INDIA'S LIFE INSURANCE INDUSTRY IS CHANGING RAPIDLY AS IT

UNCLAS MUMBAI 000469


E.O. 12958: N/A
TAGS: ECON EINV PGOV IN
SUBJECT: INDIA'S LIFE INSURANCE INDUSTRY IS CHANGING RAPIDLY AS IT
WAITS FOR LEGISLATIVE ACTION

REF: A. A. MUMBAI 369

B. B. MUMBAI 393



1. (U) Summary: Life insurance is a fast-growing industry in
India and could be a source of much needed long-term financing.
Most observers believe that the Indian Parliament will fail to
pass a bill that would increase the equity limit of foreign
investment in the insurance industry before the next national
election. Though the government-owned life insurer retains a
market lead and a government guarantee, the industry has been
rapidly evolving since it was opened up to private firms in
2000, a change best represented by the proliferation of
investment-oriented life insurance products. Private insurers
have used these products to drive life insurance growth, but
they have been controversial because they have cut into the
market share of mutual funds. The rapid growth of the industry
has also raised concerns about the quality of the products being
sold, the agents who are selling them, and whether the insurance
industry is properly assessing risk. End Summary.

Life Insurance Growth in India
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2. (U) Life insurance dominates the insurance business in
India. Of all the insurance premiums underwritten in 2006-07,
86% were life insurance premiums. Last year, life insurance
premiums grew at 47 percent, while non-life insurance premiums
grew at 22 percent. India's life insurance industry is
dominated by the former government-owned monopoly, the Life
Insurance Corporation (LIC),which underwrote 82% of life
insurance premiums issued in India in 2006-07. Though LIC
itself is still growing in terms of the value of premiums it is
underwriting, nineteen private life insurance companies share
the remainder of the market and are eating into LIC's market
share. (Note: The Indian insurance market is based on an
agency model, in which agents are not allowed to cross-sell
competing firms' products, forcing each insurance company to
roll out its own retail networks through the country. End
note.) Life insurance is important in India not just because it
presents a mechanism for saving, but because it generates
long-term liabilities that can be most productively matched with
long-term assets, such as infrastructure bonds. (Note: The
Committee on Financial Sector Reforms noted in its 2008 draft
report that given the country's infrastructure needs there is a
dearth of long-term domestic investors. End note.)

Most Say Insurance Bill Unlikely to Pass Before Elections
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3. (U) Until 1999, the insurance industry as a whole was
restricted only to government-owned companies. In 2000, the
government allowed private players to enter the market, but
foreign direct investment was limited to 26 percent, requiring
most foreign players to enter into joint ventures with local
firms. In 2005, Finance Minister Chidambaram pledged to raise
the cap to 49 percent, which would require legislation amending
the 2000 Insurance Act. However, resistance from the Left
parties prevented Chidambaram from even introducing the proposed
legislative change. After the Left parties withdrew from the
coalition government in July this year, Chidambaram renewed his
commitment to seeing the insurance FDI cap raised. The odds of
getting any legislation introduced and passed in one
parliamentary session are very slim, though. (Ref A).
Insurance companies have generally supported the passage of this
bill, as all but two private life insurance companies and one
private general insurance company are currently at or near the
26 % maximum.


4. (SBU) Congenoffs spoke with several life insurance players,
most of whom thought it is unlikely that the bill will pass this
year, assessing that the BJP was simply unwilling to cooperate
after their loss in the trust vote. The lone exception to this
came from Gaurav Garg, CEO and Managing Director at Tata AIG
Insurance, who said that the BJP would not obstruct the passage
of the bill because if the BJP wins elections, they are also
likely to pass the insurance bill. Thus, the BJP has an
incentive to have the bill passed under the Congress government
so that they-the Congress party- will have to expend their
political capital (Note: In Ref B, another Tata AIG executive
discussed lobbying the BJP to pass the insurance bill). Shikha
Sharma, managing director at ICICI Prudential Life Insurance
noted that the bill would be good for the industry not just
because of the increased FDI cap, but because the insurance
business is changing rapidly and the bill would give the
regulator more power, which is needed so that it can adapt
quickly to changing circumstances.


5. (U) Vimal Bhandari, Country Head for Aegon insurance, a
Dutch company with a joint venture with Religare Insurance, told
Congenoffs that about a third of insurance firms are currently
priced too aggressively by their domestic promoters to entice
their foreign partners to raise their stakes. Hence the 26
percent limit may not be currently binding. The bottom third of
companies (by valuation) are likely to be the most successful in
attracting additional equity, as foreign companies have a
long-term growth model for the sector. In general, he said, the
divergence between high-valuation and long-term growth models
has introduced strain in many joint venture relationships, which
raising the equity cap to 49 percent would not remove.


6. (SBU) Also at stake in the bill is a diversification clause
that would extend the period for which a single entity can own
more than 26% of an insurance firm. The IRDA Act of 1999 allows
a 10-year period of majority ownership to help build interest in
starting new firms, but many firms face forced divestiture next
year. Private insurance companies are eager to see the bill
remove the diversification requirement to maintain control over
any introduction of new ownership. Bennett, Managing Director
at Max New York Life told CONGOFF that most companies have MOUs
with their foreign partners giving them the option to buy at
market prices up to the 49 percent limit in the event that the
bill is passed. If current majority owners are forced to
divest, new ownership may attempt to renegotiate terms.


ULIPs Account for Bulk of Life Insurance Growth
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7. (U) Since the opening of the sector in 2000, private
insurers have gradually eaten into the market share of the
government-owned companies in two major areas: life insurance
and unit-linked insurance products (ULIPs). ULIPs combine a
basic life insurance policy with a mutual fund-like investment,
, so that a single premium will provide returns based both on
the success of the investment, and a benefit in the event of a
policyholder's death. According to the 2006-07 Annual Report
from the Insurance Regulatory and Development Authority -
India's insurance regulatory body- ULIP premiums grew from about
$400 million in 2003-04 to over $6 billion in 2005-06. ULIP
growth then leveled off to the still- brisk growth of 159
percent between 2005-06 and 2006-07.


8. (U) Rajeev Ahuja, an insurance specialist at the World Bank
in New Delhi, told Congenoff that the reason for the growth of
ULIPs was due to regulatory arbitrage. In opening up the
insurance market to private players, the government had not
established guidelines on the ratios of insurance and investment
for each ULIP. Private insurers therefore began offering
ULIPs that were insurance in name only, providing only token
insurance coverage with the majority of the premium going to a
capital markets investment. According to Ahuja, ULIPs quickly
became attractive because, unlike mutual funds, life insurance
products enjoy beneficial tax treatment. Other life insurance
products are forced to invest mostly in government-issued
securities, while the IRDA allows for more flexibility in the
instruments into which ULIP funds may invest. ULIPs were also
attractive from the insurer's perspective because, unlike most
insurance products, investment risk is born by the policyholder.
However, the rapid growth of ULIPs coupled with the lobbying
efforts of mutual funds made the IRDA take notice. In May 2006,
IRDA issued rules mandating-among other things-minimum insurance
coverage for ULIPs. This new regulation, combined with the
recent drop in equity markets, have helped slow ULIP growth in
this fiscal year.


Confusion Over Tax Treatment Between Mutual Funds and ULIPs.
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9. (SBU) Gary Bennett and Shikha Sharma, managing directors
respectively at Max NewYork Life Insurance and ICICI Prudential
Life Insurance, denied that ULIPs received special tax
advantage. Sharma, defensively, said that, in contrast,
equity-linked mutual funds have a tax advantages over ULIPs.
When asked why ULIPs had grown so much faster than mutual fund
products, they each argued that life insurers had simply been
more aggressive and had seen marketing opportunities that the
mutual funds had not and that life insurers had the advantage of
having a lot of physical infrastructure already in place to help
them push sales. Life insurance sales also provide better
commissions for the sales agents, providing an incentive to
market ULIPs more aggressively. [Note: Section 80C of the
Income Tax Act exempts both life insurance products and
equity-linked mutual funds from taxation. ULIPs are allowed to
invest tax free in debt. Debt-based mutual funds, by contrast,
are not exempted from tax. Recent press has speculated that the
mutual fund agency model impedes mutual fund market penetration.
End note.]


Misselling Worries Some Observers
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10. (SBU) With the rapid growth, several life insurance
company representatives expressed concern that poorly trained
sales agents were "misselling" insurance products. [Note:
Misselling happens when a customer buys a financial product
without understanding it, or when an insurance company sells a
product without an accurate presentation of the risk. End
note.] Shikha Sharma said she was pleased with the recent
slowdown in premium growth, as it gave ICICI time to ensure its
sales agents were acting appropriately. Gary Bennett said that
the education and training of life insurance sales agents was
not as rigorous is it should be, and that the standards the
government requires for the licensing of life insurance sales
agents should be higher. Gaurav Garg, of Tata AIG Insurance,
told Congenoffs predicted that the life insurance industry was
experiencing the "soft" part of the insurance cycle-a time of
great competition and low premiums that precedes a shock that
gives way to higher premiums and more stringent underwriting
standards. Bhandari of Aegon noted that under the current
agency model, the insurance sector is a high-cost, high-volume
business. This model requires any company wishing to establish
a national presence to have retail offices in at least 1100
cities. If IRDA would allow agents to cross-sell multiple
policies, this would bring costs down for the industry and
increase coverage.

LIC's Government Guarantee Still Provides Advantage
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11. (U) With over 86 percent of the market, LIC is still the
biggest player in the Indian insurance market. Despite the
opening of the sector, the company still enjoys some advantages
over private companies. Sharma and Bennett each noted that LIC
can claim a government guarantee, and does not have to retain
the same capital adequacy ratios as the private companies to
account for risk. N. Mohan Raj, Executive Director of
Investment Operations at LIC confirmed this. (Note: The Draft
Report of the Planning Commission's Committee on Financial
Sector Reforms recommends that the explicit government guaranty
of LIC liabilities-written into the LIC Act-be revoked. End
note.)


Comment
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12. (U) The failure to pass the insurance bill before the next
elections will probably not do irreparable harm to the insurance
industry. Life insurance premiums are growing healthily, even
without the hike in the equity cap to 49 percent. First-year
premiums collected in May 2008 were 23% greater than premiums
collected in May 2007, according to the latest data available
from the IRDA Journal. While this is much slower than the
growth rates of prior years, the industry may benefit from the
slowdown because it will give them time to focus on the quality
of their contracts, rather than the volume, and to battle
whatever misselling might be occurring. Allowing increased
foreign participation in the insurance market is a must from a
long-term perspective, and most observers Congenoffs spoke with
agreed that the FDI cap would be raised eventually, be it in a
BJP- or Congress-led government.

SIGNATURE