INTRODUCTION

The Committee on Reforms: In The Insurance Sector, popularly known as Malhotra

Committee had recommended in 1994 that brokers, representing the customer, be brought

in as another marketing and distribution channel, as prevalent in most of the developed

and developing markets to protect the consumer interests, to raise the level of

professional standards in risk management and underwriting and to speed up claims

settlement.

The Insurance sector in India governed by Insurance Act, 1938, the Life Insurance

Corporation Act, 1956 and General Insurance Business (Nationalisation) Act, 1972,

Insurance Regulatory and Development Authority (IRDA) Act, 1999 and other related

Acts. With such a large population and the untapped market area of this population

Insurance happens to be a very big opportunity in India. Today it stands as a business

growing at the rate of 15-20 per cent annually. Together with banking services, it adds

about 7 per cent to the country’s GDP .In spite of all this growth the statistics of the

penetration of the insurance in the country is very poor. Nearly 80% of Indian

populations are without Life insurance cover and the Health insurance. This is an

indicator that growth potential for the insurance sector is immense in India. It was due to

this immense growth that the regulations were introduced in the insurance sector and in

continuation “Malhotra Committee” was constituted by the government in 1993 to

examine the various aspects of the industry. The key element of the reform process was

Participation of overseas insurance companies with 26% capital. Creating a more

efficient and competitive financial system suitable for the requirements of the economy

was the main idea behind this reform. Since then the insurance industry has gone through

many sea changes .The competition LIC started facing from these companies were

threatening to the existence of LIC .since the liberalization of the industry the insurance

industry has never looked back and today stand as the one of the most competitive and

exploring industry in India. The entry of the private players and the increased use of the

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new distribution are in the limelight today. The use of new distribution techniques and

the IT tools has increased the scope of the industry in the longer run.

Insurance sector in India is one of the booming sectors of the economy and is growing at

the rate of 15-20 per cent annum. Together with banking services, it contributes to about

7 per cent to the country's GDP. Insurance is a federal subject in India and Insurance

industry in India is governed by Insurance Act, 1938, the Life Insurance Corporation Act,

1956 and General Insurance Business (Nationalisation) Act, 1972, Insurance Regulatory

and Development Authority (IRDA) Act, 1999 and other related Acts.

 The origin of life insurance in India can be traced back to 1818 with the establishment of

the Oriental Life Insurance Company in Calcutta. It was conceived as a means to provide

for English Widows. In those days a higher premium was charged for Indian lives than

the non-Indian lives as Indian lives were considered riskier for coverage. The Bombay

Mutual Life Insurance Society that started its business in 1870 was the first company to

charge same premium for both Indian and non-Indian lives. In 1912, insurance regulation

formally began with the passing of Life Insurance Companies Act and the Provident

Fund Act.

By 1938, there were 176 insurance companies in India. But a number of frauds during

1920s and 1930s tainted the image of insurance industry in India. In 1938, the first

comprehensive legislation regarding insurance was introduced with the passing of

Insurance Act of 1938 that provided strict State Control over insurance business.

Insurance sector in India grew at a faster pace after independence. In 1956, Government

of India brought together 245 Indian and foreign insurers and provident societies under

one nationalised monopoly corporation and formed Life Insurance Corporation (LIC) by

an Act of Parliament, viz. LIC Act, 1956, with a capital contribution of Rs.5 crore.

The (non-life) insurance business/general insurance remained with the private sector till

1972. There were 107 private companies involved in the business of general operations

and their operations were restricted to organised trade and industry in large cities. The

General Insurance Business (Nationalisation) Act, 1972 nationalised the general

insurance business in India with effect from January 1, 1973. The 107 private insurance

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companies were amalgamated and grouped into four companies: National Insurance

Company, New India Assurance Company, Oriental Insurance Company and United

India Insurance Company. These were subsidiaries of the General Insurance Company

(GIC).

http://siva8622kalvi.blogspot.in/2012/01/insurance-sector-in-india-malhotra.html

REFORMS IN INSURANCE

The insurance sector in India have come a full circle from being an open competitive

market to nationalization and back to a liberalized market again. Tracing the

developments in the Indian insurance sector reveals the 360- degree turn witnessed over a

period of almost two centuries. The business of life insurance in India in its existing form

started in India in the year 1818 with the establishment of the Oriental Life Insurance

Company in Calcutta.

The General insurance business in India, on the other hand, can trace its roots to the

Triton Insurance Company Ltd., the first general insurance company established in the

year 1850 in Calcutta by the British.

The main objective of this section is to review the insurance sector at broader aspects and

to outline the main findings of important studies relating to insurance sector to use the

analysis as a background, for delineating the area of the present work.

In 1993, Malhotra Committee, headed by former Finance Secretary and RBI Governor

R.N. Malhotra, was formed to evaluate the Indian insurance industry and recommend its

future direction. 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 then underway and recognizing

that insurance was an important part of the overall financial system where it was

necessary to address the need for similar reforms. In 1994, the committee submitted the

report and recommendations.

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The committee emphasized that in order to improve the customer services and increase

the coverage of insurance policies, industry should be opened up to competitions. 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- The Insurance Regulatory and Development Authority. Reforms in the Insurance

sector were initiated with the passage of the IRDA Bill in Parliament in December 1999.

The IRDA since its incorporation as a statutory body in April 2000 has fastidiously stuck

to its schedule of framing regulations and registering the private sector insurance

companies. Since being set up as an independent statutory body the IRDA has put in a

framework of globally compatible regulations. The other decision taken simultaneously

to provide the supporting systems to the insurance sector and in particular the life

insurance companies was the launch of the IRDA online service for issue and renewal of

licenses to agents. The approval of institutions for imparting training to agents has also

ensured that the insurance companies would have a trained workforce of insurance agents

in place to sell their products.

THE COMMITTEE ON REFORMS IN THE INSURANCE SECTOR

THE GOVERNMENT appointed the committee on reforms in the insurance sector

(1994) in april 1993 headed R.N.MALHOTRA,the former Governor of the Reserve Bank

of India.The terms of reference of the said Committee were:

(1) to examine the structure of the insurance industry as it has evolved within the existing

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framework and to assess its strength and weaknesses in terms of the objective of creative

an efficient and viable insurance industry providing a wide reach of insurance services

and a variety of insurance products wit a high quality of service to the public and serving

as an effective instrument for mobilization of financial resources for development.

(2) to make recommendations for changes in the structure of the insurance industry, as

well as the general framework of policy, as may be appropriate for the pursuit of the

above objectives keeping in mind the structural changes currently underway in other parts

of the financial system and in the economy.

(3) to make specific suggestions regarding the LIC and the GIC, which would help to

improve the functioning of these organizations in the changing economic environment

(4) to review the present structure of regulation and supervision of the insurance sector

and to make recommendations for strengthening and modernizing the regulatory system

in the tune with changing requirements.

(5) to review and make recommendations on the role and functioning of the surveyors,

intermediaries and other ancillaries of the insurance sector.

(6) to make recommendations o such other matters as the Committee considers relevant

for the health and long-term development of the insurance sector.

In under a year. the Committee submitted its Report, which was approved in principle by

the government. The major thrust of the recommendations was towards the opening up of

the insurance sector,for which initiative had to come from the government.

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LIBERALISATION OF THE INSURANCE INDUSTRY

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

farreaching 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 promoter’s

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

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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

collaborators of Indian promoters, and 14 per cent for nonresident

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 business—life 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 government’s 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

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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 onthe-

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

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American“put” options that can be exercised in the event of a

calamity, they themselves remain 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.

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MALHOTRA COMMITTEE

In 1993, the Government set up a committee under the chairmanship of RN Malhotra,

former Governor of RBI, to propose recommendations for reforms in the insurance

sector.The objective was to complement the reforms initiated in the financial sector. The

committee submitted its report in 1994 wherein , among other things, it recommended

that the private sector be permitted to enter the insurance industry. They stated that

foreign companies be allowed to enter by floating Indian companies, preferably a joint

venture with Indian partners.

 

     Following the recommendations of the Malhotra Committee report, in 1999, the

Insurance Regulatory and Development Authority (IRDA) was constituted as an

autonomous body to regulate and develop the insurance industry. The IRDA was

incorporated as a statutory body in April, 2000. The key objectives of the IRDA include

promotion of competition so as to enhance customer satisfaction through increased

consumer choice and lower premiums, while ensuring the financial security of the

insurance market.

With the Insurance Regulatory and Development Authority Act, 1999 coming into force,

the insurance industry has been opened up for the private sector. The Act provides for the

establishment of a statutory IRDA to protect the interests of insurance policy holders and

to regulate, promote and ensure orderly growth of the insurance industry. The IRDA was

formed by an Act of Parliament on April 19, 2000.

Under the IRDA Act, an ‘Indian insurance company’ will be allowed to conduct

insurance

business provided it satisfies the following conditions:

• It must be formed and registered under the Companies Act, 1956;

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• The aggregate holdings of equity shares by a foreign company, either by itself or

through its subsidiary companies or its nominees, should not exceed 26% paid up equity

capital of the Indian insurance company;

• Its sole purpose must be to carry on the life insurance business or general insurance

business or reinsurance business.

2 To operate the insurance business in India, the Indian insurance company has to obtain

a certificate of registration from IRDA.

It has also been provided in the IRDA Act that on or after the commencement of the

IRDA Act, no insurer will be allowed to carry on the life and general insurance business

in India, unless it has a paid up equity capital of Rs. 1 billion. For carrying on the

reinsurance business, the minimum paid up equity capital has been prescribed as Rs. 2

billion. The Reserve Bank of India (RBI) has also issued guidelines for banks’ entry into

the insurance business. For banks, prior approval of the RBI is required to enter into the

insurance business. The RBI would give permission to banks on a case-by-case basis,

keeping in view all relevant factors. Banks having a minimum net worth of Rs. 5 billion

and satisfying other criteria in respect of capital adequacy, profitability, non-performing

asset (NPA) level and track record of existing subsidiaries can undertake insurance

business through joint ventures, subject to certain safeguards. However, banks need not

obtain prior approval of the RBI for engaging in insurance agency business or referral

arrangement without any risk participation, subject to certain conditions.

 

    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.  

     Today there are 24 general insurance companies including the ECGC and Agriculture

Insurance Corporation of India and 23 life insurance companies operating in the country.

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     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 development as it

provides long- term funds for infrastructure development at the same time strengthening

the risk taking ability of the country.

1994, the committee submitted the report and some of the key recommendations

included:

i) 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.

ii) Competition

Private Companies with a minimum paid up capital of Rs.1bn should be allowed to enter

the

sector. 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.

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Postal Life Insurance should be allowed to operate in the rural market. Only one State

Level Life

Insurance Company should be allowed to operate in each state.

iii) Regulatory Body

The Insurance Act should be changed. An Insurance Regulatory body should be set up.

Controller of Insurance- a part of the Finance Ministry- should be made independent

iv) Investments

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 (there

current

holdings to be brought down to this level over a period of time)

v) Customer Service

LIC should pay interest on delays in payments beyond 30 days. Insurance companies

must be

encouraged to set up unit linked pension 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 insurance policies, industry should be opened up to competition. But at the

same

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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.

How big is the insurance market ?

Insurance is a Rs.400 billion business in India, and together with banking services adds

about 7% to India’s GDP. Gross premium collection is about 2% of GDP and has been

growing by 15-20% per annum. India also has the highest number of life insurance

policies in force in the world, and total investible funds with the LIC are almost8% of

GDP. 

WHY OPEN UP THE INSURANCE INDUSTRY ?

An insurance policy protects the buyer at some cost against the financial loss

arising from a specified risk. Different situations and different people require a different

mix of risk-cost combinations. Insurance companies provide these by offering schemes of

different kinds.

Insurance 20-20:

One of the main differences between the developed economies and the emerging

economies is that insurance products are bought in the former while these are sold in

latter. Focus of insurance industry is changing towards providing a mix of both protection

/ risk over and long-term investment opportunities. Some of the major international

players in the insurance business, which might try to enter the Indian market, are – Sun

Life of Canada, Prudential of the United Kingdom, Standard Life, and Allianz etc.

Although the insurance sector is officially open to private players, they still need a

license from the IRDA, Following might be the future strategies of insurance companies.

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(1)The new entrants cannot compete with the state owned LIC on price alone. Due to its

size, LIC operates at very low costs and their premier on policies that offer pure

protection are on a

par with comparable schemes across the globe. What the new insurance companies will

probably offer is higher returns than the annualized 9-10% one can hope to earn from

LIC’s policies. This will put pressure on LIC to offer more attractive returns.

(2)Consumers can also expect product innovations. For instance, at present, LIC provides

cover for permanent disability and what the new companies could offer is temporary

disability insurance as well.

(3)Apart from the basic term insurance, most insurance products worldwide are sold as long-

term investment opportunities with the protection component being clearly spelt out in

the scheme.

(6) Foreign companies would also use superior software (like APEX) that will give them an

edge over the in-house LICsoftware. This technology will help private insurers in product

development and customizing products to suit individual needs.

(8)Access to insurance too will probably become more widespread. Role of intermediaries

would decrease and sale of insurance through direct channels and banks would increase.

Simple products like term insurance might be sold through the telephone or direct mail to

high net worth clients.

Why allow entry to private players?

• The choice between public and private might amount to choosing between the

lesser of two evils. An insurance contract is a "promise to pay" contingent on a

specified event. In the case of insurance and banking, smooth functioning of

business depends heavily on the continuation of the trust and confidence that

people place on the solvency of these financial institutions. Insurance products

are of little value to consumers if they cannot trust the company to keep its

promise. Furthermore, banking and insurance sectors are vulnerable to the "bank

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run" syndrome, wherein even one insolvency can trigger panic among consumers

leading to a widespread and complete breakdown. This implies the need for a

public regulator, and notpublic provision of insurance. Indeed in India, insurance

was in the private sector for a long time prior to independence

India is poised to experience major changes in its insurance markets as insurers operate

in an increasingly deregulated and liberalized environment. However, despite the

liberalization in the insurance sector, public sector insurance companies are expected to

maintain their dominant positions, at least in the foreseeable future. Nevertheless, given

the enormous potential of the Indian market, it is expected that there will be enough

business for new entrants. For consumers, opening up of the insurance sector will mean

new products, better packaging, and improved customer service. Product innovation and

channel diversification would gain momentum, in line with the global trend of financial

services convergence. For government, insurance, especially life insurance, can

substitute for State security programmes. It can thus relieve pressure on social welfare

systems and allow individuals to tailor their security programmes to their own

preferences. This substitution role is especially valuable, given the growing demand for

social security and the increased financial challenges faced by the Indian social

insurance system.

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RECOMMENDATIONS

The Committee has made its recommendations on the Terms of Reference as under.

A. Detariffing:

1. To take immediate and urgent steps to move towards detariffing the entire general

insurance market that includes the profitable segments like the fire and engineering and

the unprofitable business segments like motor. It is strongly recommended that this issue

should be addressed on a priority basis and a free market without tariffs and price

controls should be organized. IRDA, TAC and the General Insurance Council of the

Insurance Association of India should collaborate with each other to ensure a smooth

changeover to the non tariff system not later than 1st April 2006.

2. A road map should be drawn up for this purpose. IRDA, TAC and the General

Insurance Council should encourage, assist and guide individual insurers to build up

statistical bases for their own risk acceptances on all businesses currently under tariffs,

category-wise, as is now prevalent in the respective tariffs. This will enable them to be

ready for a Pure Risk rate regime (wherein the rates will not include any administration

and /or procurement costs or profit margins) proposed by the Committee to operate at

least with effect from 1st April 2006. This will thus prepare the insurers for a completely

detariffed market two years later. Involvement of consulting actuaries of insurers in this

exercise should be considered.

Insurers should gross up the designated Pure Risk rates to cover for their administration

and procurement expenses and profit margins according to their best underwriting

judgment. To this extent the market should have floating rates in which the underwriting

skills and cost and profit considerations will have a primacy from 1st April 2006.

3. The effect and fall out of the introduction of Pure Risk rate regime in the interim may

have an adverse impact on the rates in the short run on profitable segments whereas the

rates may go up in the hitherto unprofitable segments. To avoid or mitigate unhealthy

competition in pricing, until the market stabilizes, the Pure Risk rates (which will not

include any administration and / or procurement costs or profit margins) should be

regarded as the minimum benchmark subject to strict discipline and inspection as an

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intermediate step. Insurers should be alerted on the need to control expenses to achieve

appropriate balances in their results.

During such regime of Pure Risk rates, the standard terms and conditions of the tariff

wordings should be preserved. The roadmap envisaged must thoroughly dwell on this

aspect.

The TAC should be entrusted with the responsibility to prepare Pure Risk rates to be

regarded as the minimum for two years commencing from 1st April 2006 or even earlier if

possible and such rates should have the status of tariff rates. The TAC should monitor the

breaches of Pure Risk rates.

Punishment for breaches should be hefty enough to discourage deliberate breaches.

4. Since there is an industry tariff structure currently in force on most portfolios, the

Committee is of the view, that there has been very little incentive for individual insurers

to build up their individual risk category acceptances and experiences to be able to price

risks on claims cost plus basis.

Absence of statistical data would compel an insurer to price risks on assumptions either

with a conservative element built into it or force it to follow the rates of any of its

aggressive competitor. In a strongly developed broker market, the pressure on

underwriters will be intense; and the current competition is still young, just three years

old. The Indian insurance market is yet to mature in terms of underwriting skills to be

able to face tougher competitive conditions likely to emerge in future.

Underwriting and pricing of risks should, therefore, be based on statistical data to back up

the intended pricing structure both at the level of the individual insurer and of the market

as a whole. It is time for individual insurers to start building up their statistical data on

sound lines to avoid a chaotic situation and price wars later.

The IRDA, TAC and the General Insurance Council should guide and assist individual

insurers to adjust to the transformation that a free market situation will impose on their

business practices, mindset and procedures.

The changeover has to be as smooth as possible and with full awareness of its

consequences.

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5. Customers do need price competition to experience the full benefits of liberalization.

Insurers need to practice underwriting skills and risk management techniques to evaluate

risks and price products to fit in with global trends and practices. They should be enabled

to learn from international trends and developments. Brokers and agents need to display

their professional wares and expertise.

B. Special discount, Intermediary Remuneration, Special dispensation to PSUs and

Paid-up Capital norms.

1. To continue with the 5% Special discount (that has been in usage for over 25 years) in

the interim for certain Corporate bodies – both in the private and public sector on fire and

engineering insurances only- till detariffing of rates by 1st April 2006 or earlier as the

case may be. There is no justifiable reason demonstrated to the Committee for its sudden

withdrawal.

2. Since the Rs 10 lakh paid-up capital norm for corporate bodies, as defined below, fixed

earlier for qualifying for special discount of 5% is very low under the present economic

trends, the Committee recommends that the eligibility limit for the special discount of 5%

should now be raised to a minimum paid-up capital of Rs 1 crore and above for corporate

bodies. The special discount of 5% should be further restricted to such corporate bodies

for only fire and engineering insurances.

This will widen the access of corporate client base, below paid-up capital of Rs 1 crore,

both to the agents and brokers to display their professional expertise.

There should be no special discount of 5% allowed on any tariff cover either to

individuals or corporate bodies whose paid-up capital is below Rs 1 crore.

IRDA/TAC may issue suitable instructions in this regard.

Where special discount 5% is not applicable, the agency commission for insurances of

individuals and corporate bodies with a paid –up capital below Rs 1 crore should be

restricted to a maximum of 10% for agents. The

brokerage should be a maximum of 12.5% on tariff covers.

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Although not related to the paid-up capital issue, it is recommended that for statutory

covers both the agents and brokers should be eligible to a maximum of 10%

remuneration, as no special expertise is required to sell and service these covers and

further there shall be no special discount payable on this.

For non-tariff covers the brokers should be eligible to a maximum remuneration of 17.5%

and the agents to a maximum of 15% as currently specified.

3. The Corporate bodies, whether private limited companies or public limited companies

or public sector undertakings or statutory bodies having a paidup capital of Rs 1 crore

and above and up to Rs 25 crores should be allowed to have a choice of availing either a

5% special discount and place fire and engineering businesses directly with an insurer or

seek the services of a broker/agent when they will become ineligible for the 5% special

discount. The remuneration to brokers in such an event should be limited to a maximum

of 7.5%. The agency commission should be restricted to a maximum 6.25 %.

4. The Corporate bodies, whether private limited companies or public limited companies

or public sector undertakings or statutory bodies having a paid –up capital of above Rs 25

crores should be allowed to have a choice of availing either a 5% special discount and

place the fire and engineering business directly with an insurer or seek the services of a

broker/ agent, when they will become ineligible for the 5% special discount. The

remuneration to brokers in such an event should be limited to a maximum of 6.25%. The

agency commission should be restricted to a maximum of 5%.

In suggesting the above norms and remuneration, the Committee would like to record that

these remuneration packages should be regarded only as interim measures pending the

detariffing of the market with the introduction of Pure Risk rate regime not later than 1st

April 2006. The brokers/agents should be enabled in the interim to get integrated into the

system for their future potential gains and the more important professional roles they will

be expected to play.

5. The present brokerage/commission structure as it exists in the present regulations on

tariff covers, does in the view of the Committee, encourage rebating and malpractices to

20

flourish. It has happened in the past, despite numerous measures discouraging their

proliferation by way of social control of insurance and nationalization.

The Regulator at this initial stage of liberalization of markets should be wary of such

substantial remuneration to be paid on tariff covers, wherein the professional input is

limited, whether it is the broker or the agent. Inducing competition in the market, while

controlling prices and product features for most covers will inevitably encourage

unhealthy practices to flourish.

Hence the Committee has suggested detariffing the market by the introduction of Pure

Risk rate regime not later than by 1st April 2006 as the logical step to create an

environment where competition is fair and there is a level playing field.

6. As regards the impact of brokerage and commission on procurement costs of insurers

on tariff covers, it is observed that the cost of transacting insurance business in India has

remained high at over 30% of the earned premiums generated for both the public and the

private players. Additional costs if imposed suddenly would further burden them.

Insurers have neither actively adopted nor taken any serious measures to reduce costs nor

have they any strategies in place to do so that will result in lower premiums to consumers

at least in future. Insurers have combined ratios (claims cost plus expenses) in excess of

114% on earned premiums for the year 2002/3 resulting in huge underwriting losses. The

Boards of Directors of these insurers should actively encourage drawing up of plans to

reduce management costs in order to lower their combined ratios that will ultimately

benefit consumers.

The Committee is also of the view that in a tariff market the brokerage and commission

structure as recommended above is in keeping with the services that can be rendered by

them.

Detariffing should, however, be completed not later than 1st April 2006 in order to allow

the Pure Risk rate regime and market forces to decide on prices and intermediation

expenses and allow consumers to experience the benefits of liberalization.

21

C. Remuneration of agents and brokers:

1. There should be a differential maintained between the Agents and Brokers in their

remuneration packages. The latter has more onerous responsibilities and functions to

discharge. As such the maximum brokerage payable should be a little higher than the

agency commission.

2. Agency commission for tariff covers should be revised to a maximum of 10% to

maintain a differential of 2.5% in the remuneration structure between brokers and agents /

corporate agents.

3. For statutory covers, however, 10% remuneration should be maintained for both of

them, as no special expert advice is required in providing or servicing such covers.

4. On non-tariff covers, the maximum remuneration for brokers should remain at 17.5%

and that of agents at 15%.

D. Government/Public Sector Undertakings:

1. The Committee recommends that all corporate bodies be treated alike and for

intermediation purposes treated under the Special Discount recommendation as

mentioned in B - 2 to 4 above. This is irrespective of whether they are in the private

sector or public sector. As such, public sector undertakings should be permitted to

exercise their choice for intermediary access with stipulations on paid-up capital norms,

remuneration and discounts as mentioned under in B - 2 to 4 above.

2. Fairness and equity requires that IRDA should not take a selective view in organizing

the market or in limiting the freedom of choice to any sector on its own.

22

CONCLUSION

A committee was set up in 1993 under the chairmanship of R.N. Malhotra, former

Governor of the Reserve Bank of India, to make recommendations for reforms in the

insurance sector. The Malhotra Committee recommended introduction of a concept of

“professionalisation” in the insurance sector to make out a strong case for paving the way

for foreign capital.

In its report submitted in 1994, the committee recommended, among other things, that:

Private players be included in the insurance sector.

Foreign companies be allowed to enter the insurance sector, preferably through joint

ventures with Indian partners.

The Insurance Regulatory and Development Authority (IRDA) be constituted as an

autonomous body to regulate and develop the insurance sector.

The key objectives of the IRDA would include promotion of competition so as to

enhance customer satisfaction through increased consumer choice and lower premiums

while ensuring the financial security of the insurance market.

Brokers representing the customer be brought in as another marketing and distribution

channel, a practice prevalent in most developed markets

Raise the level of professional standards in risk management and underwriting and speed

up settlement of claims.

Following the recommendations, the IRDA was constituted as an autonomous body in

1999 and incorporated as a statutory body in April 2000. With the coming into force of

the IRDA Act, 1999, the insurance industry was opened up to the private sector.

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