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By Madhusudhan Pillai
As of March 31, 2021, there were only 24 life and 34 non-life direct insurers in India, whereas there were 243 life insurance companies (1956) and 107 non-life insurance companies (1973) at the time of nationalisation. The full extent of the 49% FDI allowed with the Indian-owned and controlled regulation has been availed of only by nine of the 23 life and eight of the 28 non-life and health insurers.
The draft rules of the Indian Insurance Companies (Foreign Investment) Amendment 2021 to increase FDI in the insurance space to 74% provide that in any insurance company having foreign investment the majority of its directors and key management personnel (KMP) should be resident Indian citizens, including at least one among the chairperson of the Board, MD and the CEO. As per the FDI policy, this is linked to the Foreign Exchange Management Act 1999 and the Citizenship Act 1955, which covers Indian citizens who are resident in India for a period more than 182 days and technically limits foreign nationals to a minority in KMP and Board positions.
The conditions for companies with FDI over 49% in terms of safeguards is that not less than 50% of the Board should be comprised of independent directors, unless the chairperson is an independent director, in which case at least one-third should be independent directors. For such companies where dividend is proposed, a 30% higher solvency ratio is required, and if this is not maintained then 50% of the net profit of the financial year will have to be retained as general reserve. This is, however, based on an archaic compliance-based solvency approach rather than a risk-based approach, thereby meriting a review.
The risk-based capital (RBC) brings in quantitative capital requirements, risk management and governance standards, along with own risk solvency assessment with full disclosure. Processes would be in place, so that on an on-going basis risks are identified, measured, monitored and controlled, ensuring that the insurer maintains a capital adequacy level commensurate to their risk profile. In China, a process that began in 2012 was implemented in 2016 with the C-ROSS (China Risk Oriented Solvency System).
The first committee set up by the Insurance Regulatory and Development Authority (IRDAI) itself to look at RBC in 2011, which gave its report in 2014, noted that a snapshot of the financial position on the valuation date is insufficient evidence of appropriate risk-management processes, let alone being indicative of better financial strength. On June 10, 2016, another committee was formed to review market consistent valuation of liabilities, which submitted reports on November 19, 2016, and July 10, 2017.
On September 21, 2017, the IRDAI formed another committee to implement the RBC regime by March 2021. The IMF Financial Sector Assessment Program technical note 2018 had also recommended this move. Despite three IRDAI committees since 2011 set up to look at RBC, the proposed regulatory change in 2021 plans to use the existing yardstick as a measure of financial strength for retention of profits, and is not forward-looking.
The corporate governance requirements of a risk-based regime, once implemented, will ensure that regulated entities do indeed implement appropriate risk-management measures. Having 50% of the Board as independent directors, whether resident or non-resident, will not necessarily lead to such an outcome.
Transparency and disclosure
This is an important component of market discipline and conduct that will compel companies to manage their risks appropriately. The government had to infuse Rs 12,450 crore of capital (Rs 2,500 crore in FY19-20) in three public sector companies, along with forbearance by the regulator, to maintain solvency.
Claims of large corporate property accounts versus those of small and medium businesses indicate asymmetry with disproportionate benefits to large accounts. Retail health customers and especially policyholders over 50 years of age are made to pay a heavy price for renewals, indicating regulatory disservice to those with less bargaining power. Most private group health accounts lack transparency in pricing over the years.
This segment (excluding government business) with premium of Rs 25,880 crore and loss ratio of 99% in 2019-20 had losses ranging from 105% to 125% from 2013-14 to 2018-19, contributing to capital erosion. The non-life insurance sector as a whole has a combined operating ratio, i.e. claims plus management expenses, above 100% with an incurred claims ratio of 85.60% in FY2019-20. The Insurance Information Bureau can be used more effectively to aid transparency.
Intermediary regulations with myriad rules, asymmetries and porous rewards systems have led non-life business to cluster around larger intermediaries or aggregators. An insurance governance report submitted in October 2019 to the IRDAI noted that the top 10 direct brokers control 70% of the broking channels’ business, and in the motor business some channels exercise undue influence on customer choice. There is a need to synchronise the multiple regulations along the Insurance Core Principle 18 (ICP 18) of the International Association of Insurance Supervisors (IAIS).
The remuneration paid to intermediaries in both life and non-life insurance segments needs to be linked through a technology-enabled integrated matrix to the management expenses of insurers to prevent misallocation of returns. Despite fines being imposed on several insurers, deterrence as a tool of regulatory management is yet to be used effectively. Private equity has been funding losses of some private insurers and intermediaries with valuations sprinting ahead of fundamentals.
The number and value of all legal claims filed against insurers segment-wise will indicate the level of trust deficit in the sector. The IRDAI has also not taken any disciplinary action against any insurance company over the last ten years on grounds of non-compliance with the awards of insurance ombudsman.
The minimum capital required to set up an insurance company has also remained at Rs 100 crore since 2001, and even linking it to the Consumer Price Index would yield an equivalent figure of Rs 354 crore in 2021. Shaking off a languid approach to regulation in crucial areas and developing transparency in operations are keys to enable FDI and enhance insurance penetration.
The author is a senior insurance professional
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