Ey reforms realignment, Exercises of Advanced Education

Download Ey reforms realignment and more Exercises Advanced Education in PDF only on Docsity!

Insurance industry

Challenges, reforms and realignment

Confederation of Indian Industry

Contents 1 2 3 4 5 6 7 8

• Foreword
• Executive summary
• Introduction
• Indian economy
• Insurance industry landscape
• Underlying growth drivers for insurance in India
• Growing economy and purchasing power...............
• Rising focus on rural market
• Rising demand for motor insurance
• Robust growth in health insurance
• Emerging trends
• Regulatory trends
• Life Insurance: issues and challenges.......................
• Products
• Distribution
• Customer servicing
• Governance and regulatory issues
• Non-life Insurance: issues and challenges.................
• Products
• Distribution
• Governance and regulatory issues
• Health insurance
• Way forward
• Bibliography

Foreword

After a decade of strong growth, the Indian insurance industry is currently facing severe headwinds, grappling with slowing growth, rising costs, deteriorating distribution structure Yf\klYdd]\j]^gjek&>gjl]Õjkllae]$ since the industry was liberalized and opened to private and foreign insurers, the life insurance segment witnessed a year-on-year decline (around 10%) afl]Õjklq]Yjhj]eame[gdd][l]& The non-life segment is still struggling with underwriting losses, while health insurance is facing high claims ratio and af]^Õ[a]f[a]kafhgda[qY\eafakljYlagf&

However, the picture is not all gloomy, while in the short run the industry may be undergoing a catharsis, the long- term picture is still compelling and a stronger and better founded insurance industry is likely to emerge from this challenging situation. The industry needs to offer appropriate product designs, which enable customized solutions for evolving customer needs in a professional and transparent manner, build and maintain trust among existing and potential customers, effectively ]dan]jl]hjg\m[lZ]f]Õlklgl] customers and adopt a professional code of conduct. At the same time, the regulator needs to create a favorable environment for a competitive market

through constructive engagement and effective consultation with industry, emphasizing on proper market conduct, good governance, customer centricity and ]^Õ[a]fl\akljaZmlagf&OalY\]fkalqg^ US$64 compared to US$118 in developing countries and US$3712 in advanced economies in 2010, the domestic insurance industry still has considerable scope for growth. However, a rethinking of the approach is required for the industry to achieve its potential. Innovation is the Õjkl[YkmYdlqafla_ldq[gfljgdd]\eYjc]lk leading to drying up of incentives for product manufacturers and decline in business activities. However, this is not to say that a free rein is recommended ]kh][aYddqafÕfYf[aYdk]jna[]kk][lgj&9 certain degree of freedom aligned with the market maturity may be desirable. Perhaps after a heady period of growth and glowing projections of the future, it is time for the key stakeholders, i.e., the industry, regulator and the government to make a concerted effort for the orderly development and sustained growth of the industry. The Confederation of Indian Industry (CII) and Ernst & Young have co-authored this report to outline the current issues and challenges faced by the insurance industry and steps that could be taken to ensure that the industry achieves its potential.

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

Chandrajit Banerjee Director General Confederation of Indian Industries

Executive summary

The Indian insurance industry seems lgZ]afYklYl]g^Ömp&Oad]l]j] has been a perceptible change in the market dynamics since liberalization and economic reforms, a considerable amount needs to be done for future growth and development of the market in an orderly and sustained manner. Notwithstanding the strong improvement in penetration and density in the last 10 years, India largely remains an under-penetrated market. The market today is primarily dependent on push, tax incentives and mandatory buying for sales. There is very little customer pull, which will come from af[j]Ykaf_ÕfYf[aYdYoYj]f]kkYdgf_ with increasing savings and disposable income. Till then the stakeholders will `Yn]lgkljan]^gjhjg\m[lkaehdaÕ[Ylagf$ increasing transparency of cost and pricing, effective distribution and improving customer servicing to drive sales. In the long run the insurance industry is still poised for a strong growth as the domestic economy is expected to grow steadily, leading to rise in per capita and disposable income, while savings are expected to be stable.

gjl]Õjkllae]af)*q]Yjk$l] life insurance industry witnessed a decline afl`]Õjklq]Yjhj]eame[gdd][l]\af FY12, which declined from INR1,258 billion in FY11 to INR1,142 billion, a drop of approximately 10%. There is a perceptible shift in the life insurance market as the sales of Unit Linked Insurance Plans (ULIP) products witnessed a drop in sales and customer move toward traditional products. The

business model for insurers has been changing continuously for the past couple of years on account of regulatory changes. While the regulatory changes were aimed at customer protection and increasing transparency in pricing and operations, it gave the industry very little time to adjust, leading to a lot of uncertainty in the market environment. In addition to challenges in growth, pricing Yf\hjgÕlYZadalq$da^]afkmj]jkYj]Ydkg ^Y[]\oalKa_faÕ[Yfl[Ydd]f_]kgfl] distribution front with a reducing agency force and uncertainties in alternate channels such as Bancassurance. The cap on commission and expense ratios further imposes restriction on the competiveness of insurers and limits the expansion of distribution channels. The non-life premium underwritten grew by 23% in FY12, reaching INR530 billion from INR430 billion in FY11, but the segment is saddled with considerable underwriting losses and pricing issues in addition to high claims ratio exerting increasing pressure gfhjgÕlYZadalq&Afkmj]jkf]]\lg strengthen their risk assessment and underwriting mechanisms. There is a requirement today for long-term assets, Z]f]ÕlYf\]Ydlhgda[a]klgk]jn]l] people till the time insurance in India is considered as a household requirement than just a temporary risk-mitigating tool. Furthermore the pace of reforms needs to be increased especially in the areas of pricing and reinsurance.

The three standalone health insurers also performed well with a premium underwritten growth of 13% for FY12, reaching INR17.3 billion from INR15.4 billion in FY11. Health insurers need to balance their portfolio, which leans heavily towards group insurance and introduce more products covering individuals. The claims and fraud monitoring process also needs lgZ]kaehdaÕ]$klj]f_l]f]\Zq stricter guidelines for third party administrators. Despite strong growth, the non-life segment also faces stiff challenges in distribution, pricing and claims management and these issues need to be addressed on a priority to sustain the growth. L]af\mkljqakYlYfafÖ]pagfhgaflYf\ despite the signs of stress there is a silver lining. The insurance industry stands at the threshold of moving toward a stable hgkalagf$]dan]jaf_ÉklYZd]hjgÕlYZd] growth.” Most players will now look to reassess the entire business model from product, pricing, risk management, acquiring rural customers, distribution, claims and fraud management and a realistic pace of growth. The industry is also likely to witness consolidation YkYf\o]fl]j]_mdYlgjÕfYdar]kl`] guidelines for mergers and acquisitions. The stakeholders should work toward maintaining a favorable environment for stable growth, increasing the penetration of insurance to rural and underpenetrated areas and increasing the contribution to the economy.

Global growth is projected to drop from around 4% in 2011 (year ending December) to around 3.5% in 2012 because of weak activity during 2H and 1H12 according the IMF World Economic Outlook released in April 2012. The July update indicates a further deterioration in the situation. However, the global growth has been maintained at 3.5% for 2012 and 3.9% for 2013. The growth for emerging economies has been revised downwards by 0.1% and 0.2% for FY12 and FY13 to 5.6% and 5.9% respectively. The positives for global as well as Indian economy is the cooling of commodity prices, especially oil; but the situation in the Eurozone will continue to weigh heavily on the global as well as the Indian economy.

L]kYj]g^ÕfYf[aYdkYnaf_k[Yff]d]\ to the insurance industry is approximately 24% and given the backdrop of moderating economic growth it might change a bit. However, it is not expected to vary drastically. The household savings in FY11 stood at INR10,439.77 billion, with the share of currency increasing to 13.3% (9.8% in FY10), deposits remaining largely at the same level at 47.3% (47.2% in FY10); life insurance funds increasing to 24.2% (22.0% in FY10) and provident and pension funds slipping to 9.1% (11.5% in FY10). The insurance industry, by offering long-term savings and protection products, can channelize a larger share of household savings and enhance the d]n]dkg^ÕfYf[aYdhjgl][lagf[mjj]fldq \]Õ[a]flafl]Af\aYf][gfgeq&

Exhibit 3.2. Constitution of household savings

14%

24%

47%

9%

6%

Household savings-constitution

Currency (^) Life insurance funds Deposits Provident and pension funds

Others (Govt. claims, shares and debentures, etc)

Source: RBI Annual Report, 2011

Insurance industry

dYf\k[Yh]

Premiums

According to Swiss Re, India’s ranking in the world insurance market based on total premiums collected has dropped to number 15 in 2011 from number 11 in 2010. India’s share of the world insurance markets has declined to 1.58% in 2011 from 1.8% in 2010, being displaced by countries such as Brazil, Spain and Taiwan, which now rank higher than India. Globally, total insurance premiums for calendar year 2011 contracted by 0.8%, with premiums contracting in advanced economies at -1.1% and those in emerging economies growing at 1.3%; with life insurance contributing 57% at US$2, billion and non-life contributing the balance 43% at US$1,912 billion.

Players and market share

As at end-September 2011, the total number of insurance companies in India was 49; the life insurance industry consisted of 24 players, i.e., one public insurer and 23 private insurers, while the non-life insurance industry consisted of 25 players — 6 public insurers, 3 standalone health insurers, one reinsurer and 15 private insurers. Edelweiss Tokio Life Insurance Company Limited, which was granted registration in 2011 was the latest entrant in the life insurance sector. Religare Health Insurance Company Limited made a quiet entry in the health insurance sector in June

2012. Magma HDI General Insurance Company Limited and Liberty Videocon General Insurance Company, are the latest entrants in the non-life sector, and are due to start operations in 2012.

Based on total premium income, the Life Insurance Corporation (LIC) was the market leader in the life insurance sector with a market share of 69.78% in FY11. As at end-November 2011, ICICI Prudential Life insurance was the largest private sector player with a market share^1 of 6% followed by HDFC Standard Life Insurance at 4.6% and SBI Life Insurance at 3.5%. Based on total premium underwritten, the public sector non-life insurers held a market share^2 of 59.07% in FY11 — New India Assurance at 16.67%, United India Insurance at 14.98%, National Insurance at 14.61% and Oriental Insurance at 12.82%. As at end-March 2011, ICICI Lombard continued to be the private sector market leader with a market share of 9.99%.

Penetration and density in India

Exhibit 3.3. Insurance penetration and density in India

11.5 14.^ 16.4 19.

46.6 47.

2.88 3.^

4.8 (^) 4.7 (^) 4.

5.2 5.

0

1

2

3

4

5

6

0

10

20

30

40

50

60

70

Density Penetration

USD %

2001 2010

Source: IRDA Annual Report 2010-

Penetration and density

Penetration moved from 2.71% in 2001, when the insurance sector was opened up to the private sector, to 5.1% in

2010. In the same period, insurance density increased from US$ 11.5 to US$64.4 per capita. Globally, the average density was an average of US$3, per capita in advanced economies as against US$118 per capita in emerging economies. Since economic growth exceeded growth in the insurance sector globally, overall insurance penetration in the world economy shrank further to 8.6%, even lower than a decade ago.

(^1) Market share based on annualized new business premium (^2) Market share based on total premiums underwritten

Exhibit 3.5. Total premiums in FY

Total premium – split FY Sector Regular premium (previous yr) Renewal premium (previous yr) Total Sector Linked Non-linked Total Private 36% 64% 100% Private sector 79.20% 20.80% 100% (45%) (54%) LIC 24% 76% 100% LIC 19.30% 80.70% 100% (19%) (81%) Source: IRDA website

ICICI Prudential Life Insurance is the largest private sector player (based on market share annualized new business premium) followed closely by HDFC Standard Life Insurance. The former has lost 4% market share over the last three years due to the emergence of stronger distribution ramp ups by other players and the new regulatory regime that impacted its ULIP-dominated business mix. ICICI Prudential Life, HDFC Standard Life, SBI Life, Bajaj Allianz and Max Life have managed to uphold their position in the top eight private insurers for the last Õn][gfk][mlan]q]Yjk&O`ad]J]daYf[] and HDFC have been gaining market share, Bajaj Allianz has lost considerable share over the last three years. It can be observed that most of the top eight private life insurers have strong banking relationships. Further, the industry has seen the entry of four new bank- backed insurance players such as Canara

HSBC, Star Union Dai Ichi, IDBI Federal and India First Life Insurance. These insurers capitalize on the Bank’s captive customer base and existing branch networks. Most of these players have a small or negligible agency presence.

Non-life insurance

industry in India

According to Swiss Re, India’s non-life insurance market was ranked number 19 among 156 countries in terms of premium in FY11; India’s total premium in fgf%da^]afkmjYf[]_j]oZq0&) afÖYlagf adjusted) while the global total premium grew by 2.1%. The sector has grown at a CAGR of 16% over the last 10 years. The number of policies issued increased at a rate of 16.52% to 79.3 million in FY11 from 67.5 million in FY10. million in FY11 from 67.5 million in FY10.

The gross written premium underwritten by the non-life insurance sector in FY was INR453 billion up from INR369 billion af>Q)($j]akl]jafYka_faÕ[Yfldqa_ growth of 23% over the previous year of 15.34%. In terms of segment-wise composition, major retail lines such as motor and health constitute more than 65% of the Gross Written Premiums in the market; the higher percentage is primarily on account of the mandatory

Gross written premium - non-life insurance (in INR billion)

Exhibit 3.6. Private and public sector non life insurers

Source: IRDA website

CAGR 10 years=16%

Public Private

119 135

142 150 160

(^173177)

191

218

263

5 13

23 35

53

86

113

128

151

190

0

50

100

150

200

250

300

FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY

third party liability cover for vehicles and increasing importance of availing health insurance due to rising costs and increasing lifestyle diseases. Key [gee]j[aYddaf]kkm[`YkÕj]Yf\eYjaf] constitute around 16% of total market premiums. Personal accident, liability, aviation, engineering and miscellaneous segments are all categorized under “others,” which constitutes around 17%.

Exhibit 3.7. Non-life insurance segments – FY10 and FY

Source: IRDA Annual Report 2010-

Segment-wise gross written premium - FY

10% 6%

41%

26%

17%

Fire Marine Motor Health Others

Growing economy

and purchasing

power

The demand for insurance products is likely to increase due to the exponential growth of household savings, purchasing power, the middle class and the country’s working population. The working population (25–60 years) is expected to increase from 675.8 million in 2006 to 795.5 million in 2026. Increased incomes are expected to result in large disposable incomes, which can be tapped Zql`]ÕfYf[aYdk]jna[]kk][lgjaf_]f]jYd and the insurance sector in particular.

Working population assessment and GDP per capita till 2026

Exhibit 4.2. Working population and GDP comparison – estimation till 2026

0

20

40

60

80

100

120

0

100

200

300

400

500

600

700

800

2001 2006 2011 2016 2021 2026

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

Source: CMIE, Census of India, 2001

Number INR

69.56 100.

676 630 571 507 449 399

Rising focus on

jmjYdeYjc]l

More than two-thirds of India’s population lives in rural areas without proper access to insurance products. Micro insurance is seen as the most suitable channel to ensure coverage in these areas.

 HggjafkmjYf[]dal]jY[qYf\YoYj]f]kk$ high transaction costs and inadequate understanding of client needs and expectations has restricted the supply for micro-insurance products. As a j]kmdl$l`]eYjc]lj]eYafkka_faÕ[Yfldq underserved, creating a vast opportunity to reach a considerable number of customers.

 >jgeYeg]klZ]affaf$ea[jg insurance was able to grow to a respectable size with a total premium of INR15.43 billion collected under life and non-life micro insurance portfolios in 2011; life insurance premium contributed INR11.49 billion and non- life insurance premium contributed INR3.93 billion to the overall amount.

 Afl`]da^]afkmjYf[]k][lgj$af\ana\mYdk generated new business premium worth INR1.30 billion under 3.6 million policies, the group business amounted to INR1.55 billion under 15.3 million lives. LIC contributed most of the business procured in this portfolio by garnering INR1.23 billion of individual premium from 2.95 million lives and INR1.38 billion of group premium under 13.3 million lives. There has been a steady growth in the design of products catering to the needs of the poor, with LIC leading the race.

IRDA has been endeavoring to improve penetration of micro insurance through multiple initiatives and believes that there is tremendous scope for growth. According to the regulator, ways to increase penetration include the following:  Afkmj]jkf]]\lgaffgnYl]lgj]\m[] per policy costs as ticket size is small. One way is to go for group schemes due to their low cost of distribution, low overhead costs, easy underwriting norms, and support of nodal agency in remittance of premiums and claims. This is easily accessible through community leadership.  Insurers should use latest technological innovations such as mobile-based communications and internet to increase insurance penetration and reduce cost of operations.  ;mjj]fldq$]da_aZadalq^gjea[jg% insurance agency is limited to MFIs, SHGs, NGOs. This needs to be expanded to grocery stores, embedded into various farm equipments etc. to bring in a variety of ways to distribute them as it besets the most.

Rising demand for

motor insurance During FY03–FY10, the number of passenger cars has increased at a CAGR of 15.6%. This trend is likely to continue due to strong growth in the auto segment, resulting from an increase in consumer income levels due to which more than 28 million policies were sold in FY10. During FY11, motor insurance accounted for 42.7% of the non-life insurance segment reporting a growth of 28.2% over the previous year.

Robust growth in

]YdlafkmjYf[] Evolving medical technology and increasing demand for better health care Ykj]kmdl]\afYka_faÕ[Yfljak]afl] demand for health insurance. The Indian health insurance industry was valued at INR99.4 billion as of FY11. From the period FY03–FY10, the industry has grown at a CAGR of 32.59%. Share of health insurance was 26% of the total non-life insurance premium in FY11. Health insurance premiums are expected to increase to INR300 billion by 2015. Under the social security schemes, the Government of India’s Rashtriya Swathya Bima Yojna (RSBY) launched in 2007 for families below poverty line in the unorganized sector has gained ka_faÕ[Yf[]afl]j][]flq]Yjk&:q bearing an expense of INR30, families are insured for INR30,000. With 75% funding coming from the Government of India, the scheme ensures cashless coverage of health services through smartcard and also provides a transport allowance with an upper limit of INR1,000. Public or private insurers, based on a bidding process, can opt for providing health insurance in the state for a particular district/set of districts. IRDA has also relaxed certain requirements with respect to solvency ratio of such insurers, in a view to promote health insurance in l][gmfljq&9kg^]f%Bmdq*())$Õn] states had implemented the scheme with 23.6 million cards being issued at a total expenditure of INR100 billion.

Product innovation

With customers asking for increased levels of customization, product innovation is one of the best strategies for companies to increase their market share. LakYdkg[j]Yl]kaf[j]Yk]\]^Õ[a]f[q as companies can maintain reduced unit costs, offer improved services, [Yfaf[j]Yk]Ö]paZadalqlghYqaf[j]Yk]\ commissions and generate higher sales. Regulatory changes, especially those with respect to health insurance portability and micro insurance, offer considerable potential for insurance companies to be more innovative, while others such as product design guidelines is likely to klaÖ]affgnYlagf$a^fgl[gf[]an]\Yf\ implemented in an appropriate manner. Micro insurance is important not only from social and economic perspective hjgkh]jalqYf\ÕfYf[aYdaf[dmkagf!Zml also from insurers’ perspective for new Yn]fm]kg^kmklYafYZd]hjgÕlYZd]_jgol in future. Even the pension sector, due to its inadequate penetration (only 10% of the working population is covered), offers avenues for innovation.

Claims management

Lae]dqYf\]^Õ[a]fleYfY_]e]flg^ claims is crucial for performance in the industry. Delay in claim settlement generally results in higher claims cost. The incurred claims ratio, which measures the claims incurred to the premiums earned in the same period, stood at 97% for public insurers and 87% for private insurers in FY11 for the non-life insurance business.

In the life insurance business, LIC hYa\Z]f]Õlk[gfklalmlaf_--g^ hj]eamekmf]jojall]foad]l]Õ_mj] for private insurers stood at 35%. Some insurers have managed to limit the claims ratio by deploying in-house team of surveyors, engineers etc., stringent and sophisticated underwriting policy, geographical focus in certain segments and higher reinsurance cession especially for more complex lines of business.

HjgÔlYZd]_jgol`

In the period following the liberalization of the insurance sector (FY00–FY05), most insurers were heavily inclined to achieve jgolYll][gklg^hjgÕlYZadalq&Afl] recent years, most players have shifted from the philosophy of “growth versus hjgÕlYZadalqÊlgÉhjgÕlYZd]_jgolÊZq focusing on expanding product range, developing innovative products and building robust distribution channels. HjgÕlYZadalq[gflafm]klgZ]YZa[gf[]jf and insurers have now shifted their focus on their bottom line to avoid exerting pressure on solvency and share capital. In the last two years, most private insurers have been reducing their operating ]ph]fk]kafYegn]lgoYj\hjgÕlYZadalq& The life insurance industry reported a net hjgÕlg^AFJ.&-/Zaddagfaf>Q))Y_Yafkl a loss of INR9.89 billion in FY10. At the same time the non-life insurance industry posted loss of INR10.18 billion in FY Y_YafklYhjgÕlg^AFJ)&(,Zaddagf in FY10.

Regulatory trends

The IRDA has mandated regulatory changes in order to promote a competitive environment in both the life and non-life insurance sectors.

With Health insurance portability being introduced, insured persons are likely to get credits for the covered term across the industry and will be limited lgYkh][aÕ[afkmjYf[][gehYfq&L`] regulator envisaged that this initiative will compel the insurance industry to act toward standardization of costs af[mjj]\gflj]Yle]flk$ÕpY[[gmflYZadalq and transparency about costs and push insurers to think about product innovations to survive competition.

The IRDA has recently dismantled the third-party liability pool in motor insurance and replaced it with the declined risk pool. While it is likely to have widespread implications on the size and loss ratio of the pool, the move is expected to drive the industry toward risk-based pricing.

Recent regulations pertaining to cap on ULIP charges and increase in the lock

There is enough potential for

positive growth of the Indian

insurance industry given the

focused efforts of the regulator,

government and players in

the backdrop of rising demand

for insurance. The industry

does, however, face numerous

challenges primarily on product

designing, distribution and

regulatory front. The following

sections throw light on typical

challenges faced by the life and

non-life industry.

in period, translated to reduction in overall distributor payouts, which in turn reduced the overall contribution of ULIPs to new business premium. With a cap on surrender charges, insurers showing hjgÕlk\m]lgj]d]Yk]g^dYhk]j]k]jn]k oaddf]]\lg]n]dghdgf_%l]je]^Õ[a]f[a]k to be able to sustain the market. Other recent regulatory developments include changes in the Finance Act 2012 impacting tax exemption of life insurance policies and service tax liability, proposed guidelines for the design of life insurance products, servicing of orphan policies and standardization of the proposal form, all of which have far reaching consequences for the industry. There is enough potential for positive growth of the Indian insurance industry given the focused, synergistic efforts of the regulator, government and industry players in the backdrop of rising demand for insurance. The industry does, however, face numerous challenges primarily on the product designing, distribution and regulatory front. The following sections throw light on typical challenges faced by the life and non-life industry.

LIC are offering pension products. This resulted in a sharp decline in the new business premium collected from individual pension plans slumped to INR11.39 billion in FY12 from INR192. billion in FY11. Given the recent spate of regulatory changes, product and provider restrictions, pension schemes seem to be drying up from the market.

While the changes in ULIP guidelines j]kmdl]\afYka_faÕ[Yfl][daf]afl`] product’s share of industry sales and pension guidelines continue to be restrictive leading to a vacuum in this product line, the proposed changes in product design for life insurance products could further adversely impact the already declining fortunes of the sector in a considerable manner. The changes in product design being envisaged through these guidelines, if not implemented in an appropriate manner after conducting detailed impact assessments and establishing credible timelines, is likely to result in diminishing the scope for product innovation, increasing commoditization, as well as substantial product alterations/withdrawals resulting in increased lapsation.

Cost

The Insurance Act, 1938, prescribes a ceiling on management expenses, which include administration expenses such as commissions, fund management fees, custodial fees, and expenses on marketing and advertising. The percentage varies from insurer to insurer and primarily depends on the new business premium garnered in a year and the age of the company. According to a recent amendment, this rule is applicable to only those companies that have been afgh]jYlagfk^gjegj]lYfÕn]q]Yjk& The limit on expenses is set to protect the long-term interest of the policy holders and ensure that reckless expenditure by insurance companies might not hurt their hjgÕlYZadalqYf\dgf_l]jekmklYafYZadalq& <m]lgka_faÕ[Yfl]ph]fk]k$egklg^l] companies have accumulated losses running into millions of rupees. Companies have to furnish details of expenses in the format, i.e., form 17D prescribed by the regulator for every ÕfYf[aYdq]Yj&L]j]_mdYlgjljY[ckl] expenses and cost structures, sends

warnings to the management teams and penalizes companies failing to adhere to guidelines. The challenge for most life insurers is to control these expenses Yf\af[j]Yk]]^Õ[a]f[a]koalYna]olg Y[a]n]dgf_%l]jehjgÕlYZd]_jgol`& While Rule 17D linked to premium tenure, drives commitment towards long -term super pension (LTSP), there is a need to further optimize monitoring and governance in this regard along with an overall review of reserving, accounting and capital adequacy requirements.

Taxation

The insurance industry is facing challenges with respect to taxation on both the demand and supply side. On one hand, the service tax charged to insurance companies has been increased to 12% from the existing 10% — rate on life insurance policies where entire premium is not toward risk covered af[j]Yk]\lg+^gjl`]Õjklq]YjYf\ maintained at 1.5% for subsequent years’ policies at a time when mutual funds are exempt from such tax. On the other hand, the 2012 Budget mandated that

the sum assured be at least 10 times the premium (from the existing 5 times), compulsory service tax has been levied on all insurance. Further, with effect ^jge)9hjad()$Z]f]Õlkmf]jl] national pension schemes will not be [dmZZ]\mf\]jl]gf]dYcZ]f]Õlmf\]j section 80C making it an unfavourable avenue for long term savings. The age of senior citizens for the purpose of tax Z]f]ÕlgfafkmjYf[]hj]eamegjj]lmjfk has been reduced from 65 years to 60 q]Yjk&L]f]o]Õfalagfg^kmeYkkmj]\ YkZ]]feg\aÕ]\lg]p[dm\]l]Zgfmk amount received to claim tax deductions. The changes in the budget and taxation framework have made life insurance a relatively less attractive product while increasing the preference for mutual funds, public provident funds, non- convertible debentures, national pension schemes or tax free infra structure bonds. Changes in The Finance Act impacting the taxability of life insurance and the proposed changes under the draft Direct LYp;g]akdac]dqlgka_faÕ[Yfldq]jYad the prospects of the industry, which is dependent on the continuation of lYpZ]f]Õlk$lg`Yn]YnaYZd]Zmkaf]kk proposition.

Distribution

The main distribution channels in life insurance are the traditional individual agency channel, corporate agency (banks and others), broking channel and direct selling (which includes online selling). From an industry perspective, it is an

agency-dominated business with 90% of the total premium being sourced from the agency channel. This trend is primarily a result of LIC’s agency dominated (at 98% of business) business model. Private sector insurers have a more balanced channel distribution, with agencies contributing 47%, banks contributing 33%, corporate agents 9%, brokers 5% and direct sales 6%.

Prospects and challenges of

various channels

Life insurance, being a high involvement product, agency is the strongest channel for most product segments. Individual agents have been the dominant channel in acquiring business; however, their share has fallen from around 88% in FY2005 to 79% in FY11. The IRDA issued stringent licensing guidelines and new persistency norms in order to protect policyholders interests’ in November 2010. This led to high turnover of individual agents and reduction of corporate agents of da^]afkmj]jkogkm^^]j]\m_]ÕfYf[aYd drain as a lot of money was spent on prospecting, appointing and training of these agents. At the same time, policies procured by these agents are rendered orphan on their termination due to lack of servicing support, leading to distress of policyholders. Insurers therefore, need to focus their efforts on reviving and strengthening the tied agency channel by optimizing recruitment, training, compensation and retention

Channel split by premium of industry (%)

Exhibit 5.1. Distribution channel-wise premium

Source: IRDA website

0%

20%

40%

60%

80%

100%

120%

LIC Private LIC Private LIC Private FY09 FY10 FY Direct selling Brokers Corporate agents — other Corporate agents — banks Individual agents

of agents while constantly improving their productivity levels consistently in order to sustain the business. They also need to consider alternative channels of distribution such as bank-tie ups, which is a fee-based business with low investment as banks use their existing networks. Bancassurance has rapidly emerged as a viable channel with a 10% share; it is expected to emerge as a very strong channel for private life insurance companies. The use of internet to distribute life insurance products has only emerged j][]fldq$ZmlYkfgleY\]Yka_faÕ[Yfl impact so far, partly because of the substantial advisory component of most life insurance products. While most companies have adopted a multi-distribution approach, share of direct channel, brokers and other alternate channels remains low. Most companies are seen to be focusing on [gkl]^Õ[a]fl[Yff]dk3l]j]^gj]$l]j] has been an increased focus on these channels for select product classes, which are low involvement, e.g., protection covers and health insurance. While direct selling and other modes have remained steady, the growth in market share may be attributed to the universal banking model of selling savings and investment products under one umbrella and increased customer trust in the institutional form of selling.

Compensation

The trend in operating expense ratio of life companies shows a marginal overall decrease. However, the actual cost for LIC has increased by 35% to INR122. billion in FY10 from INR90.64 billion in FY09; private companies have managed to slightly reduce costs. Overall the industry’s total expense ratio has also decreased, which when looked at with the growth in premium indicates better cost management and improved productivity. Commission as a percentage of total expenses has been on a downward trend falling from 48% in FY04 to 36% in FY11. This indicates improved