FDI in the Insurance Sector

Introduction

The insurance sector in India used to be dominated by the state-owned Life Insurance Corporation and the General Insurance Corporation and its four subsidiaries. But in 1999, the Insurance Regulatory and Development Authority (IRDA) Bill opened it up to private and foreign players, whose share in the insurance market has been rising.

As a part of overall financial sector reforms, the Government set up the Committee for Reforms in the Insurance Sector in 1992. In its report released in early 1994, it recommended the opening up of the sector to private sector participation. This was done in 2000. Since then there has been rapid growth and share of insurance in total financial savings of the economy has improved significantly. The number of life insurance companies has increased from 13 at end March, 2003 to 18 at end March, 2008. Competition in the industry is increasing with new players trying to establish a significant presence. Currently the total insurance market in India is about US$ 30 billion, in which the element of FDI is US$ 0.5 billion. This is 1.6% of total insurance business in India. Foreign direct investment (FDIs) will increase in insurance sector by US$ 0.46 billion in next 2 years and likely to touch US$ 0.96 billion as it is still regulated. 

Relevance of the topic

Currently, only 26% of FDIs is permitted in insurance sector. The total insurance business would touch US$ 60 billion size. If insurance sector is opened up to an extent of 49% for FDIs, it is expected that FDI’s contribution to insurance business would touch nearly US$ 2 billion. In this paper we will examine the advantages and disadvantages of FDI in the insurance sector.

Analysis

Insurance and FDI

Insurance penetration in India is lower than in many East Asian countries. But the penetration as a percentage of GDP has improved from 2.5 in 2005 to 4.0 in 2007 for life insurance in India

Advantages of FDI in insurance Sector

Capital for expansion: FDI has the potential to meet India’s long term capital requirements to fund the building of infrastructures which is critical for the development of the country. Infrastructure has been the major factor which has restricted the progress of the Indian economy. Insurance sector has the capability of raising long term capital from the masses as it is the only avenue where people put in money for as long as 30 years even more. An increase in FDI in insurance would indirectly be a boon for the Indian economy, the investments not withstanding but by making more people invest in long term funds to fuel the growth of the Indian economy.

Wider Scope for Growth: FDI in insurance would increase the penetration of insurance in India, where the penetration of insurance is abysmally low with insurance premium at about 3% of GDP against about 8% global average. This would be better through marketing effort by MNCs, better product innovation, consumer education etc.

Moving towards Global Practices: India’s insurance market lags behind other economies in the baseline measure of insurance penetration. At only 3.1%, India is well behind the 12.5% for the UK, 10.5% for Japan, 10.3% for Korea and 9.2% for the US. Currently, FDI represents only Rs.827 core of the Rs.3179 crore capitalizations of private life insurance companies.

Provide customers with competitive products, more options and better service levels: Opening the FDI in the insurance sector would be good for the consumers, in a lot of ways. Increasing FDI limit would impact a lot of industries in a positive way and that we could even do without the FDI in many other sectors for some for example in real estateVikas 2010-11-09T09:38:00

How is it relevant?.

Issues in FDI in insurance sector:

Efficiency of the companies with FDI: The opening up of this sector for private participation in 1999, allowed the private companies to have foreign equity up to 26 per cent. Following this up 12 private sector companies have entered the life insurance business. Apart from the HDFC, which has foreign equity of 18.6%, all the other private companies have foreign equity of 26 per cent. In general insurance 8 private companies have entered, 6 of which have foreign equity of 26 per cent. Among the private players in general insurance, Reliance and Cholamandalam does not have any foreign equity. The aggregate loss of the private life insurers amounted to Rs. 38633 lakhs in contrast to the Rs.9620 crores surplus (after tax) earned by the LIC. In general insurance, 4 out of the 8 private insurers suffered losses in 2002-03, with the Reliance, a company with no foreign equity, emerging as the most profitable player. In fact the 6 private players with foreign equity made an aggregate loss of Rs. 294lakhs. on the other hand the public sector insurers in general insurance made aggregate after tax profits of Rs. 62570 lakhs.

2. Credibility of foreign companies: The argument that foreign companies shall bring in more expertise and professionalism into the existing system is debatable after the recent incidents of the global financial crisis where firms like AIG, Lehman Brothers and Goldman Sachs collapsed. Earlier too, The Prudential Financial Services (ICICI’s partner in India) faced an enquiry by the securities and insurance regulators in the U.S. based upon allegations of having falsified documents and forged signatures and asking their clients to sign blank forms. This was after it made a payment of $2.6 billion to settle a class-action lawsuit attacking wronginsurance sales practices in 1997 and a $ 65 million dollar fine from state insurance regulators in 1996. AMP closed its life operations for new business in June 2003. Royal Sun Alliance also shut down their profitable businesses in 2002. A recent report by Mercer Oliver Wyman, a consultancy, found that European life insurance companies are short of capital by a whopping 60 billion Euros. According to the Mercer Oliver Wyman Report the German, Swiss, French and British insurers suffer from severe capital inadequacy, which is a result of undertaking risky investments in equity and debt instruments in the past. Hence FDI in Insurance in India would expose our financial markets to the dubious and speculative activities of the foreign insurance companies at a time when the virtues of regulating such activities are being discussed in the advanced countries.

3. Greater channelization of savings to insurance: One of the most important duties played by the insurance sector is to mobilize national savings and channelize them into investments in different sectors of the economy. However, no significant change seems to have occurred as far as mobilizing savings by the insurance sector is concerned even after the liberalization of the insurance sector in 1999. Therefore the private or foreign participation has not been able to achieve the goal.

4. Flow of funds to infrastructure: The primary aim of life insurance is about mobilizing the savings for the development of the economy in long term investment in social and infrastructure sectors. The same vision was argued for the opening up of insurance market would enable huge flow of funds into infrastructure. But more than fifty percent of the policies they sell are ULIPS where the investments go into the equity markets. As per a report, 95% of policies sold by Birla Sun Life and over 80 percent of policies sold by ICICI Prudential were unit-linked policies during 2003-04. Under these schemes, nearly 50 percent of the funds are invested in equities thus limiting the fund availability for infrastructural investments. On the other hand, the LIC has invested Rs.40,000 crore as at 31.3.2003 in power generation, road transport, water supply, housing and other social sector activities. IRDA figures further imply that the share of the public sector life and non-life insurance companies in investment in infrastructure is greater than their market share. Despite the FDI cap being set at 26%, the investment from the insurance sector to the infrastructure sector was predominantly from the public sector companies. Hence the point of raising the FDI cap in the insurance sector for mobilizing resources does not hold good.

Conclusion

The outlook for the general insurance industry in India is stable based on steady fundamental credit conditions in the sector over the next 12-18 months. With the Indian economy forecast to grow at 9% in 2010 and given rising income levels and higher risk awareness among insured, the country’s insurers are optimistic about demand for their products. However, intense competition from new entrants, deregulation and a moderation in returns from the equities market will pressure pricing and ultimately short-term profitability.

At the same time, despite rising inflation and a severe correction in the stock market, the prevailing view in Asia is that while China and India are not insulated from the credit crisis afflicting the US and EU, domestic demand is strong enough to support GDP growth.

But until the existing insurance players show substantial benefits or it addresses the issues at hand, there would not be much of value addition to the country.