Indian Insurance

Sector:
Stepping into the second
decade of growth

9/14/2010
 Foreword

The insurance industry in India has progressed significantly over the last ten years, which is
amply evident in the tremendous growth in insurance business, extended outreach,
increased number of players, product innovation as well as enhanced regulatory framework.
A combination of these factors along with strong economic growth in the last few years has
positioned India as a regional insurance hub and a rapidly developing financial center.

The insurance industry is at the brink of an exciting journey — there needs to be a persistent
endeavor to sustain what has already been achieved as well as expand beyond the current
level. Furthermore, several reforms and policy measures, especially during the last couple of
years, has enabled a conducive environment for insurance companies to flourish in the
country. The coming years are critical as the regulator stance and approach of market
participants will govern the strength, stability and the sustained growth of the insurance
sector.

The insurance sector has become a major contributor to economic development especially
to infrastructure development. This growth has been fueled by India’s multiplying consumer
class, rising insurance awareness, increasing domestic savings and investments. Moreover,
it has been the joint effort of all the stakeholders, including the government, regulator and
the insurance companies to enable the positive momentum of this industry. However, still
there is a long way to cover on the road to achieve financial inclusion and bring more and
more people under the insurance blanket.

To this end, the Confederation of Indian Industry (CII) and Ernst & Young have authored this
report to evaluate the current state of the insurance industry, implication of new regulations
and what steps can be taken to improve insurance penetration.

Ashvin Parekh
Partner & National Industry Leader, Financial Services
Ernst & Young Private Limited

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Executive summary

India’s rapid rate of economic growth over the past decade has been one of the more
significant developments in the global economy. This growth has its roots in the introduction
of economic liberalization in the early 1990s, which has allowed India to exploit its economic
potential and raise the standard of living.

Together with other financial services, insurance services add about 7% to the country’s
GDP in 2009. 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. Also insurance has been an employment
generator, not only for the insurance industry, but has also created demand for a range of
associated professionals, such as brokers, insurance advisors, agents, underwriters, claims
managers and actuaries.

By nature of its business, insurance is closely related to saving and investing. Life insurance,
funded pension systems and non-life insurance, accumulate huge amounts of capital over
time which can be invested productively in the economy. The mutual dependence of
insurance and capital markets can play a powerful role in channeling funds and investment
expertise to support the development of the Indian economy.

India’s growing consumer class, rising insurance awareness, increasing domestic savings
and investments have increased insurance penetration. However, there are large untapped
areas which are hidden from the benefits of insurance. Imparting financial literacy, ensuring
Indian households transfer savings from physical assets to financial assets and taking
distribution network to rural areas will help bringing more and more people under the
insurance umbrella. While India has a higher insurance penetration as compared to China
and Brazil, it still has a long way to go.

The insurance industry in India has come a long way since the time when businesses were
tightly regulated and concentrated in the hands of a few public sector insurers. Following the
passage of the Insurance Regulatory and Development Authority Act in 1999, India
abandoned public sector exclusivity in the insurance industry in favour of market-driven
competition. This shift has brought about major changes to the industry. The inauguration of
a new era of insurance development has seen the entry of international insurers, the
proliferation of innovative products and distribution channels, and the raising of supervision
standards.

The period post sector liberalisation, which we call Phase I, has witnessed a unprecedented
surge in sales of insurance products, with the industry recording 24.2% CAGR in annualized
premium equivalent over FY00-05. The insurance industry, in its first phase of development,
has been relying on regular capital infusions from the promoters as its lifeline. High new
business strain and expanding distribution networks resulted in accounting losses across the
industry. In order to meet their commitments towards claim settlement and reserve
creation, promoters have been pumping in additional capital resulting in ‘cash-burn’. The
tradeoff between ‘growth’ and ‘profitability’ was heavily inclined towards the former.

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The next 4-5 years can be termed as Phase II which saw players focus on expanding product
range, developing innovative products and building robust distribution channel. During this
period i.e. FY05-09, the industry grew at a CAGR of 25.9%. Insurers were shifting weight
from the Phase I philosophy of ‘growth versus profitability’ to the Phase II mantra of
‘profitable growth’. As a result, focus is likely to swing from ‘growth’ to ‘profitability’, with
product pricing becoming more rational based on more conservative assumptions. Product
innovation continued and traditional policies gained some foothold in an otherwise Unit
linked incentive product (ULIP) driven market.

The Indian life insurance industry stands at the cusp of its Phase III of growth. The phase is
marked by bringing the industry to a stable position, ensuring “stable profitable growth”.
Most large players will now look to slow down distribution growth and increase focus on
retention of channel partners as well as improving channel productivity. Further, insurance
companies are working towards improving persistency.

At this cross section, the role of the regulator is going to be critical. Insurance Regulatory
and Development Authority (IRDA) is in the finalization stage of most of the regulations,
which would shape the future of the insurance industry. IRDA has come up with some
regulations to help improve disclosures, profitability, capital, consumer protection etc.
Further, the regulator is amidst finalizing the norms for initial public offering (IPO) of
insurance companies. In a sector where none of the players are listed, IPO of insurance
companies could be a milestone in the future growth of the sector.

Risk management plays a very critical role in insurance business. In the next 3-4 years, India
plans to shift from the current solvency I norms to risk-based solvency norms, called the
solvency II model. This change will result in better apportionment of risk in the backdrop of
the actual risk associated with the asset.

With the increasing competition, the industry may also witness the consolidation among
smaller players and emergence of some big players. The regulator is in the process of
finalizing guidelines for merger and acquisition in the insurance space in India. The
government, regulator and the insurance companies are now focused on maintaining a
conducive environment for sustainable growth, higher contribution of the industry to
economic development and increasing reach of insurance to the underdeveloped areas of
the country.

To summarize, Indian insurance industry is poised for a quantum leap in performance with
unprecedented growth opportunities, notwithstanding temporary sliding growth curve. The
stage is all set for the real show to begin now!

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 Table of content

Introduction ..............................................................................7
Section I: Industry overview .......................................................8
Evolution of the Industry..............................................................................8
Present state ............................................................................................10
Life insurance industry overview .............................................................................11
Non-life insurance industry overview........................................................................12
Growth drivers ..........................................................................................13
Emerging trends........................................................................................15
Contribution of the insurance sector to the economy...................................17
Contribution of insurance to infrastructure...............................................................18
Contribution of insurance to FDI...............................................................................19
Contribution of insurance to offshoring business......................................................19
Contribution of insurance to employment................................................................21

Section II: Industry at the cross-road for development ..............23

Insurance industry — significantly untapped with huge potential.................23
Recent regulatory developments that have governed the current market state
.................................................................................................................26
New disclosure norms...............................................................................................27
Altered commission structure of agents...................................................................28
IPO norms for insurance company............................................................................29
Promoting health insurance......................................................................................29
Alteration in ULIP’s...................................................................................................30
Other regulations......................................................................................................31

Section III: Critical factors for market development.....................32

Distribution channel...................................................................................32
Role of intermediaries/distributors/financial advisors...............................................32
Challenges with the existing distribution model.......................................................38
Experiences from developed insurance markets worldwide.....................................39
Focus on financial inclusion........................................................................42
Need to increase financial inclusion in India.............................................................43
Measures to increase financial inclusion in India......................................................44

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 Consumer needs and preferences ..............................................................46

Way forward.............................................................................47
Bibliography.............................................................................50

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Introduction

Insurance industry in India has completed an era of ten eventful years since the industry
was opened up for private sector in 2000. India has witnessed a rapid economic growth over
the past decade which has its roots in the introduction of economic liberalization in the early
1990s. This turn of events has allowed India to exploit its economic potential and raise the
population’s standard of living.

The Insurance sector plays an important role in the economic development of a nation. It
acts as a mobilizer of savings, financial intermediary, and promoter of investment activities,
stabilizer of financial markets and a risk manager. Life insurance sector plays an important
role in providing risk cover, investment and tax planning for individuals; non-life insurance
industry provides risk cover for assets. Health insurance and pension systems are
fundamental to protecting individuals against the hazards of life and India, as the second
most populous nation in the world, offers huge potential for that type of cover. Furthermore,
fire and liability insurance are essential for corporations to keep investment risks and
infrastructure projects under safeguard. Private insurance systems complement social
security systems and add value by matching risk with price. Accurate risk pricing is one of
the most powerful tools for setting the right incentives for the allocation of resources, a
feature which is the key to a fast developing country like India.

By nature of its business, insurance is closely related to savings and investing. Life
insurance, funded pension systems and to a lesser extent non-life insurance, will accumulate
huge amounts of capital over time which can be invested productively in the economy.

There are good reasons to expect that the growth momentum can be sustained. In
particular, there is huge untapped potential in various segments of the market. While the
nation is heavily exposed to natural catastrophes, insurance to mitigate the negative
financial consequences of these adverse events is underdeveloped. The same is true for
both pension and health insurance, where insurers can play a critical role in bridging
demand and supply gaps. Major changes in both national economic policies and insurance
regulations will highlight the prospects of these segments going forward.

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Section I: Industry overview

The insurance industry in India has come a long way since the time when businesses were
tightly regulated and concentrated in the hands of a few public sector insurers. Following the
passage of the Insurance Regulatory and Development Authority Act in 1999, India
abandoned public sector exclusivity in the insurance industry in favour of market-driven
competition. This shift has brought about major changes to the industry. The beginning of a
new era of insurance development has seen the entry of international insurers, the
proliferation of innovative products and distribution channels, and the raising of supervisory
standards.

Evolution of the Industry

The growing demand for insurance around the world is having a positive effect on the
insurance industry across all economies. India being one of the fastest growing economy
(even in the current global economic slowdown), has exhibited significant increase in its
Gross Domestic Product (GDP), even larger increase in GDP per capita and disposable
income. Increasing disposable income coupled with the high potential demand for insurance
offerings, has opened many doors for both domestic and foreign insurers. The following
table briefly depicts the evolution of the insurance sector in India.

Evolution of the Industry

Year Event

1818 Oriental Life Insurance Co. was established in Calcutta

1870 The Bombay Mutual Life Insurance Society – first insurance company formed

1907 Indian Mercantile Insurance Limited was formed

1912 - Life Insurance Companies Act & Pension Fund Act of 1912

- Beginning of formal insurance regulations

1928 Indian Insurance Companies Act was passed to collect statistical data on both life
and non-life

1938 Insurance act of 1938 passed. Strict state supervision to control frauds

1956 - 245 Indian and foreign life insurers as well as provident societies taken over by
central government and nationalized

- LIC act of 1956 passed

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 1957 Framing of a code of conduct by the General Insurance Council to ensure fair
conduct and ethical business practices

1972 General Insurance Business (Nationalization) Act was passed

1991 Beginning of economic liberalization

Malhotra Committee set up to complement the reforms initiated in the financial

1993 sector

1994 Detariffication of aviation, liability, personal accidents and health and marine
cargo products

1999 Insurance Regulatory and Development Authority (IRDA) bill passed in Parliament

2000 IRDA incorporated as the statutory body to regulate and register private sector
insurance companies.
General Insurance Corporation (GIC) and its four subsidiaries, i.e., National
Insurance Company Ltd, Oriental Insurance Company Ltd, New India Assurance
Company Ltd and United India Assurance Company Ltd made India's national
reinsurer

2005 Detariffication of marine hull

2006 Relaxation of foreign equity norms thus facilitating entry of new players

2007 Detariffication of all non-life insurance products except of the auto third-party
liability segment

In India, the Ministry of Finance is responsible for enacting and implementing legislations for
the insurance sector with Insurance Regulatory and Development Authority (IRDA) entitled
with the regulatory and developmental role. The government also owns majority share in
some major companies in both life and non-life insurance segments. The following diagram
depicts the industry structure.

Indian insurance industry structure

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 Source: IRDA

Both the life and non-life insurance sectors in India, which were nationalized in the 1950s
and 1960s, respectively, were liberalized in the 1990s. Since the formation of IRDA and
opening up of the insurance sector to private players in 2000, the Indian insurance sector
has seen rapid growth.

Present state

A growing middle-class segment, rising income, increasing insurance awareness and

increased investments and infrastructure spending, have laid a strong foundation to extend
insurance services in India. The total premium of the insurance industry has grown at a
CAGR of 24.6% between FY03 and FY09 to touch INR2,523.9 billion in FY09.

Figure: Total premiums of the insurance industry (life and non-life)

Source: IRDA

The opening up of the insurance sector for private participation/global players during the
1990’s has generated stiff competition among the players, with each offering better quality
products. This has certainly offered consumers the choice to buy a product that best fits his
or her requirements.

The number of players during the decade has increased from four and eight in life and non-
life insurance respectively in 2000 to 23 in life and 24 in non-life insurance (including 1 in
reinsurance) industry as on August 2010.

Table: Growth in the number of insurance players

Life insurers 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Public 1 1 1 1 1 1 1 1 1 1 1

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Private 3 10 12 12 13 13 15 15 21 21 22

Non-life Insurers

Public 4 4 5 6 6 6 6 6 6 6 6

Private 3 6 8 8 8 8 9 10 15 15 17

Reinsurer 1 1 1 1 1 1 1 1 1 1 1

Source: IRDA

Most of the private players in the Indian insurance industry are a joint venture between a
dominant Indian company and a foreign insurer.

Life insurance industry overview

The life insurance sector grew at an impressive CAGR of 25.8% between FY03 and FY09 and
the number of policies issued increased at a CAGR of 12.3% during the same period.
As of August 2010, there were 23 players in the sector (1 public and 22 private). Life
Insurance Corporation of India (LIC) is the only public sector player, and held almost 65% of
the market share in FY10 (based on first year premium).
In order to cater to the need for having highly customized products and prompt service, a
large number of private sector players have entered the market. Innovative products,
aggressive marketing and effective distribution have enabled fledgling private insurance
companies to sign up Indian customers more rapidly than expected. Private sector players
are expected to play a larger role in the growth of the insurance sector in the near future.
In a fragmented industry, new players are eating away the market share of larger players.
The existing smaller players have aggressive plans for network expansion as their foreign
partners are keen to take advantage of the enormous potential presented by the Indian life
insurance market.
Figure: Market share amongst private players - FY10 (based on first year
premiums)

Market shareamongst private players- FY10 ( basedon firstyear premiums)

11.6%
18.3%

10.2%

7.7%
16.5%

8.5%

4.8%
8.6%
4.0% 3.5% 11
2.8% 3.4%

ICICI Pru SBI Life Bajaj Allianz Reliance Life

Birla Sunlife HDFC Standard MNYL Kotak Mahindra
 Source: “IRDA annual report FY09, “IRDA Journal,” Insurance Regulatory and Development Authority website,
www.irdaindia.org, accessed 26 May 2010

ICICI Prudential, Bajaj Allianz and SBI Life hold almost 50% of the market share in the private
life insurance segment. To tap opportunity, banks have also started entering alliances with
insurance companies to develop/underwrite insurance products rather than merely
distribute them.

Non-life insurance industry overview

Between FY03 and FY10, the non-life insurance sector grew at a CAGR of 17.05%. Intense
competition that followed the de-tariffication and pricing deregulation (which was started
during FY07) caused the growth momentum to slow down.

As of August 2010, the sector had a total of 24 players (6 public,17 private and 1 re-insurer).
The non-life insurance sector offers products, such as auto insurance, health insurance, fire
insurance, marine insurance etc. In FY10, the non-life insurance industry had the following
product mix.

Figure: Product mix (FY10)

Product mix ( FY10)

Auto, 43.5%

Engineering, 4.8%

Marine , 6.3%

Fire, 11.3%

Health, 20.8%
All Others, 7.2%
Personal Aviation, 1.2%
Accidents, 2.5% Liability, 2.5%

Source: “IRDA Monthly Journal,” Insurance Regulatory and Development Authority website, www.irdaindia.org,
accessed 10 June 2010

The focus of the private sector players has been on auto and health insurance. Out of the
total non-life insurance premiums during FY10, auto insurance accounted for 43.5% of the

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market share. The health insurance segment has shown highest growth, with its share in
total non-life insurance portfolio increasing from 12.8% in FY07 to 20.8% in FY10. These two
sectors are highly promising, and are expected to increase their share manifold in the
coming years.

With the sector poised for immense growth, more players, including monoline players are
likely to emerge in the near future. Last two years has seen the emergence of companies
specializing in health insurance, such as Star Health & Allied Insurance and Apollo DKV.

Figure: Market share amongst players in FY10

Market share amongst player

- FY1
s0

12.4%

12.1%
13.6%

8.6%

15.7%
7.9%

2.3%
6.6%
2.4%
2.4%
2.6% 5.2%
4.0% 4.3%

New India United India Oriental National

ICICI- lombard Others Bajaj Allianz Reliance General

IFFCO-Tokio AIC Star Health & Allied Insurance

HDFC ERGO General

Royal Sundaram Tata-AIG

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

In the last decade, it was observed that most players have experienced growth by
formulating aggressive growth strategies and capitalizing on their distribution network to
target the retail segment. Although the players in the private and public sector largely offer
similar products in the non-life insurance segment, private sector players outscore their
public sector counterparts in their quality of service.

Growth drivers

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 ► India has favourable demographics to increase penetration
Life insurance coverage in India is very low and many insured are underinsured. There is a
huge potential as in the next 20 years (2006–2026), the working population (25–60 years) is
expected to increase from 675.8 million to 795.5 million. Projected per capita GDP is
expected to increase from INR18,280 in FY01 to INR100,680 in 2026, reflecting larger
disposable income. Demand for insurance products is expected to increase in the light of
increase in purchasing power.
Figure: Working population assessment and GDP per capita till 2026

800 120
700
100
600
80
500
400 60

R
IN
m

300
ilo
In

40
200
20
100
0 0
2001 2006 2011 2016 2021 2026

25-60 (in millions) Projected GDP per capita in '000s

Source: CMIE, Census of India 2001

► Health Insurance is attracting insurance companies

The Indian health insurance industry was valued at INR51.2 billion as of FY10. From the
period FY03–10, the industry has grown at a CAGR of 32.59%. Share of health insurance was
20.8% of the total non-life insurance premium in FY10. Health insurance premiums are
expected to increase to INR300 billion by 2015.
Private sector insurers are more aggressive in this segment. Favorable demographics, fast
progression of medical technology as well as increasing demand for better healthcare has
facilitated growth in health insurance. Life insurance companies are likely to target primarily
the young population so that they can amortize the risk over the policy term.

► Increasing focus on rural market

Since more than two-thirds of India’s population lives in rural areas, micro-insurance is seen
as the most suitable aid to reach the poor and socially disadvantaged sections of society.
► Poor insurance literacy and awareness, high transaction costs, inadequate
regulations, and inadequate understanding of client needs and expectations has
restricted demand for microinsurance products. However, the market remains
significantly underserved, creating a vast opportunity to reach a large number of
customers with good value insurance, whether from the base of existing insurers
or through retail distribution networks.

► In FY09, individuals generated new business premium of INR365.7 million under

2.15 million policies, the group business amounted to INR2,059.5 million under

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 126 million lives. LIC contributed most of the business procured in this portfolio by
garnering INR311.9 million of individual premium from 1.54 million lives and
INR1,726.9 million of group premium under 11.1 million lives.

► LIC was the first player to offer specialized products with lower premium cost for
rural population. Other private players have also started focussing on the rural
market to increase penetration and reach.

► Government tax incentives

Currently insurance products enjoy EEE benefit giving insurance products an advantage over
mutual funds. Insurers are motivated to purchase insurance products to get about 30%
effective tax benefit on select investments (including life insurance premiums) made every
financial year. Life insurance is already the most popular financial product among Indians
because of the tax benefits and income protection it offers in a country where there is very
little social security. This drives more and more people to come under the insurance
umbrella.

Emerging trends

► Exploring multiple distribution channels for insurance products

To increase penetration, insurance companies have a task to expand their distribution
network. In the recent past, the industry has witnessed an emergence of alternate
distribution channels, which include bancassurance, direct selling agents, brokers, online
distribution, corporate agents such as non-banking financial companies (NBFCs) and tie-ups
of para-banking companies with local corporate agencies (e.g. NGOs) in remote areas.
Agency has been the most important channel of distribution till now. The industry is viewing
movement of intermediaries from mere agents to advisors.

► Product innovation
With customers asking for higher levels of customization, product innovation is one of the
best strategies for companies to increase market share. This also creates greater efficiency
as companies can maintain lower unit costs, offer improved services and distributors can
increase flexibility to pay higher commissions and generate higher sales.
The pension sector, due to its inadequate penetration (only 10% of the working population is
covered) offers tremendous potential for insurance companies to be more innovative.

► Consolidation in future
The past few years have witnessed the entry of many companies in the domestic insurance
industry, attracted by the huge potential of insurance sector. However, increasing
competition in easily accessible urban areas, FDI limit of 26% and the recent downturn in
equity markets have impacted the growth prospects for some small private insurance
companies more than for others.
Such players might have to rethink about their future growth plans. Hence, consolidation
with big and established players might prove to be a better solution for such small insurers.

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Larger companies would also prefer to take over or merge with other companies with
established networks and avoid spending money in marketing and promotion. Therefore,
consolidation will lead to fewer but stronger players in the country and also generate
healthy competition.

► Mounting focus on EV over profitability

Many companies are achieving profitability by controlling expenses; releasing funds for
future appropriations and through strong renewal premium build up. As a few larger insurers
continued to expand, most focused on cost rationalization and aligning business models to
ground level realities. This will help them enhance insurers’ ability to realize reported
embedded value (EV) and generate value from future new business.
In the short run, companies are going to face challenge to meet the desired levels of
profitability. As companies are also planning to get listed and raise funds, higher profitability
will help companies to get better valuation of shares. However, in the long run, companies
would need to focus on increasing EV, as almost 70% of a company’s EV is influenced by
new business and profitability is not as much of an indicator for valuation. Hence, companies
are now focusing on increasing their EV than profitability figures.

► Rising capital requirement

Insurance being a capital intensive industry, capital requirements are likely to increase in the
coming period. Capital requirement in the life insurance business is a function of three
factors: (1) sum at risk; (2) policyholders’ assets; (3) new business strain and expense
overruns. With new guidelines in place, capital requirements across the sector are likely to
go up due to:
► Higher sum assured driving sum at risk.
► Greater allocation to policyholders’ assets due to lower charges.
► Back loading resulting in high new business strain, and expense overruns due to
low productivity of newly set distribution network (and inability to recover
corresponding costs upfront).

For non-life insurance companies, growing demand of health insurance products as well as
motor insurance products is likely to boost capital requirement.

With the capital market picking up and valuations on the rise, insurance companies are
looking at different ways of increasing their capital base to invest in product innovation,
introducing new distribution channels, educating customers, developing brand etc.
This is due to the following reasons

► A major portion of the costs in insurance companies is fixed (though it should be

variable or semi-variable in nature). Hence reduction in sales will not result in
lowering of operational expense, thus impacting margins. Reduced margins would
impact profitability and hence insurers would need to invest more funds.

► Sustained bearishness in capital markets could further pressurize the investment

margins and increase the capital strain especially in the case of capital/return
guarantee product.

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 ► Besides this, companies are likely to witness a sharp slowdown in new business
growth. Companies would also look at product structuring to lower their cost and
optimally utilize capital.

According to IRDA Regulations 2000, all insurance companies are required to maintain a
solvency ratio of 1.5 at all times. But this solvency margin is not sustainable. With the
growing market risks, the level of required capital will be linked with the risks inherent in the
underlying business. India is likely to start implementing Solvency II norms in the next three
to four years.
The transition from Solvency I norms to Solvency II norms by 2012 is going to increase the
demand for actuaries and risk management professionals. The regulator has also asked
insurance companies to get their risk management systems and processes audited every
three years by an external auditor. Many insurance companies have started aligning
themselves with the new norms and hiring professionals to meet the deadline.

Contribution of the insurance sector to the economy

Insurance has had a very positive impact on India’s economic development. The sector is
slowly increasing its contribution to the GDP. Also, insurance is driving the infrastructure
sector by increasing investments each year. Moreover, insurance has boosted the
employment scenario in India by providing direct as well as indirect employment
opportunities.

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

Figure: Share of life insurance premiums in GDS (household sector)

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 Share of life insurance premiums in GDS (households sector)

20% 17.9% 17.6%

15.9%
15% 12.3%
11.0%
10%

5%

0%
FY05 FY06 FY07 FY08 FY09

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

This increased contribution of insurance industry from the household GDS has been
ploughed back into the economy, generating higher growth. The following factors showcase
the contribution of insurance industry to economic growth:

Contribution of insurance to infrastructure

Generally, countries with strong insurance industries have robust infrastructure and strong
capital formation. Insurance generates long-term capital, which is required to build
infrastructure projects that have long gestation period. At the same time, insurance protect
individuals and businesses from sudden unfavorable events, which in turn leads to a better
living standard. A well-developed and evolved insurance sector is needed for economic
development as it provides long term funds for infrastructure development and at the same
time strengthens the risk taking ability.
Although the insurance sector is relatively young in India, its contribution to infrastructural
development has been increasing as depicted in the following table.

Table: Contribution of various insurance products to infrastructure (in INR billion)

FY06 FY07 FY08 FY09

Investments from traditional products

Approved securities including Central Govt.

securities 3,131 3,541 4,013 4,439

Infrastructure and social sector 546 759 763 756

Investment subject to exposure norms

including other than approved investments 1,327 1,538 2,035 2,787

Housing and fire fighting equipments 31 37 39 42

Unit linked insurance product funds

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(ULIPs)

Approved investments 234 576 1,115 1,515

Other than approved investments 25 95 219 213

Source: “IRDA annual report FY09,” Insurance Regulatory and Development Authority website, www.irdaindia.org,
accessed 20 August 2010

As on FY09, the total investments by the insurance industry have grown to INR9,742 billion
as against INR8,183 billion in the previous year. Investments by both the life and non-life
insurers increased by 20.2% and 4.6% to INR9,163 billion and INR589 billion, respectively, in
FY09.

However, there is a huge fund requirement of INR 20,562 billion as laid in the 11th five-year
plan (2008-2012) in the infrastructure sector. Given an expected robust increase in
insurance business and increasing participation of foreign insurers in India, insurance
companies are well positioned to contribute to the infrastructure development in the
country.

These investments could further increase with the development of sound debt markets,
especially the market for long-term government paper, and income tax incentives to attract
savings for infrastructural schemes. Direct investment of policyholder funds of life insurers in
government bonds is another way in which the industry has helped the development of
infrastructure. Also IRDA’s mandate for insurance companies to invest 15% of their annual
sales in infrastructure is going to boost capital requirement.

Contribution of insurance to FDI

The importance of FDI in the development of a capital-starved country like India cannot be
undermined. This is where the high growth sectors of an economy play an important role by
attracting substantial foreign investments. Presently, the total FDI in the insurance sector
was INR 50.3 billion at the end of FY09 and is estimated to be approximately INR 51 billion in
FY10. It is difficult to estimate but roughly an equal amount of additional foreign investment
can flow into the sector if government hikes the FDI limit from 26% to 49%.

Insurance sector, by its virtue of attracting long-term funds, is best placed to channelize
long-term funds towards productive sectors of the economy. Therefore, growth in their
premium collections would translate into higher investments in other key sectors of the
economy. Therefore, liberalization of the FDI norms for insurance would not only benefit the
sector, but several other critical sectors of the economy.

Contribution of insurance to offshoring business

India has become one of the most popular destinations for offshoring insurance processes
and top insurance companies in the US and Europe has moved their processes either to their
captive units or third-party outsourcing firms. Currently around 63% of India’s insurance
outsourcing revenue comes from the US and around 22% from EMEA.

19
India offers varied insurance solutions dealing with health, property, life, annuities,
reinsurance and property and casualty amongst others. The following is a list of insurance
services that are outsourced to India.

Figure: Insurance services suite

20
 Source:Infosys

Total revenue from Indian offshore insurance business process outsourcing services
increased from US$367 million in FY03 to US$790 million in FY07 and is expected to touch
US$2 billion by FY10. Increased business will also result in increased employment
opportunities in the insurance offshoring business.

Contribution of insurance to employment

Insurance helps create both direct and indirect employment in an economy. Alongside the
regular jobs in insurance, there is always demand for a range of associated professionals,
such as brokers, insurance advisors, agents, underwriters, claims managers and actuaries.
Increasing insurance business has increased the demand for highly skilled professionals as
well as semi-skilled and unskilled people. For example, life insurance has provided direct
employment to 30,912 people besides adding more than 407,768 individual agents during
FY09.

Table: Growing employment in life insurance industry

21
Parameter FY00 FY06 FY07 FY08 FY09

Direct 1,23,000 1,52,449 1,87,403 2,54,332 2,85,244

employees

Individual 7,14,000 14,22,609 19,85,457 24,98,513 29,06,281

agents
Source: Life Insurance Council of India

IRDA has mandated the appointment of actuary in all insurance companies and ensuring
certification of all products before launch. The insurance regulator has also made
compulsory for the appointed actuaries be called to all board meetings and help the insurer
ensure solvency at all points in time.

In order to ensure continued growth, the need of the hour is trained manpower with
specialized knowledge about this industry. Insurances companies need to invest in
professional training of their employees, especially for subjects such as underwriting, claims
and risk management.

22
Section II: Industry at the cross-road for development

Insurance industry — significantly untapped with huge

potential

India’s insurance industry has witnessed rapid growth during the last decade. Consequently,
many foreign companies have shown an interest in investing in domestic insurance
companies, in spite of the Government of India’s regulation, which mandates that the
foreign shareholding limit is fixed at 26% for the life as well as non-life insurance sectors.

The country’s strong economic growth in recent years has helped increase penetration
levels substantially. Premium income, as a percentage of GDP, increased from 3.3% in FY03
to 7.6% in FY09. However, penetration of insurance in India still continues to be low, as
compared to other developed and developing economies.

Figure: Insurance premiums as a % of GDP

Insurancepremiums as a %of GDP

7.3 7.6
8 6.3
7 6.7
6 4.8 6.4
5 3.7 4.2 5.5
3.3
4 4.1
g
tap
In
e
rc

3 3.5
2 2.7 3.0 0.9 0.9
0.7 0.8 0.9
1 0.6 0.7
0
FY03 FY04 FY05 FY06 FY07 FY08 FY09

Non-life insurancepremiumcontributionas a %of GDP Life insurance premium contributionas a % of GDP

Total insurance premiumcontributionas a %of GDP

Source: “IRDA annual report FY03-09,” Insurance Regulatory and Development Authority website,
www.irdaindia.org, accessed August 2010; CMIE

The Indian life insurance sector has seen tremendous growth, driven by innovation in
product offerings and distribution owing to new entrants since the opening up of the sector
in 2000. At present, it is the fifth largest life insurance market in Asia. Rapid expansion in
the life sector has coincided with a period of rising household savings and a growing middle
class on the back of strong economic growth. Innovative product design (e.g. launch of
ULIPs) and aggressive distribution strategies (e.g. development of bancassurance) by
private sector players have assisted the favourable economy in boosting premium growth.
The following diagram shows the increasing premium per capital during the same period.

23
Figure: Per capita insurance premium

Per capitainsurancepremium( INR)

2,500 2187.1
2013.8
2,000 1716.1
1921.9
1769.3
1,500 1197.2
1479.1
776.1 952.0
1,000 637.9
785.4 1003.6
628.3
500 528.4 109.5 166.6 193.7 237.0 244.5 265.2
147.8
0
FY03 FY04 FY05 FY06 FY07 FY08 FY09

Non-lifeinsurancepremiumper capita Life insurancepremium per capita

Total insurance premiumper capita

Source: “IRDA annual report FY03-09,” Insurance Regulatory and Development Authority website,
www.irdaindia.org, accessed August 2010; CMIE

The global economy has slowly started recovering from the economic recession. Lagging
employment coupled with falling aggregate wages, a weakened residential and commercial
real estate market, tight credit and a behavioral shift on the part of consumers from
consumption to savings are factors contributing to a delayed recovery. Although the global
insurance industry has not been impacted by the financial crisis as much as the banks, it still
has its set of issues. The top five issues on the global insurance watch list are:

► Manage risk: The most significant concern for insurance companies is risk in all its
forms. Increasingly, insurance companies are adopting an enterprise-wide view of
managing risks —employing a framework to address them across the organization.

► Promote compliance: The cost of regulatory compliance and the attendant

reputational risk of non-compliance are growing.

► Grow globally: Expansion into new markets will help drive profits, as developed
economies witness slower growth in demand for insurance.

► Lack of innovation around products and delivery: The use of technology and
emphasis on innovation will help provide better service and delivery. Institutions can
also strengthen their ties with customers and differentiate themselves from the
competition.

► Adapt to demographic shifts: The demographic changes in North America,

Europe, Japan and other areas is starting to shift assets from equities to annuities
and other fixed-income products.

24
Table: Global comparison of insurance premiums, penetration and density for
both life and non-life segments

Non-life premiums In 2009 Life premiums In 2009

Densit Densit
Premiu Penetrati y, US$ Premiu Penetrati y, US$
ms, US$ on, % of per ms, US$ on, % of per
Country million GDP capita million GDP capita
Developed
Australia 27,849 3 1,308.0 32,468 3.4 1,524.8
France 88993 3.1 1,289.4 194077 7.2 2,979.8
Germany 126,591 3.7 1,518.7 111,776 3.3 1,359.7
Singapore 5,188 1.7 645.6 9,057 5.1 1,912.0
South Korea 34,527 3.9 709.7 57,436 6.5 1,180.6
United Kingdom 91,560 3 1,051.2 217,681 10 3,527.6
United Arab
Emirates 4,381 2.1 952.7 732 0.4 159.2
United States 647,401 4.5 2,107.3 492,345 3.5 1,602.6
Developing
Bangladesh 205 0.2 1.3 636 0.7 3.9
Brazil 23,979 1.5 123.8 24,781 1.6 127.9
China 53,872 1.1 40 109,175 2.3 81.1
India 6,375 0.9 6.7 46,206 6.6 48.1
Indonesia 2,219 0.4 9.6 5,066 0.9 22
Malaysia 3,158 1.6 115 5,682 2.9 206.9
Mexico 9,664 1.1 88.2 7,688 0.9 70.1
Pakistan 650 0.4 3.6 543 0.3 3
Philippines 835 0.5 9.1 1,563 1 17
Romania 2,365 1.4 111.2 533 0.3 25.1
Russia 38,940 2.4 276.4 636 0 4.5
South Africa 8,215 2.9 163.9 28,773 10 574.2
Sri Lanka 358 0.9 17.7 238 0.6 11.8
Taiwan 11,443 3 494.8 52,204 13.8 2,257.3
Thailand 4,248 1.6 62.7 6,212 2.4 91.7
Vietnam 769 0.8 8.7 671 0.7 7.6
Source: “World Insurance in 2009,” Swiss Re, June 2010, Insurance Regulatory and Development Authority website,
www.irdaindia.org, accessed 06 January 2010

According to Swiss Re, among the key Asian markets, India is likely to have the fastest
growing life insurance market, with life premium CAGR of 15% for the next decade, slightly
faster than the 14% expected for China. Growing consumer class, rising insurance
awareness and greater infrastructure spending have made India and China the two most
promising markets in Asia. Europe and the Americas represent relatively mature insurance
markets.

Though India’s penetration appears higher, it is not excessive, given high level of
investment in insurance policies underwritten. Nonetheless, besides India, Taiwan is the

25
other Asian market that shares similar characteristics. Taiwan has the highest insurance
penetration in Asia, largely driven by the huge popularity of ULIPs.

The Indian insurance industry has come a long way. The last 10 years have been the most
crucial period in the establishment of this industry post formation of IRDA in 2000. The initial
4-5 years saw the entry of many private players, each trying to buy market share. The next
4-5 years were focussed on expanding product range, developing innovative products and
building robust distribution channel. The last 1-2 have been very critical as the industry is
trying to sustain its growth in light of new regulations being formulated.

The Indian insurance industry is at a threshold from where it can witness the next growth
wave, if presented with a favourable policy framework and conducive distribution
environment. The industry is going to witness the emergence of new leaders who would
make place for themselves by using instruments such as alternative channels of distribution,
cost management, product innovation etc.

At this cross section, the role of the regulator is very significant. IRDA is in the finalization
stage of most of the regulations pertaining to the industry. The regulator has come up with
some regulations to help improve disclosures, profitability, capital, consumer protection etc.

Recent regulatory developments that have governed the

current market state

The development of the insurance industry in India, as in other international markets, is

likely to be critically dependent on the nature and quality of regulation. The role of the
regulator in most markets is to ensure efficiency; transparency and fair play, while at the
same time protect the interests of the consumer. The IRDA Act 2000 has laid down the
broad regulatory framework within which insurance companies are expected to operate in
India. The provisions of this Act address issues related to ownership, solvency, investment
portfolio construction, commission structures, reporting formats and accounting standards.
The minimum paid-up equity capital requirement has been set at INR1 billion. The insurance
business is capital intensive, and international experience suggests that, on an average,
non-life insurance companies require four to five years to break even. In the interim, these
companies would require regular capital infusion for funding expected losses and meeting
solvency requirements. In this context, given the existing regulatory constraints of foreign
direct investment by the overseas partner, a substantial part of the funding would have to
be done by the Indian partner, whose financial strength is likely to influence the credit
strength of the joint venture.

Given the evolutionary stage of the Indian insurance industry, one of the focal points for the
regulator has been to ensure stability and solvency of the industry. The Act also lays down
broad guidelines for the construction of the investment portfolios of life insurance
companies. These norms have been designed to ensure that an insurer does not take on
unsustainable risks in deploying funds collected by way of premium. Overall, the regulatory
environment is favorable and one which ensures that players maintain prudent underwriting
standards, and reserve valuation and investment practices. The primary objective for the

26
current regulations is to ensure stability and fair play in the market place. Some of the
recent regulatory changes and their impact have been:

New disclosure norms

IRDA has come up with the following disclosure norms:

► IRDA has issued disclosure norms for insurance companies, mandating them to
publish accounts on a half-yearly basis. The disclosure norms are seen as a precursor
to allowing insurance companies to hit the primary market. According to the new
norms, insurers will have to publish their balance sheet on half-yearly basis starting
from the period ending 31 March 2010.

Disclosures to be made for a company launching an IPO

► All financial disclosures for the past five years prior to the IPO have to be available on
the company website. Insurance companies have to also lay down disclosure of data
on various parameters such as the calculation of economic capital, surrender and
lapse experience of business and expense patterns for a five-year period.

► Insurance companies intending to go public would also need to disclose required and
available solvency margins for five years, capital structure and details of investment
performance. A wide range of risk factors related to credit, market, insurance,
liquidity, operational and asset and liability management need to be disclosed clearly
by the insurers, accompanied by a report from an independent external actuary on
the reasonableness of the methodology adopted and assumptions made to
determine valuations.

► IRDA has also instructed all life insurers to disclose explicitly, in their benefit
Illustration document, the exact amount of commission/brokerage paid by insurers to
insurance agents. This circular comes into effect from 1 July 2010.

Implication

The regulator has directed all firms to come up with a public disclosure framework to ensure
a fair and stable insurance market. These norms would help investors to be fully aware of
the financial performance, company profile, financial position, the risk exposure, elements of
corporate governance in place and the management of the insurance companies.

The standard on public disclosures for the insurance companies, which has been prepared
out of the best international practices as followed by International Association of
International Supervisors (IAIS), will strengthen the corporate governance and market
discipline.

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

27
Altered commission structure of agents
► Insurers would be allowed to charge up to 4% on annual premium paid on ULIPs for
the first five years, and thereafter charges will be reduced during the tenure of the
policy. This figure narrows down to 3% by the 10th year in a tapered scale, ending
with 2.25% after the 15th year. The new guidelines apply from 1 September 2010.
Earlier, the regulator had allowed commissions charged by agents to not exceed
40%.

► For single-premium products, the maximum commission rate is 2% of the premium

paid, and for regular premium products, the rate is in the range of 15-30% of
premium in the first year, followed by 5-7% in subsequent years.

► As per the draft guideline, all life insurance agents will have to gather a minimum of
INR150,000 as first year premium or sell a minimum of 20 life insurance contracts.
Where an agent falls short of achieving either of the above, they would have to
achieve proportionately more in either one to make up for the shortfall. Where
average annual persistency ratio is less than 50%, the agent’s license will not be
renewed.

Implication

This move by the IRDA reflects its efforts to ensure transparency and implement more
stringent disclosure norms to avoid mis-selling. This is likely to allow insurers to recover
their cost in a “more transparent and informed way,” thereby reducing “unfair practices”
and the “information gap” in domestic insurance to enhance market discipline. Variation in
the payment structure of agents will also help companies reduce their cost. Tenure-based
commission will definitely benefit the industry. High commission will come down and there
will be better reward for longer-term policies than the shorter-term ones.

The biggest gainers from this change are customers, as products will now be more
transparent, customer-friendly and aimed at protecting the long-term interests of
customers.

With the implementation of the IRDA’s new norm, insurance companies may initially face a
setback in policy sale numbers and total premiums. Although the IRDA stance is in favor of
bringing transparency in agents’ commission structure, this norm could impact agents
negatively, at least in the short run. To address the impact of reduced commission,
insurance companies may resort to innovative ways of compensating their top-performing
agents. Non-commission-based remuneration may increase. Companies may expand their
different reward and recognition programs to make the sale of ULIPs attractive for agents in
light of these recent changes.

In the long run, the role of agents is expected to evolve with this policy change. In future,
increased transparency is likely to make agents more accountable not only in selling right
product, but also in providing better customer service. This is also likely to ensure that
agents justify the commissions they earn. From being mere agents, they will be expected to
serve as financial planners selling a bouquet of financial products.

28
IPO norms for insurance company
► The insurance regulator has reduced the waiting period for an insurance company to
make an IPO from 10 years to five years after starting operations. Earlier, the
Insurance act required an insurance company to be in the business for a minimum of
10 years before it could seek the regulator’s approval for listing.

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

► Norms for correct valuation, disclosure of operating results and profit and loss
account and filing of the draft red herring prospectus are the three essentials that a
company has to fulfill when going for public float. Besides, companies would have to
make financial disclosures, risk disclosures, investment performance etc (details
stated in the above section – “New Disclosure norms”).

Implication

Insurance companies need capital to expand, innovate and sustain in the market. Raising
capital by floating an IPO is highly preferred by insurance companies. There can be a mix of
a fresh issue of shares as well as sale of shares by the parent company. Most companies
prefer this route when they don’t have enough capital to plough back into their business.
With the IPO route of raising capital, the Indian promoter will get the opportunity to put its
equity into the market as well as FIIs will also be able to participate and pickup stake.

Promoting health insurance

► IRDA has allowed insurance companies to offer 'Health plus Life Combi Product', a
policy that would provide life cover along with health insurance to subscribers. Under
the guidelines issued by the IRDA, the life and non-life insurance firms can come
together to offer health-plus-life cover. The combi products may be promoted by all
life Insurance and non-life insurance companies, however, a tie up is permitted
between one life insurer and one non-life insurer only. Thus, a life insurer is permitted
to tie up with only one non-life insurer and vice-versa.

► The sale of the combi products can be made through direct marketing channels,
brokers and composite individual and corporate agents, common to both insurers.
However, these products are not allowed to be marketed through 'bank referral'
arrangements. The regulator further said the guidelines do not apply to micro
insurance products which are governed by IRDA (Micro Insurance) Regulations, 2005.

► Under the ‘Combi Product’, underwriting of respective portion of risk shall be

underwritten by respective insurance companies, i.e. life insurance risk shall be
underwritten by a life insurance company and the health insurance portion of risk to
be underwritten by non-life insurance company.

Implication

29
Life insurance has a much deeper penetration in India as compared to the non-life insurance
segment. This step is in sync with the government’s, regulator’s and the insurance
company’s strategy to cover more people under the insurance umbrella.

As insurers leverage on the marketing and operational network of their partner insurers, the
proposed product innovation is expected to facilitate policy holders to choose an integrated
product of their choice under a single roof without shopping around the market for two
different insurance coverages from two different insurers. Therefore, the insurers are
expected to offer the best covers as an attractive proposition for the policyholders.

Alteration in ULIP’s
IRDA has attempted to make ULIP a long-term protection contract covering risks related to
mortality, longevity and health, by simultaneously offering a fair deal to the policyholder,
doing away with excesses in the system. Key changes introduced through new guidelines
are as follows:

► Lock in period: IRDA has increased the lock-in period for all ULIPs from three years to
five years, including top-up premiums, thereby making them long-term financial
instruments that provide risk protection. All limited premium ULIPs, other than single
premium products, will have a premium paying term of at least five years.

► Level paying premiums: All regular premium/limited premium ULIPs will have
uniform/level paying premiums. Any additional payments will be treated as single
premium for the purpose of insurance cover.

► Even distribution of charges: Charges on ULIPs are mandated to be evenly distributed

during the lock in period, in order to ensure the elimination of high front ending of
expenses.

► Increase in risk component: Further, all ULIPs, other than pension and annuity
products, will provide a mortality cover or a health cover, thereby increasing the risk
cover component in such products.

► Cap on surrender charges: IRDA has recommended a cap on surrender charges at up

to 15% of the fund value in the first year for policies of tenor more than 10 years and
12.5% for policies with tenor of less than 10 years. This charge comes down to 5%
and 2.5%, respectively, in the fifth year of the policy and becomes nil for policies of
less than 10 years after the fifth year. For tenors above 10 years, the charge in the
sixth year is 2.5% which becomes nil in the seventh year.

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

Implication

The impact of these new guidelines on customers will be favourable, due to the lower
charges, guaranteed returns, etc. However, these changes will also impact the margins of

30
life insurers, as the charges, particularly surrender charges, are capped. This could have an
adverse impact on their profitability.

The possibility of a decline in the profitability and increase in the capital requirements of life
insurers has resulted in discounting the previously high multiples assigned to the new
business achieved profits (NBAP) and as such, there could be a decline in the valuation
assigned to life insurance business. The changes in ULIPs guidelines could also lead to a
delay in the IPO plans of a number of players as they will have to rework their product
offerings.

Though it may make selling difficult as it would make product inflexible, but at the same
time, it would reduce persistency risk, make AUMs stable, and boost overall certainty on
assumptions and profitability of the business underwritten.

Other regulations
Besides the above regulations, IRDA and the government are in the process of drafting more
regulatory reforms for the industry. Below are a few:

► With the private players completing nearly 10 years of existence, the industry is
looking at new ways to meet its capital needs. The government is considering
increasing the upper limit in FDI from the current 26% to 49%. With foreign partners
unwilling to dilute their stakes below 26%, since most have entered the business in
anticipation of the limit being bumped up, the local partner will be forced to reduce
its stake to 49% to meet the new norms. That could create its own complications
since under Indian company law; a 51% stake ensures ownership.

► IRDA is finalizing directives and detailed guidelines for mergers & acquisitions in the
insurance sector.

► Policy document for the smooth transition from Solvency I to Solvency II is in the
draft stage.

► A data warehouse is being set up to monitor settlement of insurance claims, better

customer relationship management and facilitate better decision making.

► IRDA is considering allowing banks to tie-up with multiple insurance companies, for
vending their products. That will give bank customers wider menu of options to
choose from, and they can buy insurance products based on their needs.

► IRDA will soon come up with norms to define terms such as critical illness and
hospitalization cost, among others, a move that will reduce the scope for disputes
between insurers and hospitals.

Regulation affects the economics of both the supply side (the policyholders – supplier of
funds) as well as the demand side (insurers – borrowers of funds). The Indian consumer
being extremely price sensitive adjusts rapidly to the altered economics, which could affect
persistency trend in the industry. To ensure further industry growth and rise in penetration
levels, IRDA’s role will be critical.

31
Section III: Critical factors for market development

Distribution channel

The effectiveness and cost of diverse distribution strategies of different players is crucial in
ensuring the success for players in the insurance business, particularly in the retail lines of
business. The low differentiation among retail insurance products suggests the criticality of
distribution reach and efficiency for success in this business.
The factors which determine the choice of distribution channel for an insurance company are

► Where are the customers?

► What is target customer profile?

► Which product (linked, traditional, term etc.) can be sold through distribution
channel?

► Which channel provides best buying experience and value to target customer
segment?

► What is the operational cost involved in each type of channel?

The customer preferences vary by market segment like geography, age, income, life style
etc, and market characteristics change over time.

Role of intermediaries/distributors/financial advisors

Insurance has to be sold the world over, and the Indian market is no exception. The touch
point with the ultimate customer is the distributor or the producer, and the role played by
them in insurance markets is critical.

Insurance distribution is not simply about pushing products. An outsized share of the value
across the entire insurance industry value chain is added in distribution. For customers, it is
in distribution that needs are understood and assessed, options (from full risk transfer to self
insurance and more exotic methods of managing risk) are identified, and counsel on the
choice of carriers and other providers is given. It is in distribution over which relationships
and trust are built with agents, brokers, and customers, opportunities identified and created,
and products and services sold.

It is the distributor who makes the difference in terms of the quality of advice for choice of
product, servicing of policy post sale and settlement of claims. In the Indian market, with
their distinct cultural and social ethos, these conditions play a major role in shaping the
distribution channels and their effectiveness.

32
The figure below provides an estimate of the current market share of the various distribution
channels used by life insurers, and gives a view of how these channels could develop in the
future.

Figure: Current market share and potential market growth

In today's scenario, insurance companies must move from selling insurance to marketing an
essential financial product. The distributors have to become trusted financial advisors for the
clients and trusted business associates for the insurance companies.

The most prominent models of insurance distribution are:

► Agents

An insurance agent has to know which product will appeal to the customer, and also know
his competitors’ products in the same space to be an effective salesman who can sell his
company, the product, and himself to the customer. To the average customer, every new
company is the same. Life insurance in India has been mostly distributed through an
elaborate network of agents.

Agency force has high gestation period and is more suitable to sell complex risk-based
products. Product market focus on relatively simpler ULIPs makes predominantly agency-
based models relatively expensive.

33
Agents are divided into various categories depending on the skills, experience and
productivity. Companies are focusing on identifying training needs and increasing
productivity of agents. The figure below provides features of agents at different levels.

Figure: Tied agency model

Agents are responsible for the reputation of the company they are working for and they also
have their obligations towards their clients. Till now, the following are the basic function
agents perform:
► Provide all the necessary application forms.

► Submit application forms to the company.

► Arrange for all the medical tests and related formalities.

► Provide reminders premiums payments and return receipts.

► Should help customer make necessary changes in address, nomination etc.

34
 ► Help in the process of assignment

► Assist customer for any loan applications and related formalities

► Should help customer revive lapsed policies

► Assist in claiming death benefits, if required

Besides the above, now agents are moving from sole contact point between a customer and
an insurance company to become financial advisors. Agents would now be responsible for
explaining the nature of a policy to the customer as that will help the customer to take an
informed decision. Their role is likely to enhance, as they will not only sell insurance
products, but offer other financial products as well to enhance customer benefits.

The limiting factor for prospective insurers will be the extensive and costly distribution
structure equipped for reaching this segment. While the public sector companies are able to
attract agents, they continue to suffer from high attrition rates due to indiscriminate agent
appointment. The most successful of these companies' tied agents are hardly of the elite
variety of salesman. They are still the neighborhood do gooders — the postman, the
schoolteacher, and the shopkeeper — who know the people and are themselves known in
the community.

The challenge here is the lack of knowledge of the competitive market and the inability to do
intelligent comparisons with the competitor's products. The new companies are looking for
educated, aware individuals with marketing flair, an elite group who can be attracted only
with high remuneration and the lure of a fashionable job, all of which may not be possible in
this business with its price pressures and the complexity of selling insurance. With this kind
of segmentation of intermediaries the test for the insurance company lies in training and
educating these people to become effective sales persons.

Also, IRDA holds mandatory test for agents and other training programs for agents in India.
IRDA norms are getting more stiff for agents (commission reduced and spread over longer
time period)is likely to be even more stricter, which would impact agents in the short run.

► Bancassurance

The new entrants cannot expect to replicate the extensive distribution network of the
nationalized insurance companies. Building a distribution network is expensive and time
consuming. As a result, private insurers have largely followed a strategy similar to that of
the foreign banks i.e. starting from the affluent segment and gradually building up the
distribution network to reach out to the middle-income segment.

Bank-backed insurers and those promoted by large banks that are better positioned due to
their relatively lower development costs, predominantly variable cost structure (typically
opening own sales branches imply higher fixed and semi-variable costs) and integration of
system that may reduce cost of operations.

Though bank-backed insurers are better off because of strong brand, variable cost business
models, access to bank’s database and walk-in customers reducing overall acquisition costs,
except LIC which clearly stands as an exception to this tenet because of its scale of
operations and productivity achieved over years of operations.

35
The bancassurance model functions at various levels, each party having a different level of
agreement. The following diagram explains the various bancassurance models with their
features.

Figure: Bancassurance model

Technological advances are expected to enable new distribution channels, while recent
regulatory changes (bank’s entry into insurance) are expected to allow cross-selling

36
between financial services companies. However, Banc-assurance is expected to gain
considerable popularity.

Increased tie-ups of banks and insurance companies indicate bank’s selling insurance
products as an opportunity to leverage their extensive branch network, and broaden their
income base to include more fee-based business. Insurers equally see bancassurance as a
low-cost option to expand their distribution network and penetrate into previously
inaccessible segments of the market.

► Other distribution methods

► Alternate distribution channels are needed for the following reasons:

► To increase insurance penetration in the country.

► To differentiate on basis of customer service. To retain and attract new customers to

expand business

► To increase insurance awareness and knowledge among people.

► To satisfy the needs of more demanding customers.

► To improve cost efficiency in insurance distribution.

Private players are exploring several alternatives to reduce the cost of replicating the
distribution network of the public sector insurance companies. While third-party distribution,
as in fast moving consumer goods, is a possibility, the complexity of insurance products,
especially given the low awareness levels, would necessitate direct selling.

One potential channel is marketing through corporate employers, that is, the employers
purchase the product on behalf of the employees or at least co-operate in the marketing
effort. The concept of “worksite marketing”, i.e. the sale of voluntary insurance products to
employees at the worksite through payroll deduction has become common. Worksite
marketing which was once the realm of a few small companies selling just a few products,
has stretched to big companies offering a number and variety of worksite products.

Brokers and corporate agents form a small part of the distribution system in India. As on 31
March 2010, there were 259 direct brokers, 33 composite brokers and six re-insurance
brokers. Not many large brokers are present in the Indian market at the moment, but
contribution from corporate brokers is likely to increase as many corporate agents are
turning brokers. Global insurance brokers such as Aon, Marsh, Willis and Howden have also
entered the Indian market.

Some products, once they receive a high level of penetration and awareness, can become
commodities and be sold through more impersonal channels. The use of the Internet to
distribute life insurance products has only emerged recently and has not made a significant
impact so far, partly because of the substantial advisory component of most life insurance
products.

Penetration in rural and semi-urban areas has become the core of distribution strategy of
insurers. As in metros and urban areas, in rural areas also, insurers have targeted the mass-

37
affluent segment. Cost of setting up operations in rural/semi-urban areas is far lower
compared with those in metros and urban areas. There is a promising potential of rural and
semi-urban offices with unrelenting expansion in these areas and presence of multiple
insurers may lead to sub-optimal operations.

These distribution networks have reached an unprecedented scale — from mobile phone
companies, to microfinance institutions to supermarket chains and churches. Millions of
customers who were previously off the grid are now within reach.

Challenges with the existing distribution model

India is arguably one of the most challenging and promising emerging insurance markets. Its
rapidly growing economy coupled with a young and huge population spell ample
opportunities for the development of insurance. However, there is much to be done to
realize this potential. In today's Indian insurance market, the main challenge to insurers and
intermediaries are:

► Building faith about the company in the mind of the client

► Intermediaries being able to build personal credibility with the clients

► Controlling operating expenses by reducing distribution cost

► Coping with IRDA norms on their commission

Traditionally tied agents have been the primary channels for insurance distribution in the
Indian market. The public sector insurance companies have their branches in almost all
parts of the country and have attracted local people to become their agents. The agents are
from various segments in society and collectively cover the entire spectrum of the society. A
person who has lived in the locality for many years sells the products of the insurance
company with a local branch nearby. This ensures the last mile touch point being closer to
the customer. Of course, the profile of the people who acted as agents suggests they may
not have been sufficiently knowledgeable about the different products offered, and may not
have sold the best possible product to the client. Nonetheless, the customer trusted the
agent and company. This arrangement worked satisfactorily in the absence of competition.

In today's scenario agents continue as the prime channel for insurance distribution in India,
as is the case in most markets, supported by call centers to a small extent. Almost all the
new players follow this model primarily because the regulations for other channels are yet to
be put in place. However, there is great excitement in the industry over the impending
broker regulations and companies are planning possible channels in their enthusiasm to
increase volumes. The belief that all these channels will grow and seamlessly integrate to
bring in business seems a fallacy.

Since controlling expenses has become a challenge and most of these expenses are
incurred on distribution, the issue of efficient cost management is strongly attached to
effective distribution. With the new IRDA regulation on the commission structure,
distributors will earn lower commissions, going forward, and will have to adjust their
business models accordingly. The challenge will be no less for insurance companies. The

38
fixed and semi-variable costs in the business are high. With restriction on ability to push the
product, gaining scales will not be easy for all.

A two pronged approach to cost management could be envisaged:

► cut commission pay-outs

► shift towards variable cost distribution models

For a standalone insurer, achieving this will be a herculean task, requiring potential to
execute low-cost customer capture independent of the distributor. In the absence of product
differentiation, the options available to insurers are limited to:

► build low-cost reach which is the most desired and most difficult

► generate higher investment yields that may strengthen the sales pitch

► build a strong retail brand which will be expensive

Insurance industry in India has seen emergence of large-bank backed insurers. So far, the
regulator has allowed banks to enter only into corporate agency tie-ups with insurers.
Hence, banks promoting insurance companies remained tied to their ventures, putting to
question the existence of arms length relationship between the bank and insurance
subsidiary.

What has emerged is a much more difficult and evolving market scene with existing players,
more new players coming in, and global marketing practices and ideas being tested. But
none of this has changed the fundamental character of the market.

Experiences from developed insurance markets worldwide

Globally, various insurance markets are in various stages of development which is also
reflected in their insurance distribution networks. On one hand, the distribution network
comprise primarily agents, given the higher face-to-face interaction required to educate
people about insurance products. Primarily, insurers follow a push strategy to market their
offerings. As the insurance penetration develops, a variety of other distribution channels
comes in the picture to supplement the agency model. However, the types and reach of
different channels is affected by a variety of factors, such as size and potential of insurance
market, geographical scenario, culture, literacy level, complexity levels of the insurance
products, development of information technology infrastructure, and availability of
associated distribution channels.
Other distribution channels, such as independent financial advisors (IFAs), brokers,
bancassurance and electronic channels emerge as the market moves to developing and
mature phases. Insurers deploy various channels keeping in mind the complexity of the
products involved and target customer base besides optimizing their distribution cost. Local
rules and regulations also play an important role in deciding the penetration of any
distribution channel. Although the composition of various insurance distribution channels
could vary across different insurance markets, broadly, it moves from being predominantly
an agency model to multi distribution model with a significant role played by IFAs and

39
brokers. The following figure explains the evolution of insurance distribution network across
countries.

Figure: Evolution of distribution network

Source: “Life Insurance,” Edelweiss, 6 August 2010, via Thomson Research

Multiple distribution networks create a range of opportunities for insurers to attract and
serve customers in a differentiated way keeping in mind the customer’s preferred
combination of product, pricing, service, and channel. It is a way to reach customers that
could not be reached before, and to extract more value from existing customers. It is,
therefore, a powerful lever to increase market and customer access, especially in mature
insurance markets.

Figure: Present state of distribution across geographies

40
 Source: More than one approach: Alternative insurance distribution models in Asia Pacific, Deloitte, 19 March 2010

The mix of distribution channels is matched by the diversity of the cultural, infrastructural,
and regulatory environments. It is evident that a ‘one size fits all’ model is not the best
approach. Rather, a multi-pronged approach that factors in country specifics, penetration
rates, and cultural characteristics appears to be the most successful model. Conversely,
market segmentation and the unique needs of customer groups appear to be dictating the
distribution channel used in a specific country.

United Kingdom

Insurance distribution channels have evolved through various phases in the UK. Before
1990s, majority of insurance distribution was undertaken by the direct sales force of
insurance companies. However, after the implementation of Polarization rules, which
mandated the individuals and companies selling insurance to tie to one company or remain
independent to handle all products across the market, IFAs became a prominent player in
insurance distribution. At present, around 45% of life insurance and 85% of pension business
is done by IFAs in the UK.

41
Besides IFAs, there are also tied advisors, which can be grouped under two categories – tied
advisors (working for one financial institution) and multi-tied advisors (offering products
from a selection of the market and usually paid on a commission basis). Typically, tied and
multi-tied advisors cater to mass markets and offer simple products whereas independent
IFAs target high net worth customers and offer tailored products.

Further, bancassurance has also emerged as a prominent distribution channel for insurance
products. Post depolarization, a variety of bancassurance models emerged in the UK. It has
emerged as an important channel for distribution of simple products, such as ULIPs and
bond products. Bancassurance market share stood at 20.3% in 2006 in the UK.

Another interesting channel that has emerged in the UK is the organized retailers, such as
Tesco, Sainbury and ASDA. They can act as corporate agent or as referral and are among
the largest distributor of insurance products in the UK. Various functions during the policy
cycle are managed between retailer and insurer. This channel can be integrated to agency
channel for better servicing and for establishing one-to-one relationship with customer.

To conclude, in the UK, banks have emerged as preferred channel for distribution of
savings/simple ULIPs; IFAs and banks for pension/retirement products and insurance
companies/tied agency for risk protection products.

Insurance is a ‘push’ product. Hence, the role of intermediary is crucial in influencing the
buyer and creating a committed customer base. In insurers’ value chain, significant value is
generated at the distribution stage. Distribution strength is a key to scalability and
sustainability of the insurance business. Given the nature of product and the emerging
regulatory environment, existing distribution strategy has been challenged.

Going forward, in India, the commission rates are likely to drop impacting the front-line sales
force, corporate agents and brokers. Alternative channels such as bancassurance, e-
channels will gain more prominence. The rural/semi-urban distribution strategy will undergo
a change; insurers will focus on top 20 towns over medium term, rather than experimenting
with low per-capita income under-penetrated areas.

Focus on financial inclusion

The approach to insurance must be in tune with the changing times. The mission of the
insurance sector in India should be to extend the insurance coverage over a larger section of
the population and a wider segment of activities.
Around 40% of the population does not have access to organized financial services sector in
India. There is a huge demand for these services in excluded regions where it is difficult to
provide these financial services. Therefore, a large section of the excluded population has to
rely on informal sector (moneylenders etc) for availing finance that is usually at exorbitant
rates.

42
Apart from the obvious and apparent benefits of improving living standards, financial
inclusion has a multiplier effect. By increasing the number of people in the umbrella, the
value of the entire national financial system increases. The consequent fuller participation
by all in the financial system makes monetary policy more effective and thus provides a
conducive environment for non-inflationary sustainable economic growth.

Despite a robust growth of 30%-40% in premiums during 2003-2008, per capita insurance
premium is also low due to a large population base and financial exclusion of a large section
of this population. The government has realized the need to increase financial inclusion in
the financial services sector, especially in insurance.

Need to increase financial inclusion in India

Since economic liberalization started in 1990s in India, financial inclusion has been at the
forefront of policy makers to ensure that the benefit of the economic growth percolates
down to the poorest of the poor. Eleventh Five-Year Plan puts special emphasis to promote
more inclusive growth in the financial services sector. The need for delivery of financial
services at an affordable cost to vast sections of disadvantaged and low-income groups is
increasing.
Financial inclusion is likely to increase in the light of limited social security by government
In India, the government provides very limited social security to its citizens as reflected in
the fact that less than 4% of the population is covered under any of the social security
scheme.
Also, the self-employed or those working for small enterprises are exempt from contributing
to the employees’ provident fund and need to make their own arrangements for savings and
protection cover. The growth of nuclear families in urban locations resulting in the
breakdown of traditional old age support structures also supports this trend.
The diagram below clearly depicts that the government expenditure on public social
protection and health expenditure is very low as compared to other countries. In the light of
the need of protection instruments, there is going to be an increase in the demand for
financial products in the years to come.

Figure: Public protection and health expenditure as a % of government

expenditure (2004)

43
 Public social protection and health expenditure as a % of
government expenditure (2004)
70%
59.6%
60% 51.6%
50% 39.9%
40%
26.1%
30% 24.0%
20.8%
20% 12.0%
9.0% 7.0%
10% 1.5%
0%
-10%

Source: “India
Life Insurance
Sector,” Credit Suisse, 29 July 2009, via Thomson Research

Measures to increase financial inclusion in India

Various measures have been taken to increase the insurance penetration in India, although,
with varied success. Some of these are listed below:

► Increase financial literacy

Given a low literacy level of around 65%, it is imperative to have even lower financial
literacy among populace. The situation is worse in semi-urban and rural areas, where people
are not even aware of the concept of insurance. Therefore, various stakeholders in the
industry need to promote financial literacy and educate populace about insurance.

Unlike other disciplines of finance, insurance is introduced to person at a much later stage of
life, which results in a limited knowledge. Hence, the level of awareness about insurance
products and services is very low.

Low level of financial literacy has been an issue in not only developing countries but also in
many of the developed countries. Countries such as the US, Australia, New Zealand, and the
UK among others, have taken considerable steps in ensuring higher levels of financial
literacy. Some of these are:

► Establishment of ‘The Adult Financial Literacy Advisory Group’ by the UK

Government in 2000to recommend ways to improve financial literacy of the
adult population with a specific emphasis on those who are disadvantaged
► Joint effort of the US Federal Government, state governments and other
stakeholders in the insurance sector to teach family economics and finance
► Measures taken by the Insurance Council of New Zealand as a part of ‘The
Enterprise New Zealand Trust’s Financial Literacy Programme’ to educate on risk
and insurance, in more than 100 schools

Closer home, IRDA had undertaken a publicity campaign to improve awareness and
knowledge about insurance products to enable customers to take informed decisions. As

44
India has a huge population, a consistent and harmonized approach by all the stakeholders
might prove to be more successful and bring in the desired results.

The primary objective of all the stakeholders (regulator and insurance companies) should
not only be limited to encourage people to buy insurance policies, but also to ensure that all
the individuals or families should be reasonably familiar with the concepts of insurance,
products, means of delivery, grievance handling process, customers’ rights etc. They should
feel comfortable in transacting with the insurance companies and their representatives.

► Ensuring Indian households transfer savings from physical assets

to financial assets
Household savings is composed of both financial and physical savings. Indians prefer their
savings in the form of physical assets instead of financial instruments, and this trend is likely
to continue despite the India growth story. Although financial inclusion is a mantra for the
RBI and the government, it is estimated that the financial savings of the household sector
have been declining over the years.
In the coming years, banks, insurance companies and other financial institutions must focus
on channelizing savings from physical assets to financial assets.

Figure: Distribution of physical and financial savings in India (as a % of household

savings)

Distribution of physical and financial savings in India (as a % of

household savings)

100
80 53 51 52 51
54 53 58 54
69
60
40
46 47 47 49 48 49 46
20 31
42

0
1970- 71 1980- 81 1990-91 2000-01 2004- 05 2005-06 2006-07 2007- 08 2008-09

Financial assets Physical assets

Source: “National Income Statistics” July 2010, CMIE

Traditionally, Indians have been more risk-averse, putting most of their savings in physical
assets rather than financial instruments. Therefore, the government should incentivize the
investment in financial instruments. Combined with an increasing savings rate, this trend is
expected to be extremely beneficial to the life insurance industry. This change has started

45
to happen over the years; however, increasing financial literacy and awareness are likely to
boost this further.
► Improve access to reach to vast sections of underprivileged and low income
groups
In a diverse and large country like India, various factors such as vast geographical spread,
lack of technology and affordability of insurance products have been hindrance to financial
inclusion. Hence use of different distribution channels, developing products for the poor,
cheaper access to financial products etc. would help increase financial inclusion.
► Insurance as a tax saving instrument
In India, insurance has so far been viewed primarily as a tax-saving instrument. This is
evident in the fact that a majority of the insurance policies are purchased in the last two
months of the financial year (February and March). As a result, many Indians buy insurance
policies without regard to their actual insurance needs. Also, many policyholders do not
reassess their insurance cover, as their income level increases and standard of living
improves. Thus, a large number of policyholders are underinsured.
India has approximately 3.5% tax paying population, which is very small. But with the
increase in the disposable income and inclusion of more people in the tax bracket, the sale
of tax saving products, especially investment in insurance products is likely to increase.

Financial inclusion will be achieved by creating a supportive socio-economic environment to

build and sustain it. The process of financial inclusion should be a virtuous circle of
sustainable income generation programs for the poor, followed by customized products by
the financial system delivered with the help of intermediaries on a mass scale by leveraging
technology and related infrastructure.

Consumer needs and preferences

Growth in insurance industry has been spurred by product innovation, vibrant distribution
channels coupled with targeted publicity and promotional campaigns by the insurers.
Innovations have come not only in the form of benefits attached to the products, but also in
the delivery mechanism through various marketing tie-ups both within the realm of financial
services and outside. All these efforts have brought insurance closer to the customer as well
as made it more relevant.
One of the crucial areas in the insurance sector is the adoption of new technology in the
industry. It is an accepted fact that insurance business is technology driven. It has the
potential to save cost and hence, the scope for reducing price of product. Coming years will
witness a total revolution in the ways of doing business. E-commerce will be increasingly
used in all sectors including banks and insurance and products will be sold on Internet.

Insurance plans for children are fast becoming popular, as they not only offer payouts that
can be timed to coincide with certain milestones in the child's life, but also financial security
if the parent dies. All the life insurance companies are showing interest towards children’s
insurance plan and willing to coming out with new innovative product lines in the future.
According to industry estimates, currently, 20-30% of business of many companies comes
from children-specific insurance policies alone.

46
Emerging lifestyle trends amid a changing fabric of the Indian society have also modified
social and financial behavior. For instance, an increase in the number of working women has
led to a demand for life insurance policies, which in turn has helped women through a micro-
entrepreneurship initiative.

Project insurance is another area which is gaining significance. This type of insurance has
been prevalent for decades for those who undertake huge and risky projects, whether
government, public sector or private sector. With the new developments, particularly in
economic and industrial area, apart from projects such manufacturing units, sales units and
medium size factories, a large number of infrastructure projects such as constructing roads,
canals, flyovers and bridges, and industrial units are coming up in large numbers. There is
therefore huge potential for this class of insurance.

One of most successful innovative product in India has been ULIPs. As a product, ULIP
gained popularity post 2003 with evolving market opportunity on the back of a booming
equity market, low household equity penetration and heavy channel incentivisation. Product
innovation is likely to continue and traditional policies are set to gain some foothold in an
otherwise ULIP-driven market.

Insurance companies are now coming up with usage based insurance, also known as pay as
you drive which is a type of automobile insurance whereby the costs of auto insurance are
dependent upon type of vehicle used, measured against Time, Distance and Place. This
differs from traditional insurance, which attempts to differentiate and reward "safe" drivers,
giving them lower premiums and/or a no-claims bonus.

The changing customer preferences and the need for developing customized products is the
new mantra of growth which most companies are following. In line with the product
philosophy to introduce innovative range of products that are most suitable to different
customer needs, companies are introducing more customer friendly products. The role of
customized products is also seen in providing a competitive advantage.

Way forward

► Huge potential will sustain robust growth

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, increased
product variants 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 relieve pressure on social welfare systems and allow individuals to tailor

47
their security programmes as per 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. In the coming years, government
expects insurance to be a key contributor to the large capital requirement for funding the
planned infrastructure projects in the country.

The life insurance segment is a major attraction for private and foreign players. Life
insurance players are realigning their business strategies in response to new IRDA norms on
capping charges. In the long term, this can create entry barriers and strengthen the
competitive strength of the incumbents. IRDA is also expecting more applications for
licenses over the next one or two years due to the rising inclination of banks to venture into
the insurance segment.

► Tightening the belt by leveraging technology and exploring alternate low

cost channels

The sector is likely to witness increase in the usage of technology in distribution channels.
Moreover, a shift from the agency model of distribution to models, such as bancassurance,
brokers, etc., will help increase reach and reduce cost. Also, there is high potential in the
micro insurance segment with majority of the Indian population residing in rural areas.

After the de-tarrification, the non-life insurance sector has witnessed a slowdown in the
premium growth. However, in the next three or four years, the industry is likely to grow at a
stable rate. Both health insurance and auto insurance are highly promising, and are
expected to increase their share manifold in the coming years.

The reinsurance industry is likely to increase pricing rates in the light of increasing claims
and decline in the value of investment income following the financial crisis. The market has
to ensure that the domestic companies increase their own capacities and introduce stricter
guidelines as first-hand risk carriers. Insurance companies have to establish business
relations with their reinsurer to prevent them from worldwide reinsurance cycle that affects
capacity and stability. In future, insurance companies are likely to compete on a number of
parameters, including price, products, underwriting and innovative sales methods. Poorly
managed companies with a weak capital base are expected to either drop out of the market
or become uncompetitive on premium rates and profits. For insurance companies, profit
from innovation will be the key to success, and technology will help private insurers to
develop and customize products to suit individual needs.

India is likely to continue its strong premium growth momentum provided private sector
players continue to innovative with product design and distribution channel usage. Robust
ULIP sales during the equity market downturn and the recent resumption of ULIP sales are
testaments to the strong demand for insurance products in India.

The Asia Pacific region has dynamic and varied insurance markets. Most countries are
experiencing significant shifts in population demographics, standards of living, income, and
education levels. Consequently, the insurance industries do not follow a standardized model
for effective distribution channels.

The ability of any private sector insurer to outperform its peers hinges on its ability to
improve on channel usage and productivity. Insurers would do well to tap into new

48
customers via new channels, while bolstering existing channel productivity to generate more
business or improve upon the quality of business already being generated.

Among all channels, agency force presents the biggest improvement opportunity. Although
the agency model has been and will remain a major distribution channel, insurers should
combine multiple channels in order to meet the needs of a socio-economically and
religiously diverse region. Insurers need to first establish physical presence in new cities and
towns and then to recruit and train agents. Drawing experience from the UK market,
insurers may also want to use retail chains effectively for better servicing customers and
building one to one relationships.

Seeing that commissions, i.e. the variable costs paid across all channels should be the same,
building the agency business incurs most fixed costs. Expansion in agency force would be
the most expensive way forward, although it would potentially provide the best returns since
this distribution means is more stable than bancassurance and there is plenty of room for
improvement as agent productivity is very low in India right now. Agent poaching and high
attrition rates have been some problems faced by the insurers but this is no different from
problems faced in other developing markets such as China.

► Sustaining growth through increased transparency

Given the rapid increase in costs associated with building agency force, insurers are also
building low-cost channels such as direct marketing, internet and telemarketing channels to
sell simple insurance policies and to service existing policyholders. Direct distribution incurs
much lower commission and is suited for simple products for which face-to-face interaction
is not required for their initiation or concluding sales. Recently, a leading insurance player
has launched the first fully-online term insurance product which is substantially low priced
compared to company’s conventional term products. Internet as a channel to launch new
and innovative products will be on the rise in future as e-commerce witnesses a surge in the
country.

The insurance industry is at a very critical stage from where either it can flourish or can
witness a muted growth. The last ten years have been the year of growth and development.
But now is the time for growth along with stabilization. IRDA, on its part, is facilitating the
expansion of the sector by formulating conducive regulations. However, along with keeping
the interests of the customers at the forefront, there is a need to facilitate a favorable
environment for distribution intermediaries, which can result in exponential growth for the
sector.

The regulator has laid down a framework for insurers to make disclosure of financial
statements, investment portfolio, and operating ratios. These disclosures are going to make
the industry stronger and also earn faith of its stakeholders. Shift from solvency I to solvency
II is also taken as a big step towards risk management. IRDA is also considering the
formulation of rules and regulations for a smooth transition to this new regulatory standard.

The growth potential and opportunities for the Indian insurance industry is enormous. In the
wake of the improving global financial situation, the industry is expected to be a major
contributor to the country’s growth.

49
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