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To study the impact of FDI in insurance we first look at the how the Indian insurance sector has evolved over the years. Indian insurance sector has experienced different phases from being an open competitive market to being nationalized and back to deregulation. The Indian insurance story began in India in the year 1818 with the establishment of the Oriental Life Insurance Company in Kolkata. In the year 1912 the Indian Life Insurance Companies Act came into existence and laid out policies and procedures to control insurance business in country. It was later amended in 1938 to protect the public. The major change came in 1956 when the central government 245 private insurers and formed the Life Insurance Corporation (LIC) of India. In 1972 the general insurance business was also nationalized.
Problems facing the Indian Insurance Sector:
The government’s intention was to create a monopoly and protect it from foreign and private competition. So, what were the implications of such a conservative approach? Insurance sector faced problems such as capital scarcity, poor product quality and technological obsolescence. In the year 2000, life insurance penetration in India stood at an abysmal 2.4%. (Table 1, Figure 1). There is a huge lack of proper awareness regarding the need of insurance. Insurance premiums are looked at as a means of tax evasion and savings. The true importance of insurance often gets overlooked. In addition to this, India is a country with a huge lower middle class section. In their daily struggle to try and get both the ends meet, insurance premiums come as a luxury. The inflexible and expensive plans offered in the market make it more difficult for the common people to invest. The situation in rural India is even worse.
A small fraction of the people have bank accounts, and the concept of insurance is very much alien. People have little disposable income, and the only form of life insurance is joint family system. Insurance is a sensitive business and even after the liberalization of the 1990’s, the insurance sector was not opened for private competition. The breakthrough finally came in the year 1999, when the government opened up the insurance sector to private competition and allowed upto26% stake for FDI in insurance companies. There is evidence to show that the above reforms ensure healthy competition in the sector. The life insurance penetration increased to 4.4% in 2010-11 (Table 1). Insurance density measured as the ratio of premium in USD to total population increased from 11.5 in 2001 to 64.4 in 2010(Table 1). However, according to the 2010-11 annual IRDA report it is still very less compared to developed economies, for example UK has the highest insurance density of 3436.3 in 2010.
Table 1, Source: IRDA
With the help of reforms today there are around 24 life insurance players in the market compared to just one LIC before deregulation. However, LIC still holds majority share in most segments (Table 1).
What is the role of FDI?
Insurance is a capital intensive business. Insurers need to infuse capital at regular intervals both for new business plans and to expand their infrastructure base which includes expenses on initial operations, training costs for development of distribution channels and creating niche markets etc. Insurance markets world over have indicated that it is a high gestation period industry and companies take seven to ten years to break-even. During the financial year of 2010-11 only 12 life insurers out of existing 23 private players reported profits. Even the largest private life insurer ICICI Prudential had to suffer 8 years of continuous losses before reporting profits in 2009-10.The Indian private players are much cash starved as shown by the operating expense ratio of 20.97 compare to LIC’s 6.58.
Increased capital infusion by foreign partners can help insurers stay afloat. Currently, 22 out of 24 life insurance players and 18 out of 27 non-life insurers in India have foreign partners, and many more are in the queue to enter the Indian market. Why Indian Insurance sector is attractive to Foreign Direct Investors? Every industry has a unique market structure and it is considered that the relationship between openness to foreign investment and market structure is complex. Caves, R E (1996) states that there are empirical evidences which show the positive relationship between the extent of foreign investment and the degree of market concentration. It could be said that foreign investment is being attracted by industries with high concentration and high profitability.
The short-run effect of foreign entry is to increase the number of firms and reduce concentration. After the reforms of 1999 FDI was allowed and the bar was set at 26% which did not really attract FDI as most big MNCs look for more decision making power. On the contrary, the FDI limit in the insurance sector is higher not only in other BRIC nations but also in other Asian countries such as Japan, Korea, Indonesia and Malaysia, in comparison to India’s 26%, which was a further disincentive for foreign investors to invest in India.
In spite of that, India has an immense and almost untapped potential market for insurers, and is a highly attractive investment destination for foreign investors. The rise of the educated middle class promises sustaining growth opportunities for the industry to start with. Further, the presence of IRDA as a competent regulatory body promotes the interest of the insurers. Beyond this lies the immense potential at the bottom of the pyramid, i.e. in rural and semi-urban India. The awareness about insurance as a concept needs to be shifted from a tax-saving scheme to a prudent necessity. Impact and future prospects of FDI in insurance:
The influx of FDI into the insurance sector has the capability to revolutionize the insurance sector in India. The recent reforms of raising FDI cap from 26% to 49% will further incentivize the foreign investors to come to India. This additional financial stake means higher operational flexibility for foreign investors, which in turn will entice them to contribute to more technical aspects of the insurance business including product innovation, streamlining the claims settlement processes and implementation on technologically best processes. Not only new entrants but even existing foreign players will increase their stake and pump in more money. For example Aviva Plc, Allianz SE and ING Group NV are among global insurers that will be able to further invest in their Indian ventures This will lead to the introduction of an array of innovative products, focused towards the large segment of uninsured and underprivileged urban and rural population.
This reform will also go a long way towards bridging the gap between the insurers and the above mentioned target segments. Warren Buffett, the billionaire chairman of Berkshire Hathaway Inc., said last year during a visit to India that the prior limit on overseas ownership of local insurers made investments in the country less attractive. Berkshire began selling auto coverage in the country last year after forging an agreement with Bajaj Allianz General Insurance. “India would be more attractive if we could buy more than 26 percent,” Buffett said at a media conference in Bangalore in March 2011. “That is a factor in the decision of not investing.”
Apart from solving the capital and other strategic problems of the private insurance players, these reforms will go a long way towards improving the overall economy of India. This will take place by generating more jobs in the service sectors, and provide a significant contribution to the GDP of the nation. The current contribution of the insurance sector to the GDP of India is roughly 4.5% according to insurance regulator IRDA. Throwing it open to foreign investors can help the sector grow at 11-12% per annum. To witness such a growth, it is necessary to redirect the household savings into insurance products, a large chunk of which is currently being invested into physical assets such as gold and land instead of financial products.
This in turn will ensure that the long term public saving flow into the market and gets unlocked and invested into critical and capital starved sectors like infrastructure, where the government envisages an investment of about $1 trillion in the next 5 years. This will trigger a new phase of growth for the nation and create benefits for all. On the other hand, the private sector players like LIC will not be directly impacted by this move, even though this step will bridge the existing gap between the private and public players in this sector, in terms of scale and market share.
Citations and references
1.Press Information Bureau, Government of India http://pib.nic.in/newsite/erelease.aspx?relid=88152 2.http://www.business-standard.com/india/news/analysis-setting-up%5Cwell-lit-springboard%5C-for-insurance-industry/190084/on 3.http://profit.ndtv.com/news/opinions/article-reforms-ii-actionable-or-simply-intent-311728 4.http://www.bloomberg.com/news/2012-10-04/india-clears-fdi-in-insurance-pensions-as-singh-reboots-economy.html 5.http://timesofindia.indiatimes.com/business/india-business/Insurance-rejig-to-give-tax-breaks-easier-policy-terms/articleshow/16633661.cms