In
moves that have surprised many, the UPA government has,
in the midst of a global financial crisis whose lessons
are still being distilled, decided to press ahead with
liberalization of the insurance sector. At the fag end
of its term and in a truncated parliament session that
has other important business to deal with, the government
appeared to be in a desperate rush to table two bills
to amend the laws applicable to the insurance sector.
The two bills—The Insurance Laws (Amendments) Bill and
the Life Insurance Corporation (Amendment) Bill—were
introduced in the Rajya Sabha and Lok Sabha respectively
on December 22 without adequate discussion in the midst
of the din generated by the BJP’s demand for the resignation
of Minority Affairs Minister A R Antulay. Whether consciously
or not, the BJP has helped the government to keep alive
the issue of insurance privatization.
While it is unlikely that the government would be able
to pass these bills during its current term, it has
by tabling them kept the process of insurance sector
liberalization and privatization open, despite the global
shift in favour of public ownership in the wake of the
financial crisis. The aim is obviously to keep the focus
on privatization with dilution of public control and
provision of a greater role for foreign firms in the
insurance sector. This emphasis comes through from the
four principal elements of the current legislative effort.
The first is to permit public insurance companies to
mobilize additional money from the markets. The second
is to relax the cap on foreign direct investment or
ownership by foreign players in the insurance sector
as a whole. The third is to reduce the capital requirements
for private players in certain areas, such as the health
insurance sector. And the fourth is to emphasis self-regulation
with capital adequacy over structural regulation of
the sector.
In the case of the general insurance sector, besides
raising the FDI cap from 26 to 49 per cent, the relevant
bill allows the four state-owned general insurance companies—Oriental
Insurance Company, New India Assurance, United India
Insurance and National Insurance Company—to tap capital
markets for funds after obtaining permission from the
government. The bill also allows insurance companies
"to raise newer capital through newer instruments
on the pattern of banks".
Moreover, in a move widely seen as aimed at helping
Lloyds of London in the first instance, the bill seeks
to allow foreign re-insurance companies to open offices
and conduct business in the country with a minimum capital
of Rs. 200 crore. Thus far, only the General Insurance
Corporation could provide reinsurance in India. In addition,
to make entry into the rapidly expanding health insurance
market easier for private players, the bill proposes
to reduce minimum investment limit for health insurance
companies from Rs. 100 crore to Rs. 50 crore. Also,
the bill seeks to do away with the requirement that
promoters have to divest specified part of their equity
after ten years, allowing promoters to retain control
of these corporations. Finally, as part of the new regulatory
framework, a Life Insurance Council and General Insurance
Council are to be set up as self-regulating bodies.
While these are major changes, the big story is what
this government or any version of it that may come to
power after the next election has in store for the Life
Insurance Corporation. The Life Insurance Corporation
Amendment Bill is presented as an innocent piece of
legislation aimed at increasing the capital base of
LIC, to bring it on par with private insurers. The problem
arises when this is read along with the changes being
pushed through in the general insurance sector. The
government plans to allow government-owned insurance
companies to mobilize money from the capital market,
allowing for a dilution of the government’s shareholding.
And this comes along with the decision to raise the
cap on foreign direct investment in the insurance sector
from 26 per cent to 49 per cent. If in time, these provisions
are extended to cover the LIC, the government would
recapitalize LIC not with its own money but with money
mobilized from the market and from foreign investors.
This fear stems from the implicit effort to homogenize
the insurance sector, bringing the LIC on par with the
private sector. This does signify a move to accelerate
the shift in the form of regulation away from direct
control through public ownership of institutions in
the life and general insurance sectors to self-regulation
based on IRDA norms and guidelines and capital adequacy
requirements. The use of capital adequacy is reflected
in the provision in the bill to cap the sovereign guarantee
provided to those insured by the LIC and replacing it
with a provision that a part of the surplus—which is
the excess of assets over liabilities actuarially calculated—must
be treated as a solvency margin and placed in a reserve
fund, which the corporation can access in times of need.
As of now, 95 per cent of these surpluses are distributed
to policy holders as bonuses and the rest is transferred
to the government as dividend against its Rs. 5 crore
investment. The bill provides for the transfer to policyholders
to be capped anywhere between 90 and 95 per cent, with
the balance divided between the government and the reserve
fund. Thus, state control and state guarantee are to
be replaced with self regulation, capital adequacy and
solvency margins. This is clearly a sign of long-term
intentions.
It should be clear that these bills are aimed at making
the insurance sector private dominated, self-regulated
and “competitive”. Is there a case for such a transition?
There is much evidence on the adverse consequences of
such competition and the beneficial effects of government
intervention in the insurance sector. The insurance
industry delivers "products" that are promises
to pay, in the form of contracts, which help lessen
the incidence of uncertainty in various spheres. The
insured pays to fully or partially insulate herself
from risks such as an accident, fire, theft or sickness
or provide for dependents in case of death. In theory,
to enter such a contract, the insured needs information
regarding the operations of the insurer to whom she
pays in advance large sums in the form of premia, in
lieu of a promise that the latter would meet in full
or part the costs of some future event, the occurrence
of which is uncertain. These funds are deployed by the
insurer in investments being undertaken by agents about
whose competence and reliability the policy holder makes
a judgment based on the information she has. The viability
of those projects and the returns yielded from them
determine the ability of the insurer to meet the relevant
promise. To the extent that the different kinds of information
required are imperfectly available, the whole business
is characterised by a high degree of risk.
This makes excessive competition in insurance a problem.
In an effort to drum up more business and earn higher
profits, insurance companies could underprice their
insurance contracts, be cavalier with regard to the
information they seek about policy holders, and be adventurous
when investing their funds by deploying them in high-risk,
but high-return ventures. Not surprisingly, countries
where competition is rife in the insurance industry,
such as the US, have been characterised by a large number
of failures. As far back as 1990, a Subcommittee of
the US House of Representatives noted in a report on
insurance company insolvencies revealingly titled "Failed
Promises", that a spate of failures, including
those of some leading companies, was accompanied by
evidence of "rapid expansion, overreliance on managing
general agents, extensive and complex reinsurance arrangements,
excessive underpricing, reserve problems, false reports,
reckless management, gross incompetence, fraudulent
activity, greed and self-dealing." The committee
argued that "the driving force (of such 'deplorable'
management practices) was quick profits in the short
run, with no apparent concern for the long-term well-being
of the company, its policyholders, its employees, its
reinsurers, or the public." The case for stringent
regulation of the industry was obvious and forcefully
made.
Things have not changed much since, as the failure and
$150 billion bail-out of global insurance major American
International Group (AIG) in September made clear. AIG
was the world’s biggest insurer when assessed in terms
of market capitalisation. It failed because of huge
marked-to-market losses in its financial products division,
which wrote insurance on fixed-income securities held
by banks. But these were not straightforward insurance
deals based on due diligence that offered protection
against potential losses. It was a form of investment
in search of high returns, which allowed banks to circumvent
regulation and accumulate risky assets. As the Financial
Times (September 17, 2008) noted, “banks that entered
credit default swaps with AIGFP could assure auditors
and regulators that the risk of the underlying asset
going bad was protected, and with a triple A rated counterparty.”
That is, AIG used policy-holder money and debt to invest
like an investment bank through its financial products
division. When a lot of its assets turned worthless
AIG could not be let go, because that would have systemic
implications. The alternative was nationalization.
It is in this background that we need to address the
question of the "efficency" of competition
from private entrants. To start with, against the promised
private gains in terms of the efficiency of service
providers, we need to compare the potential private
loss in the form of increased risk and the social loss
in the form of the inability of the state as a representative
of social interest to direct investments by the insurance
industry. Further, if insolvencies become the order
of the day, there could be private losses as well as
social losses because the state is forced to emerge
as the "insurer of last resort". The losses
may far exceed the gains, implying that the industry
should be restructured with the purpose of realising
in full the advantages of public ownership.
Yet India’s government pushes ahead with privatization,
despite the fact that there is no evidence of the nationalised
insurance industry failing on grounds of meeting its
obligations either to the insurees or to the government.
The LIC has not merely put at the Government's disposal
large volumes of capital for investment but also addressed
the problems of insurance for the poor. It is not only
the global experience with privatized insurance but
the Indian experience with nationalised insurance that
does not seem to matter. In the circumstance, the two
insurance bills appear to be declarations of India's
intentions to globalise further during the current Prime
Minister’s tenure, independent of the consequences for
its people.
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