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Sunanda K. Chavan
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Liberalisation of Insurance Industry - October 13th, 2010

Liberalisation of Insurance Industry

While no aspect of the reform process in India has gone smoothly since its inception in 1991, no individual initiative has stirred the proverbial hornets' nest as much as the proposal to liberalise the country's insurance industry. However, the political debate that followed the submission of the report by the Malhotra ComŽmittee has presumably come to an end with the ratification of the Insurance Regulatory Authority (IRA) Bill both by the central Cabinet and the standing committee on finance.

This section traces the evolution of the life insurance companies in the US from firms underwriting plain vanilla insurance contracts to those selling sophisticated investment contracts bundled with insurance products. In this context, it brings into focus the importance of portfolio management in the insurance business and the nature and impact of portfolio related regulations on the asset quality of the insurance companies.

It also provides a rationale for the increased autornatisation of insurance companies, and the increased emphasis on agent independent marketing strategies for their products. If politicised, regulations have potential to adversely affect the pricing of risks, especially in the non life industry, and hence the viability of the insurance companies. Finally, the backdrop of US experience provides some pointers for Indian policymakers.


The insurance sector continues to defy and stall the course of financial reforms in India. It continues to be dominated by the two giants, Life Insurance Corporation of India (LIC) and the General Insurance Corporation of India (GIC), and is marked by the absence of a credible regulatory authority.
The first sign of government concern about the state of the insurŽance industry was revealed in the early nineties, when an expert committee was set up under the chairmanship of late R.N.Malhotra.

The Malhotra Committee, which submitted its report in January 1994, made some far-Žreaching recommendations, which, if implemented, could change the strucŽture of the insurance industry. The Committee urged the insurance compaŽnies to abstain from indiscriminate recruitment of agents, and stressed on the desirability of better training facilities, and a closer link between the emolument of the agents and the management and the quantity and quality of business growth.

It also emphasised the need for a more dynamic manŽagement of the portfolios of these companies, and proposed that a greater fraction of the funds available with the insurance companies be invested in non government securities. But, most importantly, the Committee recomŽmended that the insurance industry be opened up to private firms, subject to the conditions that a private insurer should have a minimum paid up capital of Rs. 100 crore, and that the promoter's stake in the otherwise widely held company should not be less than 26 per cent and not more than 40 per cent. Finally, the Committee proposed that the liberalised insurance industry be regulated by an autonomous and financially independent regulatory authorŽity like the Securities and Exchange Board of India (SEBI).

Subsequent to the submission of its report by the Malhotra CommitŽtee, there were several abortive attempts to introduce the Insurance RegulaŽtory Authority (IRA) Bill in the Parliament. It is evident that there was broad support in favour of liberalisation of the industry, and that the bone of contention was essenŽtially the stake that foreign entities were to be allowed in the Indian insurŽance companies. In November 1998, the central Cabinet approved the Bill which envisaged a ceiling of 40 per cent for non Indian stakeholders: 26 per cent for foreign collaborators of Indian promoters, and 14 per cent for nonŽresident Indians (NRI’s), overseas corporate bodies (OCB’s) and foreign institutional investors (FII’s). However, in view of the widespread resentment about the 40 per cent ceiling among political parties, the Bill was referred to he standing committee on finance.

The committee has since recommended at each private company be allowed to enter only one of the three areas of business life insurance, general or non life insurance, and reinsuranceŽd that the overall ceiling for foreign stakeholders in these companies be reduced to 26 per cent from the proposed 40 per cent. The committee has also recommended that the minimum paid up share capital of the new insurance companies be raised to Rs. 200 crore, double the amount proŽposed by the Malhotra Committee.
Economic Rationale

The insurance industry is a key component of the financial infraŽstructure of an economy, and its viability and strengths have far reaching consequences for not only its money and capital markets,' but also for its real sector. For example, if households are unable to hedge their potential losses of wealth, assets and labour and non labour endowments with insurance contracts, many or all of them will have to save much more to provide for events that might occur in the future, events that would be inimical to their interests. If a significant proportion of the households behave in such a fashion, the growth of demand for industrial products would be adversely affected.

Similarly, if firms are unable to hedge against "bad" events like fire and the job injury of a large number of labourers, the expected payoffs from a number of their projects, after factoring in the expected losses on account such "bad" events, might be negative. In such an event, the private investŽment would be adversely affected, and certain potentially hazardous activities like mining and freight transfers might not attract any private investment. It is not surprising, therefore, that economists have long argued that insurance facility is necessary to ensure the completeness of a market.

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