chapter 1 introduction, background & scope of the...

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Chapter 1

Introduction, Background & Scope of the Study

Section 1 - Introduction & Background

1.1 The Insurance Sector in India

It has now been more than a decade since the opening up of the insurance sector in India to the

private and foreign players in the year 2000. The past decade has seen considerable growth in the

insurance sector supported by a large number of innovative products, growth of new distribution

channels, better risk management mechanisms, strengthening of overall regulatory regimes etc.

All this can be characterized as a natural and positive outcome of increasing competition.

The insurance industry in India is divided into 2 basic sectors – Life Insurance and Non-life /

General Insurance.

Before year 2000, the insurance sector had only government-owned entities. LIC (Life Insurance

Corporation of India), formed in 1956, was the only life insurance provider. In the general

insurance space there were 4 public sector players after nationalization in 1973 - National

Insurance, New India Assurance, Oriental Insurance and United India Insurance.

All this changed in the year 2000 when private and foreign players were allowed to start operations.

A host of private players entered this market and things changed considerably since then (IRDA

Annual Reports - New Business & Gross Written Premium growth numbers, specified later in the

chapter).

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1.2 Changing Regulatory Landscape

The liberalization process brought out significant changes to the insurance regulatory landscape

whereby a separate legislation called the Insurance Regulatory & Development Authority Act,

1999 was enacted to protect the interests of holders of insurance policies, to regulate, promote and

ensure orderly growth of the insurance industry and to establish a separate regulatory authority

called Insurance Regulatory & Development Authority (IRDA) for carrying out the objectives of

the Act.

1.3 Foreign Ownership

Post liberalization, foreign companies are allowed to invest themselves or through subsidiary

companies or nominees, up to a maximum equity shareholding of 26%, resulting in private players

having presence in the form of joint ventures between Indian corporate houses and established

foreign insurance players. Foreign Direct Investment related decisions are often taken based on

the expert advice of the local consultant which typically involves analyzing investment structuring

and related aspects such as use of various financial instruments, investment through overseas

jurisdictions, ease of repatriation of funds etc. These decisions are crucial in terms of achieving

tax and regulatory efficiency at the investment stage itself.

1.4 Licensing Requirements

Every company desirous of carrying on insurance business in India is required to obtain a license

from IRDA. The licensing process generally takes 9-12 months and is carried out with the help of

a regulatory consultant. The minimum paid-up equity capital requirement under the Insurance Act,

1938 is Rs. 1.5 billion for life insurance business. (IRDA Registration of Insurers Regulations,

2001)

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Over the years, IRDA has framed detailed regulations and guidelines to regulate several important

aspects relating to carrying on of insurance business such as -

Reinsurance for life and non-life businesses

Insurance Brokers and Third Party Administrators

Preparation of Actuarial Report and Abstract

Assets, Liabilities and Solvency Margin of Insurers

Investment Regulations

Preparation of Financial Statements and Auditor’s Report of Insurance Companies

Distribution of Actuarial Surplus

Protection of Policyholders’ Interests

Licensing of Insurance Agents

Mergers & Acquisitions

Issue of Capital & Initial Public Offering

Banks as Insurance Brokers

New ULIP Guidelines & Regulations, October 2010

1.5 Growth and Evolution of Life Insurance Sector till FY 2011 (before change in ULIP

guidelines)

The insurance industry in India was opened up for private and foreign participation to ensure that

penetration and density increased further in line with the growth momentum of the economy.

Currently, the life insurance sector in India comprises of 24 companies including LIC.

The steady growth in Gross Written Premium (GWP) and New Business Premium (NBP) of the

life insurance sector till FY 2011 has been mapped in the graphs as below:

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Fig.1.1

Total Gross Written Premium of Life Insurance Sector till FY 2011(prior to new ULIP guidelines)

INR Billion

Source: IRDA Annual Report FY 2010-11, December 2011

Fig.1.2

Total New Business Premium of Life Insurance Sector till FY 2011 (prior to new ULIP guidelines)

INR Billion


141

430659

447599 536

97199 169 198 262

197

326

278

426

500728

2 0 0 1 2 0 0 2 2 0 0 3 2 0 0 4 2 0 0 5 2 0 0 6 2 0 0 7 2 0 0 8 2 0 0 9 2 0 1 0 2 0 1 1

ULIP Trad

338

756

937873

1099

1264

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Fig.1.3

Total New Business Premium of Private Life Insurers till FY 2011(prior to new ULIP guidelines)

INR Billion


As can be seen from the above New Business Premium graphs, there has been a positive growth

for the life insurance sector as well as private players till FY 2011. LIC always had a very strong

traditional products portfolio in addition to linked products, but the private players have mainly

grown by selling Unit Linked Insurance Plans (ULIPs) through equity, debt and balanced funds.

These numbers have been shown only till FY 2011 due to the fact that ULIP regulations changed

in October 2010, thereby completely changing the entire landscape and the way of doing life

insurance business, especially for the private players. The new ULIP regulations by IRDA have

been detailed in Chapter 2 - Literature Review. These regulations significantly affected the sector

growth post FY 2011, especially for private players. The business impact of new ULIP regulations

has been detailed and analyzed in Chapter 4 – Results & Discussion (Figures 4.20-4.44).

Till FY 2011, the development opportunity for life insurance coverage had been driven by the

continued growth of India’s population and economy. This increase in prosperity had been

combined with stringent regulations and unique product development in the insurance industry,

85

172

304 295 318271

03

1024

56

18

22

33 4766

123

2 0 0 1 2 0 0 2 2 0 0 3 2 0 0 4 2 0 0 5 2 0 0 6 2 0 0 7 2 0 0 8 2 0 0 9 2 0 1 0 2 0 1 1

ULIP Trad

103

194

337 342384 394

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which had helped develop the business to meet the changing coverage needs of India’s fast-moving

society. The development & growth of the life insurance industry in India can be attributed

primarily to better terms and the surge in availability of a wide variety of modern and new

insurance products including unit-linked products, whole life coverage, maximum net asset value

(NAV) guarantee, increased use technology for various operations including distribution,

improved financial literacy, insurance education etc. (Anant Gupta, 2011, Article on Indian

Insurance Sector, International Reinsurance Review, Euro money Yearbooks, England).

1.6 Improved penetration and density, but still trailing many economies

The total penetration and density of life insurance sector in India has increased from 2001 onwards

till 2012 as below, though it is still significantly trailing other countries:

Fig.1.4

Life Insurance Penetration in India (%)


2.15

2.59

2.26

2.53 2.53

4.14 4

4.64.4

3.43.17

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

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As can be seen from the above graph, the life insurance penetration (Total Premium/GDP)

increased to 4.6% in 2009-10, before showing a declining trend for the next 3 years, primarily

driven by negative growth in the sector due to change in ULIP regulations by IRDA in October

2010 (Chapter 4, Figures 4.43, 4.44).

Fig.1.5

Insurance Penetration in Select Countries


As can be seen from the above graph, the insurance penetration in India in 2012 is much lesser as

compared to other developed economies, also indicating that there is a huge untapped potential

and opportunity for the growth of insurance sector in India.

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Fig.1.6

Life Insurance Density in India (USD per annum)


Fig.1.7

Insurance Density in Select Countries


9.111.7 12.9

15.718.3

33.2

40.4 41.2

47.7

55.7

49

42.7

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

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1.7 Profitable Business Model: A Concern

Even though Indian life insurance companies had been performing well till FY 2011 and were

projected to grow through to 2020, the industry was not able to exactly find a solution to its

mounting profitability problems. Most private life insurance companies had pursued only top line

growth at any cost, thereby leading to inefficient business models and inferior operating margins

in comparison to international benchmarks. Overall, there had been a limited focus on the end

customer, with intermediaries and agents always given a more prominent role by life insurers. The

companies have not been successful in maximizing value from existing customers. Insurance is

still very much ‘SOLD’ in India, and not ‘BOUGHT’, with consumer centricity virtually being

non-existent in the industry. (Anant Gupta, 2011, Article on Indian Insurance Sector, International

Reinsurance Review, Euro money Yearbooks, England).

1.8 Exploring the Channels of Distribution

It is extremely important to take cognizance of the role of distribution in enhancing the domain of

life insurance. Although the tied agency style of distribution has been largely successful in the

monopolistic regime, the introduction of brokers, corporate agents, banc assurance and other

alternate channels of distribution have been seen to be contributors to the growth achieved in the

competitive era post Year 2000.

Alongside the emergence of these multiple channels, the distribution reach has increased nearly

six-fold for life, marking a shift in the gradual evolution of the Indian life insurance market from

a state monopoly into a truly competitive system. (Anant Gupta, 2011, Article on Indian Insurance

Sector, International Reinsurance Review, Euro money Yearbooks, England).

1.9 Unit Liked Insurance Plans (ULIPs)

An ULIP is a life insurance plan which provides a combination of life risk cover and investment.

The dynamics of the capital and stock markets have a direct bearing on the performance of the

ULIPs, with the investment risk borne by the policyholder. The investment is denoted by units

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earmarked separately for each policyholder and is represented by the value it has attained, which

is called as Fund Account Value. (Total Units * Net Asset Value/Unit).

The structure & design of an ULIP is explained as below:

Life insurance plan which provides a combination of life risk cover and investment;

Death Benefit – Higher of Sum Assured or Fund Account Value in Type I plans;

Total of Sum Assured & Fund Account Value in Type II plans.

Sum Assured is determined based on chosen multiplier applied to annual premium

(Minimum Multiplier is ‘10’ & ‘15’ depending upon the policy term – IRDA ULIP

Guidelines, 2010).

The investment risk is completely borne by the investor/policyholder.

The returns depend upon the performance of the funds in capital markets.

Choice of investing as a lump-sum (single premium) or making premium payments

regularly every year.

Fund Account Value and associated returns are currently exempt from Income-Tax

under the purview of a life insurance policy.

In an ULIP, the invested amount of the premiums after deducting all the charges and premium for

risk cover under all policies in a particular fund as chosen by the policy holders are pooled together

to form a Unit Fund. A Unit is the component of the Fund in a Unit Linked Insurance Policy.

The returns in ULIP depend upon the performance of the fund in the capital markets. ULIP

investors have the option of investing across various schemes - diversified equity funds, balanced

funds, debt funds etc.

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1.10 Structure of Charges in ULIPs

1) Premium Allocation Charge

A certain percentage of the first year premium and renewal premium is appropriated mainly

towards commission expenses and other selling costs, before allocating the units under the policy

(average PAC is approximately 5%-6% of FYP throughout the sector – ULIP sales brochures of

insurance companies).

2) Mortality Charge

This is the charge for the cost of insurance cover and depends upon number of factors such as age,

amount of coverage, state of health etc., levied on a monthly basis by way of cancellation of units

for each policy (ULIP sales brochures of insurance companies). This is also subject to service tax.

3) Fund Management Charges

Charges levied for the management of the fund on total Assets under Management (AUM) as %

p.a., and is deducted on a daily basis before arriving at the Net Asset Value (NAV) of the fund.

This is currently capped at a maximum of 1.35% p.a. by IRDA (IRDA ULIP Guidelines 2010 &

ULIP sales brochures of insurance companies). This is also subject to service tax.

4) Policy Administration Charge

This is the charge for regular administration of the policy and is levied by cancellation of units on

a monthly basis for each policy (ULIP sales brochures of insurance companies). This is either a

fixed amount or a percentage of premium or sum assured. This is also subject to service tax.

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1.11 Comparison of Indian ULIPs with Foreign VULs

ULIPs in India can be compared with a similar product in developed life insurance markets such

as USA or UK, commonly called as VUL - Variable Universal Life Insurance.

Variable Universal Life Insurance (VUL) is a type of life insurance that builds cash value. In a

VUL, the cash value can be invested in a wide variety of separate accounts, similar to mutual

funds, and the choice of which of the available separate accounts to use is entirely up to the contract

owner or policy holder. The 'variable' component in the name refers to this ability to invest in

separate accounts whose values vary—they vary because they are invested in stock and/or bond

markets. The 'universal' component in the name refers to the flexibility the owner has in making

premium payments. The premiums can vary from nothing in a given month up to maximums

defined by the Internal Revenue Code for life insurance. This flexibility is in contrast to whole life

insurance that has fixed premium payments that typically cannot be missed without lapsing of the

policy (although one may exercise an Automatic Premium Loan feature, or surrender dividends to

pay a Whole Life premium).

Variable universal life is a type of permanent life insurance, because the death benefit will be paid

if the insured dies any time as long as there is sufficient cash value to pay the costs of insurance in

the policy. With most if not all VULs, unlike whole life, there is no endowment age (which for

whole life is typically 100).

If investments made in the separate accounts out-perform the general account of the insurance

company, a higher rate-of-return can occur than the fixed rates-of-return typical for whole life.

The combination over the years of no endowment age, continually increasing death benefit, and if

a high rate-of-return is earned in the separate accounts of a VUL policy, this could result in higher

value to the owner or beneficiary than that of a whole life policy with the same amounts of money

paid in as premiums. Thus a VUL in some ways is similar to ULIPs offered in India.

There are differences in the regulations because life insurance companies are governed by different

regulatory bodies subject to the laws of each individual country. In USA, another use of Variable

Universal Life Insurance is among relatively wealthy persons who give money yearly to their

children to put into VUL policies under the gift tax exemption. Often this is done within a VUL

policy because this allows a tax deferral, provides for permanent life insurance, and can usually be

accessed tax-free by borrowing against the policy. VUL policies have a great deal of flexibility in

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choosing how much premiums to pay for a given death benefit. The minimum premium is

primarily affected by the contract features offered by the insurer. To maintain a death benefit

guarantee, that specified premium level must be paid every month. To keep the policy in force,

typically no premium needs to be paid as long as there is enough cash value in the policy to pay

that month's cost of insurance. In India, in case of non-payment of ULIP premium in any year, the

policy does not remain in force and the death benefit risk cover (Sum Assured) gets discontinued.

1.12 SEBI – IRDA Debate over Regulation of ULIPs

SEBI (Securities and Exchange Board of India) is the regulator of the capital markets in the

country. All the AMCs have to register their mutual fund products with SEBI before raising money

from the public against these fund offerings.

IRDA (Insurance Regulatory and Development Authority of India) is the sole regulator of all

insurance companies and their products including ULIPs. The debate between SEBI & IRDA

started in early 2010 when SEBI banned 14 life insurance companies from raising further money

from policyholders by selling ULIPs until registering them with SEBI, and thereby ruled that the

ULIPs should be regulated by SEBI, & not IRDA. This was primarily the effect of AMCs and

Mutual Funds filing a complaint with SEBI about regulation of ULIPs by IRDA. ULIPs were sold

essentially as mutual fund investment plans but masqueraded as life insurance plans with very high

agent commissions allowed by IRDA, whereas SEBI had completely eliminated commissions on

mutual fund plans. This resulted in a non-level playing field, entirely favoring ULIPs and

cannibalizing mutual funds. IRDA responded by asking the life insurers to ignore the SEBI ruling

and continue business as usual, which attracted Ministry of Finance to settle the debate.

In September 2010, the Government promulgated the Securities & Insurance Laws (amendment

and validation) Ordinance 2010 to make necessary changes in the RBI Act 1934, Insurance Act

1938, SEBI Act 1992 and Securities Contract Regulations Act 1956, to keep the ULIPs and similar

products under definition of the life insurance business. IRDA was made the sole regulator of

such products provided it made some desired changes in the ULIP guidelines and make it more

policy-holder friendly. (IRDA new ULIP guidelines have been covered in detail in Chapter 2 –

Literature Review).

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Till then, ULIPs had been sold in massive numbers from FY 2006-2011, as can be seen from the

graphs in Figures 1.2 & 1.3, especially by private life insurance companies, primarily as

investment and mutual fund plans that were tax-exempt under the disguise of a life insurance

policy. The first year commissions on ULIPs ranged between 25%-30% (Annual Reports of

Companies) and agents were mainly inclined to sell ULIPs, resulting in large scale top line

premium numbers for companies. Higher commissions in the first year resulted in low unit

allocations for policyholders, thereby making them lose money due to lower returns.

This change in ULIP regulations in October 2010 provided an opportunity for conducting an in-

depth study on the existing structure & design of new ULIPs, and also closely examine their

sustainability in future from the perspectives of all the 3 stakeholders – policy holder,

agent/distributor and the insurance company itself.

Section 2 - Scope of the Study

2.1 Scope & Relevance of the Research Study

This research on “Structure, Regulations and Sustainability of ULIPs in India” includes a

detailed study of Unit Linked Insurance Plans (ULIPs) under the new regulations with specific

focus on their structure and design (insurance & investment content), market-conduct

developments, tax concessions, with an ultimate objective of exploring whether the present ULIP

is really an insurance product or an investment product, and whether it is sustainable in future in

its current form, taking into account the different perspectives of life insurance companies, agents

& customers. In this context, in case if the present ULIPs are projected to be not sustainable in the

future, the researcher will examine and make recommendations for ULIPs that shall provide a

balance between insurance & investment content for the customer, and also make them attractive

for the companies and their agents to sell.

This study becomes directly relevant and significant in the light of changes in ULIP guidelines by

IRDA in October 2010, which resulted in a) lower commissions & charges, thereby threatening to

affect distribution and new business premium generation, and b) slight increase in death risk cover

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or insurance content. Hence it became pertinent to actuarially & statistically model & measure the

insurance & investment content in ULIPs, and also closely examine their sustainability in the

current structure and design.

This study measures the insurance and investment content in ULIPs of top life insurance

companies by using actuarial and statistical model for expected returns, in an attempt to

significantly add to the existing body of literature and work in India on ULIPs, which doesn’t

include this kind of detailed empirical analysis of Mortality-adjusted and unadjusted returns.

2.2 Research Problem Statement

In view of the above scope of the research study on “Structure, Regulations & Sustainability of

ULIPs in India”, the research problem or question is defined as below:

''Is the current ULIP in India really an insurance product or still very much an investment product,

designed for regulatory arbitrage?

In this light, is it really sustainable in the future?"

2.3 Research Objectives

1. To determine whether the current ULIP is really an insurance plan or primarily an

investment plan, based upon the insurance & investment content measured by using

actuarial and statistical model for expected mortality-adjusted & unadjusted returns.

2. To examine whether ULIP is sustainable in future in its current form and design from the

perspectives of agents, customers and life insurance companies.

chapter 1 introduction, background & scope of the...

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