Thursday, February 28, 2013

Insurance Future And FDI

‘Yes, insurance needs better cover but not with foreign capital’

The article by V.K. Shunglu in The Hindu , “The risk business needs better cover” (Op-Ed, February 14, 2013) is one-sided and conspicuously understates certain key aspects of insurance reforms undertaken in the country a decade ago. It misses the basic premise on which an insurance business is run — that of “trust” and the long-term “promises to be upheld.”
This industry should not be seen merely in economic terms. The settlement of the death claim of Hemant Karkare, chief of the Mumbai Anti-Terrorist Squad, who was killed in Mumbai’s 26/11, presents a clear-cut example of Trust.

Mumbai’s Dadar branch of the Life Insurance Corporation (LIC) had settled the death claim amount of Rs.25 lakh within five days whereas a private company (name withheld), where Karkare had coverage for a similar amount, had rejected the claim — and, after a lapse of six months — by stating that the deceased had wilfully risked his life, even after knowing that his life was in danger. That’s why I said the insurance business should not be seen in purely economic terms.

The tag of public sector should not be the reason for spewing venom. There are certain “Crown jewels such as LIC”; it settles 98.6 per cent of claims, the only insurance company in the world to do so. It is true, as Mr. Shunglu says, that the insurance business has become a key player in underpinning the long-term foundations of India’s capital markets and financial system. But for satiating the needs of India’s capital markets, these private insurance companies have done little good for gullible policyholders and their hard-earned monies.

This is an industry in which even with a small amount of investment i.e. Rs.100 crore, thousands and lakhs of crores of public money can be garnered. It is firmly believed that the Foreign direct investment (FDI) hike will allow foreign capital with small investments to gain greater access and control over large domestic savings. The annual report (2011-2012) of the Insurance Regulatory and Development Authority (IRDA) points out that FDI brought in by private life insurance companies up to March 31, 2012, was a meagre Rs.6,324.27 crore, which was to meet share capital requirements prescribed by the regulator. Not a single pie was invested in the infrastructure sector. It is LIC which is a saviour, and the government of the day is utilising it as a captive investor, just as it has done in the case of petroleum major ONGC.
In our country, insurance companies are mopping up people’s savings. During 2011-12, domestic savings were 32 per cent of GDP. Financial experts say that domestic savings, and not FDI, are crucial for any country’s economic development. In India, LIC has provided Rs.7,04,151 crore to the 11th Five-Year Plan (2007-2012) while the four general insurance companies and GIC of India have contributed about Rs. one lakh crore. Where will the government get these huge investments from if it tries to weaken the public sector insurance companies?

The World Economic Forum Financial Development Report 2012 tells the success story of LIC. It shows that given the low level of income and low disposable income of most Indians, insurance penetration in India is much greater than in countries with a per capita income that is 10 times higher. It is remarkable that with a per capita GDP of $1,388.80, India has achieved a life insurance penetration of 3.61 per cent as against 3.56 per cent of the United States with a per capita GDP of $4,8386.77. It is also a matter of pride that the report places India at the top of global rankings in terms of Life Insurance Density (measured as a ratio of direct premium to per capita GDP of 2011).

The LIC, the four general insurance companies in the public sector and GIC of India are doing an excellent job despite competition from private insurance companies. In 2011-12, LIC earned a premium of Rs.81,514.49 crore registering a market share of 71.36 per cent in premium income. It sold 3.57 crore new policies, to take an 80.9 per cent market share in the number of policies. Similarly, the four insurance companies have earned a premium income of Rs.30,532 crore and registered 58 per cent of market share.

The financial crisis in the U.S. and Europe has seriously eroded confidence in the banking and insurance sectors. At the same time, our domestic private insurance partners hardly need capital to be infused by their foreign counterparts, as put forth by the votaries of FDI increase.

Partners of private insurance companies in India like the Tatas and Reliance are on an acquisition spree, spending billions of dollars, both on the domestic and foreign fronts during the last five years. The others, like the State Bank of India and other public sector banks have capital reserves of their own. Some foreign partners have exited not due to a delay in the increase of FDI cap but because they are in search of greener pastures.

The author has also put forth another interesting argument — that shareholders and company boards be left free to determine whether additional investment should be through FDI or FII or by other means.
The world saw the bubble burst in 2008 due to such flawed and mistaken judgements by company boards and shareholders, when they invested the earnings/savings of innocent policyholders into Collateralised debt obligations, or CDOs. India was saved from such a situation because of the domination of the public sector in the banking and insurance sectors. Even the Prime Minister and the Finance Minister have shared this view.

Looking back, it is time to learn lessons from the global collapses of banks, insurance companies and other financial institutions like Lehman Brothers, etc. Foreign investment per se, does not bring any good with it, especially in fragile sectors like insurance. This sector is the pillar of any upcoming and growing economy.

(M.S.R.A. Srihari is a former joint secretary, Insurance Corporation Employees Union,

The risk business needs better cover

The Hindu The insurance industry requires significant inputs of capital sustained over a long period to build a viable business and meet growing policyholder commitments. A file picture of a protest against the insurance Bill. Photo: G. Krishnaswamy

Permitting a 49 per cent foreign investment limit in the insurance sector, without specifying if that should be FDI or FII, can be a win-win way out for stakeholders

The opening up of India’s public monopoly insurance sector to competition from private companies in 2000 was billed as a major financial system reform. It was clearly understood that ownership rules for insurance would be liberalised progressively apace with liberalisation in other parts of the financial services industry. Since then, a large number of insurance joint ventures between domestic and foreign partners have been formed. They have transformed the Indian insurance scene and provided a much better deal to consumers.

There is now a wider choice of products providing protection against many more types of risk. Most importantly, the insurance industry has become a key player in underpinning the long-term foundations of India’s capital markets and financial system. It is a growing source of finance for infrastructure. Insurance has also been a significant source of foreign capital inflows — directly and indirectly.

The market since 2000

Moreover, the entry of private competition has forced the former public monopoly insurers to improve their performance and efficiency. Yet, despite these benefits, the government has not yet — after 13 years — lived up to its promise of fostering the growth of the industry by increasing the Foreign direct investment (FDI) limit in insurance from 26 per cent to 49 per cent. That unjustifiable delay now compromises the financial standing of many insurance joint ventures (JV) and puts a question mark over the future of an industry that is vital to the health of the financial system.

Let’s look closely at what has happened since 2000. The insurance industry requires significant inputs of capital sustained over a long period to build a viable business and meet growing policyholder commitments. It takes eight to 10 years to reach break-even. The private industry in India has lost a combined $4 billion in the last decade. In the non-life segment, 13 private sector insurers have reported losses in 2011. Many of the smaller insurance companies have looked at options to introduce new domestic partners, but there are no buyers. Most existing foreign promoters have a long-term view. They are unfazed by medium-term losses which they regard as necessary investments to generate future returns. They are looking to increase their ownership stake while their domestic partners have neither the capital resources nor the inclination to do so. A few foreign firms have grown impatient with the slow pace of progress and exited.

Following a long period of inaction and delay, the Union Finance Minister has taken the bull by the horns. He is committed to continuing with liberalising and reviving the industry. He realises that urgently needed infrastructure will require a far greater volume of investment by insurance companies and pension funds. Yet, unanticipated complications have arisen.
Getting sidetracked

The core issue of lifting the FDI cap to permit inflows of capital from foreign partners, thus allowing the insurance industry to strengthen its capital base and grow, has been sidetracked by a proposal to permit new investment to come in only through Foreign Institutional Investors (FII) rather than the FDI route. That is odd for an industry that requires a longer term investment horizon than FIIs have. India’s insurance industry needs around $12 billion in capital up to 2020. Life insurance penetration is only 4.4 per cent of the country’s Gross domestic product (GDP) in terms of total premium underwritten in a year. The sector needs huge and sustained infusion of funding to build viable businesses for the long term.

The idea of increasing the capital base of the industry through FII (instead of FDI) emanated from an understanding between the government and the Opposition, which avoided lifting the FDI cap. That opposition was bolstered by the strong position taken by the Joint Parliamentary Standing Committee on Finance on grounds that remain arguable and contentious. For a variety of reasons, the notion of allowing a capital increase only through FII would be a non-starter. FIIs have a very limited role to play in insurance 

companies, e.g. those listed in secondary markets, or a few profitable early entrants about to launch initial public offerings (IPO). It has no useful role to play in JVs requiring significant direct injection of capital.

The Insurance Regulatory and Development Authority (IRDA) has warned publicly against the entry of FIIs in insurance. Interestingly, the government has always been more in favour of FDI rather than FII, regarding FII as being “hot” and volatile.

Factor of destabilisation

For insurance JVs that are yet some distance away from IPOs, neither foreign nor domestic investors have any incentive to allow FII inflows that will dilute extant ownership rights and oblige operating JVs to sell shares to disinterested third parties at below par. Therefore, little new investment is likely to come in. Existing JV agreements often have clauses that do not allow other foreign investors to take up equity and dilute the rights of extant shareholders who have sustained losses for a long period of time. If the idea is to increase capital inflows, this is therefore unlikely to have much impact, except for a few insurance JVs that are at the IPO stage.

If the FII-only route becomes enshrined in the amended law, it would allow new foreign entrants to establish JVs and own 49 per cent of shares immediately using a combination of 26 per cent FDI and 23 per cent FII. In contrast, existing foreign promoters would be prevented from investing more in their own JVs if the amended Bill permitted an increase in the foreign shareholding percentage through FII only. So extant foreign promoters would be incentivised, again perversely, to abandon current ventures and start new ones. That would destabilise the entire insurance industry.

A compromise

From a practical perspective, the issue of new capital needed to strengthen the industry can be resolved by allowing the market to work and permitting an increase in the total foreign investment limit to 49 per cent, regardless of whether that increase is through FDI or FII. Such a compromise would not change the government’s original stance, but would accommodate the desire to permit FII as well.

The amended Insurance Bill should keep matters simple by lifting the total foreign investment limit to 49 per cent. Shareholders should be left to determine the best way to address a company’s needs — whether through FDI or FII. It should, therefore, also allow company boards to decide whether the investment should be in the form of entirely new capital or through a change in the ownership structure of existing capital. The amended Bill should leave it to the IRDA to approve such changes.

If a domestic shareholder in a JV wants to stand diluted or sell his/her shares, why should the government wish to prevent his foreign partner from buying that stake and increase its shareholding up to a limit of 49 per cent? That is for the company rather than the government to decide.

In the end, what the amended Insurance Bill needs to ensure is that India wins — i.e. policyholders, employees, shareholders, companies, and even the government — through an approach to increasing FDI in insurance that is transparent and flexible. It is time for the argument to end and for an amended Bill that is sufficiently foresighted and flexible to stand the test of time to be passed without delay.

(Vijay Kumar Shunglu is former Comptroller and Auditor General of India and has headed several key government committees on various issues.)

Vijay Kumar Shunglu responds

Foreign players were permitted to enter the insurance sector quite a few years ago, and they have done so. The current debate is not about their continuance or restoration of public sector monopoly in the insurance business. It is about their enhanced participation and its potential for creating substantial economic benefit.

It is true that the industry needs significant capital in the future. Whereas the LIC has existed for more than 55 years, the private life insurance industry (23 companies) has generally developed in three waves over the past decade. While a few in the first wave may not require significant capital, half of the companies remain in the early development stages and continue to require significant capital.

Unlike other businesses, life insurance companies need to build up huge reserves to pay future claims of their policyholders and to pay for significant upfront costs prior to profits emerging from long-term sales. Unfortunately, it is also true that some domestic promoters would like to sell all or a part of their shares and/or stop funding new capital given their shorter-term investment time horizon.

It is also not the case that all foreign companies are good. Nor are the foreign promoters of Indian life insurance companies speculators on the verge of bankruptcy. They are large, multi-national life insurance companies who have been in the business for decades.

Economic and industry experts have all lined up in support of the Insurance Bill and the increase in foreign investment to 49 per cent, including India’s own independent insurance regulatory body, IRDA.

The amended Insurance Bill, due to be tabled before Parliament in the Budget Session, is not something to be feared. As I stated in my article, I continue to recommend that the amended Insurance Bill should keep matters simple by lifting the total foreign investment limit to 49 per cent and ensure its passage. Shareholders should be left to determine the best way to address a company’s needs — whether through FDI or FII

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