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21

st
July 2014

Foreign Direct Investment in Insurance Sector


1) The Budget presented on 10
th
July 2014 by the Hon. Finance Minster,
Shri.Arun Jaitley, contained a major policy decision, of the present government,
regarding Foreign Direct Investment (FDI). The FDI limit in the Insurance
Sector is to be raised to 49% and 49% FDI is to be allowed also in the Defence
Sector. A rational, rather than an emotional approach is necessary to judge
whether this is a good or bad decision and whether there is an alternative. In this
article, I will discuss in detail the impact of FDI in the insurance sector and, at
the end, briefly touch upon the Defence Sector.

2) FDI in Insurance Sector Will this decision be beneficial or harmful to the
insurance industry? What are the reasons behind the pressure building up to
raise the limit? What is the amount of Capital deployed so far and how much
more capital may be required? Is the FDI route the only choice open to the
Indian Insurance Industry? These and other related issues will be discussed,
with reference to the life insurance industry. General Insurance is a completely
different subject and I am not venturing into it.

3) I discussed this issue in my Blog, one year ago, in June 2013. Now that the
Hon. Minister of Finance has included it in his budget speech, we can expect this
to be implemented in a few months. What would be its impact? In my view, the
impact would be positive, since the country would get a few billion dollars for
nothing. A companys capital has no relevance to its business performance. A
company with no capital and a company with a capital 100 billion rupees will be
on the same footing.
4) As I have said in all my earlier articles, a life insurance company does not
need any Capital. Mutual insurance companies are an example. Wikipedia, the
free encyclopedia, defines a mutual insurance company as,
an insurance company owned entirely by its policyholders. Any profits earned
by a mutual insurance company are rebated to policyholders in the form
of dividend distributions or reduced future premiums. In contrast, a stock
insurance company is owned by investors who have purchased company stock
and, any profits generated by a stock insurance company are distributed to the
investors without necessarily benefiting the policyholders.

5) The Wikipedia gives also the following additional information. The concept
of mutual insurance originated in England in the late 17th century to cover
losses due to fire. The mutual/casualty insurance industry began in the United
States in 1752 when Benjamin Franklin established the Philadelphia
Contributionship for the Insurance of Houses from loss by fire.

6) A few decades ago there were many big mutual insurance companies round
the world. The number has now come down. Not because of any inherent
disadvantage in being a mutual. Two reasons can be cited for the trend towards
demutualisation of Mutuals.
A mutual insurance company cannot raise any capital. When Expansion
through Merger & Acquisition (M&A) became a fashion, a number of
mutual insurance companies demutualised and became stock insurance
companies, since capital is needed for acquiring (to gobble up) another
company.
The persons who administer a mutual insurance company do not get any
significant financial reward, since the entire surplus goes back to
policyholders. Demutualising the company and, in the process, acquiring a
significant proportion of its shares, can give vey high financial benefits.
7) In our country, after the opening of the insurance sector, the condition
regarding Minimum Solvency Margin automatically shut out the entry of
mutual insurance companies. At the time of inception, an insurance company
will not have any free reserves and can only show the capital against the
minimum solvency margin required, viz. 150% of Rs.500 million = Rs.750
million. Since a mutual will not have any capital, it cannot satisfy the minimum
solvency requirement at the time of inception.

8) One should not however be under the impression that, before the introduction
of the concept of Solvency Margin the life insurance companies were in a
financially weaker position. They had the required level of Solvency Reserve, in
an implicit rather than an explicit form. Margins provided in the Valuation Bases
to take care of possible adverse experience were higher than what are being
provided now. The higher margins used to result in much higher liability. The
difference between the value of assets needed to meet this increased liability and
the value of assets needed to meet the liability estimated with normal margins
was the implicit Solvency Reserve. The same solvency Reserve is now being
shown in an explicit form. The main advantage in the current system is that,
even a non-actuary can reasonably judge the financial strength of a life insurance
company. A minimum solvency margin was also prescribed, perhaps to keep out
the mutual insurance companies. In India, the IRDA took this strategy many
steps further by introducing the Highest Minimum Solvency Margin, perhaps to
give an impression that, it is not possible to start a life insurance company
without FDI. It was also being said in the insurance circles that, the foreign
partners in the joint ventures were given the impression (ofcourse, not an
assurance) that the FDI limit would be gradually increased to 74%.

9) TABLE-A below, gives the capital deployed by the 24 life insurance
companies, including LIC, as at 31
st
March 2013, and total of linked and non-
linked premium income during 2012 13. Since some companies bring in
additional capital in the form of reserves (a practical and sensible step), and
virtually no reserves were created out of Surplus (except in the case of LIC), the
second column in TABLE-A represents (Capital + Reserve).
TABLE-A
EQUITY SHARE CAPITAL OF LIFE INSURERS, as at 31
st
March 2013
All amounts in Rupees (crores) [ One Crore = Ten Million]

Company

Capital
+
Reserve

Total
Premium
Income

%
(3) / (2)
First
Year
Prem.
Income

%
(5) / (2)

Aegon Religare 1,200 431 35.9% 136 18.3%
Aviva 2,005 2,141 106.8% 687 40.0%
Bajaj Allianz 4,844 6,893 142.3% 2,988 76.3%
Bharti Axa 1,999 745 37.3% 249 11.8%
Birla Sunlife 2,490 5,216 209.5% 1,837 78.6%

Canara HSBC 1,075 1 ,912 177.9% 607 74.3%
DLF Pramerica 646 237 36.7% 140 11.8%
Edelweiss Tokio 550 55 10.0% 47 2.0%
Future Generali 1,452 678 46.7% 240 26.0%
HDFC Standard 2,204 11,323 513.7% 4,436 173.5%

ICICI Prudential 5,129 13,538 264.0% 4,809 89.7%
IDBI Federal 800 805 100.6% 345 38.9%
Indiafirst 605 1,690 279.3% 1,316 162.3%
ING Vysya 1,466 1,742 118.8% 638 43.4%
Kotak Mahindra 803 2,778 346.0% 1,188 189.9%

Max Life 2,151 6,639 308.6% 1,899 86.3%
METlife 2,015 2,430 120.6% 840 54.7%
Reliance 3,393 4,045 119.2% 1,377 53.3%
Sahara 331 205 61.9% 61 23.6%
SBI Life 2,710 10,450 385.6% 5,183 307.6%

Shriram Life 338 618 182.8% 421 152.7%
Star Union
Dai-Ichi
419 1,069 255.1% 745 230.3%
Tata AIA 1,954 2,760 141.2% 560 48.1%

(Private Sector)

40,579

78,398

193.2%

30,749

85.2%

LIC of India

100

208,804

208,804.0%

76,612

81,862.0%
LIC had all along only a token capital of Rs.5 crores, just to make the
Government legally eligible to receive the annual dividends. It appears that
recently, at the insistence of the IRDA, the token capital was raised to Rs.100
crores, an absolutely meaningless exercise.

10) Column (3) of the above TABLE gives the ratio of Total Premium Income
to (Capital + Reserves) and Column (6) gives the ratio of First Year Premium
Income to (Capital + Reserves), both as percentages. The above TABLE shows
that, to procure a total premium of Rs.1.93, which is made up of Re.0.85 first
year premium and Rs.1.08 renewal premium, the 23 private life insurance
companies have deployed a capital of Re.1.

11) From the above TABLE, the top 8 companies and the bottom 8 companies,
on the basis of (Capital + Reserve) deployed, have been taken and the
percentages of their First Year Premium Income and Total Premium Income to
(Capital + Reserves) are given.
Top 8 companies, on the Basis of (Capital + Reserve)
TABLE-B

Company
Capital
+
Reserve
Total
Prem.
Income

%
(3) / (2)

First
Year
Prem.
Income

%
(5) / (2)

ICICI Prudential 5,129 13,538 264.0% 4,809 89.7%
Bajaj Allianz 4,844 6,893 142.3% 2,988 76.3%
Reliance 3,393 4,045 119.2% 1,377 53.3%
SBI Life 2,710 10,450 385.6% 5,183 307.6%

Birla Sunlife 2,490 5,216 209.5% 1,837 78.6%
HDFC Standard 2,204 11,323 513.7% 4,436 173.5%
Max Life 2,151 6,639 308.6% 1,899 86.3%
MET Life 2,015 2,430 120.6% 840 54.7%


12) DLF Pramerica and Edelweiss Tokio have been omitted in TABLE-C
below, since they have been started very recently.
Bottom 8 companies, on the Basis of (Capital + Reserve)
TABLE-C
Company Capital
+
Reserve
Total
Premium
Income
%
(3) / (2)

First
Year
Premium
Income
%
(5) / (2)

Future Generali 1,452 678 46.7% 240 26.0%
Canara HSBC 1,075 1 ,912 177.9% 607 74.3%
Kotak Mahindra 803 2,778 346.0% 1,188 189.9%
IDBI Federal 800 805 100.6% 345 38.9%

Indiafirst 605 1,690 279.3% 1,316 162.3%
Star Union Dai-Ichi 419 1,069 255.1% 745 230.3%
Shriram Life 338 618 182.8% 421 152.7%
Sahara 331 205 61.9% 61 23.6%

13) It can be seen from TABLEs B and C that, there does not appear to be any
significant correlation between the size of Capital and performance of a life
insurance company.

14) Let us next look at the assets corresponding to the capital. Data in TABLE-
D was taken from the Shareholders Balance Sheet of IRDAs Annual Report.
The figures are only approximate since it is too time consuming to arrive at the
exact figures from the information available in the Balance Sheet. The
approximation is however quite sufficient for the present purpose. It can be seen
from this TABLE that, assets available cover only 60% of the (Capital +
Reserve) deployed. The balance 40% has been consumed by Expense Overrun.
We will be seeing shortly what is meant by Expense Overrun.









TABLE-D
Assets Corresponding to (Capital + Reserves) as at 31.12.2013
All Amounts in Rs.(crores) One Crore = 10 millions

Company
Capital +
Reserves

Assets

(3) / (2)
Aegon Religare 1,200 75 6.3%
Aviva 2,005 780 38.9%
Bajaj Allianz 4,844 5,022 103.7%
Bharti Axa 1,999 130 6.5%
Birla Sunlife 2,490 1,433 57.6%

Canara HSBC 1,075 434 40.4%
DLF Pramerica 646 138 21.4%
Edelweiss Tokio 550 426 77.5%
Future Generali 1,452 310 21.3%
HDFC Standard 2,204 834 37.8%

ICICI Prudential 5,129 4,800 93.6%
IDBI Federal 800 269 33.6%
Indiafirst 605 412 68.1%
ING Life 1,466 333 22.7%
Kotak Mahindra 803 667 83.1%

Max Life 2,151 2,035 94.6%
PNB METlife 2,015 522 25.9%
Reliance 3,393 1,340 39.5%
Sahara 331 303 91.5%
SBI Life 2,710 2,810 103.7%
Shriram Life 338 338 100.0%
Star Union DaiIchi 419 255 60.9%
Tata AIA 1,954 920 47.1%
Total (Private
Sector)

40,579

24,586

60.6%


Control on Cost (Expense)
15) Sec.40A and Sec.40B, of the Insurance Act, 1938, and Rule 17D of
Insurance Rules, 1939, impose certain restrictions on Agency Commission and
Management Expenses of life insurance companies. If the provisions in these
Sections and Rule had been strictly followed, there would have been no Expense
Overrun. In the case of LIC, these restrictions were strictly imposed by the then
Controller of Insurance, right from the beginning. Now, there is a demand from
some private insurance companies that these restrictions should be removed.
Surprisingly, this demand has been supported also by the Insurance Council. It is
argued that, when a company is able to demonstrate the minimum required
solvency ratio of 150%, why should there be an additional restriction on cost
ratios. Let us see why these restrictions were imposed in 1938, almost eight
decades ago.
Without such restrictions, substantial portion of the capital invested could
have been siphoned away gradually through spurious expenses. With the
ceilings placed on first year cost ratio and renewal cost ratio, the scope for
passing spurious accounting entries in respect of expenses gets curtailed. It is
not prudent to go into details of how this can be done, in an article placed for
public view. During my 33 years of service in LIC, I did not know much
about these practices. Only while working as a consultant, after retirement, I
understood the real purpose behind the imposition of these limits in the Act.
The foresight of those who drafted that 1938 Act is really amazing.
What about limits on commission expenses? If this is not done, some
companies may be able to inflate the agency commission rates and use the
excess commission available to give substantial rebates to attract new
business. The malady of Rebate, which is already stalking the Indian
Insurance Industry, will then become uncontrollable.
There was also another reason. In those days, taxation of life insurance
companies was on the basis of (Income Minus Expense). By increasing the
expenses through spurious entries, a company can evade tax. Placing a
ceiling on expenses could have been a pre-emptive step to check tax
evasions. Due to continuous efforts of the LIC, the basis of taxation has now
been changed to valuation surplus. There is always a possibility of the
Government reverting back to the earlier system.

16) A closer look at the basis used for determining tabular rates of premium in
those days will show that, the ceilings imposed on commission and operational
expenses ensured that the actual expenses incurred did not at any time exceed the
provision available for expenses in the premium rates.

What is meant by Expense Overrun?
17) The total income of a life insurance company is the sum of Premium,
Investment and Miscellaneous incomes. The total expense is the sum of
expenses in respect of Agency Commission, Operational Expenses, Tax,
Accounting Provisions and Miscellaneous Expenses. The excess of income over
expenses during a year should not be less than the Increase in Liability during
the year. If it is higher, the excess amount is called Surplus and, if it is lesser, the
difference is known as Deficit. Occurrence of deficit indicates that the total
expense incurred is higher than the provision for expenses available in the
premiums charged.

18) The expense incurred under a life insurance policy during the First Policy
Year is significantly higher than expense incurred during subsequent policy
years. Collecting upfront this additional expense incurred in the first year, will
make the first year premium significantly higher than the premium for
subsequent years. This is not a good marketing strategy. So, while determining
premium rates, this additional expense incurred in the first year is distributed
uniformly over the entire premium paying term. When a new policy is issued,
therefore, the expenses incurred during the first policy year will be substantially
higher than the provision available for expenses in the premium collected and
expense overrun can occur. In the case of a new life insurance company, there
will be Expense Overrun during the first year of operation of the company. This
will persist for two or three more years till sufficient volume of renewal
premium income emerges. A newly formed life insurance company will
generally break even in the fourth or fifth year.

Breaking Even
19) A life insurance company is said to achieve Break Even when the excess of
income over expenses during a year is not less than the increase in policy
liability during the year. (For publicity purposes, some companies conveniently
define break even as excess of income over expenses). A company should have
sufficient capital to meet this expense over run. How do mutual insurance
companies, which have no capital, meet the expense over run? By borrowing
required amount of Working Capital. Till the breakeven point is reached, their
balance sheets will be in the red.

20) A life insurance company should normally reach the breakeven point within
five years. If it does not or, if the company has to continue to infuse capital in
order to meet solvency margin requirement, the Regulator has to take a closer
look into the working of the company. Expense overrun may continue beyond
fourth or fifth year,
When the business procured is not commensurate with the infrastructure
(Number of Agents and Offices) set up for procuring business or
When there is high policy discontinuance (Lapsation) which retards the
building up of sufficient renewal premium income.

Infrastructure 1 Agents
21) Business can be procured through Tied (dedicated) Agents, Bank-assurance
or other sources like Corporate Agents, Brokers etc. TABLE-E gives the
percentage First Year Premium (FYP) procured through Tied Agents and Bank-
assurance. FYP procured through other sources will be (100% FYP through
agents and bank-assurance).
TABLE-E
Percentage of first Year Premium Procured Through Different sources
Private Sector Life Insurers L I C

No. of
Agents

% First Year
Premium Through

No. of
Agents

% First Year
Premium Through

Agents
Bank-
assurance

Agents
Bank-
assurance
(In000s) (In000s)

2004- 05

N.A

59.3%

15.4%

1,042

98.8%

0.9%

2005-06

N.A

59.7%

16.9%

1,052

98.4%

1.3%

2006- 07

890

65.8%

16.6%

1,103

97.3%

1.2%

2007- 08

1,327

59.8%

18.9%

1,194

98.4%

1.3%

2008- 09

1,593

54.9%

24.8%

1,345

97.3%

1.7%

2009- 10

1,575

50.7%

24.9%

1,403

97.8%

1.6%

2010- 11

1,302

46.9%

33.2%

1,337

97.5%

1.8%

2011- 12 1,081

44.1%

39.0%

1,278 96.6%

2.6%

2012- 13

950

39.7%

43.1%

1,173

95.9%

3.2%
N.A. -- Not available

22) It can be seen from the data contained in this TABLE that, the number of
agents employed by the private sector companies has come down sharply since
2009 10. It has also come down in the case of LIC, but not so sharply. But,
such a fall in the strength of the agency force for three successive years has
never before happened in the case of LIC and should be a matter of serious
concern. The main reason for this may be the Unilateral and Unrealistic changes
brought about by the IRDA in respect of life insurance products. This has
reduced to the minimum the number of products available for marketing, and
made the already difficult task of agents more difficult. Many of the part-time
agents might have got disheartened and discontinued their agency. There can
also be other reasons and the same have to be ascertained if this disturbing trend
is to be first halted and then reversed.

23) The First Year Premium (FYP) during 2012 13 was Rs.30,749 crores (one
crore = 10 million) in the case of private insurers. About 40% of this premium
was procured by 950,000 agents. So, average FYP per agent was,
(30749 cr. x 0.4 / 950000) = Rs. 129,469
The FYP during 2012 13 was Rs.76,612 crores in the case of LIC. About 96%
of this premium was procured by 1,173,000 agents. So, average FYP per agent,
in the case of LIC, was,
(96% of 76612 / 1173000) = Rs.627,004

24) This low productivity of agency force in the case of private insurers can also
be a reason for the delay in breaking even. Recruiting a large number of agents
each year, training them and helping them to pass the qualifying examination
conducted by the IRDA, all involve heavy cost. If more than 50% of these
agents drop out within a very short time and also the productivity of those
continuing remains low, the operational cost will escalate. For example, during
the year 2007 2008, 7.73 lakh new agents were recruited by the private
insurers and 3.36 lakh agents dropped out. In the year 2012 13, 2.83 lakh
agents were recruited and 4.14 lakh agents dropped out. This is the malady of the
insurance industry. In a competitive environment, the task of the agent becomes
more difficult. With every company keen to appoint more and more agents, the
density of agents in an area becomes more than double. Instead of addressing
this issue, the Regulator is only aggravating the problem by disheartening the
agency force through its Regulations. This problem of agency depletion is being
faced also by the LIC, but to a slightly lesser extent and the Corporation keeps
also the recruitment cost to a minimum by arranging in-house training.

25) TABLE-F below gives the average number of new policies procured by an
agent. This data has been taken from the Annual Report of the IRDA.

Average Number of new policies procured by an Agent TABLE-F
2007 - 08 2008 09 2009 -10 2010 11 2011 - 12
Private
Insurers

7

6

4

4

3

LIC

32

28

28

26

27

The low productivity shows that, proper training is not being given by private
insurers to the agents and, man-power recruited at significant cost gets wasted.
Sufficient number of competent trainers is available within the country and
engaging them to train and motivate the agents selected is certain to pay rich
dividends at very little cost. It is also to be noted that, the sale of unit linked
policies touched the peak in 2007 08 and so, the average number of policies
procured by an agent in that year would have been high.

Infrastructure 2 Number of Offices
26) The second element of the Infrastructure is number of offices. TABLE-G
below, taken from the Annual Report of the IRDA, gives the number of Offices
being maintained by private insurers and LIC.

Number of Offices Maintained by Private Insurers and the LIC
TABLE-G
2006 07 2007 08 2008 - 09 2009 -10 2010 11 2011 - 12
Private
Insurers

3,072

6,391

8,785

8,768

8,175

7,712

LIC

2,301

2,522

3,030

3,250

3,371

3,455

27) The above TABLE shows that, the number of branch offices is gradually
reducing in the case of private sector. The reduction was 1,073 offices, in the
three years between 2008 09 and 2011 12. According to the Annual Report
of the IRDA for the year 2012 13, During the year under review, the
decreasing trend in the number of life insurance offices in India continued as in
the previous year. The private insurers closed 1,097 offices and at the same time
opened 144 offices in 2012-13; therefore there was a net reduction of 953
offices. On the other hand, the public sector LIC established 71 new offices and
closed none. Thus, as at 31
st
March 2013, private sector companies had
6,759 offices and the LIC, 3,526 offices.
The FYP Income per office, during the year 2012 13 was therefore,
In respect of Private Insurers (30749 crores / 6759) = Rs.4.55 crores
In respect of LIC (76612 crores / 3526) = Rs.21.7 crores.

28) The above workings demonstrate what is meant by Business procured
being not commensurate with the infrastructure set up for procuring
business.

Number of Employees
29) No data is available in the Annual Reports of the IRDA in respect of
number of employees. It may be available in the Annual Reports of respective
companies, but these reports are not readily available in the public domain. Since
private sector companies outsource many routine administrative functions and,
data in respect of outsourcing is also not available, it may not be possible to
analyse this factor.

Reduction in Cost
30) When an office is closed, most of the staff members attached to that office
will also get retrenched. In the three years between 2009 10 and 2012 13, the
private sector life insurers reduced the number of offices by 22%, reduced also
the staff correspondingly and effected a net reduction of 40% in the number of
agents. With this, the overall cost ratio also reduced, during this period, by about
15% (from 28.5% to 24.6%). However, the total premium income and first year
premium reduced respectively by 1.2% and 20%. During the same period, LIC
registered a decrease of 16.5% in number of agents (definitely a cause for
concern), an increase of 15% in the number of offices, an increase of about 15%
in the overall cost ratio, from 13.1% to 15.1% (again a cause for concern), a
moderate increase of 7% in FYP income and 12% in total premium income.
During 2013 14, while the private sector insurers registered a further decrease
of 4% in the FYP income, LIC registered an increase of 17.5%.

31) On the whole, the last four years appear to have been quite tough for
life insurance companies and the problem has been compounded by the new
Regulations, on Proposal Forms, Products and Reinsurance, of the IRDA.

32) The problems confronting the life insurance industry are therefore,
Low productivity of agents, caused perhaps by lack of proper training
Lack of planning, which is evident in the opening and closing of too many
offices in a haphazard manner
Unreasonable regulatory changes by the IRDA
In what way the raising of FDI limit to 49% will help in solving these
problems, pertaining mainly to planning, training and regulatory
interventions? So, why worry about FDI limit?

Role of capital
33) In a manufacturing industry, the Capital plays an active role and is used for
building the factory and purchasing the required machinery. In the life insurance
industry, it plays only a passive role. It just remains invested, earning
interest/dividend. The meager capital of Rs.5 crores, with which LIC started
functioning in 1956, remains fully intact even today and nothing was ever spent
out of it. The insurance industry in Sri Lanka was opened to private sector
towards the end of eighties. The minimum capital prescribed was 100 million Sri
Lankan Rupees which was equivalent to 60 million (i.e.6 crore) Indian Rupees at
the then exchange rate. The premises for housing the office can be taken on rent.
Only machinery required is agents. Neither their recruitment and training nor
Tables and chairs will cost much. Computers can be taken on hire. To achieve all
these, a Working Capital is sufficient. The company can expand by continuous
recruitment and training of agents. The expansion will be slow initially and then
will gradually gather momentum. Once the take off point is reached, the
expansion will be very rapid. This is how mutual insurance companies were
built up. Massive Capital would be required only when a Company becomes too
ambitious and tries to reach the top position in the industry within a few years.
This is exactly what happened in the case of new companies that entered the
insurance market in the last 12 years and will go down in the History of Indian
Insurance as a standing example of How to waste capital.

34) The gestation period is quite long in life insurance industry. The person
starting a life insurance company will have to struggle for atleast 10 years before
the benefits start flowing. The next generation will see the benefits not just
flowing, but pouring. The LIC had to struggle for two decades to integrate the
240 companies taken over by it in 1956. The next decade was a period of
consolidation. Now, the entity (Government of India) that established it almost
six decades ago is seeing dividends just pouring in.

Performance of LIC
Premium Income
35) The total premium income can be divided into four parts.
Traditional Individual Assurance premium
Traditional Individual Pension/Annuity premium
Group Assurance premium
Group pension premium
Unit Linked premium
Under Group premiums and Pension/Annuity premiums, the profit margin is
quite low and can even be negative at times. So, while studying the premium
growth rate, concentrate mainly on Traditional, Individual Assurance and Unit
Linked premiums. Under the last one, the risk is least and margins are high. That
is the reason for the private insurers concentrating only on unit linked market.
Since, for the present, this market is dormant, let us study only the growth of
Traditional Assurance premium.

TABLE-H Rate of Growth of
Total Traditional Individual Assurance Premium
All Amounts in Rs.(crores) (one crore = 10 million)


Year
Total
Traditional
Premium
Income

Rate of
Growth

Year
Total
Traditional
Premium
Income

Rate of
Growth

2003 04

54,068

12.1%

2008 09

102,705

24.1%

2004 05

61,328

13.4%

2009 10

106,820

4.0%

2005 06

71,083

15.9%

2010 11

122,278

14.5%

2006 07

78,401

10.3%

2011 12

141,575

15.8%

2007 08

82,748

5.5%

2012 13

159,907

12.8%

36) The average rate of growth of Traditional, Individual Assurance Premium
over the period, 2003-04 to 2012-13 is 12.8%. Just by chance, this is the same as
the growth rate in 2012 2013. During the two year period 2006-08, due to high
growth rate in linked premium, the growth rate in traditional premium suffered.
Over the previous 15 year period 1998-99 to 2003-04, this grew from Rs.2,957
crores to Rs.54,068 crores. The average rate of growth during this period was
thus 21.4%. The set back in the traditional, individual assurance premium, in
respect of which there was not much competition from private insurers, has to be
taken note of and special efforts have to be made to revive this sector of
business.

Expenses
37) TABLE-I below, gives the Year-wise Overall Cost Ratio during the last 10
years. That is, ratio of total expenses (only commission and operating expenses)
to total premium income (individual, group, linked and non-linked). It can be
seen from the above Table that, but for a marginal decrease in 2011-2012, the
cost ratio is increasing since 2009-2010.

TABLE-I Overall Cost Ratio
All Amounts in Rs.(crores) (one crore = 10 million)
Financial
Year
Total
Premium
Income

Total
Expenses

Overall
Cost Ratio

Rate of Growth
of Total
Premium

2003 04

63,533

10,929

17.2%


2004 05

75,127

12,491

16.6%

18.2%

2005 06

90,792

13,142

14.5%

20.9%

2006 07

127,823

16,254

12.7%

40.8%

2007 08

149,790

17,924

12.0%

17.2%

2008 09

157,288

19,119

12.2%

5.0%

2009 10

186,077

24,379

13.1%

18.3%

2010 11

203,473

30,328

14.9%

9.3%

2011 12

202,869

28,977

14.3%

(0.003)%

2012 13

208,804

31,498

15.1%

2.9%

38) It would be interesting to look also at the movement of Overall Cost Ratio
for earlier years. TABLE-J gives this information for 15 years, from 198889 to
2002- 03. The data contained in the first TABLE were taken from the Annual
Reports of the IRDA, while taking the corresponding ratios for the private sector
companies, the data contained in the second TABLE were taken from the Annual
Reports of LIC.

TABLE-J Overall Cost Ratio (1988 2003)

1988 - 89

1989 - 90

1990 91

1991 - 92

1992 - 93

25.5%

23.8%

23.2%

22.3%

22.9%

1993 - 94

1994 - 95

1995 96

1996 - 97

1997 - 98

21.8%

21.4%

20.8%

21.4%

20.4%

1998 - 99

1999 - 00

2000 01

2001 - 02

2002 - 03

20.3%

20.9%

19.5%

17.8%

17.5%

a) It can be seen from the above two TABLEs that, for 19 years from 1988-89
to 2007-08, the overall cost ratio had been decreasing steadily, except on
three occasions when there were slight upward movements. But, it has started
increasing after 2007-08, except for a marginal decrease in the year 201112.
b) It can be seen from TABLE-E that, the Number of Agents has started
decreasing from 2010 11 onwards.
c) It can be seen from TABLE-I that, the rate of growth of Total Premium
Income is also slowing down from 2010 - 11.

39) The increase in overall cost ratio can be explained to a certain extent by the
high inflation over the last few years. This has affected all organisations. But,
the organisations offering pension benefits to their employees (Public Sector
banks and insurance companies and some Private Sector banks) have been
affected more due to the steep increase in the contribution to be made to their
Pension Funds. But for this increase, the cost ratio in 2012 13 might have been
at the same level as that in 2011 12. Still, the three points mentioned above
should be a cause for concern and special efforts should be made to address
these issues.

Persistency
40) Let us look at one more parameter, viz. Persistency Rate. The TABLE
below gives the Persistency Rates (excluding Linked business) for the last 24
years.
Year Persistency Year Persistency

1989 90

96.48%

2001 02

92.31%

1990 91

94.10%

2002 03

94.625

1991 92

95.27%

2003 04

93.61%

1992 93

93.12%

2004 05

93.72%

1993 94

96.16%

2005 06

93.85%

1994 95

95.04%

2006 07

94.28%

1995 96

94.19%

2007 08

94.18%

1996 97

96.72%

2008 09

94.05%

1997 98

94.97%

2009 10

93.44%

1998 99

94.21%

2010 11

93.45%

1999 00

95.67%

2011 12

87.38%

2000 01

93.68%

2012 - 13

89.78%

41) In the above calculations too, only the Traditional, Individual Assurance has
been taken, since the linked premiums were introduced only a few years ago.
Persistency Rate for year N has been defined here as,
[(Renewal Premium for the year N) /
{(Non single first year premium + Renewal premium) for year (N 1)}]
Since the above definition does not take into account the loss in premium income
due to maturity claims and expected death claims, the Persistency Rate may get
understated by about one percentage point in the case of long established
companies like the LIC. It can be seen that the Corporations record in respect
of Persistency had been excellent for many years and has fallen below 90% only
after 2010 11.

42) To sum up,
Number of agents started decreasing from 2008 09
Persistency Rate started decreasing from 2010 11
Total premium income started recording single digit growth from 2010 11
Overall cost ratio started rising from 2008 09

43) Are the above four results interconnected?
When an agent discontinues his agency and drops out, the policies introduced
by him/her tend to lapse. So, when a significant number of agents drop out,
the persistency rate is affected.
When persistency rates start falling, it is reflected in the decline of total
premium income.
When there is fall in number of agents, the rate of growth of new premium
(first year premium) income will also decrease. This too will affect the rate of
growth of total premium income.
In the calculation of overall cost ratio, expenses come in the numerator and
the total premium income comes in the denominator. When the expenses
increase under the impact of inflation and the rate of growth of total premium
income decreases due to depletion in number of agents, the overall cost ratio
will start increasing.
The ultimate impact will be on the valuation surplus and bonus.

44) So, the key to the entire issue is the fall in number of agents. If it had
occurred only in the case of LIC, one can say that the competition is affecting
the performance of the Corporation. But, when the private insurance companies
have suffered a higher depletion of agency force, one cannot blame the
competition. The real reason, in my view, is too much of Regulatory intervention
in the day to day working of the insurance sector. The absolute authority to
intervene should go hand in hand with accountability, which alone would
ensure proper application of mind before any action taken. Unfortunately,
accountability is conspicuous by its absence.

45) What should be the response of LIC in this situation? In the game of cricket,
a batsman will generally take fresh guard after reaching the land mark of 100
runs. The corporation had been going strong for more than two decades. It
should have taken fresh guard, i.e. thoroughly reviewed and restructured its
strategy in 2005 itself. The batsman takes fresh guard also when a new bowler
comes on to bowl. In the same way, an insurance company has to reassess its
work and reformulate its strategy whenever a significant policy change takes
place in the Regulators office. Such a reassessment should have taken place
four years ago.

46) It is not yet too late for the Corporation to reformulate its Product
Development and Marketing strategies, in order to recapture the dynamism it
displayed continuously for more than two decades. But, any discussions in this
regard should be informal and not formal. Those who retired during the last
three years and who have not taken up an assignment in any organisation
(Government or Non-Government) may also be included in such informal
discussions and, these discussions should focus mainly on strengthening the
agency force. Simultaneously, the working of Branches and Divisional Offices
has to be toned up, to make them more policyholder and agent friendly.

The LIC and Ministry of Finance
47) Before the opening of insurance sector, the Corporation was under the
control of Controller of Insurance in the beginning and then, under the control of
the Insurance Wing of the Ministry of Finance. During this period of about 45
years, it had absolute operational freedom. The Confidence, Trust and Respect
that it enjoyed during this period played a major role in its development as
a National Institution. These are conspicuous by their absence during the last
12 years, and one gets an uncomfortable feeling that it has begun telling on its
performance.

48) During the year 2013 2014, the Corporation paid about Rs.1,500 crores
(Rupees 15 billion) to the Government as dividend and about Rs.4,500 crores as
Tax (excluding Service Tax). Thus, its contribution during the year 2013 2014
to the National Exchequer would have been about Rs.500 crores per month.
This can be easily raised to Rs.1,000 crores per month in the next five years,
provided the Corporation is again placed directly under the Finance Ministry,
restoring back its operational freedom. If the present trend is allowed to
continue, its contribution to Public Exchequer may even fall below Rs.500 crores
per month.

49) If the Corporation is placed directly under the Ministry of Finance, restoring
fully its operational freedom, two interesting contests will develop.
Contest between a group of private insurers with a Capital of more than
Rs.50,000 crores (Rs.500 billion), 50% of which will be FDI, and a national
institution with virtually no Capital
Contest between the IRDA (Insurance Regulatory and Development
Authority) and the Ministry of Finance as to which is better in Regulating as
well as Developing the insurance industry.
Such a healthy contest will prove highly beneficial to the country. It is
meaningless to either worry about or agitate against the raising of FDI limit to
49% in the insurance sector.
FDI is a non-issue and has no role to play in the development of insurance in
the country. If it still comes, just welcome it. With open arms It will only
add to our foreign exchange reserves.

FDI in Defence Sector (a laymans view)
50) Every country needs armaments to defend its rights and independence.
These armaments can be either purchased from other countries or produced
internally. Purchasing from other countries will involve Foreign Exchange and
the purchasing country will always be at the mercy of the supplying countries,
which may betray it and leave it in lurch, in crucial times. To produce them
internally, a huge capital outlay is needed. Trying to invest the capital required
may lead to high inflation. So, FDI is the only option available. (I will discuss
later, in a separate short article as to how such a capital can be raised internally,
keeping also inflation under check. The method may be unconventional and
experts may brush it aside. But, in my view, it would be effective)

51) Is there any risk in allowing FDI in defence sector? It would be less than the
risk involved in buying our requirements from outside. Producing defence
requirements internally has got many advantages.
It is cheaper. For the cost of buying one fighter plane atleast two can be
produced internally.
Ancillary industries that develop around such defence establishments will
result in manifold increase in employment opportunity
It will eventually lead to self sufficiency in defence requirements

52) If increasing the FDI limit to 49% in the defence sector is to succeed, we
have to develop properly our languishing defence establishments. The Defence
Research & Development Organisation (DRDO) was established in the fifties.
But, it was always underutilised, since the defence ministry as well as the
defence services preferred purchasing their requirements from outside. When
Mr.Abdul Kalam was appointed as a Director in the DRDO, he brought about
good coordination between DRDO and ISRO (Indian Space Research
Organisation) and utilised the services of the DRDO personnel for the
development work of the ISRO. Mr.Kalams greatest virtue has always been his
ability to get the best out of every member of his team. The ISRO too has
always been doing its best to utilise Indian expertise and knowhow. The
satellites it is launching are fabricated fully in the HAL (Hindusthan Aeronautics
Ltd.), Bangalore. Very few may be aware that, the computer used in the launch
of its first satellite, a few decades ago, was the one manufactured by Electronics
Corporation of India Ltd (ECIL), Hyderabad. It was the TDC316 computer.
Since this computer did not have the required capacity for the task, ECIL
combined two computers, back to back, and accomplished the task satisfactorily.

53) The ECIL produced also a more powerful, third generation computer,
TDC332. But, it did not succeed commercially since the Government, as well as
Private organisations, were always enamoured by imported computers.

Conclusion
54) Enhancing the FDI limit to 49% is alone not enough. The Government has
to ensure that we place full trust in our national institutions and avoid wastage of
foreign exchange, involved in preferring (out of sheer fancy) foreign expertise
and knowhow to Indian expertise and knowhow.

55) Safeguarding the interests of LIC of India falls in this category. The
Corporation needs neither Capital nor Preferential Treatment. It needs only the
restoration of its Operational Freedom. It can then effectively channelise the
countrys savings and provide enough long term investment. Today, the value of
the funds under the management of LIC is Rupees 15 Lakh Crores (Rs.15
Trillion). In another seven years, it can become Rs.30 trillion and can provide
long term capital needed by the Defence as well as other sectors.

56) The Government has to make a very simple choice. Whether or not to
restore to the LIC its operational freedom or to continue to depend on FDI for
everything? It is the duty of the employees and agents of LIC, as well as the
members of the public, to peacefully and effectively lobby, at all levels, for this
cause.


21
st
July 2014 (R.RAMAKRISHNAN)
(Actuary)