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CHAPTER 3

INCREASING IMPORTANCE OF LIFE INSURANCE CORPORATION IN INDIA AND IN SELECTED ASIAN

COUNTRIES

3.1 Need of Insurance

As individuals it is inherent to differ. Each individuals

insurance needs and requirements are different from that of the

others. Insurance Plans and policies that talk to you individually and

give you the most suitable options that can fit your requirement.

What would happen to your family's financial health if you

and your income were gone? Could they maintain their

standard of living? Pay for college tuition? Household bills?

What about monthly mortgage or rent?

Having adequate life insurance coverage should be an

essential part of your overall financial plan - at every age.

And the sooner you buy, the better. That's because the

younger and healthier you are when you purchase coverage,

the less you'll pay in premiums. Some life insurance plans

also offer cash savings options, which means the sooner you

begin saving, the sooner the cash value of the plan can begin

growing1.

If you're working, your employer may provide you with a

life insurance policy as part of your benefits. But depending

1 Skipper, H., Jr., 1997, Foreign Insurers in Emerging Markets: Issues and Concerns, Center for Risk Management and Insurance, Occasional Paper, 97-102.

92

on your personal situation, that policy may not be adequate

for your unique situation and needs. Our Life Insurance

Needs Assessment Calculator can help you estimate your

life insurance needs based on your unique personal situation

and goals. If you find you need more than your employer

provides, check to see if they allow you to purchase

additional coverage. The rates for these "supplementary"

plans are often more affordable than what you could find on

your own.

It's important to review your life insurance needs regularly

to ensure your policy keeps pace with changes in your life.

For example, events like marriage, divorce, birth/adoption

of a child, reduction or increase in your income, children

entering or finishing college, and large purchases like a new

home can all impact the level of coverage you may need.

Depending on what changes have occurred, you may need

to reassess your coverage needs. The Calculator can help

you reassess your needs. At the same time, check your

beneficiary designation on your policy to make any

necessary updates to be sure your policy benefits are

distributed in accordance to your wishes2.

We're experts in life insurance coverage. For more than 90

years, we've worked with thousands of employers to provide cost-

2 Soo, H. H., 1996, Life Insurance and Economic Growth: Theoretical and Empirical Investigation, Doctoral Dissertation, University of Nebraska.

93

effective, quality life insurance coverage we believe is unsurpassed in

value. What makes our life insurance coverage so special?

Easy-to-understand materials and helpful tools to help you

understand coverage options so you can be confident your

family's financial health is protected.

Prompt, reliable service that ensures questions are answered

quickly and claims are paid promptly and accurately. Plus

legal and bereavement counseling for beneficiaries.

Value-added, no cost services that start working on day one to

help you better manage your life and health. Like tools to help you

prepare a will. And discounts for savings on fitness clubs, smoking

cessation, weight loss programs, and even massages. The Importance

of Life Insurance

When it comes to wealth management and financial planning ,

one of the most important, yet most overlooked products is life

insurance. It often serves as the foundation to any plan, and most

advisers consider it to be paramount in importance3.

The major reason one would acquire life insurance is to

protect his family after his death. Just think about it; how

would your family pay for your mortgage, school tuition or

even groceries if you were to suddenly pass away? A life

insurance policy would protect your loved ones financially

3 Ibid

94

and help them keep their present lifestyle without much

interruption. Life insurance would also cover any burial or

cremation expenses you may have upon your death--which

can often cost thousands of dollars.

Investment

If you decide to purchase an investment type of insurance,

called a whole life insurance policy, part of your premium

will go to an account that can be accessed later, even without

someone dying first. This can be used as a savings

instrument to accumulate substantial wealth or it can be

used in an emergency, such as a serious illness or disabling

injury. The benefit of this type of insurance is that if you

start early, even when you have no real beneficiaries, you

are building up value for yourself4.

Protecting Assets

You may have real and personal property that you would

not want to go to ruins if you should pass away. With a life

insurance policy, you can protect a home, boat, business or

any other property for which you have an outstanding loan

or tax bill or which requires significant upkeep. This

prevents your family or other beneficiaries from having to

sell the property because they cannot afford to pay for it.

4 Stiglitz, J. E., 1985, Credit Markets and the Control of Capital, Journal of Money, Credit and Banking, 17: 133-152.

95

Leaving a Legacy

People who purchase a life insurance policy may also be

interested in leaving a legacy behind by donating the

proceeds of their policy to a particular school or an

organization. In most states, such organizations receive the

sums tax free and you may be able to write off the premiums

from your taxes as well.

Proper Selection

With the importance of life insurance comes the importance

of shopping around. Make sure to talk to a number of agents

and compare various plans before deciding on a purchase, as

pricing and features can vary greatly. Also, make sure

whomever you speak with is a licensed insurance agent and

can provide you with the best policy for your specific

situation.

3.2 Interdependence of LIC and GIC

A number of factors that might be assumed to be strong drivers

of insurance market growth appear much less significant in practice,

including demographic factors, such as the share of the population

that is approaching or at retirement relative to the share that is

young, and the educational level of the population. Notably, social

provision of insurance, such as social security and government health

insurance, appears to grow in tandem with the provision of private

96

insurance perhaps because both are associated with increasing

incomes – rather than acting as substitutes as some have conjectured.

In addition, even though urbanization might be expected to lead to

growth in insurance coverage due to the associated separation from

traditional informal insurance practices prevalent in rural settings,

urbanization does not appear to be a significant driver5.

Variation in Insurance Coverage. Although the key drivers

noted above are relatively robust in explaining insurance market

coverage, nonetheless there is substantial variation in insurance

coverage among economies that cannot be fully explained by these

factors. This suggests some idiosyncratic factors may be at work.

Observers have noted an S-curve relationship between per capita

income and insurance penetration: insurance penetration is

moderately positively correlated with per capita income within the

group of low income countries and the same is true for the highest

income countries. However, within the group of middle income

countries, insurance penetration is strongly positively correlated with

per capita income. This S-curve is somewhat misleading however,

since it compares countries at different levels of per capita income,

but does not predict how insurance penetration will rise as an

individual country becomes wealthier over time. Indeed, even after

controlling for income, there is substantial heterogeneity in insurance

coverage between regions (with Latin America and the Middle East

5 Swiss Reinsurance Company, 2005, World Insurance in 2004: Growing Premiums and Stronger Balance Sheets, No. 2.

97

lagging behind) and even among different countries within regions (a

handful of countries in Latin America have much deeper insurance

markets than the remainder). Analysis of the heterogeneity even

within the group of relatively wealthy OECD member countries leads

some analysts to conclude that a full understanding of the

relationship between insurance and growth requires some analysis of

cultural and institutional characteristics within individual countries.

At minimum, the high degree of heterogeneity might suggest

that attitudes towards insurance and risk must be taken into account

in the development of country and regional insurance markets.

Related, it suggests an important role for industry wide initiatives on

consumer education and self-regulation in addition to the

development of trustworthy regulatory and supervisory frameworks

as the globalization of insurance markets proceeds.

Micro-Insurance The contribution of insurance to an economy’s

growth and efficiency is not the only entry point into its role in

development. The contribution of insurance to poverty alleviation

and the welfare of the poor is also potentially of considerable

importance, although the quantitative evidence on this point is not on

very firm grounding.

Nonetheless, case studies and other qualitative evidence make

a persuasive case that the potential social value of so-called micro-

insurance provision to poor households and small-scale

entrepreneurs warrants a great deal more experimentation with

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business models and products to develop scaleable approaches that

combine commercial and philanthropic elements6.

3.2.1 LIC—Its Track Record

LIC, set out with clear objectives, grew steadily and spread the

message of insurance to the farthest corners of the nation. From a

new business of Rs. 329 crore sum assured under 9.5 lakhs policies

procured during the period of 16 months from 1.9.56 to 31.12.57, LIC

progressed to the new business of Rs. 91,213 crore under 170 lakhs

policies in the year ending on 31st March, 2000. The first premium

received reached Rs. 4,959 crore compared to Rs. 13 crore in 1957. Its

rural business was significant, representing 16.7% of the total number

of policies. The bonus rates were n the rising curve. As a learning

organization, it took periodical steps to reorganize its functions and,

by empowering the staff, could take the range of services nearest to

the policy holders.

It was able to break new grounds in extending group and social

security schemes to the weaker sections. It has a vast network of 2048

branches, 100 divisions and seven zonal offices spread over the

country. Its marketing force consisted of over 19,000 development

officers and 8 lakh full-time and part-time agents7.

The vast premium income mobilized by LIC helped the nation

in economic development, especially in building up infrastructure. In 6 Ibid 7 Wacziarg, R., and K. H. Welch, 2003, Trade Liberalization and Growth: New Evidence, NBER Working Paper 10152.

99

1999-2000, its accumulated investment in infrastructure was Rs.

1,17,888 crore, helping the country in improving the quality of the

people at large through the enhancement of basic amenities like

potable water, drainage, housing, electrification and transport.

LIC has made notable contributions to the development of the

equity market. It has participated in the establishment of institutions

lie NSC, IDBI, UTI and NIA. LIC has taken advantage of information

and Technology and initiated measures for the convenience of the

policy holders.

3.2.2 GIC—The Four Subsidiaries

The general insurance business was only Rs. 24 crore by way of

premium in 1951. It rose to Rs. 130 crore at the time of nationalization

in 1971 when 108 private general insurance companies were

amalgamated into four public sector general insurance companies

with General Insurance Corporation of India as the holding

company. The four subsidiaries were, National Insurance Co. Ltd.,

New India Assurance Co. Ltd., Oriental Insurance Co. Ltd., and

United India Insurance Co. Ltd. They operate through 2699 branches,

1360 divisional offices and 92 regional offices. The Indian general

insurance market today is of about Rs. 20,000 crore as gross annual

premium out of which 73% is earned by public sector companies. A

peep into the share of different branches of business as at the end of

March 2006 indicates that contribution from motor insurance was

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43% followed by fire at 18%, marine at 6% engineering at 4% and the

rest, 18%.

The 'Slow' Progress

Despite all these achievements, the progress of the insurance

industry in this country was very slow compared to world standards.

By 2000, of the 100 crore people in India, hardly 25 crore were

covered by life insurance. The share of insurance funds in household

savings was 12.8% during 2000-2001.

There are two traditional ways to measure the role of insurance

in the economy. Insurance density shows the average annual per

capita premium within a country, converted from local currency into

US dollars. India occupies a very low position with $8.5 (2.4 non-life

and 6.1 for life) compared to Malaysia $140.4 (62.3 and 78) South

Korea $1,022.8 (262.3 and 760.5) South Africa $490.9 (77.9 and 413.0)

and China $13.3 (5.0 and 8.3).

The other index, insurance penetration, is the ratio of annual

gross insurance premium to the gross domestic product (GDP). The

country's life insurance premium was mere a 1.39% and for non-life,

it was still lower, at 0.6 per cent. The comparative figures for other

countries are: Malaysia (2.16 and 1.72) South Krea (8.39 and 2.89)

south Africa (13.92 and 2.62) and China (1.02 and 0.61). In1999, in the

global insurance market, the US accounted for one-third of the total

premium and Japan had 21.29 per cent share. India could account for

a mere 0.36 per cent only. So, the insurance industry, even in the

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nationalized set up, could not make the desired progress in keeping

pace with international standards.

The patterns of insurance coverage suggest a positive

correlation with income – at least up to a point where the value of

insurance begins to diminish relative to the value of overall

household assets. But this does not tell us anything about the

potential social value of insurance provision at lower levels of income

– only that poor consumers either do not or cannot purchase

insurance at currently prevailing prices and availability. Moreover,

insurance market development faces many special informational

challenges that have been extensively documented in economic

research even in wealthier countries. Put simply, insurance is likely

to be relatively more expensive – even prohibitively so - for low

income households and small-scale entrepreneurs because of the high

informational problems and transactions costs relative to the size of

the risk to be insured. As a result, most types of insurance are simply

not available to the vast majority of the world’s poorer citizens.In the

absence of risk pooling mechanisms, plunges in incomes due to

death, disability, and adverse agricultural outcomes often translate

into substantial decreases in consumption and investment that can

permanently set back a poor family’s livelihoods and prospects.

When drought or floods lead to low agricultural yields, critical health

interventions may be delayed, education of younger members of a

household put on hold indefinitely, and land, livestock or equipment

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permanently forfeited. Due to the catastrophic consequence of such

losses, there is extensive evidence that in the absence of formal

insurance poor households and communities attempt to ‘self-insure’

through a combination of building assets and diversifying sources of

income. The result most likely is investment in a set of lower risk but

also lower return activities – and even this degree of self-insurance is

highly incomplete.

There are also a variety of mechanisms that have emerged at

the community level, such as community pooling of informal

insurance contributions to cover burial costs. Community-based

insurance mechanisms surmount the problems of transactions costs

and lack of legally enforceable contracts through personal

relationships and piggybacking on traditional small-scale financial

collection mechanisms, similar to the early stages of micro-credit.

However, they offer only feeble protection in the face of community-

wide, covariate shocks, since they do not typically pool risk across

broader populations and are limited in the types of products they can

provide. For micro entrepreneurs and farmers, the net result can be a

significant drag on overall economic performance as they choose to

invest in activities that might offer the best risk-return profile from an

individual point of view but are sub optimal from an economy-wide

point of view where a higher returning but riskier set of investments

might lead to better aggregate outcomes.

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High transactions costs are the main impediment standing in

the way of a systematic shift from informal to formal mechanisms for

managing and pooling risk for poorer households and small

entrepreneurs. As such, the emerging field of micro-insurance faces

many of the same challenges faced by micro-credit two decades ago

in developing creative mechanisms for reducing or subsidizing

transactions costs. Indeed, micro-credit institutions are among the

first to venture into micro-insurance products, and their most

popular initial insurance product offering was ‘credit-life’ insurance

to pay off any debts associated with outstanding micro-credit loans in

the event of death.

As this field expands, it might follow a trajectory similar to that

of micro-finance, perhaps starting with NGO providers funded on a

philanthropic basis, but rapidly expanding to include commercial

partners as financial intermediaries as scaleable business models

emerge. In parallel, in some countries the public sector is taking a

greater interest in the provision of social insurance to poorer

populations – through subsidized public insurance schemes for

health, natural disasters, or weather-related crop insurance.

Government mandates for compulsory insurance also expand the

covered population although the difficulty of achieving risk-based

pricing can lead to market distortions8.

8 Ward, D., and R. Zurbruegg, 2000, Does Insurance Promote Economic Growth? Evidence from OECD Countries, Journal of Risk and Insurance, 67(4): 489-506.

104

Household Insurance:

Micro-finance providers and other community-based financial

intermediaries have begun to diversify into insurance products. In

Uganda, 2 million people have purchased life insurance bundled

with savings and micro-credit. Burial insurance is growing rapidly in

other areas, and there are some experiments with property insurance

such as for livestock and dwellings.

Natural Disasters, Weather, and Crop Insurance

There should be enormous potential for natural disaster and

weather insurance to improve the performance of lower income

economies, which tend to be more vulnerable to high volatility in

incomes due to commodity price fluctuations and natural disasters

due to poor building codes and infrastructure. Current investments

in new products and innovations in weather and natural disaster

insurance should be followed closely, as it is anticipated that climate

change will exacerbate the incidence of weather patterns and natural

disasters in many poor areas. In recent years, the World Bank and

other donors have been involved in experiments in countries such as

Turkey and Mexico that provide earthquake risk insurance financed

through a combination of reinsurance and the capital markets. In

areas of Asia and Africa, there is growing interest in weather

derivatives to insure against weather-associated agricultural losses.

These are designed to sidestep the traditional incentive (moral

hazard) problems associated with crop insurance by using

105

independent measurements of weather outcomes such as rainfall

rather than crop yields.

Health Insurance

As with the wealthier economies, the development of health

insurance markets in developing economies depends on the

composition of health delivery providers – whether private or public

– and the government’s involvement in health insurance provision.

However, there is a strong tendency in poorer economies for

households to bear responsibility for paying a much higher

proportion of overall health costs out of pocket than in richer

economies, which leads to under investment in health services

(particularly on the preventive side) and vulnerability to health

related consumption shocks. Thus, a strong case can be made for

improving health outcomes in poor countries through a varied

combination of public and private insurance provision depending on

the institutional setting. Indeed, countries such as Mexico and

Colombia have undertaken interesting reforms in this area in recent

years, and this is likely to be an area of strong growth9.

Small-Scale Entrepreneurs

The economic contribution of small enterprises to middle- and

high-income economies is well-known. However, in many poor

economies, start-ups and small-scale enterprise fall short of their

9 Webb, I., M. F. Grace, and H. D. Skipper, 2002, The Effect of Banking and Insurance on the Growth of Capital and Output, Center for Risk Management and Insurance, Working Paper 02.

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potential due to a variety of barriers, including access to capital. As

attention to these barriers grows, it is critical to put insurance high on

the list. While the risk appetite of large corporations can be debated,

small scale entrepreneurs whose household wealth is tied up in their

business enterprises are undoubtedly preoccupied with managing

risk. In the absence of risk management tools provided by formal

insurance, there will be a tendency to under invest in higher risk,

higher return activities, thus diminishing the potential contribution

of the critical small and medium sized enterprise sector to

employment, investment, and growth overall. In sum, extending

accessible insurance products to poor households and small scale

entrepreneurs should be a core part of the agenda of democratizing

access to financial assets. When successful programs are taken to

scale, it will not only add measurably to social welfare but also hold

the promise of generating a more productive and higher growth mix

of activities and investments – with a payoff perhaps greater than

micro-credit.

Globalization of Insurance markets

Although the evidence suggests that insurance market

deepening should be a priority in the financial sector strategies of

developing countries, awareness of the role of insurance lags behind

that of banking and capital markets. For these reasons, it is important

to raise the visibility of this sector and to clarify what unique

regulatory provisions might be needed to enable insurance market

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development alongside other facets of financial deepening. For many

countries, a good starting point would be to include analysis and

recommendations specifically for insurance in financial sector

assessments.

Institutional Foundations for Insurance and Market

development. The development of robust insurance markets

generally requires many of the same foundations as for banking and

financial market deepening: reasonable macroeconomic and political

stability, clear property rights, enforceability of contracts, and

safeguards against corruption. However, these are necessary but not

sufficient conditions. Insurance market deepening also depends on

the scale and growth of related markets, including sales of cars and

other consumer durables, residential and commercial mortgage

markets, business, establishments, disposable income, and

commercial and trade transactions, to name a few. Growth in these

related markets is critical in order for the nascent insurance industry

to reach scale in developing shared infrastructure, underwriting

capacity, statistical databases for actuarial purposes, and the

associated skills10.

A variety of public goods are critical for jump starting and

sustaining the growth of domestic insurance markets. These include

the collection and sharing of data on a consistent basis, common

supervisory principles, for instance on reserves and solvency, and 10 Zou, H., and M. B. Adams, 2006, The Corporate Purchase of Property Insurance: Chinese Evidence. Journal of Financial Intermediation, 15(2): 156-196.

108

consumer education. Recognizing the critical role of such public

goods, several of the multinational development banks, international

associations of regulators and supervisors as well as private sector

associations are already active in providing technical assistance on all

of these dimensions.

According to an in-depth survey of the factors that have slowed

the expansion of insurance markets in Latin America, the region’s

insurance professionals view the lack of sufficient education about

insurance as the greatest impediment to market development. They

also cited lack of confidence in the effectiveness of the judicial system

and law enforcement’s failure to collect information about thefts and

automobile accidents as key impediments to market development.

Insurance for Different Stages of Economic Development

Although there is broad agreement on the need for adequate

regulatory and supervisory frameworks, there is some debate on the

content of these frameworks, and in particular the extent to which

developing countries can or should harmonize their standards to

global best practice or seek some intermediate Global best practices

relying on disciplined transparency and corporate governance are

still largely lacking in many developing countries. For some regions

within Africa and Latin America, a strong case can be made for the

development of regional standards that are common across groups of

neighboring countries or Free Trade Agreement (FTA) partners.

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Regional harmonization offers many benefits, and it can be a step

toward global standards.

The International Association of Insurance

Supervisors has articulated the Core Principles of Insurance

Supervision, but the implementation of those Core Principles has

barely begun. Given the evidence connecting insurance market

takeoff to achievement of middle income status, a case can be made

that low income economies below this threshold should concentrate

limited resources on either specific insurance segments (such as

natural disaster risk mitigation) or other sectors. In countries with

limited capacity, it makes sense to undertake institutional

development sequentially – for instance focusing initially on laws

and regulations that are foundational for overall financial sector

expansion rather than specific to insurance. In parallel, the growing

field of micro-insurance is likely to yield products and business

models that contribute to social welfare and small enterprises in low

income economies, while establishing broad familiarity with formal

insurance and setting the stage for future growth as income rises11.

LIC / GIC (Insurance) Examinations

In India, by and large, Insurance was under Government

Undertaking till the recent years, but after the opening of Indian

Market, now-a-days many of the multinational Insurance companies

11 Author's calculations based on premium data collected and published by Swiss Re.

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have come to offer more job opportunities in the insurance sector in

India. But still the major Indian Government undertaking Insurance

Enterprises namely LIC (Life Insurance Corporation), GIC (General

Insurance Corporation) and Postal Life Insurance are always in the

top place in recruiting the candidates for the placements by giving

secured job to its Competitive Exams. People prefer to serve in these

Establishments in large number.

Career Arena of Insurance

In the three major Insurance Companies of Indian Government

i.e. Life Insurance, General Insurance and Postal Insurance, following

positions are recruited every year basis:

Officer positions

Agent positions

Insurance surveyor positions

Following are the important Insurance Competitive Exams to

enter into the Indian Government Insurance Career:

LIC Officers' Exam

LIC Development Officers' Exam

GIC Officers' Exam

GIC Assistants Exam

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Economic, Demographic, and Institutional Determinants of Life

Insurance Consumption across Countries

Life insurance has become an increasingly important part of the

financial sector over the past 40 years, providing a range of financial

services for consumers and becoming a major source of investment in

the capital market. But what drives the large variation in life

insurance consumption across countries remains unclear. Using a

panel with data aggregated at different frequencies for 68 economies

in 1961--2000, this article finds that economic indicators--such as

inflation, income per capita, and banking sector development--and

religious and institutional indicators are the most robust predictors of

the use of life insurance. Education, life expectancy, the young

dependency ratio, and the size of the social security system appear to

have no robust association with life insurance consumption. The

results highlight the importance of price stability and banking sector

development in fully realizing the savings and investment functions

of life insurance in an economy. Copyright 2003, Oxford University

Press.

3.3 Determinants of Life Insurance

The purpose of this study is to determine whether factors

influencing the lapse rates on ordinary life insurance products can be

identified and their importance statistically assessed. In this study,

we refer to ordinary life insurance as including the two traditional

components of term and whole life. The lapse rate is a key operating

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parameter that reflects both consumer behavior and

insurer managerial decisions involving life policies. Projections of the

lapse rate are also critical in structuring securitization arrangements.

Interest in lapse rate determinants has become more prominent

in recent years as some financial service firms have applied

securitization techniques to life insurance policies held by

individuals. Under securitization arrangements, the insured person

conveys the payment rights of his/her policy to the firm structuring

the securitization product. In return, the insured person receives a

one-time cash payment. The securitizing firm pools these policies,

using them as the basis for asset-backed securities. Insurance

companies, too, may engage in the securitization of their life

insurance liabilities by transferring life policies and the assets that

back them. For example, such an action was undertaken by

Prudential Financial in 2001 as a component to its demutualization.

In both cases, assumptions concerning lapse rates are basic to the

securitization process. In this paper, we do not attempt to assess the

impact of securitization, since this trend is still in its early stages. (1)

Rather, we direct our efforts to expand our understanding of lapse

rate determinants.

Of special interest in the area of lapse rate analysis is the role of

the financial stress position of the insurer, and whether and in what

ways stress considerations may influence policyholder lapsation/

persistence. To our knowledge, financial stress has not been

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previously examined in the framework of a formal cross-sectional

statistical study to identify the influence on the lapse rates for

ordinary life policies12.

We interpret this result as suggesting that a life company under

financial stress operates with a reduced level of managerial discretion

since company management, in these circumstances, is typically

concerned about the company's credit rating position. In contrast, the

ordinary life lapse rates for companies characterized by low and mid-

range financial stress do not closely fit the model. These findings

provide analytical direction to studies of ordinary life products by

showing the important role of the financial stress dimension.

Lapsation Issues Shaping Model Development

The lapse rate on life policies has traditionally been one of the

central parameters in the managerial framework for life insurers.

Consumer demand is widely recognized to be sensitive to pricing for

both term and whole life product lines. These ordinary life products

are regarded as "commodities." That is, these products are

relatively homogeneous in nature, offered by a large number of

insurers, and are competitively priced. Lapsation and policy

terminations may be initiated by consumers at any time by failing to

pay premium billings on term and whole life policies. The non-

renewal of term and whole life policies may also occur on renewal

anniversaries for policies with guaranteed renewable riders. 12 See Appendix A for a complete list of countries grouped by income. Exceptions are Ward and Zurbruegg (2000) and Webb et al. (2002).

114

From the company's perspective, life insurance products, and

especially whole life products, typically entail large

underwriting and upfront origination costs, heavily driven by sales

costs and commissions. (2) This cost structure provides insurers a

strong motive toward lower lapse rates. Too high a lapse rate may

impair the ability of the insurer to recoup these costs, given the

projected benefits payouts required under these lines of insurance.

Companies that are in a stronger market position will be able to price

more aggressively than companies in a weaker market position13.

From the consumer's perspective, both term and whole life

policy holders with health or other insurability problems tend to

lapse less frequently, because their alternatives are limited and can be

more expensive. The effect is to introduce a tendency toward adverse

selection. Healthy individuals may lapse or fail to renew at the

guaranteed-renewal dates if they can find less expensive term

insurance when passing a medical exam. This adverse selection effect

causes the insurer to experience a higher rate of claims on the

remaining policies than would have been expected from the entire

pool of original insureds.

The Statistical Approach, Data Availabilities, and Variable

Specification

13 Even though it is recognized that insurance activity not only would have an effect on economic growth as a provider of risk and indemnification but also as an institutional investor by mobilizing savings, this article, due to data limitations, assesses the effect of insurance on economic growth only as a provider of risk and indemnification.

115

This study uses the single equation-multiple regression

statistical framework to examine the issue of lapse rate determinants.

The cross-section analytical approach is selected. In the course of our

study, we identified heteroskedasticity problems, and chose to deal

with these using the White (1980) estimation technique.

The lapse rate and other data in this study are compiled based

on the set of 162 companies rated for financial stress by the Moody's

Investors Service credit rating organization. All available Moody's

rated companies were used. This company set was matched to

operating life insurance companies reported by the National

Association of Insurance Commissioners (NAIC).

The base year for our work is 2003; this was the latest available

year at the time of this study. By 2003, a slow economic expansion

was widely acknowledged to be underway, following the recession

that ended in November 2001. This base year is not cyclically

exceptional in the sense of being neither a year of recession nor the

peak of a boom14.

Lapse Rate. As compiled by the NAIC organization, the lapse

rate is reported for ordinary life insurance products. To form the

lapse rate for a specific life insurer, the value of lapsed policies for

ordinary life products is divided by the average total life insurance in

force during the time period. This ratio is multiplied by a scaling

14 Insurance companies provide firms with trade credit insurance, and banks usually finance these "receivables" supported by the insurance.

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factor of 100. Ordinary life policies include the following types of

insurance plans: level term life; decreasing term; renewable term;

traditional whole life; interest sensitive whole or universal life; and

graded-premium whole life.

Financial Stress Ratings. Several outside agencies provide

financial stress ratings, including: Moody's, A. M. Best, and Fitch.

After reviewing the methodologies of these agencies and after

discussions with practitioners and state-level insurance regulators,

we chose the Moody's ratings because of the greater degree of

delineation provided by their evaluation system. We wish to examine

whether the Moody's financial stress measure is statistically

supported as a determinant of the lapse rate.

Life operating companies face the decision of how to structure

assets and liabilities to achieve specific target financial ratings. The

lapse rate is one of the internal operating parameters that many

analysts believe will be affected by a company's rating. For our

purpose, the Moody's ratings range from Aaa (as 1) to B2 (as 15). A

positive relationship is expected between financial stress ratings and

the lapse rate.

These considerations are examined in this study for the Full

Sample of life companies taken together, and also by segmenting the

sample, as follows: the Low Risk panel consists of all life companies

rated by Moody's as Aa1 and above; the Mid-range Risk panel, for

Aa2 to A1; and the Higher Risk panel, with ratings below A1. In the

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segmented analysis, the effect of the financial stress rating will be

transferred to the constant term within the linear regression

framework. The constant intercept term is expected to be higher in

the case of the Higher Risk panel, relative to the Mid-range and Low

groups. The Moody's ratings variable is included in the segmented

analysis to capture any possible "within panel" financial stress

effects15.

The second interpretation of ordinary life pricing arises from

the inherent complexity of life insurance markets in a cross-sectional

sense, the data dimension selected for this paper. Some companies

have pursued sales and marketing strategies that result in stronger

market positions. Examples of such market specializations or niches

are companies that market to fraternal or religious organizations or

that address specific geographic or urban-rural market segments.

In this context, the pricing variable may serve as an indicator of

the ability of a life company to acquire a sufficient position of market

strength to allow its price to deviate from pricing on average across

all companies. Under this interpretation, a higher price may indicate

a stronger market position, implying a lower lapse rate, a negative

relationship.

15 Ward and Zurbruegg (2000) also include a number of explanatory variables in the analysis like changes in private saving rates, the general government budget surplus, population size, the general government level of current expenditure, and youth plus old age dependency ratio (proportion of the total population under 16 and over 65 years of age).

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The approach of this study provides a natural basis for

evaluating which of these two interpretations of the pricing variable

is dominant in a cross-sectional context. To address this question, our

study employs two pricing-related variables: one for pricing (per-unit

premium revenues) directly; and the other, a compositional variable

to reflect the mix between term and whole life policies. The average

price per dollar of ordinary life is computed by dividing the premium

income from ordinary life by the value of ordinary life in force. The

compositional variable is the ratio of term life in force to whole life in

force. A higher percentage of term policies (without a renewal rider)

may be associated with a lower lapse rate, given that the expiration

of non-renewal term policies is not regarded as lapsation; in contrast,

the cancellation of a whole life policy is reported as a lapse. The

inclusion of the compositional variable in the analysis has the effect

of holding the term-whole life composition constant, allowing the

isolation of the pricing effects. When combined together in a

regression framework, these joint variables should capture the role of

the pricing factor as it affects the lapse rate.

Life Insurer Size. Insurer size may influence the lapse rate by

serving as a proxy for the financial health of the life company in ways

that are not fully captured by the Moody's financial stress variable.

Under this view, a large company may achieve a higher level of

diversification than a smaller firm. In addition, the larger firm may

have support in the event of extreme financial stress from the "too big

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to fail" doctrine that has been invoked from time to time by

regulatory authorities in allied financial service fields. Given these

perspectives, we wish to account for possible size effects in model

specification. Following earlier studies, we use the natural log of the

total admitted assets of the insuring company. We expect a negative

association between the size variable and the lapse rate16.

Ordinary Life Profitability. The management of ordinary life

products within companies will be influenced by the relative

importance of ordinary life insurance lines within the overall profit

mix of the firm. Companies for which ordinary life products are

important in the product mix will be more responsive to adverse

changes in the lapse rate for these products. We address this issue

using a profit margins measure. This is defined as the ratio of the net

operating gains from ordinary life policies (after Federal income

taxes), divided by total net gains across all product lines for the

company.

We expect companies to adjust their marketing and sales

strategies to emphasize those product lines with the highest

profitability, whether sold using commission-compensated agents or

a non-agency distribution system. Through sales and marketing

choices, approaches can be undertaken to use information and

product alternatives that can influence the lapse behavior of policy

16 In order to assess a causal relationship with economic growth, Ward and Zurbruegg (2000) average the explanatory variables for the period 1980-1996. A total of 55 countries are included in their study

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holders. In cases where ordinary life would be more profitable

relative to other lines of business, we would expect companies to

undertake strategies to hold down the lapse rate. In such cases, we

would expect a negative association between this profitability

variable and the lapse rate in the ordinary life business line17.

IMPORTANT ASPECTS OF INSURANCE BUSINESS

1. Actuary

An ACTUARY is a person who has passed specialized

examinations conducted by the Actuarial Society of India or the

Institute of Actuaries, London. Actuaries are technical experts who

have received specialist training in the mathematics of insurance.

Their job is to ensure that the insurance products provided by the

company are mathematically sound. They undertake various

activities lie calculation of mortality rates, estimating expenses to be

incurred by the insurance company in administrating various

policies, and determining the rate of return that will be earned by the

company on its investments. Based on the above, they decide on the

premiums to be charged on various policies. As is obvious from the

above, a good actuary has to be a good economist, a good statistician

as well as a good security analyst. Every insurance company requires

good actuaries to continuously study its operations and advise the

management on the appropriateness of their policies.

17 Countries were selected mainly by data availability, based on a requirement that each country have at least 15 years of continuous data.

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2. Underwriting

An UNDERWRITER scrutinizes, analyzes and takes the

decisions on the proposals received for insurance. While analyzing

the risks arising from the insurance applications, the underwriters

ensure that the company issues the maximum possible policies while

keeping the risk of loss within acceptable limits. Any applications tat

pose reasonable risks are accepted and those posing lower or higher

than average risks are accepted at lower or higher rates of premium

than normal. Any applications posing unreasonable risks are

declined. The job of accepting or declining the proposals of insurance

received by a company and deciding on the premium at which to

accept the proposals is done by the underwriting department18.

3. Policy Owner Services

The employees in this area are the ones who issue the actual

policy documents. They also ensure customer satisfaction by

attending to various requirements arising during the duration of a

contract lie nominations, assignments, alterations, etc. These

employees are basically responsible for maintenance of policy

records, processing customer requests and informing policy-owners

about any material changes that affect their policies.

4. Claim Administration

18 Life and nonlife business are categorized in accordance with standard EU and OECD conventions. In this framework, accident and health insurance are considered nonlife insurance, regardless of how these lines are classified in the individual countries (Swiss Reinsurance Company, 2005, p. 30).

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The employees in this area are responsible for the actual

settlement of claims. They analyze the claims received against

various policies. After thoroughly studying the claims, they decide

whether the claim is valid. They calculate the benefit amounts for

settlement of all valid claims. Any claims that are found invalid are

rejected.

5. Marketing

The marketing department studies consumer behaviour, needs

and wants. On the basis of these studies, they give suggestions for

new products which can satisfy those needs. The marketing

executives also develop marketing plans, design promotional

material for the different products, market the products to the

customers and provide them services. The marketing department's

role starts even before the inception of a product and carries on well

after the product has been sold to the customer.

6. Investment

The employees in this area manage the company's assets and

investments. They study the financial markets in order to give

recommendations on the best avenues of investments so that the

company can maximize its returns.

7. Accounting

As in any other organization, the accountants in an insurance

company keep records of the income and expenses. They keep track

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of the income from premiums and investments as also the expenses

for running the office, agents' commission, claim payments, etc. They

prepare the reports and statements which show the financial position

of the company. The policy holders, shareholders, and insurance

regulators can get to know the financial status of the insurance

company from these reports.

8. Information Systems

The employees looking after this area provide their services to

all the departments of an insurance company. They design and

maintain computer systems so that any required information can be

easily retrieved at any time. They also develop and test new systems

and procedures for the company, install them and ensure that they

operate efficiently and effectively.

9. Legal & Compliance

The employees in this department play an important role in

ensuring that the company is complying with all the regulations and

laws in the country. They develop the policy forms, contracts for

agents, etc., in line with the existing rules and regulations and also

advise the staff and management on any legal issues. In case there is

any dispute arising out of a claim, the attorneys from the legal

department defend the company's position.

These, then are the different activities carried out by the various

departments in an insurance company. An equally important activity

which has not been covered above is the distribution of the different

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products of the insurance companies. This distribution is carried out

by various components of the distribution channel.

10. Distribution Channels

These are routes by which the product prepared by the

producer reaches the ultimate consumer. Thus, the distance between

the producer and the consumer is bridged by the distribution

channel.

In the case of insurance companies, the distribution system is a

network of individuals and organizations that are involved in

making the insurance products available to the customers. They form

a link between the insurance company and the buyers of insurance

products.

The various components of the distribution channel in an

insurance company are:

11. Agents

An insurance agent is an agent licensed under section 42 of the

Insurance Act, 1938. He/she receives payment by way of commission

for procuring insurance business. He/she is also responsible for

business relating to the continuance, renewal or revival of policies of

insurance. An agent could also be a corporate agent i.e. a company or

firm could also be a corporate agent i.e. a company or firm could also

be an agent.

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The primary function of an agent is t procure business for the

insurance company. However, the agent can only procure business

for the particular insurance company which he/she represents, and

for no other company. Once the insurance contract has been put into

force, the agent has to ensure continuance of the policy through

regular payment of renewal premiums. In case of a claim, the agent

should help the insured in proper settlement of claims.

12. Insurance Brokers

An individual or firm, whose full-time occupation is the

placement of insurance business with insurance companies, is known

as an insurance broker. The broker receives brokerage as a

percentage of the premium from the insurer.

The main difference between an agent and a broker is that there

are no restrictions on the procurement of business by a broker for

various different insurance companies, while the agent can only

procure business for that particular company which he represents.

Insurance brokers give advice to the insured without charging

them.

13. Insurance Consultants

Insurance consultants are usually specialists who give advice to

consumers who wish to buy insurance products. However, unlike the

brokers, they get paid by the insured for this advice.

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14. Banking Outlets

These days, there has been a trend of using outlets of banks for

distribution of insurance products. The logic behind this is that, as

both banks and insurance companies target the same segments of

population, using the bank outlets for distribution of insurance

products, it can help in saving overheads as well as infrastructure

costs. The concept of bancassurance has gained importance in the

banking sector which is good for the insurance sector.

II New Product Creation

Having discussed the various activities undertaken by different

departments in an insurance company, as well as the distribution

channel through which insurance products are routed, it will now be

easier to understand the different stages involved in the creation of a

new product by an insurance company. The stages are as under—

1. Idea Generation—This is the beginning of the process of

product development. Out of all the persons associated with

insurance mentioned above, any one can contribute the idea for a

new product. The product could either be a totally new one, or it

could involve some modification of an existing product.

2. Comprehensive Business Analysis—This is the stage where

all the experts analyze the feasibility of the new product.

The actuaries check out if the proposed product is

mathematically viable.

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The marketing department finds out through market analysis if

the product actually satisfies some customer needs.

The legal department an accountants examine the legal

implications, tax benefits, etc.

The investment department can think of investment avenues

for the funds generated by the new product and the expected returns

for the same.

Once all this research is completed, the product development

team puts forward the proposal for the approval of the senior

management.

3. Technical Designing—Once the product has been cleared

during the above stage, the actual technical design of the product is

decided upon by the experts.

The actuaries decide on the premium structure the benefits, etc.

The legal experts design the actual policy documents, etc., in keeping

with the regulations.

The underwriters establish the underwriting standards for that

particular product.

4. Implementation—After completion of the technical design

stage, the actual implementation begins.

The legal department gets the requisite permission for sale of

the product.

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The marketing department handles the advertising, promotion,

etc., for launch of the new product.

Other departments lie Information Systems, Accounts, etc.,

make preparations for support of the new product.

5. Product Introduction—Once the above stage is completed,

the actual distribution of the new product is commenced. The agents

and the other employees are trained on the new product and all the

other departments also begin performing their roles in supporting

the new product.

6. Sales Monitoring and Review—As is the case with any new

product launched in the market, the 'last but not the least' step

involves the monitoring of sales and review of the feedback on the

product. After the product has been sold in the market, the insurance

company evaluates the performance of the new product. The

concerned departments collect feedback on the new product from

customers so that the company can decide whether the new product

has been successful in addressing the customers' needs or if some

changes need to be made.

In case any changes are required in the product, the company

takes the required action in keeping with the feedback.