Turbulent times ahead for the insurance sector

The timing could not have been worse. With the Parliamentary Standing committee rejecting the proposed amendments in the Insurance Bill, the insurance sector faces a very serious reality check regarding its future.

Whether it concerns the new norms on unit-linked policies for life insurers or third party motor pool losses for the non-life sector, the fact is the India insurance story is desperately seeking some life-giving sustenance.

Crippled with regulatory issues, low margins and lack of a policy road map, the industry today is reeling from negative growth and job losses. This has meant a further delay in break-even periods and lower returns for promoters.

No surprise then that domestic promoters have reached the end of their tether and are trying to encash whatever investments they had made over a period of time.

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Bharti Group, Dabur Group, Future Group, DLF, Sundaram Group, Reliance ADAG to name a few, are either trying to sell their entire stake in the respective joint-ventures or trying to monetise a part of their investment.

The results, however, have been somewhat mixed, with some insurers like MetLife and Reliance Life succeeding in diluting a part of their stake and roping in new investors, while others have not been that lucky.

In fact, players like Bharti, and Sundaram Group have been unlucky enough to see their deals fall though after initial headways.

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A dismal year for Life

To say that the last year has been a rough one for the life insurance industry is an understatement. The new regulations that kicked in around September, 2010 effectively took the wind out of the sails of life insurance in the country thanks to the Insurance Regulatory Development Authority (Irda), capping commissions and other charges on unit-linked products.

Similarly, the regulator also increased the lock-in period for unit-linked products from the existing three years to five years. The numbers say it all.

During April-October period, life insurance industry sold close to 19.6 million policies, 15.31 per cent lower, compared to 23.14 million policies sold in the same period last year. As a result the first year premium collection of the life insurance industry, was down by 20.04 per cent to Rs 55,737.84 crore (Rs 557.37 billion) as against Rs 69,707.92 crore (Rs 697.07 billion) in the corresponding period last year.

The result was obvious. As sales dried up, companies had no option but to begin reducing the number of employees, branches and agency force.

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Consequently, there was a sharp drop in sales of unit-linked plans which constituted more than 90 per cent of the sales of life insurance companies.

From a people's perspective, the results were disastrous. During 2010-11, one out of four people employed in the private life insurance sector lost their jobs in the country.

For instance, total number of people employed by the top five life insurance companies as on March 31, 2011 stood at 60,215 as against 81,507 in the corresponding period last year. Also, these life insurers closed down more than 900 branches, and more than 1,74,000 agents suddenly found themselves out of a job.

To some, the culprit for this was clear. "Changes by Irda in September 2010 to the pension plans in terms of a minimum guarantee, was a step backwards. It is difficult, if not impossible, for life insurance companies to apply that kind of guarantee on very long term commitments," Dean A Connor, President Sun Life, said.

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To make things worse, considering the choppy equity market and the high inflationary scenario, the sales of Ulips are unlikely to pick up in the current financial year and the experts fears that the growth of the life insurance industry is likely to remain subdued over the next 6-12 months. In other words, expect no improvement in the next six months.

Meanwhile, the regulator's efforts to come out with guidelines for an initial public offering (IPO) is unlikely to have any immediate impact on the life insurance industry. According to a recent report by rating agency Moody's, with the Insurance Bill rejected -- which means no immediate chance of increasing the FDI limit to 49 per cent from present 26 per cent.

The effects of this are not hard to imagine. "Life insurers that have more than 10 years of operations in India include HDFC Standard Life Insurance, ICICI Prudential Life Insurance, Max New York Life Insurance, Reliance Life Insurance, and SBI Life Insurance. All of these are joint ventures with both domestic and foreign partners.

However, the Insurance Act of India caps foreign ownership of insurance ventures at 26 per cent, and while Parliament has a bill to raise the cap to 49 per cent, it has not yet acted on it. Therefore, we expect foreign partners of these in insurance ventures will oppose an IPO until their ownership increases to avoid additional share dilution following an IPO," Moody's said.

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If all of this doesn't spell doom for an already beleaguered industry another important statistic will make foreign insurers think twice about heading towards Indian shores. "If you look at 15 different markets in Asia where we are present, the lowest margins of all markets is in India," said Mark Tucker Group Chief Executive and President, AIA.

According to a latest study by McKinsey, the returns and profit margins in India is one of the lowest in the region. The study shows, return on reserves from the life insurance sector in India is the lowest, at -27 basis points, whereas it is 110 basis points in China.

Similarly, the profit margins or the new business adjusted profit (NBAP) margins in India is at 18 per cent, faring poorly with China, where the NBAP in the same period stood at 30-60 per cent.

"In the past decade, ending 2010-11, the total capital invested by private sector life insurers was over $7.5 billion, of which 50 per cent or close to $4 billion was invested to fund accumulated losses, which have largely been incurred to create distribution capacity," the report said.

"A lot of this investment were made with an underlying understanding that the sector will be opened up to the foreign players. However, it has been 8 years, since the issue of raising the FDI cap to 49 per cent is pending with the parliament. Foreign promoters will not invest any further if there is no policy road map ahead of them," said an analyst.

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General Insurance sunk by motor losses

Though the general insurance sector continues to grow at an healthy rate of 20-22 per cent, profitability still eludes the sector, courtesy, the third party motor pool losses. The industry took a hit of more than Rs 10,000 crore (Rs 100 billion) last year, on third party motor pool losses.

As a result, only four out of 24 private general insurance companies in the country, reported profits during 2010-11 as the provisioning on the portfolio was raised from 136 per cent to 153 per cent.

To give some relief to the insurers, the third party premiums were increased by roughly 10-60 per cent, but insurers say that this hasn't been sufficient.

What's worse is that the industry is again staring at a similar fate. Based on an independent peer review, Irda might increase the reserve or provisioning requirement again to 205-175 per cent from 153 per cent. If implemented, the industry will be forced to take another hit of Rs 6,000-Rs 10,000 crore (Rs 60 -100 billion).

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Motor portfolio, which constitutes around 43 per cent of the total premiums, has always been the Achilles heel for the general insurance companies in India, due to inherent losses on the account of commercial third party losses.

Total premiums collected by the general insurance companies stood at around Rs 44,000 crore (Rs 440 billion) during 2010-11, of which motor premiums constituted Rs 18,000 crore (Rs 180 billion). Typically third party liability accounts for 35 per cent of the total motor premiums.

In a bid to distribute the losses among the insurers, Indian Motor Third Party Insurance Pool (IMTPIP) was created in April 2007, for commercial vehicle third-party insurance business. Share of each insurer was decided according to the overall market share of all lines of business.

"The third party motor pool has outlived its purpose and actually becoming a drag for the industry. Clearly, there will be a need for capital for the industry if the provisions are raised and it will hit profitability of the industry this year," said Bhargav Dasgupta, MD & CEO, ICICI Lombard GIC.

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Problem is, the premiums for the third party covers are tariffed in India, whereas every other line of general insurance business is de-tariffed, where the premiums are market determined.

"A free market system is always a good solution when we are trying to bring some innovation. You have to move with the changes that are happening at the market place in order to want to sustain a stable development,"Julio A. Portalatin ,President and CEO, Chartis Growth Economies and Senior Vice President-General Insurance AIG, Inc, told Business Standard in a recent interview.

Though the regulator is weighing various options in order to try and solve the problem, say, by way of dismantling the entire pool or introducing a "declined pool, all these solutions invariably mean higher capital for the industry, perhaps at a cost of profitability.

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And with only 26 per cent holding, even the foreign promoters are thinking twice to invest more into the sector, especially when progress involves more capital infusion.

"The issues like IPO are tough to take a call on when you have 26 per cent holding. Unless the numbers change in a way that allows us to bring in more innovation and more investment in India so that we can continue to get good return, any discussion on potential IPO at least from our side is a bit premature," Portalatin adds.

Whether it is the life business, or non-life, what the insurance industry is urgently in need of is capital.

But without a clear roadmap regarding important policy issues such as boosting the FDI limit domestic promoters will run out of both patience and options, and foreign players, who remain the most likely source of additional capital, will remain unconvinced about the industry's viability. This doesn't bode well for an industry already on the ropes.