Fdi in Insurance Sector

Project Report on FDI in Insurance Sector

Submitted in partial fulfillment of degree of B.Com (Hons.) At University of Delhi

Submitted by:

Under the guidance of -----------------------Department of Commerce -------------------------UNIVERSITY OF DELHI SESSION :- 2014-15

DECLARATION

This is to declare that the work entitled “FDI in Insurance sector” is based on my original work. Wherever assistance has been clearly acknowledged.

(Mentor) (Mentee)Content

1. 2. 3. 4.

Introduction Report Aim & Objectives Study Methodology Overview a. History of Insurance b. Registration of insurance companies c. Manner of calculation of twenty six percent equity capital held by a foreign company d. Fdi in insurance: how much to cap a critical appraisal

5. 6. 7. 8.

e. Present Condition Arguments for and against FDI in Insurance Sector Interpretation of data Conclusion Bibliography

INTRODUCTION The history of India’s political economy is replete with missed opportunities. The approach to growth and investment has been often stranded in the many romantic notions of self-reliance and what constitutes national interest. In every decade since Independence, the approach to foreign direct investment has been influenced by a mistrust triggered by a colonial hangover. Every time India has opened its doors – or windows if you please – to foreign investment, it has been characterized by gradualism in the wake of much opposition. The debates around opening or expanding FDI are similar – as it was when telecom or banking opened up for foreign investment. What is important to recognize is that every such initiative has been beneficial, delivering greater common good. India maintained a favourable policy towards FDI during the early plans, mare specifically till around the year 1967. FDI was regarded as indispensable for development and was thus welcome. But some preconditions were laid down to protect national interests. However from 1968 onwards, tight regulations were imposed on FDI and this phase continued till about 1980. Restrictions began to be relaxed on gradual liberalization introduced in the FDI sector between 1980 and 1990. And then with economic reforms initiated in July 1991, liberalization became the keyword. Ceiling on FDI in many sectors was raised, automatic approval was given for FDI inflow, and foreign technology agreements were liberalized. Foreign Investment Promotion Board was set-up. Many new sectors have been opened up for foreign direct investment. Higher economic growth is driven by competition and consumer choice. Competition drives efficiency and efficiency drives growth. This is true of every country that has done well economically. It is also true of India since 1991, in segments where competition has been introduced. Any attempt to artificially introduce protection always has costs. Inefficient producers are protected, but at the expense of consumers. Consumers suffer from higher prices, bad service and limited choice. This is straightforward under-graduate economic theory. The gains to inefficient producers are more than neutralized by losses to consumers, leading to an overall deadweight welfare loss to the country. In this argument, the colour of the competition, whether it is domestic or foreign, does not matter. In addition, there is the macroeconomic argument about a current account deficit having to be met through capital account inflows and non-debt-creating FDI inflows are preferable to debt-creating capital inflows. While these broad arguments about competition and FDI are accepted, the question to ask is, why should the insurance sector not be subject to these compelling arguments? Is there anything special about insurance that rational arguments should not be applied to this sector? In every sector where India has opened up to FDI, be it manufacturing or be it services, two propositions are empirically evident. First, liberalization helps consumers. Second, fears about inefficient producers being eliminated are also vastly exaggerated. Instead, producers of goods and services adapt and survive, based on access to capital, technology, knowhow, improved management practices and customer orientation. Therefore, protection not only

harms the cause of consumers, it also harms the cause of producers. There is no reason why insurance should be treated differently. And economic logic and rationale should not be conditional on whether one is within the government or is in opposition. Generally speaking FDI refers to capital inflows from abroad that invest in the production capacity of the economy and are “usually preferred over other forms of external finance because they are non-debt creating, non-volatile and their returns depend on the performance of the projects financed by the investors. FDI also facilitates international trade and transfer of knowledge, skills and technology.” India's foreign investment policy is fairly liberal, allowing up to 100% foreign investment in most sectors. However, some sectors have caps on FDI. The government also imposes caps on portfolio investments, within the FDI caps or separately, to cap total foreign equity in certain sectors. These caps apply mainly in areas considered strategic or sensitive, as well as to any investments considered to have national-security implications. In most sectors, investment up to the caps is permitted on the "automatic route", meaning that companies need only file papers with the central bank after investing. In areas that the government wants to monitor more closely, prior approval is necessary from the Foreign Investment Promotion Board. Foreign Direct Investment in India is allowed through four basic routes namely, financial collaborations, technical collaborations and joint ventures, capital markets via Euro issues, and private placements or preferential allotments. FDI inflow helps the developing countries to develop a transparent, broad, and effective policy environment for investment issues as well as, builds human and institutional capacities to execute the same. The insurance sector is of considerable importance to every developing economy; it inculcates the savings habit, which in turn generates long-term investible funds for infrastructure building. The nature of insurance business ensures constant inflow of funds - the payout is staggered and contingency related thereby making it readily available for investment on infrastructure building. Its contribution to GDP is quite significant. The Union government had opened up the insurance sector for private participation in 1999, also allowing the private companies to have foreign equity up to 26 percent. Following the opening up of the insurance sector, many private sector companies have entered the insurance business. The insurance sector has been a fast developing sector with substantial revenue growth in the non-life insurance market, but in spite of its huge population, India only accounts for 3.4% of the Asia-Pacific general insurance market's value. The cap on foreign companies equity stake in insurance joint venture is 26%, but is expected to rise to 49%. The investment pattern with regard to foreign direct investment (FDI) and inflows from non-resident Indians remains resilient and FDI inflows into the country grew by an impressive 145% between fiscal 2006 and 2007 and by a respectable 46.6% between fiscal 2007 and 2008. However, owing to the economic downturn, the growth in FDI inflows in fiscal 2009 slowed to 18.6% from the previous fiscal. Foreign investment, in addition to technological improvement and expertise, brings with it a plenty of risks. An increase in the size of foreign holding in the insurance sector will certainly expose the country to risks. At the same time, it is important to recognize that FDI in Insurance can address several issues

pertaining to the sector such as encouraging development of innovative financial products, improving the efficiency of the Insurance Search sector.

REPORT AIMS & OBJECTIVES The aim of this report is to provide an analysis the arguments for and against FDI in India's insurance sector. The report's objectives are to investigate the Indian insurance sector and review current policy and regulations with regards to foreign investors so as to gain an understanding of the current position on FDI, as well as an overview of the Indian system. This will be followed by an examination of the arguments both for and against changing current policy and improving the regulatory environment. This will enable us to assess the key factors to considered in making policy changes in the future.

of

be

The next objective will then be to compare the thoughts and opinions of people working within or alongside India's domestic insurance sector, via a survey, to interpret the domestic market sentiment towards foreign investment, and to explore thoughts on the issues faced by the sector. It will then be possible to consider what solutions could potentially resolve the issues.

STUDY METHODOLOGY Study Approach This particular study on FDI in India's insurance sector will utilize an inductive approach to the research, which should help to achieve the aim and objectives. The investigation will allow us to form a reasoned opinion as to what government policy changes are required to make the opening up of FDI in insurance as successful as possible for the India's economy. This study will be based predominantly on qualitative research techniques, using primary methods as well as secondary methods, in order to allow for an in-depth and insightful exploration of current issues surrounding FDI in India's insurance sector, and to assist in gaining an understanding of the 'sentiment' in India towards foreign investor and their potential impact on the insurance sector and wider economy. There will be a certain amount of quantitative analysis undertaken with the data received from the proposed research survey. The survey based on closed-ended-question only. The report hopes to establish if there is a genuine argument for government policy to change in favor of FDI in insurance sector, to assess and make recommendations of changes to current policy, and to consider the risks to India's economy, and society, with a view to encouraging 'socially responsible investment'. To initiate this study, three questions were originally designed to help construct aims and objectives, and to provide some initial focus. The three questions were: 

Are you aware about FDI in Insurance Sector?



Are you aware of the current FDI in Insurance Sector Regulation policy?



Do you think that FDI is required in Insurance Sector?

Primary data The primary data that I collected were the first hand information, which I received through personal interviews with the agents and through questionnaires. This data gave the most vital information for making my analysis of the prevailing FDI in India's insurance sector behavior of the agents.

Secondary data

a) Internet:- Searching the internet extensively the starting point of this research and provided some valuable secondary data. Website such as the Government of India's Ministry of Finance www.finmin.nic.in which provides information on current FDI policy through the Foreign Investment Promotion Board (FIPB), and also provides press releases and data and statistics have been useful. The report also references some small domestic industry group's website useful, and other trade lobby sites. One particular notable internet resource was the Center for Policy Alternatives (www.cpasind.com) which have provided particularly informative reports on some of the key issues with FDI in Indian insurance sector b) Academic textbooks:- There is a vast amount of literature on FDI in general; however there is less on FDI in India, and limited amounts that are specifically focused on the insurance sector. The available texts on general FDI were useful background research though.

OVERVIEW History of insurance A contract of insurance may be defined as a contract whereby, one person, called the ‘insurer’, undertakes, in return for the agreed consideration, called the ‘premium’ to pay to another person, called ‘assured’, a sum of money or its equivalent on the happening of a specified event. The aim of all insurance is to make provisions against dangers which beset human life and dealings. Those who seek it endeavor to avert disasters from themselves by shifting possible losses on the shoulders of others who are willing for pecuniary consideration, to take risk thereof, and in the case of life assurance, they endeavor to assure to those dependant on them a certain provision in case of their death, or to provide a fund out of which their creditors can be satisfied.

A.Ancient India In India, insurance has a deep-rooted history. It finds mention in the writings of Manu (Manusmrithi ), Yagnavalkya ( Dharmasastra ) and Kautilya ( Arthasastra ). The writings talk in terms of pooling of resources that could be re-distributed in times of calamities such as fire, floods, epidemics and famine. This was probably a pre-cursor to modern day insurance. Ancient Indian history has preserved the earliest traces of insurance in the form of marine trade loans and carriers’ contracts. Insurance in India has evolved over time heavily drawing from other countries, England in particular.

B. The British Period 1818 saw the advent of life insurance business in India with the establishment of the Oriental Life Insurance Company in Calcutta. This Company however failed in 1834. 1870 saw the enactment of the

British Insurance Act. This era, however, was dominated by foreign insurance offices which did good business in India. The Indian Life Assurance Companies Act, 1912 was the first statutory measure to regulate life business. In 1928, the Indian Insurance Companies Act was enacted to enable the Government to collect statistical information about both life and non-life business transacted in India by Indian and foreign insurers including provident insurance societies. In 1938, with a view to protecting the interest of the Insurance public, the earlier legislation was consolidated and amended by the Insurance Act, 1938 with comprehensive provisions for effective control over the activities of insurers.

C. The Nationalized Era The Insurance Amendment Act of 1950 abolished Principal Agencies. However, there were a large number of insurance companies and the level of competition was high. There were also allegations of unfair trade practices. The Government of India, therefore, decided to nationalize insurance business. An Ordinance was issued on 19 th January, 1956 nationalizing the Life Insurance sector and Life Insurance Corporation came into existence in the same year. The LIC absorbed 154 Indian, 16 non-Indian insurers as also 75 provident societies—245 Indian and foreign insurers in all. The LIC had monopoly till the late 90s when the Insurance sector was reopened to the private sector.

D. The Liberalized Era This millennium has seen insurance come a full circle in a journey extending to nearly 200 years. The process of re-opening of the sector had begun in the early 1990s and the last decade and more has seen it been opened up substantially. In 1993, the Government set up a committee under the chairmanship of RN Malhotra, former Governor of RBI, to propose recommendations for reforms in the insurance sector. The committee submitted its report in 1994 wherein, among other things, it recommended that the private sector be permitted to enter the insurance industry. They stated that foreign companies be allowed to enter by floating Indian companies, preferably a joint venture with Indian partners. Following the recommendations of the Malhotra Committee report, in 1999, the Insurance Regulatory and Development Authority was constituted as an autonomous body to regulate and develop the insurance industry. The IRDA opened up the market in August 2000 with the invitation for application for registrations. Foreign companies were allowed ownership of up to 26%. In December, 2000, the Subsidiaries of the General Insurance Corporation of India were restructured as independent companies and at the same time GIC was converted into a national reinsurer. Parliament passed a bill de-linking the four subsidiaries from GIC in July, 2002.

Today there are a number of private sector insurance companies. The table below shows the breakup of insurance companies:-

No of Public Sector

No of Private Sector

Companies

Companies

Life Insurance

01

20

21

General Insurance

06

14

20

Re insurance

01

00

01

Total

08

34

42

Type of Business

Total Companies

REGISTRATION OF INSURANCE COMPANIES Section 14(2) of the Insurance Regulatory and Development Authority Act, 1999 states that the authority shall have the power and function to issue to the applicant a certificate of registration, renew, modify, withdraw, suspend or cancel such registration.

Procedure for registration An insurance company must be first incorporated under the Companies act 1956 and must also be registered with the Insurance Regulatory and Development Authority (IRDA) which is governed by both the Companies Act 1956 and the Insurance Regulatory and Development Authority Act 1999. Section 3 of the Insurance Act provides that every application for registration shall be made in such a manner as may be determined by the irda and shall be accompanied by the documents mentioned therein. Separate Regulations are passed by IRDA called the IRDA Registration of Indian Insurance Companies Regulations 2000. As per that a new entrant Indian Insurance Company desiring to carry on insurance business in India shall make an application for registration in form IRDA/R1.This form requires the applicant to give his details prescribed therein with which the Insurance Regulatory and Development Authority will screen his status and if it is satisfied that he can carry on all functions in respect of the insurance business including management of investments with his own organization and is a bona fide applicant, and that his previous application has not been rejected in the previous five financial years, and his [previous certificate has not been withdrawn or cancelled and his name contains the words insurance

company or assurance company, the authority gives him an application for registration in form IRDA/R2; otherwise it will reject his application after giving him a reasonable opportunity for hearing as to why his application shall not be rejected. The order rejecting the application must be communicated to him by the Authority within 30 days of such rejection. The applicant on receipt of the rejection order may apply to the Authority within 30 days for reconsideration of its decision. An applicant whose application has been finally rejected may make a fresh application after a period of two years with a new set of promoters or for a new type of insurance business. If his application in form IRDA/R2 is accepted, the Authority will furnish him with an application in Form IRDA/R2. On receipt of application in form IRDA/R2, the authority makes an inquiry as it deems fit and if it is satisfied in that inquiry then may register the applicant as an insurer for the class of business for which the applicant is found suitable and grants him a certificate in form IRDA/R3. The certificate issued in the beginning will be valid for a year. Thereafter, there shall be an annual renewal.

Renewal of Registration An insurer, who has been granted a certificate under section 3 of the Act, shall make an application in form IRDA/R5 for the renewal of the certificate, to the authority before 31 December each year, and such an application shall be accompanied by evidence of the payment of the fee which shall be the higher of:



Fifty thousand rupees for each class of insurance business, and



One-fifth of one per cent of total gross premium written direct by an insurer in India during the financial year preceding the year in which the application for renewal of certificate is required to be made, or Rs. 5 crores, whichever is less; and in the case of an insurer solely carrying on reinsurance business, instead of the total gross premium written direct in India, the total premium in respect of facultative reinsurance accepted by him in India shall be taken into account.

Cancellation or Suspension of Certificate 

The registration of an Indian Insurance Company or insurer who:



Conducts its business in a manner prejudicial to the interests of the policy holders;



Fails to furnish any information as required by the authority relating to its insurance business;



Does not submit periodical returns as required under the Act or by the Authority.

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Does not cooperate in any inquiry conducted by the Authority;

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Indulges in manipulating the insurance business;

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Indulges in unfair trade practices;



Fails to make investment in the infrastructure or social sector specified under sub-s1 (a) of s. 27(d) of the Insurance Act.

may be suspended for a class or classes of insurance business for such period as may be specified by the Authority by an order.

MANNER OF CALCULATION OF TWENTY SIX PERCENT EQUITY CAPITAL HELD BY A FOREIGN COMPANY Regulation 11 of Insurance Regulatory and Development Authority (Registration of Indian Insurance Companies) Regulations, 2000 states that calculation of the holding of equity shares by a foreign company either by itself or through its subsidiary companies or its nominees referred to as foreign investor) in the applicant company, shall be made as under and shall be aggregate of: The quantum of paid up equity share capital held by the foreign company either by itself or through its subsidiary companies or nominees in the applicant company; the quantum of paid up equity share capital held by other foreign investors, non-resident Indians, overseas corporate bodies and multinational agencies in the applicant company; and the quantum represented by that proportion of the paid up equity share capital to the total issued equity capital of an Indian promoter company mentioned in sub-clause (i) of clause (g) of regulation 2 held or controlled by the category of persons mentioned in the two clauses above.

For purposes of calculation referred to above, account need not be taken of the holdings of equity in an Indian promoter company held by foreign institutional investors, other than the foreign promoters of the applicant and their subsidiaries and nominees, and Indian mutual funds to the extent the investment of foreign institutional investors and Indian mutual funds are within the approved limits laid down by the Securities and Exchange Board of India under its rules, regulations or guidelines issued from time to time.

FDI IN INSURANCE: HOW MUCH TO CAP A CRITICAL APPRAISAL In India, FDI in insurance sector is allowed up to 26 % at the present. But compared to other sectors like call centers, BPOs, pharmaceuticals, power, hotel and tourism where FDI up to 100% is allowed, this is much lower.

General Overview of the Problem There are sub-plots within the main story, as the insurance industry considers whether or not the FDI cap in the insurance sector will actually be raised. The common man's picture of the fight for FDI was seen solely as a political one -- where the Left is acting spoilsport in raising the FDI cap from the current 26 percent to 49 per cent. The reality, however, is that the industry is as divided as the political parties. Indian corporate chiefs like Deepak Parekh and Rahul Bajaj are keen to dilute their holding in their respective insurance joint ventures. At the same time, they want to maintain their majority stakes.

It is the smaller players who are eager for a hike in the FDI cap. The current FDI limit will restrict the growth of private insurance players because a sizeable working capital is required, points out Philip G Scott, group executive director, Aviva Plc. He admits that growth at Aviva could suffer. "We have contingency plans in place but in a worst-case scenario, business will need to grow much more slowly if FDI is not raised," he adds. Aviva is a 26:74 joint venture with the Dabur group. Foreign partners are equally keen to increase their share in insurance joint ventures to make current investments worthwhile. "Raising the FDI cap will give confidence to foreign investors to do business on a scale that is not restrictive," says Sunil Mehta, country head, AIG. His view is shared by a number of global chiefs who have of late visited India and met the regulator. There is some hesitancy among international investors who have a limited appetite to invest in equity capital, bring in the necessary IT and expertise, when they can have only 26 per cent stake. "There are many more choices for us globally to deploy capital where we can best achieve the interest of shareholders," says Aviva's Scott. Another development, which is adding to the discomfort to foreign players, is the acute shortage of domestic partners which can invest 74% of the initial capital of $22.7 million. This shortage of domestic players has increased the valuation of the stakes to be hold by domestic players. The overseas partners are prepared to pay high premium from the day one to the domestic partner and if it is ready to pull out of the existing partner the valuation stake is still higher. This is also luring the domestic players to look for a new partner.

Problems of Raising the Capt to 49%. At the moment, Indian promoters are apprehensive that should FDI be raised, foreign partners will have an upper hand in the 10th year of operation. Their concern follows the Insurance Act dictating the dilution of Indian promoters' stake in favor of the general public. This means that while Indian promoters would end up holding 26 per cent according to the IRDA Act, their foreign counterpart could have a higher stake of 49 per cent. Describing all the impacts of a potential lifting of the cap is rather tricky, as the main problem with this policy decision is that it is difficult to separate the costs and benefits of FDI versus those of increased FDI. There is a "tipping-point" where the domestic industry loses economic control of the sector and that is where the cap should be placed. The Indian government has estimated this point to be 51%, thus placing the cap at 49%.C S Rao, chairman of Insurance Regulatory and Development Authority, says in response to industry's apprehensions that the clause would necessarily be amended, "else both the shareholders will need to bring down their respective holding to 26 per cent." The IRDA Act had not visualized foreign holding rising from the current 26 per cent to 49 per cent. At the same time, India Inc hopes to make a killing when it sells its stakes to foreign partners. "Dilution of shareholding will be at a premium. I cannot see Indian promoters diluting at par after having put in the majority of funds in the beginning when the venture was taking off," says Shikha Sharma, managing director, ICICI Prudential Life Insurance Company. Foreign partners have already indicated their keenness to raise their stakes, even if it is at a premium. Prudential Plc, the foreign joint venture partner of ICICI, has beefed up plans to hike its stake in ICICI Prudential Life Insurance Company.

Issue of Penetration of Insurance Markets to All Regions The insurers of India address issus of poor insurance penetration, low insurance density with hardly any insurance protection against natural calamities like droughts, floods, hurricanes and earthquakes. The insurance market is developing in the region only now and it has to be nurtured carefully. The nationalized companies did contribute to the spread of insurance beyond the metropolitan areas and succeeded in popularizing the concept in rural and semi-urban areas. There was, however, a huge gap between the potential available and its exploitation. The public sector companies had numerous problems such as over-staffing, inadequate infrastructure, and antiquated procedures. In the absence of competition the consumer didn’t benefit in terms of wider choice, lower price for insurance cover and adequate level of service. With the adoption of the Insurance Regulatory and Development Authority (IRDA) Act in April, 2000, the insurance market was opened up to the private sector with limited exposure to foreign equity. The insurance premium in India accounted for a mere 2 per cent of GDP as against the world average of 7.8% and G-7 average of 9.2% during 90s. The insurance premium as a percentage of savings in India is 5.95% as compared to 52.5% in UK. The nationalized insurance companies could barely unearth the vast potential of the Indian population since the policies lacked flexibility and the Indian life insurance products were not linked to the contemporary investment avenues. In 2013, the Indian economy is expected to touch $ 2 trillion in GDP. Yet for the size of the economy and its potential, India has an abysmal level of insurance penetration and density. Total penetration at 5.1 percent is less than world average of 6.9 per cent. Remember India is currently among the top ten economies in nominal GDP and fourth largest in terms of purchasing power parity. But in terms of penetration, it is ranked lower than South Africa and Taiwan. The World Economic Forum Financial Development Report 2012 ranks India 17th of 62 nations surveyed in life insurance penetration, 52nd in non-life insurance penetration and 50th in real growth of direct insurance premium – well below its potential and far below smaller economies. If one splits the penetration into segments of life and non-life the performance of “Life” at 4.4 per cent looks good. But one must remember that this is an economy with virtually no social security coverage and no pension benefits for those outside the organized sector. A 2008 survey by the National Council for Applied Economic Research with Max New York Life shows that while 78 per cent of the people were aware of life insurance ownership of products was only 24 per cent. To get a perspective of the scale of uncovered population, one must remember that less 11 per cent of the total workforce is part of the organized sector. The Economic Survey puts the total workforce in the organized sector at 28.7 million. The unorganized sector or the informal economy accounts for over 90 per cent of workforce and about 50 per cent of the national product. I am of the firm belief that it is possible to sustain a high level of growth in the insurance market in view of the large untapped potential. India is a nation of a billion people and is one of the fastest growing economies. It has a large middle class with high household savings rates and disposable incomes. The size of the family is shrinking and this section of the population is looking at opportunities for obtaining appropriate risk cover coupled with maximization of returns on their investments. Indian economy, predominantly an agrarian economy, offers enormous growth opportunities for the insurance sector. As

per experts, rural sector can become a prominent contributor in the overall growth of the insurance industry in India, provided the needs & occupational structure of people living in villages is understood.

Problem of Investment of the Funds collected by the Insurance Companies The insurance sector has been an important source of low cost funds of long-term maturities all over the world. In the Indian context, however, the insurance companies, particularly in life insurance, apart from covering risk are also committed to repayment of the principal with interest although with long maturities and thereby tend to act as investment funds. One of the reasons that this has happened is that the average premium charged by the insurance companies in India tends to be relatively high due to obsolete and rigid actuarial practices and inefficient operations. There is pressing need to reorient the insurance sector in a manner that it fulfills its principal mandate of providing risk cover. The opening up of the insurance sector to private participation, including banks in August 2000 has been able to instill an element of competition which in turn is promoting efficiency and professionalism and enhancing consumer choice through product innovation. In my opinion India is hungry for Long term capital needs to fund the building of infrastructures, which is the need of the hour. Infrastructure or the lack of it has been the brake, which have hindered the leap of the Indian Economy. Despite shortcomings, Indian Economy has come a long way, but every industry leader would crib at the infrastructure bottlenecks that they have face everyday in their effort for growth.

Should the FDI Limit be Increased The opening up of the cap on FDI investment in India from 26 to 49% has been discussed and rediscussed. The main concerns with this liberalization are political rather than purely economic in nature, although there are distributional impacts to be considered.

In my opinion increasing the FDI limit would be an appropriate measure which would be in the interest of the country. We already have a strong regulatory body and there are big Insurance companies already knocking at our doors. Also, LIC is already big enough that it shouldn't be scared of competition. With the kind of brand recognition, penetration and trust that LIC commands in India, it shouldn't really be a big deal. Growing steadily, the insurance sector in India is one of the most talked of sectors amongst the foreign investors. Numerous opportunities are available in this sector for both domestic as well as international players. Traversing a full circle, from a liberal competitive market to nationalization and then back to liberalization, the insurance sector in India has shown rapid expansion over the past few years. Increasing demand of consumer and industrial products and services plus elimination of a few of the trade and investment barriers have been the main drivers behind the exponential growth of the insurance sector in India. By only Increasing the FDI in Insurance, we could even wait out a little longer on the FDI caps in other sectors. By increasing the FDI in Insurance, that would take care of the year's FDI target of the country in one go. But that is not the reason why I say that increasing the FDI in insurance only would affect a lot of other Industries in a positive way, and that we could even do without the FDI in many other sectors for some time, Real estate for one. FDI in insurance would increase the penetration of Insurance in India, where the penetration of Insurance is abysmally low with insurance premium at about 3% of GDP against about 8% global average. This would be through better marketing effort by MNCs, better product innovation, consumer education and so on. By more investment in the investment sector, India would get adequate supply of long term capitals, which India currently needs very badly. It is to be remembered that people generally invest for long term in insurance policies, say for around 30 years. From the perspective of the domestic private players, FDI is instrumental in filling the savings-investment gap in developing countries, and facilitates mobility of long-term capital flows into the destination economy. Thus, a higher FDI cap would lower the entrylevel barriers to insurance as well as allow domestic players to recapitalize their firms. Also, private sector players in the insurance markets are now beginning to look at savings-linked and pure risk policies in order to diversify their markets. These are capital intensive ventures, and most firms are relying on FDI to provide the required capital. The impact on the LIC and GIC is again, very controversial. Since 1999, these two companies have seen a turn-around in their levels of product diversification, service packages and customer service. They still retain the largest market share in the sector, and many consumers view this turn-around as positive. Product range and diversity has increased substantially since the opening up of the insurance sector. The advent of competition has ensured that consumer needs are catered to, and now there are specific packages that are tailored to targeted consumer groups. The hiking of the cap will introduce more players into the market and this would increase consumer surplus significantly. FDI has been seen to be beneficial to the recipient nation because of the positive technology spillovers generated. This is particularly applicable in the Indian context as since the industry has been opened up, the perception of insurance has changed from just a practice of "risk reduction" to a method of short term

profit-oriented investment. There are huge varieties of both life and non-life insurance policies and packages, and measures like banc assurance, unit linked insurance, savings linked insurance and the like are being introduced to great success. The entry of a large number of Indian and Foreign private companies in life insurance business has to lead greater choice in terms of products and services. In the years since the IRDA Act initiated market reforms, the insurance sector has experienced some remarkable changes. The premium underwritten in India and abroad by life insurers in 2006-07 has grown by 47.38 per cent as against 27.78 per cent in 2005-06. First year premium including single premium accounted for 48.45 per cent of the total life premium, whereas renewal premium accounted for the remaining. First year premium including single premium recorded a growth of 94.96 per cent in 2006-07 compared to 47.94 per cent in 2005-06, driven by a significant jump in the unit-linked business. The private life insurers have increased their market share from 14.25 percent in 2005-06 to 18.08 per cent in 2006-07. This has not affected the growth of LIC, as the premium collected by LIC in 2006-07 has increased by 40.79 per cent over the premium collected in 2005-06. In the case of general insurers the growth was 21.51 per cent as against 15.62 per cent in the previous year. In 2006-07, the four public sector general insurers had reported a growth of 8.18 per cent (6.87 percent in the previous year) in underwriting of premium within and outside India whereas eight private sector insurers reported a growth of 61.24 per cent. The market share of private insurers had increased to 34.72 per cent compared to 26.34percent in 2005-06 implying a decline in the market share of the public sector insurers. The number of policies underwritten by the private insurers increased by 51.48 per cent whereas it declined by 2.25 per cent for public insurers. The position has now gradually changed after the opening of the insurance sector markets, where in the first 2 years most of the private companies suffered losses and had a very small share of the insurance market. Now slowly the private companies by offering better products in a competitive environment have established their market share and even though LIC still is the market leader, but its share is gradually decreasing and private insurers are gaining the confidence of the consumers. In the light of these facts, I feel that it is now high time that cap on FDI in the insurance sector should be increased to 49%.

Effects of Opening of Insurance Sector to Foreign Investors More job opportunities:

Inflow of foreign capital



Indigenous reinsurance



Facilitate technology transfer



Wide distribution channel

PRESENT CONDITION Size of insurance sector in India Currently, only 26% of FDIs is permitted in insurance sector. Insurance is a US$41-billion industry in India, and Increased by 36% in 2006-07 over the previous year. Life Insurance-US$35 billion industry with US$24 billion accounting for First Year Premium. Non-Life Insurance-US$5.6-billion industry. The total insurance business would touch US$ 60 billion size. If insurance sector is opened up to an extent of 49% for FDIs, it is expected that FDI’s contribution to insurance business would touch nearly US$ 2 billion. In this paper we will examine the advantages and disadvantages of FDI in the insurance sector.

Competition in Insurance Sector Even after the liberalization of the insurance sector, the public sector insurance companies continue to dominate the insurance market, enjoying over 90 per cent of the market share. In fact, the LIC, which is the only public sector life insurer, enjoys over 98 per cent of the market share in Life insurance. According to the Annual Report of the IRDA, 9 out of the 12 private companies in life insurance suffered losses in 2002-03. The aggregate loss of the private life insurers amounted to Rs. 38633 lakhs in contrast to the Rs.9620 crores profit earned by life India Corporation. When we look at the profit ratios the public sector insurance companies have more profit and even in the private players say for Reliance have more profit but have no foreign equity. If profit is considered as one parameter to measure the performance then the cap on the FDI in insurance won't have any significant change.

Insurance Sector in India poised for tremendous expansion: IRDA has also notified Micro Insurance regulations facilitating insurers to tap the potential of rural markets. It is evidenced that micro insurance would facilitate access of insurance to rural and remote areas. Micro Insurance being an integral part of overall insurance system, attempts to offer the target specific insurance products at a moderately lower cost, for a lower coverage of amount. Foreign equity up to 26% is allowed in the insurance sector. The entry of foreign partners has resulted in the sector attracting FDI of US 543 million as on 31st March, 2007. The private companies have formed a niche for themselves. They have been able to increase their share in the insurance market in competition with their counterparts in the public sector. As a part of the reform process, premium rates for non-life insurance products have been de-tariffed w.e.f. 1.1.2007.Insurance sector though the growth in recent years has been significant; India is far behind the world averages and ranks 78th in terms of insurance density and 54th in terms of insurance penetration. The world averages are US $ 469.6 in terms of insurance density and 8.06% in terms of insurance penetration. Against this, insurance density was US$ 19.70 and insurance penetration was 3.17% in India for the year 2003. Even after the liberalization of the insurance sector, the public sector insurance companies have continued to dominate the insurance market, enjoying over 90 per cent of the market share. In fact, the LIC, which is the only public sector life insurer, enjoys over 98 per cent of the market share in Life insurance. Market Share of Life and non-Life Insurance Sectors (as % of total premium underwritten by insurers)

Given the huge market share enjoyed by the public sector companies, the argument, which is often made by advocates of greater liberalization, that the entry of private players would bring down the cost of insurance due to enhanced competition, does not seem to be convincing. The price making capacity of the market leaders in the public sector is likely to remain intact for the time being. The foreign insurance companies do have the reputation of charging less premium compared to the risks involved and promising abnormally high returns, in order to grab greater market share. Such competition, however, although

capable of bringing down the ‘cost’ of insurance for a while, has often led to gigantic frauds and bankruptcies. Moreover, as is the case in other markets, the initial flurry of entries into the Indian insurance market would invariably be followed by a phase of mergers and acquisitions that would lead to cartelisation, precluding the possibility of competition driving down the costs in the medium run. In the long run, other forms of non-price competition like aggressive advertisement wars, are likely to lead to increasing costs, eventually harming the interests of the consumers. These phenomena in the insurance market have been observed in several advanced countries. If the public sector companies start imitating the strategies of the foreign insurance companies in order to defend their market shares, it would be at the cost of undermining their important social objectives, which they have been fulfilling so impeccably till date.

Freedom for profit on sale of investments: To support general insurance players to be vibrant participants in capital markets, there is a requirement for specific release from income-tax on profit on sale of investments. The issue of acceptability of UPR (unexpired premium reserves) as per IRDA regulations rather than as per Insurance Act only, for IT deductions. The UPR is at present restricted to the extent of limits specified in rule 6E of the Income Tax rules due to which insurance companies need to pay tax beyond their profit disclosed in their audited accounts.

Implications for Resource Mobilization A major role played by the insurance sector is to mobilize national savings and channelize them into investments in different sectors of the economy. However, no significant change seems to have occurred as far as mobilizing savings by the insurance sector is concerned, following the liberalization of the insurance sector in 1999. Data from the RBI show that the trend of the savings in life insurance by the households to GDP ratio, while showing a clear upward trend through the 1990s signifying increasing business for the insurance sector, does not show any structural break after 1999 (see chart below). It can be inferred therefore that the foreign capital which flowed in after the opening up of the insurance sector has not been accompanied by any technological innovation in the insurance business, which would have created greater dynamism in savings mobilization.

Far from expanding the market for the insurance sector, the business activities of the private companies are limited in urban areas, where a fairly good market network of the public sector insurance companies already exists. The glaring evidence for this is the composition of agents operating in the insurance sector. According to the IRDA Annual Report the number of insurance agents in urban and rural India was in 100:76 ratio in the public sector companies, in 2001-02. For the private insurance companies this ratio was 100:1.4. Due to their urban-biased operational activity, the private insurance companies can neither increase the insurance base of the economy significantly, nor lead to substantial employment generation. Given this scenario, further increase in foreign participation is only going to lead to intensified competition for the urban insurance markets, rather than leading to a growth in overall savings. While the proposals for hike in FDI were placed, the arguments advanced were that FDI will continue to be encouraged and actively sought, particularly in areas of infrastructure, high

POLICY AND REGULATORY ENVIRONMENT technology and exports.

Alongside the Foreign Investment Promotion Board (FIPB) previously mentioned, there is also the Investment Commission which was established in December 2004 as part of the Ministry of Finance so as to facilitate and enhance investment in India. They make recommendations on policy and procedure to the Government and recommend projects that should be fast tracked through the approval process. They also assist in promoting India as an investment destination.

Diagram indicates the relationship among the elements influencing the formulation of foreign investment policy as was explained before. A summary of the relationship among the elements of economic policy and investment policy objectives, economic policy and investment policy means, investment environment and investment policy means, and investment environment and investment policy objectives is as follows.

Concept of FDI policies

a. Economic policy and investment policy objectives: the main reason for the government inducement of foreign investment is to achieve economic development by including it policies to improve employment rates, stabilize interest rates and foreign exchange rates, improve balance of payments, performing restructuring of industry and corporate. Accordingly, foreign investment policy can be a sub policy of national economic policy and on the same line; the investment policy objective can be one of the national economic objectives. Therefore, the investment policy cannot be established separately from the economic policy and it is restricted by the national economic policy. b. Economic policy and investment policy means: Investment incentive systems, i.e., tax reduction or exemption, government grants, and rental fee reduction or exemption for government property, as means for attracting foreign investment, can be non-compatible with other economic policy means which is designed to attain each economic objective. For example, granting tax reduction or exemption to a foreign investor as support means for attracting investment can be noncompatible with other economic policies established to form a sound national finance system. The investment incentive system, which supports green field investment, will not be helpful to an economic policy in which corporate restructuring is pursued in the M&A type. The investment policy means to attain investment policy objectives can be influenced by other national economic policies. c. Investment environment and investment policy means: Generally, degree of investment incentives offered to foreign investors by the host government and the attractiveness of investment location of the host country, which is in inverse proportion. If a country has a well developed consumer

market or the cost of production factor is low, attracting MNC is rather easy even without the special investment incentives. On the contrary, if a nation has unfavorable market size and production efficiency, it has to promote its location attractiveness through relatively enhanced investment incentives. The investment incentive can be not only an investment policy means but also an element composing the investment environment itself. d. Investment environment and investment policy objectives: Among the economic policy objectives, the investment environment influences investment policy objectives when the investment policy objectives to induce and attain foreign investment are selected. As the investment environment becomes more attractive, a few restrictions are only possible in selecting investment policy objectives from among the economic objectives. While the possibility is low for a country with a high level of technology to select high-tech and enhanced industrial structure as its investment policy objectives, the possibility is high for a nation with insufficient technology and industrial foundation to select hi-tech and enhanced industrial structure as its investment policy objectives. A typical example is Malaysia, which selected advancing industrial structure as its investment policy objectives to convert its labor-intensive industry structure to a capitalintensive industry structure. The Investment Commission (2009) believes the Foreign Investment regime in India as “one of the most transparent and liberal… among emerging and developing countries. Differential treatment is limited to a few entry 29 rules, predominantly in some Services sectors.” Currently, an application must be made to either the FIPB or the Secretariat for Industrial Assistance (SIA) depending on which Approval route is being used, providing the proposed details of investment, the business plan, financial and foreign company information, etc. A declaration is also required to confirm whether the applicant has previous collaborations or trade mark agreements in India in the same sector/field to which the application relates 30 (KPMG 2008) Foreign investment can be approved via one of two different routes:a) Automatic Approval route requires no prior approval, and filing of the investment details to the Reserve Bank of India (RBI) post-facto is literally for data records only. The automatic route is appropriate in any sector where there is no 'sector cap' i.e. sectors where 100% foreign ownership is allowed and some other specified sectors for example