50261857 Indian Insurance Sector2

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Indian insurance sector

Stepping into the next decade of growthSeptember 2010

Confederation of Indian Industry


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Indian insurance sector: stepping into the next decade of growth 3The insurance industry in India has progressed significantly over the last decade, which is amply evident in the strong growthwitnessed in the insurance premiums, strengthened outreach, increased number ofplayers, product innovation and itsenhanced regulatory framework. A combination of these factors, along with strong

economic growth in the last few years,has positioned India as a regional insurance hub and a rapidly developing financial center.The insurance industry is amid an exciting journey there needs to be a persistent endeavor to sustain what has alreadybeen achieved as well as expand beyond the current level. Furthermore, several reforms and policy measures, especiallyduring the last couple of years, have enabled a favorable environment for insurance companies to flourish in the country. Thecoming years are critical as the regulator stance and approach of market participants will govern the strength, stability andthe sustained growth of the insurance sector.

The insurance sector has become a major contributor to economic development, especially to infrastructure development.This growth has been fueled by India s multiplying consumer class, rising insurance awareness, increasing domestic savingsand investments. Moreover, it has been the joint effort of all stakeholders, including the government, regulator and insurancecompanies to enable the positive momentum of this industry. However, there is still a long way to cover on the road toachieve financial inclusion and bring more and more people under the insurance blanket.To this end, the Confederation of Indian Industry (CII) and Ernst & Young have co-authored this report to evaluate the currentstate of the insurance industry, implication of new regulations and the steps that can be taken to strengthen the penetrationof insurance products.ForewordAshvin ParekhPartner & National Industry Leader,Financial ServicesErnst & Young Private LimitedChandrajit BanerjeeDirector General,Confederation of Indian Industry


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Executive summary ....................................................................................................................... 1Introduction ................................................................................................................................. 3Section I: Industry overview........................................................................................................... 5Evolution of the industry .......................................................................................................... 5Current scenario...................................................................................................................... 7Growth drivers....................................................................................................................... 10Emerging trends .................................................................................................................... 11Contribution of the insurance sector to the economy ................................................................ 12Section II: Industry at cross-roads of development ....................................................................... 17

Insurance industry: significantly untapped latent potential ........................................................ 17Recent regulatory developments that govern the current market state....................................... 20Section III: Critical factors for market development....................................................................... 25Distribution channels ............................................................................................................. 25Focus on financial inclusion..................................................................................................... 34Consumer needs and preferences............................................................................................ 36Way forward ............................................................................................................................... 39Bibliography ............................................................................................................................... 42Contents Executive summary ....................................................................................................................... 1Introduction ................................................................................................................................. 3Section I: Industry overview........................................................................................................... 5Evolution of the industry .......................................................................................................... 5Current scenario...................................................................................................................... 7Growth drivers....................................................................................................................... 10Emerging trends .................................................................................................................... 11Contribution of the insurance sector to the economy ................................................................ 12Section II: Industry at cross-roads of development ....................................................................... 17Insurance industry: significantly untapped latent potential ........................................................ 17Recent regulatory developments that govern the current market state....................................... 20Section III: Critical factors for market development....................................................................... 25Distribution channels ..........................................................


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................................................... 25Focus on financial inclusion..................................................................................................... 34Consumer needs and preferences............................................................................................ 36Way forward ............................................................................................................................... 39Bibliography ............................................................................................................................... 42Contents


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Indian insurance sector: stepping into the next decade of growth


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Executive summary

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

Together with other financial services, insurance servicescontributed 7% of the country s GDP in 2009. A well-developed and evolved insurance sector is a boon foreconomic development as it provides long-term funds forinfrastructure development and concurrently strengthensthe risk-taking ability of the country. Further, insurancehas been a notable employment generator, not only for theinsurance industry, but has also created significant demand

for a range of associated professionals such as brokers,insurance advisors, agents, underwriters, claims managersand actuaries.

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

India s growing consumer class, rising insurance awareness,increasing domestic savings and investments are among themost critical factors that have positively driven the marketpenetration of the insurance products among its consumer

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

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

The period post-sector liberalization, which we call Phase


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I, has witnessed an unprecedented surge in the sales ofinsurance products, with the industry recording a CAGR of24.2% in annualized premium equivalent during FY00 05.The insurance industry, in its first phase of development, hasbeen relying on regular capital infusions from the promotersas its lifeline. High new business strain and expandingdistribution networks have resulted in accounting lossesacross the industry. In order to meet their commitmenttoward claim settlement and reserve creation, promoters



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have been investing additional capital, resulting in cashburn. The tradeoff between growth and profitability washeavily inclined toward the former.

The next four to five years can be termed as Phase II,which saw players focus on an expanding product range,developing innovative products and building a robustdistribution channel. During this period, i.e., FY05 09, theindustry grew at a CAGR of 25.9%. Insurers were shiftingweight from the Phase I philosophy of growth versusprofitability to the Phase II mantra of profitable growth. As a result, the focus shifted from growth to profitability, with product pricing becoming more rational based on moreconservative assumptions. Product innovation continuedand traditional policies gained some foothold in an otherwiseunit-linked incentive product (ULIP) driven market.

The Indian life insurance industry stands at the threshold

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

At this cross section, the role of the regulator becomescritical. The Insurance Regulatory and DevelopmentAuthority (IRDA) is in the finalization stage vis--vis most ofits regulations, which would be instrumental in navigatingthe future course of the insurance industry. IRDA hasintroduced certain regulations to help improve disclosures,

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

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

With the rising competition, the industry may also witnessconsolidation among smaller players and the emergenceof some large players. The regulator is in the process offinalizing guidelines for mergers and acquisitions in theinsurance space in India. The government, regulator andthe insurance companies are now focused on maintaininga favorable environment for sustainable growth, highercontribution of the industry to economic development andthe increasing reach of insurance to the underdevelopedareas of the country.

To summarize, the Indian insurance industry is poised for a


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quantum leap in performance with unprecedented growthopportunities, notwithstanding a temporary sliding growthcurve. The stage is now well poised for the real showto commence.



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Introduction

The economic reforms initiated in the early 90s paved theway for the growth and opening up of the financial sector,which led to a sustained period of economic growth. Theinsurance industry was opened up for private players in2000, and has seen tremendous growth over the pastdecade with the entry of global insurance majors. India isfast emerging as one of the world s most dynamic insurancemarkets with significant untapped potential.

The insurance sector plays a critical role in a country seconomic development. It acts as a mobilizer of savings, afinancial intermediary, a promoter of investment activities,a stabilizer of financial markets and a risk manager. The

life insurance sector plays an important role in providing

risk cover, investment and tax planning for individuals; thenon-life insurance industry provides a risk cover for assets.Health insurance and pension systems are fundamental toprotecting individuals against the hazards of life, and India,as the second-most populous nation in the world, offerssignificant potential for that type of cover. Furthermore,fire and liability insurance are essential for corporationsto safeguard infrastructure projects and investment risks.Private insurance systems complement social securitysystems and add value by matching risk with price.



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

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

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

significant untapped potential in various segments of themarket. While the nation is heavily exposed to naturalcatastrophes, the insurance cover to mitigate the negativefinancial consequences of these adverse events is still

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



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Section I:Industry overviewSection I:Industry overviewThe insurance industry in India has come a long way sincethe time when businesses were tightly regulated andconcentrated in the hands of a few public sector insurers.Following the passage of the Insurance Regulatory andDevelopment Authority Act in 1999, India abandonedpublic sector exclusivity in the insurance industry in favorof market-driven competition. This shift has brought aboutmajor changes to the industry. The beginning of a new era ofinsurance development has seen the entry of internationalinsurers, the proliferation of innovative productsand distribution channels, as well as the raising ofsupervisory standards.

Evolution of the industry

The growing demand for insurance around the worldcontinues to have a positive effect on the insurance industryacross all economies. India, being one of the fastest-growingeconomies (even in the current global economic slowdown),has exhibited a significant increase in its GDP, and aneven larger increase in its GDP per capita and disposableincome. Increasing disposable income, coupled with the highpotential demand for insurance offerings, has opened manydoors for both domestic and foreign insurers. The followingtable briefly depicts the evolution of the insurance sectorin India.



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Exhibit 1.1. Tracing the chronological evolution of the insurance industry

Year Event1818 Oriental Life Insurance Co. was established in Calcutta.1870 The first insurance company, Bombay Mutual Life Insurance Society, was formed.1907 The Indian Mercantile Insurance Limited was formed.1928 The Indian Insurance Companies Act was passed to collect statistical data on both life and non-life.1938 The Insurance Act of 1938 was passed; there was strict state supervision to

control frauds.

1912 . Life Insurance Companies Act and the Pension Fund Act of 1912Beginning of formal insurance regulations 1956 .The Central Government took over 245 Indian and foreign life insurers as well as provident societies and nationalized these entities.. The LIC Act of 1956 was passed.

1957 The code of conduct by the General Insurance Council to ensure fair conductand ethical business practices was framed.1972 The General Insurance Business (Nationalization) Act was passed.1991 Beginning of economic liberalization1993 The Malhotra Committee was set up to complement the reforms initiated in the financial sector.

1994 Detariffication of aviation, liability, personal accidents and health and marine cargo products2005 Detariffication of marine hull2006 Relaxation of foreign equity norms, thus facilitating the entry of new players

1999 The Insurance Regulatory and Development Authority (IRDA) Bill was passed in the Parliament.2000 IRDA was incorporated as the statutory body to regulate and register private sector insurance companies. General Insurance Corporation (GIC), along with its four subsidiaries, i.e., National Insurance Company Ltd., Oriental Insurance Company Ltd., New India Assurance Company Ltd. and United India Assurance Company Ltd., was made India snational reinsurer.2007 Detariffication of all non-life insurance products except the auto third-party liability segment



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

Exhibit 1.2. Indian insurance industry structure

Ministry of Finance(Government of India)IRDALife insurance Non-life insurance

PublicPrivate

PublicPrivateCurrent scenario

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

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

142223264327100102030405005001,0001,5002,0002,5003,000FY03 FY04 FY05 FY06 FY07 FY08 FY09INR billionNon-life insurance premium Life insurance premiumy-0-y growth (in %)Source: IRDA

Both the life and non-life insurance sectors in India, which


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

Growth rate (in %)

Source: IRDA

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

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The number of players during the decade has increased fromfour and eight in life and non-life insurance, respectively, in2000 to 23 in life and 24 in non-life insurance (including 1in reinsurance) industry as in August 2010.

Exhibit 1.4. Growth in the number of insurance players

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010Life insurersPublic 1 1 1 1 1 1 1 1 1 1 1Private 3 10 12 12 13 13 15 15 21 21 22Non-life insurersPublic 4 4 5 6 6 6 6 6 6 6 6Private 3 6 8 8 8 8 9 10 15 15 17Reinsurer 1 1 1 1 1 1 1 1 1 1 1Most of the private players in the Indian insurance industryare a joint venture between a dominant Indian company anda foreign insurer.

Life insurance industry overview

The life insurance sector grew at an impressive CAGR of25.8% between FY03 and FY09, and the number ofpolicies issued increased at a CAGR of 12.3% during thesame period.

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

To address the need for highly customized products andensure prompt service, a large number of private sectorplayers have entered the market. Innovative products,aggressive marketing and effective distribution haveenabled fledgling private insurance companies to sign upIndian customers more rapidly than expected. Private sectorplayers are expected to play an increasingly important rolein the growth of the insurance sector in the near future.

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

Exhibit 1.5. Market share amongst private players FY10

(based on first year premiums) (in %)

ICICI Pru,16.5

Met Life, 2.8Tata AIG, 3.4 Bajaj Allianz, 11.6Kotak Mahindra, 3.5MNYL, 4.8


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Others, 8.6SBI Life, 18.3New entrants, 4.0

Reliance Life, 10.2

HDFC Standard, 8.5

Birla Sunlife, 7.7

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



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

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

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

Royal Sundaram, 2.4 Tata-AIG, 2.3HDFC ERGO New India, 15.7

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

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

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

United India,13.6Bajaj Allianz, 6.6%Reliance General, 5.2Star Health andAllied Insurance, 2.6General, 2.4Oriental, 12.4National, 12.1ICICI-lombard, 8.6IFFCO- Tokio, 4.3AIC, 4.0Others, 7.9



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Growth drivers

India s favorable demographics help strengthenmarket penetrationThe life insurance coverage in India is very low, andmany of those insured are underinsured. There isimmense potential as the working population (25 60years) is expected to increase from 675.8 million to

795.5 million in the next 20 years (2006 2026). Theprojected per capita GDP is expected to increase fromINR18,280 in FY01 to INR100,680 in FY26, which isindicative of rising disposable incomes. The demand forinsurance products is expected to increase in light ofthe increase in purchasing power.Exhibit 1.8. Working population assessment and GDPper capita till 2026

800

120700

100

600

80

500

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

Rising focus on the rural marketSince more than two-thirds of India s population lives inrural areas, micro insurance is seen as the most suitableaid to reach the poor and socially disadvantagedsections of society.

Poor insurance literacy and awareness, hightransaction costs and inadequate understandingof client needs and expectations has restricted thedemand for micro-insurance products. However,the market remains significantly underserved,creating a vast opportunity to reach a large numberof customers with good value insurance, whetherfrom the base of existing insurers or through retail2001 2006 2011 2016 2021 2026


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In million

distribution networks.

INR

400

60

300

In FY09, individuals generated new business premium40

200

worth INR365.7 million under 2.15 million policies,

20

100

and the group insurance business amounted to

0

0INR2,059.5 million under 126 million lives. LICcontributed most of the business procured in this

Projected GDP per capita in '000sportfolio by garnering INR311.9 million of individualpremium from 1.54 million lives and INR1,726.9Age group 25 60 (in million)

Source: CMIE, Census of India 2001

million of group premium under 11.1 million lives.

Health insurance attracts insurance companies .

LIC was the first player to offer specialized productsThe Indian health insurance industry was valued atINR51.2 billion as of FY10. During the period FY03 10,the growth of the industry was recorded at a CAGRof 32.59%. The share of health insurance was 20.8%of the total non-life insurance premiums in FY10.Health insurance premiums are expected to increase toINR300 billion by 2015.

with lower premium costs for the rural population.Other private players have also started focussing onthe rural market to strengthen their reach.

Government tax incentivesCurrently, insurance products enjoy EEE benefits, giving


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



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to avail the nearly 30% effective tax benefit on selectinvestments (including life insurance premiums) madeevery financial year. Life insurance is already the mostpopular financial product among Indians because ofthe tax benefits and income protection it offers ina country where there is very little social security.This drives more and more people to come within theinsurance ambit.

Emerging trends

Exploring multiple distribution channels forinsurance products

To increase market penetration, insurance companiesneed to expand their distribution network. In therecent past, the industry has witnessed the emergenceof alternate distribution channels, which include

bancassurance, direct selling agents, brokers, onlinedistribution, corporate agents such as non-bankingfinancial companies (NBFCs) and tie-ups of para-banking companies with local corporate agencies (e.g.NGOs) in remote areas.

Agencies have been the most important and effectivechannel of distribution hitherto. The industry is viewingthe movement of intermediaries from mere agentsto advisors.

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

The pension sector, due to its inadequate penetration(only 10% of the working population is covered) offerstremendous potential for insurance companies to bemore innovative.

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

Such players may have to rethink about their futuregrowth plans. Hence, consolidation with large andestablished players may prove to be a better solutionfor such small insurers. Larger companies would alsoprefer to take over or merge with other companies withestablished networks and avoid spending money inmarketing and promotion. Therefore, consolidation will


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result in fewer but stronger players in the country aswell as generate healthy competition.

Mounting focus on EV over profitabilityMany companies are achieving profitability bycontrolling expenses; releasing funds for futureappropriations as well as through a strong renewalpremium build up. As a few larger insurers continueto expand, most are focused on cost rationalizationand the alignment of business models to ground levelrealities. This will better equip insurers to realizereported embedded value (EV) and generate value fromfuture new business.

In the short term, companies are likely to facechallenges to achieve the desired levels of profitability.As companies are also planning to get listed and raisefunds, the higher profitability will help companies toget a better valuation of shares. However, in the long

term, companies would need to focus on increasingEV, as almost 70% of a company s EV is influenced byrenewal business and profitability is not as much of anindicator for valuation. Hence, players are now focusingon increasing their EV than profitability figures.



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

up due to:

Higher sum assured driving higher sum at risk

Greater allocation to policyholders assets due tolower charges

Back loading of charges is resulting in high newbusiness strain, and expense overruns due to lowproductivity of the newly set distribution network (andinability to recover corresponding costs upfront)For non-life insurance companies, the growing demandfor health insurance products as well as motorinsurance products is likely to boost thecapital requirement.

With the capital market picking up and valuations onthe rise, insurance companies are exploring variousways of increasing their capital base to invest in productinnovation, introducing new distribution channels,educating customers, developing the brand, etc.

This is due to the following reasons:

A major portion of the costs in insurance companies isfixed (though it should be variable or semi-variable innature). Hence, the reduction in sales will not result inthe lowering of operational expenses, thus adverselyimpacting margins. As such, reduced margins wouldimpact profitability, and insurers would need to investadditional funds.

The sustained bearishness in capital markets couldfurther pressurize the investment margins andincrease the capital strain, especially in the case ofcapital/return guarantee product.

Besides, companies are likely to witness a slowdownin new business growth. Companies may also optfor product restructuring to lower their costs andoptimally utilize capital.According to IRDA Regulations 2000, all insurancecompanies are required to maintain a solvency ratioof 1.5 at all times. But this solvency margin is notsustainable. With the growing market risks, the levelof required capital will be linked to the risks inherent


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in the underlying business. India is likely to startimplementing Solvency II norms in the next three tofour years.

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

Contribution of the insurance sectorto the economy

Insurance has had a very positive impact on India seconomic development. The sector is gradually increasing

its contribution to the country s GDP. In addition, insuranceis driving the infrastructure sector by increasing investmentseach year. Further, insurance has boosted the employmentscenario in India by providing direct as well as indirectemployment opportunities.

Due to the healthy performance of the Indian economy,the share of life insurance premiums in the gross domesticsavings (GDS) of the households sector has increased.



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Exhibit 1.9. Share of life insurance premiums in GDS

(household sector) (in %)2015.917.9 17.61511.0 12.31050FY05 FY06 FY07 FY08 FY09

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

The increased contribution of the insurance industryfrom the household GDS has been ploughed back into theeconomy, generating higher growth. The following factors

showcase how the contribution of the insurance industry hasstrengthened economic growth:

Contribution of insurance to infrastructure

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

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

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

FY06 FY07 FY08 FY09Investments from traditional productsApproved securities including CentralGovernment Securities3,131 3,541 4,013 4,439Infrastructure and social sector 546 759 763 756Investment subject to exposure norms,including other than approved investments1,327 1,538 2,035 2,787Housing and fire-fighting equipment 31 37 39 42Unit-linked insurance product funds (ULIPs)

Approved investments 234 576 1,115 1,515Other than approved investments 25 95 219 213Source: IRDA annual report FY09, Insurance Regulatory and Development Authority website, www.irdaindia.org, accessed 20 August 2010



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

However, as outlined in the Eleventh Five Year Plan (2008 2012), there is a significant fund requirement of INR20,562billion in the infrastructure sector. Given an expected robustincrease in the insurance business and the increasingparticipation of foreign insurers in India, insurancecompanies are well positioned to contribute to infrastructuredevelopment in the country.

These investments could further increase with thedevelopment of sound debt markets, especially the marketfor long-term government paper and income tax incentivesto attract savings for infrastructural schemes. The

direct investment of policyholder funds of life insurers ingovernment bonds is another way in which the industry hashelped the development of infrastructure. In addition, IRDA smandate for insurance companies to invest 15% of theirannual sales in infrastructure is expected to boostcapital formation.

Contribution of insurance to FDI

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

to increase to approximately INR51 billion in FY10. It isdifficult to estimate, but an equal amount of additionalforeign investment, can roughly flow into the sector if thegovernment increases the FDI limit from 26% to 49%.

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

Contribution of insurance to the offshoring business

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

India offers varied insurance solutions dealing with health,property, life, annuities, reinsurance and casualty, among


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others. The following is a list of insurance services that areoutsourced to India.

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



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ApplicationUnderwriting New business Policy Treaty Underwritingprocess support administration administration supportPolicy Claimsadministration processing and issuanceClaims and Annuitiesservicing accountingTechnical Claimsmanagementand maintenance adjudicationCustomer relationship andinformation managementInsuranceworkflowActivedesk solutionCustomer relationship andinformation managementActive desk solution

Reinsurance treatyadministrationInsurance workflowHire-to-retireProcure-to-payOpen block lifeadministrationClosed block lifeadministrationProduceradministrationserviceRetirementservicesHire-to-retireProcure-to-payProcure-to-pay Hire-to-retire

Exhibit 2.1. Insurance services suite

Life insurance, pension

Property and casualty insurance

Reinsurance

and annuities

BPO

Technologyenabled

End-to-endplatform

Analytics

ProductanalyticsCustomer


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analytics Profitability analytics Claims analytics Risk analyticsApplication developmentand maintenanceLife, retirement services,producer administrationplatformBusiness process and operationsconsulting

Technology andconsulting

Source: Infosys



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Contribution of insurance to employment

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

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

IRDA has mandated the appointment of actuaries in allinsurance companies, ensuring the certification of allproducts before launch. The insurance regulator has also

made it mandatory for appointed actuaries to attend allboard meetings to help the insurer ensure solvency at allpoints in time.

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

Exhibit 2.2. Growing employment in the life insurance industry

Parameter FY00 FY06 FY07 FY08 FY09Direct employees 1,23,000 1,52,449 1,87,403 2,54,332 2,85,244Individual agents 7,14,000 14,22,609 19,85,457 24,98,513 29,06,281Source: Life Insurance Council of India


16


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Section II:Industry at cross-roadsof developmentSection II:Industry at cross-roadsof developmentInsurance industry: significantly

untapped latent potential

India s insurance industry has witnessed rapid growth duringthe last decade. Consequently, many foreign companieshave expressed their interest in investing in domesticinsurance companies, despite the Government of India sregulation, which mandates that the foreign shareholdinglimit is fixed at 26% for the life as well as non-lifeinsurance sectors.

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

Exhibit 2.3. Insurance premiums as a % of GDP

In percentage

7.6

7.3

8

6.3

3.5 4.15.5 6.46.7

4.8

6

3.7 4.23.3

42

2.7 3.0 0.90.9 0.90.7 0.800.6 0.7The Indian life insurance sector has witnessed exponentialgrowth, driven by innovation in product offerings anddistribution owing to market entrants since the opening up


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of the sector in 2000. Currently, it is the fifth-largest lifeinsurance market in Asia. The rapid expansion in the lifesector coincided with a period of rising household savingsand a growing middle class, backed with strong economicgrowth. Innovative product design (e.g. launch of ULIPs)and aggressive distribution strategies (e.g. development ofbancassurance) by private sector players have significantlycontributed to strong premium growth. The followingdiagram shows the increasing premium per capita during thesame period.

Exhibit 2.4. Per capita insurance premium

2,500

2,187.1

2,000

628.31,003.61,479.11,769.3637.9 776.1952.01,197.22,013.81,921.9785.41,716.11,500

1,000

265.2

500

528.4 237.0 244.5147.8 166.6 193.7109.5

0

FY03 FY04 FY05 FY06 FY07 FY08 FY09

Non-life insurance premium contribution as a % of GDPLife insurance premium contribution as a % of GDPTotal insurance premium contribution as a % of GDPSource: IRDA annual report FY03 09, Insurance Regulatory and DevelopmentAuthority website, www.irdaindia.org, accessed August 2010; CMIE

FY03 FY04 FY05 FY06 FY07 FY08 FY09

Non-life insurance premium per capitaLife insurance premium per capitaTotal insurance premium per capitaSource: IRDA annual report FY03-09, Insurance Regulatory and DevelopmentAuthority website, www.irdaindia.org, accessed August 2010; CMIE



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The global economy has slowly started recovering from theeconomic recession. Lagging employment, coupled withdeclining aggregate wages, a weakened residential andcommercial real estate market, tight credit and a behavioralshift on the part of consumers from consumption to savingsare factors contributing to a delayed recovery. Althoughthe global insurance industry has not been impacted by thefinancial crisis as much as the banks, it still has its set ofissues. The leading five issues on the global insurance watchlist are:

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

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

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

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

Adapting to demographic shifts: The demographicchanges in North America, Europe, Japan and other areasis starting to shift assets from equities to annuities as wellas other fixed-income products.Exhibit 2.5. Global comparison of insurance premiums, penetration and density for both life and non-life segments

Non-life premiums in 2009 Life premiums in 2009Country Premiums,US$ millionPenetration,% of GDPDensity,US$ per capitaPremiums,US$ millionPenetration,% of GDPDensity,US$ per capitaDevelopedAustralia 27,849 3 1,308.0 32,468 3.4 1,524.8France 88993 3.1 1,289.4 194077 7.2 2,979.8Germany 126,591 3.7 1,518.7 111,776 3.3 1,359.7Singapore 5,188 1.7 645.6 9,057 5.1 1,912.0South Korea 34,527 3.9 709.7 57,436 6.5 1,180.6United Kingdom 91,560 3 1,051.2 217,681 10 3,527.6


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United Arab Emirates 4,381 2.1 952.7 732 0.4 159.2United States 647,401 4.5 2,107.3 492,345 3.5 1,602.6Indian insurance sector: stepping into the next decade of growth


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Non-life premiums in 2009 Life premiums in 2009Country Premiums,US$ millionPenetration,% of GDPDensity,US$ per capitaPremiums,US$ millionPenetration,% of GDPDensity,US$ per capitaDevelopingBangladesh 205 0.2 1.3 636 0.7 3.9Brazil 23,979 1.5 123.8 24,781 1.6 127.9China 53,872 1.1 40 109,175 2.3 81.1India 6,375 0.9 6.7 46,206 6.6 48.1

Indonesia 2,219 0.4 9.6 5,066 0.9 22Malaysia 3,158 1.6 115 5,682 2.9 206.9Mexico 9,664 1.1 88.2 7,688 0.9 70.1Pakistan 650 0.4 3.6 543 0.3 3Philippines 835 0.5 9.1 1,563 1 17Romania 2,365 1.4 111.2 533 0.3 25.1Russia 38,940 2.4 276.4 636 0 4.5South Africa 8,215 2.9 163.9 28,773 10 574.2Sri Lanka 358 0.9 17.7 238 0.6 11.8Taiwan 11,443 3 494.8 52,204 13.8 2,257.3Thailand 4,248 1.6 62.7 6,212 2.4 91.7Vietnam 769 0.8 8.7 671 0.7 7.6Non-life premiums in 2009 Life premiums in 2009Country Premiums,US$ millionPenetration,% of GDPDensity,US$ per capitaPremiums,US$ millionPenetration,% of GDPDensity,US$ per capitaDevelopingBangladesh 205 0.2 1.3 636 0.7 3.9Brazil 23,979 1.5 123.8 24,781 1.6 127.9China 53,872 1.1 40 109,175 2.3 81.1India 6,375 0.9 6.7 46,206 6.6 48.1Indonesia 2,219 0.4 9.6 5,066 0.9 22Malaysia 3,158 1.6 115 5,682 2.9 206.9Mexico 9,664 1.1 88.2 7,688 0.9 70.1Pakistan 650 0.4 3.6 543 0.3 3Philippines 835 0.5 9.1 1,563 1 17Romania 2,365 1.4 111.2 533 0.3 25.1Russia 38,940 2.4 276.4 636 0 4.5South Africa 8,215 2.9 163.9 28,773 10 574.2Sri Lanka 358 0.9 17.7 238 0.6 11.8Taiwan 11,443 3 494.8 52,204 13.8 2,257.3Thailand 4,248 1.6 62.7 6,212 2.4 91.7


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Vietnam 769 0.8 8.7 671 0.7 7.6Source: World Insurance in 2009, Swiss Re, June 2010, Insurance Regulatory and Development Authority website, www.irdaindia.org, accessed

06 January 2010

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

Though India s penetration appears higher, it is notexcessive, given the high level of investments in insurancepolicies underwritten. Nonetheless, besides India, Taiwan isthe other Asian market that shares similar characteristics.

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

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



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for the current regulations is to promote stability and fairplay in the market place. Some of the recent regulatorychanges and their impact include:

New disclosure norms

IRDA has come up with the following disclosure norms:

IRDA has issued disclosure norms for insurancecompanies, mandating them to publish accounts on a half-yearly basis. The disclosure norms are seen as a precursorto allowing insurance companies to hit the primarymarket. According to the new norms, insurers will have topublish their balance sheet on a half-yearly basis, startingfrom the period ending 31 March 2010.Disclosures to be made for a company launching an IPO

All financial disclosures for the past five years prior tothe IPO have to be available on the company website. Inaddition, insurance companies have to disclose the dataon various parameters such as the calculation of economiccapital, surrender and lapse experience of business andexpense patterns for the five-year period.Indian insurance sector: stepping into the next decade of growth


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

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

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

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

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

Altered commission structure of agents

Insurers would be allowed to charge up to 4% on annualpremium paid on ULIPs for the first five years, andthereafter, charges will be reduced during the tenure ofthe policy. This figure narrows down to 3% by the tenthyear in a tapered scale, ending with 2.25% after thefifteenth year. The new guidelines apply from 1 September2010. Earlier, the regulator had allowed commissionscharged by agents to not exceed 40%.

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


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According to the draft guidelines, all life insurance agentswill have to gather a minimum of INR150,000 as thefirst-year premium or sell a minimum of 20 life insurancecontracts. When an agent falls short of achieving eitherof the above, they would have to proportionately achievemore in either one to make up for the shortfall. Wherethe average annual persistency ratio is less than 50%, thelicense of the agent will not be renewed.Implications

This move by the IRDA reflects its efforts to ensuretransparency and implement more stringent disclosurenorms to avoid mis-selling. This is likely to allow insurers torecover their cost in a more transparent and informed way, thereby reducing unfair practices and the informationgap in domestic insurance to enhance market discipline.Any variation in the payment structure of agents will alsohelp companies to reduce their costs. Further, tenure-based commissions will definitely benefit the industry. High

commission is also expected to come down and there willbe better reward for longer-term policies than the shorter-term ones.

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

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



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commission, insurance companies may resort to innovativeways of compensating their top-performing agents. Noncommission-based remuneration may increase. Companiesmay expand their different reward and recognition programsto make the sale of ULIPs attractive for agents in light ofthese recent changes.

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

IPO norms for insurance company

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

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

The norms for correct valuation, disclosure of operatingresults and profit and loss account and filing of thedraft red herring prospectus are the three essentialsthat a company has to fulfill when opting for a publicfloat. Besides, companies would have to make financialdisclosures, risk disclosures, investment performance, etc.(details stated in the above section Newdisclosure norms ).Implications

Insurance companies need capital to expand, innovateand sustain in the market. Insurance companies typicallyprefer to raise capital by floating an IPO. There can be amix of a fresh issue of shares as well as the sale of sharesby the parent company. Most companies prefer this routewhen they do not have enough capital to plough back intotheir business. With the IPO route of raising capital, Indian

promoters will get the opportunity to put their equity intothe market as well as FIIs will also be able to participate andacquire stakes.

Promoting health insurance

IRDA has allowed insurance companies to offer Healthplus Life Combi Product, a policy that would providelife cover along with health insurance to subscribers.Under the guidelines issued by the IRDA, life and non-lifeinsurance firms can also partner in offering the health-


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plus-life cover. The combi products may be promoted by alllife insurance and non-life insurance companies, however,a tie up is permitted between one life insurer and one nonlifeinsurer only. Thus, a life insurer is permitted to enteran alliance with only one non-life insurer and vice-versa.

The sale of combi products can be made through directmarketing channels, brokers and composite individual andcorporate agents, common to both insurers. However,these products are not allowed to be marketed through

bank referral arrangements. The regulator furtherspecified that the guidelines do not apply to micro-insurance products, which are governed by IRDA (MicroInsurance) Regulations, 2005.

Under the Combi Product, the underwriting of therespective portion of the risks will be underwritten byrespective insurance companies, i.e., life insurance riskwill be underwritten by the life insurance company and the

health insurance portion of risk will be underwritten by thenon-life insurance company.Implications

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

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



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

Alteration in ULIPs

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

Lock-in period: IRDA has increased the lock-in period forall ULIPs from three years to five years, including top-up premiums, thereby making them long-term financialinstruments that provide risk protection. All limited

premium ULIPs, other than single premium products, willhave a premium paying term of at least five years.

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

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

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

Cap on surrender charges: IRDA has recommended a capon the surrender charges at up to 15% of the fund value inthe first year for policies with a tenor more than 10 yearsand 12.5% for policies with a tenor of less than 10 years.This charge comes down to 5% and 2.5%, respectively, inthe fifth year of the policy, and becomes nil for policies ofless than 10 years after the fifth year. For tenors above 10years, the charge in the sixth year is 2.5%, which becomesnil in the seventh year.

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

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


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an adverse impact on their profitability.

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

Though it may make selling difficult as it would makeproducts inflexible, it would certainly reduce persistencyrisk, make AUMs stable, and boost the overallcertainty on assumptions and the profitability of thebusiness underwritten.

Other regulations

Besides the above regulations, IRDA and the governmentare in the process of drafting more regulatory reforms for

the industry such as:

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


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increasing the upper limit in FDI from the current 26% to49%. Foreign partners are largely unwilling to dilute theirstakes below 26%, since most of them enter the businessin anticipation of the limit being increased. This may resultin the local partner being compelled to reduce its staketo 49% to meet the new norms. This could create its owncomplications, since according to the Indian company law;a 51% stake ensures ownership.IRDA is finalizing directives and detailed guidelines for mergers and acquisitions in the insurance sector.The policy document for the smooth transition from Solvency I to Solvency II is in the draft stage.A data warehouse is being set up to monitor the settlement of insurance claims, better customerrelationship management and facilitate betterdecision making.IRDA is considering allowing banks to tie up with multiple insurance companies to vend their products. This will give

bank customers a wider menu of options to select from, sothat they can buy insurance products based ontheir needs.IRDA will soon come up with norms to define terms such as critical illness and hospitalization cost, among others,a move that will reduce the scope for disputes betweeninsurers and hospitals.Regulation affects the economics of both the supplyside (the policyholders supplier of funds) as well as thedemand side (the insurers borrowers of funds). The Indianconsumer, being extremely price sensitive, adjusts rapidlyto the altered economics, which could affect the persistencytrend in the industry. IRDA s role will be critical for furtherindustry growth and the rise in penetration levels.increasing the upper limit in FDI from the current 26% to49%. Foreign partners are largely unwilling to dilute theirstakes below 26%, since most of them enter the businessin anticipation of the limit being increased. This may resultin the local partner being compelled to reduce its staketo 49% to meet the new norms. This could create its owncomplications, since according to the Indian company law;a 51% stake ensures ownership.IRDA is finalizing directives and detailed guidelines for mergers and acquisitions in the insurance sector.The policy document for the smooth transition from Solvency I to Solvency II is in the draft stage.A data warehouse is being set up to monitor the settlement of insurance claims, better customerrelationship management and facilitate betterdecision making.IRDA is considering allowing banks to tie up with multiple insurance companies to vend their products. This will givebank customers a wider menu of options to select from, sothat they can buy insurance products based ontheir needs.IRDA will soon come up with norms to define terms such as critical illness and hospitalization cost, among others,a move that will reduce the scope for disputes betweeninsurers and hospitals.Regulation affects the economics of both the supplyside (the policyholders supplier of funds) as well as the


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demand side (the insurers borrowers of funds). The Indianconsumer, being extremely price sensitive, adjusts rapidlyto the altered economics, which could affect the persistencytrend in the industry. IRDA s role will be critical for furtherindustry growth and the rise in penetration levels.


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Section III:Critical factors formarket developmentSection III:Critical factors formarket developmentDistribution channels

The effectiveness and cost of diverse distribution strategiesof different players is crucial in ensuring the success ofplayers in the insurance business, particularly in the retaillines of business. The low differentiation among retailinsurance products suggests the criticality of distributionreach and efficiency for success in this business.

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

Where are the customers?

What is target customer profile?

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

Which channel provides best buying experience and valueto target customer segment?

What is the operational cost involved in each typeof channel?The customer preferences vary by market segmentvis--vis geography, age, income, life style, etc., and marketcharacteristics change over time.

Role of intermediaries/distributors/financial advisors

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

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

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


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



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Potential channel growth(Medium term)BancassuranceTied agentsInternetDirectWorksiteBrokersCorporate agentsExhibit 2.6.: Current market share and potentialmarket growth

High

LowLow Current market share High

Bancassurance: Insurance products Direct: Sales through calloffered through banks centres and/or direct mailing

Brokers: Representatives for buyers Internet: E-commerce saleswho deal with either agents or through internet portalscompanies in arranging for coverage

Tied agents: Insurancecompanies aligned agency force

Corporate agents: Non-bankinstitutions involved in the

Worksite: Marketing arrangements

sale of insurance products

with entities to sell insurance totheir employees

Source: Watson Wyatt

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

The most prominent models of insurance distribution are:

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

The agency force has a high gestation period and is


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Exhibit 2.7. Tied agency model

Nascentagency force"Trained" and"independent"agency force"Mature" and"highly" productiveagency force.Low productivity.Heavy investment required in product and process training.Insurers focus on controlling attrition.Insurers' brand strength, product innovation and commission rates are critical i

n preventing attrition.High productivity.Loyalty (propelled by trailing commission build up).Equips the organization with the ability to sell complex risk and asset protection productsSource: Life Insurance, Edelweiss, 6 August 2010, via Thomson Research

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

Provide all the necessary application forms

Submit application forms to the company

Arrange for all the medical tests and related formalities

Provide reminders premiums payments andreturn receipts

Should help customers make necessary changes inaddress, nomination, etc.

Help in the process of assignment

Assist customers for any loan applications andrelated formalities

Should help customers revive lapsed policies

Assist in claiming death benefits, if requiredBesides the above, agents are now moving from thesole contact point between a customer and an insurancecompany to become financial advisors. Agents would nowbe responsible for explaining the nature of a policy tocustomers as that will help customers to take informed


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decisions. Their role is likely to enhance, as they will not

only sell insurance products, but offer other financialproducts as well to enhance customer benefits.

The limiting factor for prospective insurers will be theextensive and costly distribution structure equipped forreaching this segment. While public sector companies areable to attract agents, they continue to suffer from highattrition rates due to the indiscriminate agent appointment.The most successful of these companies tied agents arehardly of the elite variety of salespeople. They are still theneighborhood do-gooders the postman, the schoolteacherand the shopkeeper who know the people and arethemselves known in the community.

The challenge here is the lack of knowledge of thecompetitive market and the inability to do intelligentcomparisons with the competitors products. New companies

are looking for educated and aware individuals with amarketing flair, an elite group that can be attracted onlywith high remuneration and the lure of a fashionable job, allof which may not be possible in this business with its pricepressures and the complexity of selling insurance. Withthis kind of segmentation of intermediaries, the test forthe insurance company lies in training and educating thesepeople to become effective sales individuals.



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

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

Exhibit 2.8. Bancassurance model

Bank-backed insurers and those promoted by large banks thatare better positioned due to their relatively lower developmentcosts, predominantly variable cost structure (typically openingown sales branches imply higher fixed and semi-variable costs)and the integration of systems that may reduce the costof operations.

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

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

DistributionagreementStrategicallowanceJointventureFinancialservicesgroup.Insurer able to leverage the bank's infrastructure; source of fee-based income for the bank.Bank and insurer may have a fragmented view of their customers.Low level of integration.Reluctance of bank staff to sell insurance; insurer has little control over distribution.Insurer able to leverage the bank's infrastructure; source of fee-based income for the bank.Integration in product development and channel management.Sharing of customer database.Reluctance of bank staff to sell insurance to sell insurance; insurer has little


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control over distribution.Joint decision making; bank participation in product and distribution design.High system integration, infrastrucural utilization; low-cost model.Insurer loses control on distribution.Bank may be able to realize higher profitability as an insurance distributor rather than as a producer.Full integration of system; low cost model.Potential for fully integrated products and developing a one stop shop for financial services.Insurer is ill equipped to exercise control over distribution.Bank may be able to realize higher profitability as an insurance distributor rat

her than as a producerSource: Life Insurance, Edelweiss, 6 August 2010, via Thomson Research



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Technological advances are expected to enable newdistribution channels, while recent regulatory changes(bank s entry into insurance) are expected to allow cross-selling between financial services companies. However,banc-assurance is expected to gain considerable popularity.

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

Other distribution methodsAlternate distribution channels are needed for thefollowing reasons:

To increase insurance penetration in the country

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

To increase insurance awareness and knowledgeamong people

To satisfy the needs of more demanding customers

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

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

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

Some products, once they receive a high level of penetration


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and awareness, can become commodities and be soldthrough more impersonal channels. The use of the internetto distribute life insurance products has only recentlyemerged, and has not made a significant impact so far,partly because of the substantial advisory component ofmost life insurance products.

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

These distribution networks have reached an unprecedentedscale from mobile phone companies to microfinance

institutions to supermarket chains and churches. Customers,in vast numbers, who were previously off the grid are nowwithin reach.

Challenges with the existing distribution model

India is arguably one of the most challenging and promisingemerging insurance markets. Its rapidly growing economy,coupled with a young and diverse population, open ampleopportunities for the development of insurance. However,there is much to be done to realize this potential. In today s



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

Building faith about the company in the minds of clients

Intermediaries being able to build personal credibilitywith clients

Controlling operating expenses by reducingdistribution costs

Coping with IRDA norms on their commissionIt is the traditionally tied agents that have been the primarychannels of insurance distribution in the Indian market.Public sector insurance companies have their branchesin almost all parts of the country and have attracted localpeople to become their agents. These agents are fromvarious segments in society and collectively cover the entire

spectrum of the society. A person who has lived in thelocality for many years sells the products of the insurancecompany with a local branch nearby. This ensures the lastmile touch point being closer to the customer. Of course,the profile of the people who acted as agents suggests thatthey may not have been sufficiently knowledgeable aboutthe different products offered, and may not have sold theappropriate product to the client. Nonetheless, the customer

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

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

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


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A two-pronged approach to cost management canbe envisaged:

Cut commission pay-outs

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

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

Generate higher investment yields that may strengthenthe sales pitch

Build a strong retail brand, which will be expensiveThe insurance industry in India has seen the emergenceof large bank-backed insurers. So far, the regulator hasallowed banks to enter only into corporate agency tie-upswith insurers. Hence, banks promoting insurance companiesremained tied to their ventures, putting to question theexistence of the arm s length relationship between the bankand insurance subsidiary.

The emergence of a much more difficult and evolvingmarket scene, with existing players, more new playerscoming in and global marketing practices and ideas beingtested, is distinctly visible. But none of this has changed thefundamental character of the market.

Experiences from developed insurance markets worldwide

Globally, various insurance markets are at varying stagesof development, which is also reflected in their insurancedistribution networks. On one hand, the distribut

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