limited
Cholamandalam General Insurance www.cholainsurance.com
Co. Ltd.
Export Credit Guarantee Corporation www.ecgcindia.com
HDFC Chubb General Insurance Co. Ltd.
REINSURER
General Insurance Corporation of www.gicindia.com
India
PROTECTION OF THE INTEREST OF POLICY

HOLDERS
Towards achieving the objective of protecting the interest of insurance policy
holders, the authority has taken the following steps:
IRDA has notified Protection of Policyholders Interest Regulations 2001
to provide for: policy proposal documents in easily understandable
language; claims procedure in both life and non-life; setting up f
grievance redressal machinery; speedy settlement of claims; and
policyholders` servicing. The Regulation also provides for payment of
interest by insurers for the delay in settlement of claim.
The insurers are required to maintain solvency margins so that they are in
a position to meet their obligations towards policyholders with regard to
payment of claims.
It is obligatory on the part of the insurance companies to disclose clearly
the benefits, terms and conditions under the policy. The advertisements
issued by the insurers should not mislead the insuring public.
All insurers are required to set up proper grievance redress machinery in
their head office and at their other offices.
41
The Authority takes up with the insurers any complaint received from the
policyholders in connection with services provided by them under the
insurance contract.
In December, 2000, the subsidiaries of the General Insurance Corporation
of India were restructured as independent companies and at the same time GIC
was converted into a national re-insurer. Parliament passed a bill de-linking the
four subsidiaries from GIC in July, 2002.
Today there are 14 general insurance companies including the ECGC and
Agriculture Insurance Corporation of India and 14 life insurance companies
operating in the country.
The insurance sector is a colossal one and is growing at a speedy rate of
15-20%. Together with banking services, insurance services add about 7% to the
country`s GDP. A well-developed and evolved insurance sector is a boon for
economic developments as it provides long-term funds for infrastructure
developments at the same time strengthening the risk taking ability of the
country.
CHAPTER 9
CURRENT SCENARIO OF INSURANCE INDUSTRY
India`s insurance sector is zooming to show an unprecedented

progressive growth of more than 200% by the period of 2009-09. The
Associated Chambers of Commerce and Industry of India has clocked out that
during this period, private players in the industry will see a growth of about 140
per cent, owing to the adoption of the aggressive marketing techniques in
comparison to the growth rate of 35 per cent-40 per cent achieved by the state
owned insurance companies. The chamber is expected to raise the business of
insurance to reach at Rs. 2000 billions in coming 2 years from the present level
of Rs. 500 billion. With the result of adoption of the intense marketing strategies
by the private players, the declination has been witnessed in respect of the share
of the state owned insurance companies captured in the market.
The market share fallout has been noticed in context of such companies
like GIC, LIC, which have come down to nearly 70 per cent in the past 4-5
years from the 97 per cent. The experts have forecasted the more severe
competition in the insurance sector likely to be occurred in the near future. Till
recently, insurance sector was majority driven by the government sector players
but now many private sector multinational players have come into the pictures.
42
Like HDFC, ICICI, Kotak, Mahindra and Birla Sunlife. Insurance sector has
been characterized as the booming sector of the Indian arena, which has shown
the growth rate of more than 15 per cent to 20 per cent. Insurance in India is put
under the federal subject and is governed by the Insurance Act, 1938, the Life
Insurance Corporation Act, 1956 and General Insurance Business
(Nationalization) Act, 1972, Insurance Regulatory and Development Authority
(IRDA) Act, 1999 and by various other acts.
CHAPTER 10
POSITIVE IMPACTS OF LIBERLISATION ON THE
INSURANCE INDUSTRY
The liberalisation in insurance sector will help to increase the capital

formation in the country due to more employment, interest and savings.
It facilitates heavy investments in social sector.
Due to liberalisation the people will get better and cheaper insurance
services.
New private players will get the benefit of untapped markets.
More competition in this business will spur firms to offer several new
products and more complex and extensive risk categorization.
It helps to develop insurance market internationally, enabling healthy
competition in the insurance sector.
43
The productivity as well as efficiency will increase due to liberalisation.

Banks with their wide area network with branches in all the parts of the
country will have very good opportunity to enter the insurance business.
The liberalisation has extended the scope of insurance to village and rural
areas.
By allowing foreign equity participation (not exceeding 26%), various
joint ventures between foreign investors and Indian partners will be
operating, resulting into supplementation of domestic savings and
economic progress of the nation.
NEGATIVE IMPACTS OF LIBERLISATION ON THE

INSURANCE INDUSTRY
The liberalisation will create cut throat competition in the insurance

market which is not in the interest of the industry, customers or the
country.
There are multiple distribution channels which includes the agents,
brokers, corporate intermediaries, bank branches and direct marketing in
the insurance market and there will be competition among the channels.
The insurers will have to face an acute problem of the redresser of
consumers` grievances for deficiency in products and services, as IRDA
has appointed ombudsman to look into the grievances of the
policyholders.
The liberalisation of insurance sector brings an end to the government
monopoly in this sector and private companies exercise their domination.
44
The private sector companies develop and introduce only those

policies/schemes which involve minimum risk burden and are more
profitable to them.
CHAPTER 11
CONCLUSION
From the above discussion, in our country, insurance and legitimate need in
order to achieve greater density and insurance for in-motion of large long-term
savings for long gestation infrastructure, increase the efficiency of the business
governor and you can conclude that the entry of private sector business. New
players, but should not be treated as opposition to the enterprise of government,
they can be supplemented in order to achieve the growth target of the insurance
business in India.
While the insurance industry still struggles to move out of the shadows cast by
the challenges mentioned above; in the long run the insurance industry is poised
for a sturdy growth due to the significant untapped potential in various segments
of the market. A concerted set of action is required by the players and the
policyholders alike to battle these challenges and for the Indian insurance
45
industry to make its next quantum leap. How these challenges are handled and
weeded out will play a critical role in shaping the markets evolution over the
next decade.
CHAPTER 12
REFERENCES
BIBLIOGRAPHY:
Principles & Practices Of Banking & Insurance- Vipul Publications
Environment & Management Of Financial Services-Vipul Publications
WEBLIOGRAPHY:
www.irda.gov.in
www.wikipedia.com
www.scribd.net
www.slideshare.net
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IMPACT OF LIBERALISATION ON THE INSURANCE INDUSTRY.

IMPACT OF LIBERALISATION ON THE INSURANCE INDUSTRY.

collaborators of Indian promoters, and 14 per cent for non-resident Indians

IMPACT OF LIBERALISATION ON THE INSURANCE INDUSTRY.

IMPACT OF LIBERALISATION ON THE INSURANCE INDUSTRY.

IMPACT OF LIBERALISATION ON THE INSURANCE INDUSTRY.

IMPACT OF LIBERALISATION ON THE INSURANCE INDUSTRY.

1) Number of Private Players:

IMPACT OF LIBERALISATION ON THE INSURANCE INDUSTRY.

IMPACT OF LIBERALISATION ON THE INSURANCE INDUSTRY.

3) Innovative Distribution Channels:

IMPACT OF LIBERALISATION ON THE INSURANCE INDUSTRY.

portfolio, growing by 29.76% (y-o-y) in FY06 while non-linked products

IMPACT OF LIBERALISATION ON THE INSURANCE INDUSTRY.

The level of penetration which is the measure of premiums as a

IMPACT OF LIBERALISATION ON THE INSURANCE INDUSTRY.

IMPACT OF LIBERALISATION ON THE INSURANCE INDUSTRY.

IMPACT OF LIBERALISATION ON THE INSURANCE INDUSTRY.

IMPACT OF LIBERALISATION ON THE INSURANCE INDUSTRY.

Opening up the sector has transformed the landscape. The Indian

IMPACT OF LIBERALISATION ON THE INSURANCE INDUSTRY.

IMPACT OF LIBERALISATION ON THE INSURANCE INDUSTRY.

Recognition of the benefits of foreign participation to the Indian economy

IMPACT OF LIBERALISATION ON THE INSURANCE INDUSTRY.

pillars of financial systems, insurance serves a distinctive role in managing risk,

Our experience in India is a significant case in point. The World Banks

Services underpin economic development efforts because more efficient

IMPACT OF LIBERALISATION ON THE INSURANCE INDUSTRY.

Insurance companies can be broadly divided into four categories:

IMPACT OF LIBERALISATION ON THE INSURANCE INDUSTRY.

In principle, both the shareholders in a stock company and the

IMPACT OF LIBERALISATION ON THE INSURANCE INDUSTRY.

THE IMPACT OF REGULATION

IMPACT OF LIBERALISATION ON THE INSURANCE INDUSTRY.

IMPACT OF LIBERALISATION ON THE INSURANCE INDUSTRY.

companies indulge in retroactive loss loading, thereby passing on the cost of

IMPACT OF LIBERALISATION ON THE INSURANCE INDUSTRY.

SUMMING UP : POINTERS FOR INDIAN

A significant part of the activities of the insurance industry of an

IMPACT OF LIBERALISATION ON THE INSURANCE INDUSTRY.

IMPACT OF LIBERALISATION ON THE INSURANCE INDUSTRY.

enhances the efficiency of market participants, the process of creative

IMPACT OF LIBERALISATION ON THE INSURANCE INDUSTRY.

IMPACT OF LIBERALISATION ON THE INSURANCE INDUSTRY.

The Insurance Regulatory and Development Authority (IRDA) since its

1) The Need For Raising FDI limit:

IMPACT OF LIBERALISATION ON THE INSURANCE INDUSTRY.

2. Ambitious infrastructure projects of Government can get stable long term

2) Micro Insurance in Rural Market of India:

IMPACT OF LIBERALISATION ON THE INSURANCE INDUSTRY.

general as it is a low value product. Micro insurance requires an intermediary

IMPACT OF LIBERALISATION ON THE INSURANCE INDUSTRY.

outreach to provide micro insurance facilities without any further adding

IMPACT OF LIBERALISATION ON THE INSURANCE INDUSTRY.

An insurance company limits the amount of risk it takes depending on the

IMPACT OF LIBERALISATION ON THE INSURANCE INDUSTRY.

and are conscious of the fact that reinsurance is an important criterion to

6) Regulation Regarding Reinsurance in India:

IMPACT OF LIBERALISATION ON THE INSURANCE INDUSTRY.

8) Alternative Risk transfer:

IMPACT OF LIBERALISATION ON THE INSURANCE INDUSTRY.

The Government of India in1993 set up a high powered committee by

IMPACT OF LIBERALISATION ON THE INSURANCE INDUSTRY.