Bringing down an edifice

The Life Insurance Corporation's corporate office in Chennai. - N. SRIDHARAN

The entry of foreign players puts enormous pressure on the profitable, efficient and socially responsible public insurance companies of India.

THE opening of the Indian insurance sector to 49 per cent foreign direct investment (FDI) is one of the more controversial economic reform measures that the United Progressive Alliance (UPA) government has taken. It is certainly one of the most contested decisions as, by any measure of profitability or efficiency, the state-controlled insurance sector has performed remarkably well.

The decision has predictably been welcomed by corporate India and the mainstream media as a step in the direction of insurance sector privatisation.

The announcement to increase the permissible foreign equity stake in an insurance company from the current level of 26 per cent to 49 per cent was made by the Finance Minister during his Budget speech in 2004, and again this year. This, despite sustained and informed opposition, not just from the Left, on whose support the present government is dependent, but also from the strong trade union movement within the insurance sector which has led a countrywide campaign of education and information on just how misconceived such a measure is from the point of view of the national interest. Significantly, there is also opposition to the liberalisation of the insurance sector from other segments of the political spectrum, including the Congress party, within Parliament.

Simply put, the opposition to the liberalisation of the insurance sector rests on two arguments. The first is that public sector insurance, both in the life and non-life sectors, has performed remarkably well both in terms of profitability and reach since the nationalisation of these sectors in 1956 and 1972 respectively. Therefore, there is no good reason to weaken these efficient and profitable entities, which disinvestment has already succeeded in doing.

Second, there is not even a strong case for FDI in insurance based on the performance of the global insurance industry. Today there is a crisis of confidence among the insuring public in the West, as several leading global insurance players, including many who have opened operations in India, are under the scanner of regulatory bodies in their countries for irregularities ranging from failure to meet insurance claims, to financial mismanagement, to outright fraud. It is in this situation that foreign equity investment in insurance in India is being increased.

"At the end of the day, the essence of efficiency in an insurance company is about whether your claims are paid or not," N.M. Sundaram, president, All India Insurance Employees Association (AIIEA), told Frontline. "In that, public sector performance is near 100 per cent. The world average is very much lower - it has stayed at 40 per cent or so. On these grounds, we are amongst the most efficient. The second aspect is that internationally, insurance companies are in very bad shape, both in America and Europe. The normal practice of a company in the United States is to repudiate the claims. In fact, the extent of fraud perpetrated in the U.S. is documented. A U.S. House of Representatives Sub-Committee in 1990 in a report called `Failed Promises' analysed it. Such a scenario was present in India before insurance nationalisation".

Public sector monopoly over insurance was broken in 1999, when the National Democratic Alliance (NDA) government opened the sector to FDI. The Insurance Regulatory and Development Authority (IRDA) Act allows foreign companies a 26 per cent equity stake in Indian insurance companies. The entry-level capital requirement for private companies was kept at Rs.100 crores.

The table shows the number of registered insurers in India. The Life Insurance Corporation of India (LIC) is the only life insurer in the public sector. Eleven of the 13 private companies have an FDI of 26 per cent of the equity, one (HDFC) has 18.60 per cent, and Sahara India is wholly Indian owned. Seven of the eight private companies in the general insurance sector have foreign equity holdings of 26 per cent. The only one that does not is Reliance General Insurance Co. Ltd. Of the 13 companies in the private life insurance sector, only one, namely Sahara India, does not have a foreign promoter.

According to the IRDA Annual Report 2003-04, all the private life insurance companies made losses amounting to Rs.2,91,275 lakhs after tax. The LIC, on the other hand, made Rs.55,181 lakh profit after tax in this period. In the non-life sector, the combined profits after tax of the private sector companies was just Rs.6,701 lakhs, whereas the combined profits of the public sector companies was Rs.1,34,399 lakhs. The public sector still holds the overwhelming market share of premiums underwritten. Of the total premiums (first year premiums and renewal premiums) in 2002-03, the LIC had 95.29 per cent of the market share while the private sector has just 4.71 per cent. In the non-life segment, the new insurers held a market share of 13 per cent.

The rationale for the liberalisation of the insurance industry rests on the argument that India requires a large dose of investment in social infrastructure, which will come from private insurance companies. Curiously, this was precisely the argument that was put forward by the government as justification of the nationalisation of the life insurance industry in 1956. Life insurance was nationalised following a series of solvencies and bankruptcies of private insurance companies. More important, however, the government felt that in government hands, the sector would be able to channel resources for savings and national investment. Profit-driven private companies could not be expected to promote insurance in the rural areas.

The private sector is unlikely to generate the anticipated funds for social infrastructure, as 90 per cent of its premium income comes from unit-linked products that are invested in the stock market, a volatile and risky investment source. On the other hand, the total investments of the LIC that have gone directly into infrastructure development, stood at Rs.3,43,128.80 crores on March 31, 2004. The corresponding amount generated by all the private insurers amounted to Rs.321 crores.

Further, rural penetration by private insurers is almost non-existent, as they service the profitable, urban segment of the insurance market. By contrast, in 2003-04 alone 17.85 per cent of the new policies underwritten by the LIC were from the rural sector. The average policy size of an insurer in a private company is Rs.3,00,000; the corresponding policy size in the LIC is Rs.72,000, suggesting the different consumer segments that public and private insurance sectors service.

The social objectives of insurance still remain relevant, 50 years after the nationalisation of the life insurance sector, and five years after the entry of private players in insurance. Despite the fact that India lags behind most other countries of the world on two important insurance indicators, namely insurance density (the share of insurance in the gross domestic product), and insurance penetration (the per capita expenditure on insurance), the fact remains that the LIC is the largest insurer in the world, servicing 17 crore policies.

"The Finance Minister announced that the country needs $150 billion for infrastructure development," said Amanullah Khan, AIIEA general secretary. "One single institution, the LIC, can achieve that in six to seven years. The LIC is growing at 25-30 per cent, and in 2003-04 the total premiums it generated was Rs.63,000 crores. Why does the government have to look outside for funds?"

CURRENT trends in the global insurance industry do little to support the government's decision to liberalise at this stage. Several of the foreign insurance partners of Indian companies are in a serious credibility crisis with the insuring public. The big insurance scam that the U.S. media is avidly following is the investigation opened by U.S. Securities and Exchange Commission officials and the New York Attorney-General against the insurance giant, the American International Group (AIG), which holds 26 per cent stake in TATA-AIG Life Insurance Co. Ltd. Investigations are under way against its former chairman, Maurice R. Greenway, for his role in dressing up the company's financial results through questionable insurance transactions. The AIG's dealings with General Re, one of the biggest re-insurance vendors of the world, which had been acquired in 1998 by a holding company owned by Warren E. Buffet, is part of the investigation. AIG has acknowledged that the deal with General Re was improper. The investigation has resulted in a steep fall in the stock price of the company, and in a lowering of its book value by $1.7 billion.

In 2003, U.S. regulators conducted investigations into the business practices of Prudential Financial Services, the U.S. insurance company that has tied up with ICICI. According to media reports, regulators uncovered a range of fraudulent sales practices, including the falsification of documents, forging of signatures, and the practice of asking clients to sign blank forms. The company has been in trouble with regulators from 1993. In 1997 the company had to pay $2.6 billion in a class action lawsuit against fraudulent life insurance sales practices.

The U.S. media has reported on the suit filed by the California Insurance Commissioner against the insurance broker Universal Life Resources, MetLife, Prudential Financial, Cigna Corp and Unum Provident. MetLife has a 26 per cent equity stake in MetLife India Insurance Co. Ltd. According to media reports, Standard Life, which has an 18.6 per cent stake in HDFC Standard Life Insurance Co. Ltd, is also in deep financial difficulties.

In deference to the huge opposition to the entry of FDI in insurance, the government was forced to include the provision in the National Common Minimum Programme (CMP) that LIC and General Insurance Corporation (GIC) would not be disinvested. However, it can hardly be called a level playing field between the private and public sectors. The burden of the social goals of insurance has to be borne by the public sector insurance companies, while their access to the profit-making avenues of insurance is restricted. Traditionally, the public sector provided low premium policies through cross subsidisation with high premium policies. Today, the private sector in both life and non-life insurance is taking the cream of the insurance in high- profit urban areas. They have also effected a shift in product designing by introducing policies that are equity-linked, without stating what the associated risks for the insurer are.

The issue of the solvency margin has put a great deal of pressure on public sector insurance companies. The IRDA has stipulated that 4 per cent of premiums generated must be reserved as a solvency margin, a reserve fund in case the company closes. The LIC never created a separate fund for this purpose as technically the Government of India guaranteed all policies. The public sector companies argue that to demand a solvency fund from a start-up company is one thing, but to demand that the LIC make a provision in its budget for a solvency fund with retrospective effect for 50 years would be most unfair, as this would amount to Rs.18,000 crores. The IRDA has asked the LIC to raise this sum by going to the market and selling its shares. The pressure being put on the LIC on the issue of the solvency margin is seen as a means of paving the way for the eventual privatisation of the company.

The LIC has argued that for a start-up investment of Rs.5 crores by the government in 1956, the LIC has paid the government Rs.4,091 crores as dividend over the years, and this sum should regarded as a solvency margin. Failing this, the Government of India should stand as guarantor for the solvency margin. The IRDA regulator has shot this down on the grounds that it would go against its objective of creating a "level playing field".

With its burgeoning middle class, India is a prospective market for European and U.S. insurance companies, especially when their own insurance markets are in a sluggish stage. Their entry will continue to put enormous pressure on the public insurance companies who will have to compete with them in the marketplace, while yet having to fulfill their commitments toward socially responsible insurance.