Lessons from the insurance sector

Patterns in the insurance sector in India post-liberalisation have so far contradicted the predictions of those who argued that the opening up would deliver lower prices and better services for consumers.

DESPITE what people in general are told, there are very few things in the discipline of economics which are undisputed. Much of what is presented as "obvious" or "inevitable" often has poor foundations in theory and little justification in terms of empirical experience. Recent theoretical work indeed tends to point to the fragility of assumptions that underlie many established axioms. Truly, economics is at best an inexact science, highly probabilistic, and ultimately dependent upon intuition or "hunch".

Nevertheless, there are some arguments which are almost universally accepted (given the ceteris paribus condition, "other things remaining equal"). Thus, one of the first things that students of economics are taught is that when there are more producers in the market, competition tends to drive the price down to a level which is lower than when there are fewer producers.

The same is therefore supposed to be true of markets which were previously closed to competition, and are opened to new entrants. The expectation is that when monopolies or oligopolies are forced to confront new players, they will respond by lowering their prices or improving quality, even if the new entrants have higher costs to begin with.

This is why supporters of the Insurance Regulatory and Development Authority Bill, 1999 argued that opening up the sector to more domestic and foreign competition would ensure much better conditions for consumers. It was argued that more products (in the form of new types of insurance policies) would be available and that premium rates would fall as new entrants offered them, and that the existing nationalised insurance companies would be forced to deal with the threat and even reality of competition.

But such are the peculiarities of economics in the current context that even this obvious expectation has been belied. In fact, so far precisely the opposite tendency has been observed. Several new insurance companies, almost all with some foreign backing as well, have entered the market over the past six months in particular. Yet on July 1, a number of nationalised general insurance companies took measures to raise rates of premium and actually reduce the number of types of policies on offer.

The rates offered for vehicle insurance show this very clearly. Rates of premium on cars have gone up by around 40 per cent on average. Meanwhile, a category like third party insurance for two-wheelers, for which the premium rates used to be quite low, has seen an increase of nearly three times. Some companies even plan not to provide insurance for this category at all. When questioned about these increases, insurance officers have pointed to the effect of the new multinational-assisted entrants into the insurance business, and the much higher rates they are charging!

In other words, what they are suggesting is that now competition is going to be based not on prices, as was fondly believed earlier, but on profits. Insurance companies, not just the private ones but even in the public sector, are anxious to show profits on all lines of activity. Indeed, the public sector companies are especially keen to show that they are no less efficient than private players, and therefore end up using very similar tactics.

What this shows most starkly is that the cross-subsidisation which was characteristic of the insurance sector earlier, and which indeed is typical of most public sector service provision, is disappearing. The general insurance companies have already been instructed to calculate profits on each line of business separately. Life insurance is likely to follow suit.

The irony is that both the life insurance and general insurance corporations were already highly profitable in the aggregate. Their cross-subsidies, which were based on some notions of income and the ability of people to pay, and the need to provide insurance services to as many people as possible, did not prevent them from providing large surpluses to government coffers. Now, however, because they are concerned about showing profit rates or margins which are comparable to those of the private sector, they are likely to turn more cautious and more stingy about providing insurance cover to a range of consumers, simply in order to maintain "competitive" profitability.

What does this mean for consumers? It means the complete opposite of what was promised when the insurance sector was liberalised. Thus, not only have premium rates gone up quite sharply, but it may become more difficult to be eligible for a whole range of policies. So people may actually find it more difficult or more expensive to take on policies in areas where they really require it, that is, where they are in fact at risk.

Also, rates of claim settlement in India were earlier the highest in the world, at more than 90 per cent in life insurance and 70 per cent in general insurance, compared to around 40 per cent internationally in both categories. These rates are now likely to fall, as companies try to ensure higher profit margins through resort to this method as well. This means that in the event of some misfortune, which may be covered by the policy on paper, the policy-holder would be less likely than before to get his or her claim settled.

This whole process may appear very paradoxical. But actually it brings out very clearly why privatisation of certain services, as well as the opening up of this sector in particular, may be very problematic, and why the concerns of critics at the time were not misplaced. It should also be noted that this is quite unlike the privatisation of loss-making concerns in the manufacturing sector, which often simply reflects the urgent need to restructure and allow the government to move out of dead-end economic activities.

THERE were many points with respect to insurance sector liberalisation that the critics had raised. There was the possibility of fraud by, or failure of, private companies, which would adversely affect those who had sunk their life savings in such companies. The high incidence of such cases was indeed why the companies in India had been nationalised in the first place. There was the potential misuse of the huge pool of savings raised by this sector, which could be utilised for productive investment, including by the state.

In addition to these very serious worries, there was also the concern that consumers, who were supposed to be the main beneficiaries, would in fact be adversely affected. At the time such fears were simply laughed at. But already, with the recent change in the price structure, there is evidence that such a tendency of worsening conditions for insurance consumers may not be so far-fetched.

It is especially sad because it is so unnecessary. It is bad enough that private sector insurance companies, in their zeal to cut costs and improve profitability indicators, ignore the basic interests of people and effectively deny important sections of people insurance cover for different categories. This is, after all, only to be expected in a business driven entirely by profit. In fact, one of the reasons for curtailing services and raising costs is the huge increase in advertising costs which all the companies - private and public - are now engaging in, which makes the need to generate more revenue even more imperative.

But when public sector companies start behaving in exactly the same way, then it is worse than pointless. The entire purpose of having public provision of such services is to ensure that they do not simply behave like other private players. The meeting of broader social goals can then be achieved by cross-subsidisation, which is sustainable as long as the entire operation remains profitable. There is no need for such enterprises to be as profitable as possible using any possible means, because then the basic objective of using public corporations to provide public services would not be met.

The tragedy is that when the government itself starts imposing upon such public companies the pressure of being profitable at all costs, people will end up finding little to choose between the public and private sectors. It could well be that there is an implicit agenda in this, eventually to privatise these large and profitable public sector companies which would anyway behave no differently from private players.

While this may serve the purpose of those who are ideologically committed to the destruction of public sector activity independent of context, it can do little to serve the real interests of the citizens of this country.