Why allow entry to private players?
The choice between public and private might amount to choosing between the lesser of two evils. An insurance contract is a "promise to pay" contingent on a specified event. In the case of insurance and banking, smooth functioning of business depends heavily on the continuation of the trust and confidence that people place on the solvency of these financial institutions. Insurance products are of little value to consumers if they cannot trust the company to keep its promise.
Furthermore, banking and insurance sectors are vulnerable to the "bank run" syndrome, wherein even one insolvency can trigger panic among consumers leading to a widespread and complete breakdown. This implies the need for a public regulator, and not public provision of insurance. Indeed in India, insurance was in the private sector for a long time prior to independence.
The Life Insurance Corporation of India (LIC) was formed in 1956, when the Government of India brought together over two hundred odd private life insurers and provident societies, under one nationalized monopoly corporation, in the wake of several bankruptcies and malpractice’s'.
Another important justification for Nationalisation was to raise the much-needed funds for rapid industrialization and self-reliance in heavy industries, especially since the country had chosen the path of state planning for development. Insurance provided the means to mobilize household savings on a large scale.
LIC's stated mission was of mobilizing savings for the development of the country and also conducting business in the spirit of
1 A comprehensive historical account of Life insurance business in India and LIC in particular is provided in LIC (1970) and LIC (1991) respectively.
2 This latter emphasis on trusteeship was relevant then, in light of major insolvencies and fraudulent practices of so many private insurance companies prior to 1956.
ü Trusteeship
The non-life insurance business was nationalized in 1972 with the formation of General Insurance Corporation (GIC). Thus the fact that insurance is a state monopoly in India is an artifact of recent history the rationale for which needs to be examined in the context of liberalization of the financial sector. If traditional infrastructure and "semi-public goods" industries such as banking, airlines, telecom, power, and even postal services (courier) have significant, private sector presence, continuing a state monopoly in provision of insurance is indefensible.
This is not to deny that there are some valid grounds for being cautious about private sector entry. Some of these concerns are:
(a) That there would be a tendency of private companies to "skim" the markets; thus private players would concentrate on the lucrative mainly urban segment leaving the unprofitable segment to the incumbent LIC.
(b) That without adequate regulation, the funds generated may not be deployed in sectors (which yield long-term social benefits), such as infrastructure and public goods; similar without regulation, private firms may renege on their social sector investment obligations. Meeting these concerns requires a strong regulatory body. Another commonly expressed fear is that there would be massive job losses in the industry as a whole due to computerization. This however does not seem to be corroborated by the countries' experience'.
Moreover, apart from consideration based on theoretical principles alone, there is sufficient evidence that suggests that introduction of private players in insurance can only lead to greater benefits to consumers.
This can be seen from the fact that the spread in insurance in India is low compared to international benchmarks. The two convention measures of the spread of insurance are penetration and density. The former measure (premiums per unit) of GDP, and the latter, premiums per capita. Less than 7% of the, population in India has life insurance cover. In Singapore, around 45 per cent of the people are covered and in Japan, this is close to 100 per cent.
In the US, over 81 per cent the households have insurance cover. India has the biggest life insurance sector in the world if we go by the number of policies sold, but the number of policies sold per 10 persons is very low.
The demand for insurance is likely to increase with rising per-capita incomes, rising literacy rates and increase of the service sector, as has been seen from the example of several other developing countries.
In fact, opening up of the insurance sector is an integral part of the liberalization process being pursued by many developing countries. After Korean and Taiwanese insurance sectors were liberalized, the Korean market has grown three times faster than GDP and in Taiwan the rate of growth has been almost 4 times that of its GDP. Philippines opened up its insurance sector in 1992.
There are several other factors that call for private sector presence. Firstly, a state monopoly has little incentive to innovate or offer a wider range of products. This can be seen by a lack of certain products from LlC's portfolio, and lack of extensive risk categorization in several GIC products, such as health insurance. In fact, it seems reasonable to conclude that many people buy life insurance just for the tax benefits, since almost 35 per cent of the life insurance business is in March, the month of financial closing.
This suggests that insurance needs to be sold more vigorously. More competition in this business will spur firms to offer several new products, and more complex and extensive risk categorization. The system of selling insurance through commission agents needs a better incentive structure, which a state monopoly tends to stifle. For example LIC pays out only 5 per cent of its income as commissions, whereas this share in Singapore is 16 per cent, and in Malaysia it is close to 20 percent.
Private sector presence will also mean that the current investment norms, which tie up almost 75 per cent of insurance funds in low yielding government securities, will have to go. This will result in more proactive and market oriented investment of funds.
This needs to be tempered by prudential regulation to ensure solvency'. Of course, this also implies that cross-subsidising across policyholders of different types that is seen both in life and non-life insurance will diminish. Since public sector firms are required to sell subsidized insurance to weaker sections of society, a separate subsidy mechanism will have to be designed. The India Infrastructure Report (GOI, 1996) estimates that the funds required in the next two decades are more than Rupees 4000 billion.
Finally, private sector entry into insurance might be simply a fiscal necessity. Since large scale funds form long term contractual savings need to be mobilized, especially for investment in infrastructures the option of not having more (private) players in the insurance sector is too costly
The choice between public and private might amount to choosing between the lesser of two evils. An insurance contract is a "promise to pay" contingent on a specified event. In the case of insurance and banking, smooth functioning of business depends heavily on the continuation of the trust and confidence that people place on the solvency of these financial institutions. Insurance products are of little value to consumers if they cannot trust the company to keep its promise.
Furthermore, banking and insurance sectors are vulnerable to the "bank run" syndrome, wherein even one insolvency can trigger panic among consumers leading to a widespread and complete breakdown. This implies the need for a public regulator, and not public provision of insurance. Indeed in India, insurance was in the private sector for a long time prior to independence.
The Life Insurance Corporation of India (LIC) was formed in 1956, when the Government of India brought together over two hundred odd private life insurers and provident societies, under one nationalized monopoly corporation, in the wake of several bankruptcies and malpractice’s'.
Another important justification for Nationalisation was to raise the much-needed funds for rapid industrialization and self-reliance in heavy industries, especially since the country had chosen the path of state planning for development. Insurance provided the means to mobilize household savings on a large scale.
LIC's stated mission was of mobilizing savings for the development of the country and also conducting business in the spirit of
1 A comprehensive historical account of Life insurance business in India and LIC in particular is provided in LIC (1970) and LIC (1991) respectively.
2 This latter emphasis on trusteeship was relevant then, in light of major insolvencies and fraudulent practices of so many private insurance companies prior to 1956.
ü Trusteeship
The non-life insurance business was nationalized in 1972 with the formation of General Insurance Corporation (GIC). Thus the fact that insurance is a state monopoly in India is an artifact of recent history the rationale for which needs to be examined in the context of liberalization of the financial sector. If traditional infrastructure and "semi-public goods" industries such as banking, airlines, telecom, power, and even postal services (courier) have significant, private sector presence, continuing a state monopoly in provision of insurance is indefensible.
This is not to deny that there are some valid grounds for being cautious about private sector entry. Some of these concerns are:
(a) That there would be a tendency of private companies to "skim" the markets; thus private players would concentrate on the lucrative mainly urban segment leaving the unprofitable segment to the incumbent LIC.
(b) That without adequate regulation, the funds generated may not be deployed in sectors (which yield long-term social benefits), such as infrastructure and public goods; similar without regulation, private firms may renege on their social sector investment obligations. Meeting these concerns requires a strong regulatory body. Another commonly expressed fear is that there would be massive job losses in the industry as a whole due to computerization. This however does not seem to be corroborated by the countries' experience'.
Moreover, apart from consideration based on theoretical principles alone, there is sufficient evidence that suggests that introduction of private players in insurance can only lead to greater benefits to consumers.
This can be seen from the fact that the spread in insurance in India is low compared to international benchmarks. The two convention measures of the spread of insurance are penetration and density. The former measure (premiums per unit) of GDP, and the latter, premiums per capita. Less than 7% of the, population in India has life insurance cover. In Singapore, around 45 per cent of the people are covered and in Japan, this is close to 100 per cent.
In the US, over 81 per cent the households have insurance cover. India has the biggest life insurance sector in the world if we go by the number of policies sold, but the number of policies sold per 10 persons is very low.
The demand for insurance is likely to increase with rising per-capita incomes, rising literacy rates and increase of the service sector, as has been seen from the example of several other developing countries.
In fact, opening up of the insurance sector is an integral part of the liberalization process being pursued by many developing countries. After Korean and Taiwanese insurance sectors were liberalized, the Korean market has grown three times faster than GDP and in Taiwan the rate of growth has been almost 4 times that of its GDP. Philippines opened up its insurance sector in 1992.
There are several other factors that call for private sector presence. Firstly, a state monopoly has little incentive to innovate or offer a wider range of products. This can be seen by a lack of certain products from LlC's portfolio, and lack of extensive risk categorization in several GIC products, such as health insurance. In fact, it seems reasonable to conclude that many people buy life insurance just for the tax benefits, since almost 35 per cent of the life insurance business is in March, the month of financial closing.
This suggests that insurance needs to be sold more vigorously. More competition in this business will spur firms to offer several new products, and more complex and extensive risk categorization. The system of selling insurance through commission agents needs a better incentive structure, which a state monopoly tends to stifle. For example LIC pays out only 5 per cent of its income as commissions, whereas this share in Singapore is 16 per cent, and in Malaysia it is close to 20 percent.
Private sector presence will also mean that the current investment norms, which tie up almost 75 per cent of insurance funds in low yielding government securities, will have to go. This will result in more proactive and market oriented investment of funds.
This needs to be tempered by prudential regulation to ensure solvency'. Of course, this also implies that cross-subsidising across policyholders of different types that is seen both in life and non-life insurance will diminish. Since public sector firms are required to sell subsidized insurance to weaker sections of society, a separate subsidy mechanism will have to be designed. The India Infrastructure Report (GOI, 1996) estimates that the funds required in the next two decades are more than Rupees 4000 billion.
Finally, private sector entry into insurance might be simply a fiscal necessity. Since large scale funds form long term contractual savings need to be mobilized, especially for investment in infrastructures the option of not having more (private) players in the insurance sector is too costly