4.

Indian insurance industry

History:
Life insurance came to India from England in 1818 when oriental life insurance company started in Calcutta by Europeans. After this many insurance companies had been started in India. But these companies were looking after only the needs of European community established in India. Indian people were not being insured by these companies. First Indian life insurance company came as Bombay mutual life insurance assurance. Second company was Bharat insurance company came in 1896. After this the united India in madras, national Indian and national insurance in Calcutta and the co-operative assurance in Lahore were established in 1906. To regulate Indian insurance business first insurance act came in 1912 as life insurance company act and provident fund act. These acts consist of premium rates tables and periodical valuations of companies. In the first two decade of 20th century many life insurance companies were started. So the insurance act came in 1938 to governing life and non life insurance companies and to provide strict state control. In 1956 the life insurance business in India was nationalized. In 1956 life insurance corporation of India (LIC) was created to spreading life insurance much more widely particularly in rural areas. In that year LIC had 5 zonal offices, 33 divisional offices and 212 branch offices. In 1957 the business of LIC of sum assured of 200crores, 1000crores in 1970, and 7000crores in 1986.

Indian regulatory development authority:

In 1999, the Insurance Regulatory and Development Authority (IRDA) was constituted as an autonomous body to regulate and develop the insurance industry. The IRDA was incorporated as a statutory body in April, 2000. The key objectives of the IRDA include promotion of competition so as to enhance customer satisfaction through increased consumer choice and lower premiums, while ensuring the financial security of the insurance market. The IRDA opened up the market in August 2000 with the invitation for application for registrations. Foreign companies were allowed ownership of up to 26%. The Authority has the power to frame regulations under Section 114A of the Insurance Act, 1938 and has from 2000 onwards framed various regulations ranging from registration of companies for carrying on insurance business to protection of policyholders interests.

Role of IRDA:
Protecting the interests of policyholders. Establishing guidelines for the operations of insurers, and brokers. Specifying the code of conduct, qualifications, and training for insurance intermediaries and agents. Promoting efficiency in the conduct of insurance business. Regulating the investment of funds by insurance companies. Specifying the percentage of business to be written by insurers in rural sectors. Handling disputes between insurers and insurance intermediaries.

Changing perception of Indian customers:

Indian Insurance consumers are like Indian Voters, they are soft but when time is right and ripe, they demand and seek necessary changes. De-tariff of many Insurance Products are the reflection of changing aspirations and growing demand of Indian consumers.

For historical years, Indian consumers were at receiving end. Insurance Product was underwritten and was practically forced onto consumers on a Take-it-As-itbasis. All that got changed with passage of IRDA act in 1999. New insurance companies have come into existence leading to open competition and hence better products for customers.

Indian customers have become very sensitive to Coverage / Premium as well as the Products (read Risk Solution), that is given to them. There are not ready to accept any product, no matter even if that is coming from the market leader, should that product is not serving the purpose. A case in point is ULIP Product / Group Life and Credit Life in Life Insurance segment and Travel / Family Floater Health and Liability Insurance in the Non-life segment are new age Avatar. The new products are constantly being demanded by Indian consumers, which is putting huge pressures on Insurance companies (Read Risk Under-writers) and Brokers to respond.

Customers are looking at Insurance for covering Pure Risk now which I have covered in my next section. Another good reason why we are seeing quick changes in the buying behavior of Insurance from mere Investment to risk mitigation is the cost of Replacement of Goods (ROG) or Cost of Services (COS). Now Indian customers are aware of insurance industry and insurance products provided by companies. They have become more sensitive. They would not accept any type of insurance product unless it fulfills their requirements and needs. In historic days customers looking at insurance products as a life cover which can provide security against any unacceptable events, but now customers look at insurance products as an investment as well as life cover. So todays customers wants good return from the insurance companies. The Indian customers forms the pivot of each companys strategy. Investment of Indian household savings (as a % in different sector) BANK DEPOSITS CORP. BANKS SHARES AND DEBENTURES 39% 2% 1%

MUTUAL FUNDS NBFCS GOVT. BONDS

2% 3% 13%

INSURANCE PF/ RETIRE FUNDS CURRENCY

13% 21% 6%

Source: - www. avivaindia.com

Changing face of Indian insurance industry:

After the Insurance Regulatory and Development Authority Act have been passed there has been establishment of many private insurance companies in India. Previously there was a monopoly business for Life Insurance Corporation of India (L.I.C.) who was the only life-insurance company for the people till 2000. L.I.C. still holds 71.4% of the market share in 2006. But after the introduction of private life insurance companies there is a great competition in Indian market now. Everyone is trying to capture the fresh market here and penetrate it with aggressive marketing strategies. Today life-insurance is not only limited up to just life risk cover and maturity period bonuses but changed to greater return from the investments. With the introduction of the unit linked insurance policies these companies are investing the money in different investment instruments like shares, bonds, debentures, government and other securities. People are

demanding for higher returns with the life risk cover and private companies are giving 30-40% average growth per annum. These life-insurance companies have every kind of policies suiting every need right from financial needs of, marriage, giving birth and rearing up a child, his education, meeting daily financial needs of

life, pension solutions after retirement. These companies have every aspects and needs of our life covered along with the death-benefit. In India only 25% of the population has life insurance. So Indian life-insurance market is the target market of all the companies who either want to extend or diversify their business. To tap the Indian market there has been tie-ups between the major Indian companies with other International insurance companies to start up their business. The government of India has set up rules that no foreign insurance company can set up their business individually here and they have to tie up with an Indian company and this foreign insurance company can have an investment of only 24% of the total start-up investment.

Indian insurance industry can be featured by:

Low market penetration. Ever growing middle class component in population. Growth of customers interest with an increasing demand for better insurance products. Application of information technology for business. Rebate from government in the form of tax incentives to be insured. Today, the Indian life insurance industry has a dozen private players, each of which are making strides in raising awareness levels, introducing innovative products and increasing the penetration of life insurance in the vastly

underinsured country. Several of private insurers have introduced attractive products to meet the needs of their target customers and in line with their business objectives. The success of their effort is that they have captured over 28% of premium income in five years. The biggest beneficiary of the competition among life insurers has been the customer. A wide range of products, customer focused service and professional advice has become the mainstay of the industry, and the Indian customers forms the pivot of each companys strategy. Penetration of life insurance is beginning to cut across socio-economic classes and attract people who have never purchased insurance before. Life insurance is also now being regarded as a versatile financial planning tool. Apart from the traditional term and saving insurance policies, industry has seen the entry and growth of unit linked products. This provides market linked returns and is among the most flexible policies available today for investment. Now products are priced, flexible, and realistic and sustain so people in better position to understand the risk and benefits of the product and they are accepting these innovative products. So it is clear that the face of life insurance in India is changing, but with the changes come a host of challenges and it is only the credible players with a long term vision and a robust business strategy that will survive. Whatever the developments, the future and the opportunities in this industry will surely be exciting. There are 12 private players in Indian life insurance market.

6 bank owned insurers: - HDFC standard life, ICICI prudential, ING Vysya, MetLife, OM Kotak, SBI life. 6 independent insurers: - Aviva, ANP sanmar, Birla sun life, Bajaj Allianz, Max New York life, Tata AIG. Major international insurers are- Prudential and Standard life from UK, Sun life of Canada, AIG, MetLife and New York life of the US.

Increasing growth since liberalization:

YEAR FY03 FY04 FY05 FY06 FY07 LIC (in bn rs.) 110 120 130 140 240 PRIVATE PLAYER 10 20 40 60 160

Source: - Insurance Industry (ICFAI publication book)

Possibilities for insurance companies in India:

Further deregulation of the market. Greater concern for the customers. Newer products and services. Competition and quality consciousness. Cost effective operations. Restructuring of the public sector. Consolidation of domestic insurance markets. Technology driven shift in product design. Actual operations and distribution. Convergence of financial services.

5. Global insurance industry

Globally, insurers increasingly are pressured by the demands of their clients. The development of global insurance industry over the past few years was influenced by booming stock markets which enabled considerable capital gains to be made in non life business. Increase in insurers equity capital increased underwriting capacity, while demand did not develop at the same pace, resulting in decrease in insurance policies prices. The stock market boom of the past few years led to demand for unit linked insurance products. The global insurance industry is growing at rapid pace. Most of the markets are undergoing globalization. Lot of mergers and acquisition are taking place in the insurance world. The rapidity in the industry, technological improvement has resulted in pressures on a few economic parameters. The world insurance industry is at peak of its globalization process. Global insurance market is increasing by an average of six percent per year since 1990. Insurance companies have collected $2443.7 billion premium world wide according to the global development of premium volume in 144 countries in 2005. $1521.3 has been generated as life insurance premium and $922.7 as non life insurance premium. The US accounted for 35% of global life and non life premium, Japan had global share of 21%, and UK was having 10% of global share.

Influence on Indian insurance industry:

In this era of globalization, insurance companies face a dynamic global environment. Dramatic changes are taking place owing to the internationalization of activities, appearance of new risk, new types of covers to match with new risk situations, and unconventional and innovative ideas on customer services. Low growth rates in developed markets, changing customers needs, and the uncertain economic conditions in the developing world are exerting pressure on insurers resources and testing their ability to survive. Now the existing insurers are facing difficulties from non-traditional competitors those are entering the retail market with new approaches and through new channels. India has a rapidly growing middle class and this section can afford to buy insurance products. This shows the attraction that the Indian market holds for foreign insurers who have been putting pressure on developing countries as well as on India to open up its market.

Life insurance penetration as a % of GDP

United kingdom Japan Korea United states Malaysia 8.9% 8.3% 7.3% 4.1% 3.6%

India China Brazil

3.0% 1.8% 1.3%

Source: - www.indianinsuranceresearch.com

6. Functioning of insurance industry:

Insurers business model:
Profit = earned premium + investment income - incurred loss - underwriting expenses Insurers make money in two ways: (1) through underwriting, the processes by which insurers select the risks to insure and decide how much in premiums to charge for accepting those risks and (2) by investing the premiums they collect from insured. The most difficult aspect of the insurance business is the underwriting of policies. Using a wide assortment of data, insurers predict the likelihood that a claim will be made against their policies and price products accordingly. To this end, insurers use actuarial science to quantify the risks they are willing to assume and the premium they will charge to assume them. Data is analyzed to fairly accurately project the rate of future claims based on a given risk. Actuarial science uses statistics and probability to analyze the risks associated with the range of

perils covered, and these scientific principles are used to determine an insurer's overall exposure. Upon termination of a given policy, the amount of premium collected and the investment gains thereon minus the amount paid out in claims is the insurer's underwriting profit on that policy. An insurer's underwriting performance is measured in its combined ratio. The loss ratio (incurred losses and loss-adjustment expenses divided by net earned premium) is added to the expense ratio (underwriting expenses divided by net premium written) to determine the company's combined ratio. The combined ratio is a reflection of the company's overall underwriting profitability. A combined ratio of less than 100 percent indicates underwriting profitability, while anything over 100 indicates an underwriting loss. Insurance companies also earn investment profits on float. Float or available reserve is the amount of money, at hand at any given moment that an insurer has collected in insurance premiums but has not been paid out in claims. Insurers start investing insurance premiums as soon as they are collected and continue to earn interest on them until claims are paid out. . Naturally, the float method is difficult to carry out in an economically depressed period. Bear markets do cause insurers to shift away from investments and to toughen up their underwriting standards. So a poor economy generally means high insurance premiums. This tendency to swing between profitable and unprofitable periods over time is commonly known as the "underwriting" or insurance cycle. Finally, claims and loss handling is the materialized utility of insurance. In managing the claims-handling function, insurers seek to balance the elements of

customer satisfaction, administrative handling expenses, and claims overpayment leakages.

Investment management:
Investment operations are often considered incidental to the business of insurance, and have traditionally viewed as secondary to underwriting. In the past risk management was the most important part of business, whereas today the focus has shifted to fund management. Investment income is a large component of insurance revenues, skilful and careful management of funds. Insurance is a business of large numbers and generates huge amount of funds over time. These funds arise out of policyholder funds in the case of life insurance, and technical and free reserves in the non-life segments. Time lag between the procurement of premium and the payment of claim provides an interval during which the funds can be deployed to generate income. Insurance companies are among the largest institutional investors in the world. Assets managed by insurance companies are estimated to account for over 40% of the worlds top ten asset managers. Returns on investments influence the premium rates and bonuses and hence investment income will continue to be an important component of insurance company profits. In life insurance, benefits from insurance profits accrue directly to policy holders when it is passed on to him in the form of a bonus. In non life insurance the benefits are indirect and mostly by the creation of an investment portfolio. Investment income has to compensate for underwriting results which are increasingly under pressure. In the case of insurance, the difference between revenue and the expenses is known as operating surplus.

Revenue =premium. Expenses =sum of claims + commission payable on procurement of business + operating expenses. Operating surplus =revenue-expenses.

Net investment income includes income from trading in and holding stock market securities including government securities, special deposits with the central government, loans to several public utilities and service providers in state government. Insurance premium collected is converted in a pool of fund then divided in to four expenses. To pay the expenses of the management. To pay agency commission. To pay for the claims. Surplus money will be invested in govt. securities.

Requirements of an insurance risk

Insurance normally insure only pure risks .However, not all pure risk is insurable .certain requirements usually must be fulfilled before a pure risk can be privately insured .From the view point of the insurer, there are ideally six requirement of an insurable risk

 There must be a large number of exposure units The loss must be accidental and unintentional. The loss must be determinable and measurable. The loss should not be catastrophic. The chance of loss must be calculable. The premium must be economically feasible

Comparison of Insurance with other Similar Factors (1) Insurance and gambling compared Insurance is often erroneously confused with gambling .There are two important differences between them .First ,gambling creates a new speculative risk ,while insurance is a technique for handling an already existing pure risk .thus ,if you bet Rs 300 on a horse ,a new speculative technique is created ,but if you pay Rs 300 to an insurer for fire insurance ,the risk of fire is already present and is transferred to the insurer by a contract. No new risk is created by the transaction. The second difference between insurance and gambling is that gambling is socially unproductive, because the winners gain comes at the expense of the loser .In contract; insurance is always socially productive, because neither the insurer nor the insured is placed in a position where the gain of the winner comes at the expense of the loser. The insurer and the insured have a common interest in the prevention of a loss. Both parties win if the loss does occur .Moreover, consistent gambling transaction generally never restore the losers to their former financial position .In contract ,insurance contracts restore the insureds financially in whole or in part if a loss occurs

(2) Insurance and hedging compared The concept of hedging is to transferring the risk to the speculator through purchase of future contracts .An insurance contract, however, is not the same thing as hedging .Although both technique are similar in that risk is transferred by a contract, and no new risk is created, there are some important difference between them. First, an insurance transaction involves the transfer of insurable risks, because the requirement of an insurable risk generally can be met .However, hedging is a technique for handling risks that are typically uninsurable ,such as protection against a decline in the price agriculture products and raw materials. A second difference between insurance and hedging is that insurance and hedging is that insurance can reduce the objective risk of an insurer by application of the law of large numbers. As the number of exposure units increases, the insurers prediction of future losses improves, because the relative variation of actual loss from expected loss will decline .thus, many insurance transactions reduce objective risk. In contract, hedging typically involves only risk transfer , not risk reduction .The risk of adverse price fluctuation is transferred because of superior knowledge of market conditions .The risk is transferred, not reduced, and prediction of loss generally is not based on the law of large numbers.

Various types of life insurance policies: Endowment policies: This type of policy covers risk for a specified

period, and at the end of the maturity sum assured is paid back to policyholder with the bonuses during the term of the policy. Money back policies: This type of policy is for periodic payments of partial survival benefits during the term of the policy as long as the policy holder is alive.

 Group insurance: This type of insurance offers life insurance protection under group policies to various groups such as employers-employees, professionals, co-operatives etc it also provides insurance coverage for people in certain approved occupations at the lowest possible premium cost. Term life insurance policies: This type of insurance covers risk only during the selected term period. If the policy holder survives the term, risk cover comes to an end. These types of policies are for those people who are unable to pay larger premium required for endowment and whole life policies. No surrender, loan or paid up values are in such policies.

Whole life insurance policies: This type of policy runs as long as the policyholder is alive and is covered for the entire life of the policyholder. In this policy the insured amount and the bonus is payable only to nominee on the death of policy holder.

Joint life insurance policies: These policies are similar to endowment policies in maturity benefits and risk cover, but joint life policies cover two lives simultaneously such as married couples. Sum assured is payable on the first death and again on the death of survival during the term of the policy.

 Pension plan: a pension plan or annuity is an investment over a certain number of years but does not provide any life insurance cover. It offers a guaranteed income either for a life or certain period.

Unit linked insurance plan: ULIP is a kind of insurance plan which provides life cover as well as return on premium paid over a certain period of time. The investment is denoted as units and represented by the value called as net asset value (NAV).

7. Insurance and economy

Indian economy is growing in reference to global market. Business of insurance with its unique features has a special place in Indian economy. It is a highly specialized technical business and customer is the most concern people in this business, therefore this business is able to spur the growth of infrastructure and act as a catalyst in the overall development of Indian economy. The high volumes in the insurance business help spread risk wider, allowing a lowering of the rates of the premium to be charged and in turn, raising profits. When there is a bigger base, the probabilities become more predictable, and with system wide risks balanced out, profits improve. This explains the current scenario of mergers, acquisitions, and globalization of insurance. Insurance is a type of savings. Insurance is not only important for tax benefits, but also for savings and for providing security. It can be serving as

an essential service which a welfare state must make available to its people. Insurance play a crucial role in the commercial lives of nations and act as the lubricants of economic activities. Insurance firms help to spread the potentially financial consequences of risk among the large number of entities, to mobilize and distribute savings for productive use, facilitate investment, support and encourage external trade, and protect economic entities against external risk.

Insurance and economic growth mutually influences each other. As the economy grows, the living standards of people increase. As a consequence, the demand for life insurance increases. As the assets of people and of business enterprises increase in the growth process, the demand for general insurance also increases. In fact, as the economy widens the demand for new types of insurance products emerges. Insurance is no longer confined to product markets; they also cover service industries. It is equally true that growth itself is facilitated by insurance. A well-developed insurance sector promotes economic growth by encouraging risktaking. Risk is inherent in all economic activities. Without some kind of cover against risk, some of these activities will not be carried out at all. Also insurance and more particularly life insurance is a mobilizer of long term savings and life insurance companies are thus able to support infrastructure projects which require long term funds. There is thus a mutually beneficial interaction between insurance and economic growth. The low income levels of the vast majority of population have been one of the factors inhibiting a faster growth of insurance in India. To some extent this is also compounded by certain attitudes to life. The

economy has moved on to a higher growth path. The average rate of growth of the economy in the last three years was 8.1 per cent. This strong growth will bring about significant changes in the insurance industry.

At this point, it is important to note that not all activities can be insured. If that were possible, it would completely negate entrepreneurship. Professor Frank Knight in his celebrated book Risk Uncertainty and Profit emphasized that profit is a consequence of uncertainty. He made a distinction between quantifiable risk and non-quantifiable risk. According to him, it is non-quantifiable risk that leads to profit. He wrote It is a world of change in which we live, and a world of uncertainty. We live only by knowing something about the future; while the problems of life or of conduct at least, arise from the fact that we know so little. This is as true of business as of other spheres of activity. The real management challenges are uninsurable risks. In the case of insurable risks, risk is avoided at a cost.