IN moves that have surprised many, the United Progressive Alliance (UPA) government has, in the midst of a global financial crisis whose lessons are still being distilled, decided to press ahead with the liberalisation of the insurance sector. At the fag end of its term and in a truncated Parliament session that had other important business to deal with, the government appeared to be in a desperate rush to table two Bills to amend the laws applicable to the insurance sector.
The two Bills The Insurance Laws (Amendments) Bill and The Life Insurance Corporation (Amendment) Bill were introduced in the Rajya Sabha and the Lok Sabha respectively on December 22 without adequate discussion in the midst of the din generated by the Bharatiya Janata Partys (BJP) demand for the resignation of Minority Affairs Minister A.R. Antulay. Whether consciously or not, the BJP has helped the government keep alive the issue of insurance privatisation.
While it is unlikely that the government will be able to pass these Bills during its current term, it has, by tabling them, kept the process of insurance sector liberalisation and privatisation open despite the global shift in favour of public ownership in the wake of the financial crisis.
The aim is obviously to keep the focus on privatisation and dilution of public control and provision of a greater role for foreign firms in the insurance sector. This emphasis comes through in the four principal elements of the current legislative effort.
The first is to permit public insurance companies to mobilise additional money from the markets. The second is to relax the cap on foreign direct investment (FDI) or ownership by foreign players in the insurance sector as a whole. The third is to reduce the capital requirements for private players in certain areas, such as health insurance. And the fourth is to emphasis self-regulation with capital adequacy over structural regulation of the sector.
In the case of the general insurance sector, besides raising the FDI cap from 26 to 49 per cent, the relevant Bill allows the four state-owned general insurance companies Oriental Insurance Company, New India Assurance, United India Insurance and National Insurance Company to tap capital markets for funds after obtaining permission from the government. The Bill also allows insurance companies to raise newer capital through newer instruments on the pattern of banks.
Moreover, in a move widely seen as aimed at helping Lloyds of London in the first instance, the Bill seeks to allow foreign reinsurance companies to open offices and conduct business in the country with a minimum capital of Rs.200 crore.
Thus far, only the General Insurance Corporation could provide reinsurance in India. In addition, to make it easy for private players to enter the rapidly expanding health insurance market, the Bill proposes to reduce the minimum investment limit for health insurance companies from Rs.100 crore to Rs.50 crore. Also, it seeks to do away with the requirement that promoters have to divest specified part of their equity after 10 years, allowing promoters to retain control of these corporations. Finally, as part of the new regulatory framework, a Life Insurance Council and General Insurance Council are to be set up as self-regulating bodies.
While these are major changes, the big story is what this government or any version of it that may come to power after the next election has in store for the Life Insurance Corporation (LIC) of India. The Life Insurance Corporation (Amendment) Bill is presented as an innocent piece of legislation aimed at increasing the capital base of LIC, to bring it on a par with private insurers. The problem arises when this is read along with the changes being pushed through in the general insurance sector.
The government plans to allow government-owned insurance companies to mobilise money from the capital market, allowing for a dilution of the governments shareholding. And this comes along with the decision to raise the cap on FDI in the insurance sector. If in time these provisions are extended to cover the LIC, the government would recapitalise LIC not with its own money but with money mobilised from the market and from foreign investors.
This fear stems from the implicit effort to homogenise the insurance sector, bringing the LIC on a par with the private sector. This does signify a move to accelerate the shift in the form of regulation away from direct control through public ownership of institutions in the life and general insurance sectors to self-regulation based on Insurance Regulatory and Development Authority (IRDA) norms and guidelines and capital adequacy requirements.
The use of capital adequacy is reflected in the Bill provision to cap the sovereign guarantee provided to those insured by the LIC and replace it with a provision that a part of the surplus the excess of assets over liabilities actuarially calculated be treated as a solvency margin and placed in a reserve fund that the corporation can access in times of need.
As of now, 95 per cent of these surpluses are distributed to policyholders as bonuses and the rest is transferred to the government as dividend against its Rs.5 crore investment. The Bill provides for the transfer of surplus to policyholders to be capped anywhere between 90 and 95 per cent, with the balance divided between the government and the reserve fund. Thus, state control and state guarantee are to be replaced with self-regulation, capital adequacy and solvency margins. This is clearly a sign of long-term intentions.
It should be clear that these Bills are aimed at making the insurance sector private-dominated, self-regulated and competitive. Is there a case for such a transition? There is much evidence on the adverse consequences of such competition and the beneficial effects of government intervention in the insurance sector.
The insurance industry delivers products that are promises to pay, in the form of contracts that help lessen the incidence of uncertainty in various spheres. The insured pays to fully or partially insulate himself/herself from risks such as an accident, fire, theft or sickness or provide for dependents in case of death. In theory, to enter into such a contract the insured needs information regarding the operations of the insurer to whom he/she pays in advance large sums in the form of premium, in lieu of a promise that the insurer will meet in full or part the costs of some future event, the occurrence of which is uncertain. These funds are deployed by the insurer in investments being undertaken by agents about whose competence and reliability the policyholder makes a judgment on the basis of information he/she has.
The viability of those projects and the returns they yield determine the ability of the insurer to meet the relevant promise. The whole business is characterised by a high degree of risk depending on the extent of the imperfection of the different kinds of information required. This makes excessive competition in insurance a problem.
In an effort to drum up more business and earn higher profits, insurance companies could underprice their insurance contracts, be cavalier with regard to the information they seek about policyholders, and be adventurous by deploying their funds in high-risk but high-return ventures. Not surprisingly, countries such as the United States where competition is rife in the insurance industry have been characterised by a large number of failures.
As far back as 1990, a subcommittee of the U.S. House of Representatives noted in a report on insurance company insolvencies, revealingly titled Failed Promises, that a spate of failures, including those of some leading companies, was accompanied by evidence of rapid expansion, over-reliance on managing general agents, extensive and complex reinsurance arrangements, excessive underpricing, reserve problems, false reports, reckless management, gross incompetence, fraudulent activity, greed and self-dealing.
The committee argued that the driving force [of such deplorable management practices] was quick profits in the short run, with no apparent concern for the long-term well-being of the company, its policyholders, its employees, its reinsurers, or the public. The case for stringent regulation of the industry was obvious and forcefully made.
Things have not changed much since, as the failure and $150 billion bailout of global insurance major American International Group (AIG) in September made clear. AIG was the worlds biggest insurer in terms of market capitalisation. It failed because of huge marked-to-market losses in its financial products division, which wrote insurance on fixed-income securities held by banks. But these were not straightforward insurance deals based on due diligence that offered protection against potential losses. It was a form of investment that in search of high returns allowed banks to circumvent regulation and accumulate risky assets. As Financial Times (September 17, 2008) noted, banks that entered credit default swaps with AIGFP could assure auditors and regulators that the risk of the underlying asset going bad was protected, and with a triple A rated counterparty.
That is, AIG used policyholder money and debt to invest like an investment bank through its financial products division. When a lot of its assets turned worthless, AIG could not be let go because that would have systemic implications. The alternative was nationalisation. It is in this background that we need to address the question of the efficiency of competition from private entrants.
To start with, against the promised private gains in terms of the efficiency of service providers, we need to compare the potential private loss in the form of increased risk and the social loss in the form of the inability of the state as a representative of social interest to direct the insurance industrys investments.
Further, if insolvencies become the order of the day, there could be private losses as well as social losses because of the state being forced to emerge as the insurer of last resort. The losses may far exceed the gains, implying that the industry should be restructured with the purpose of realising in full the advantages of public ownership.
Yet, the Indian government pushes ahead with privatisation despite the fact that there is no evidence of the nationalised insurance industry failing to meet its obligations either to insurees or to the government. The LIC has not merely put at the governments disposal large volumes of capital for investment but also addressed the problems of insurance for the poor.
It is not only the global experience with privatised insurance but the Indian experience with nationalised insurance that does not seem to matter. In the circumstance, the two insurance Bills appear to be declarations of Indias intentions to globalise further during the current Prime Ministers tenure, independent of the consequences for its people.
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