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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
Source: IRDA Annual Report FY 2010-11, December 2011
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
Source: IRDA Annual Report FY 2010-11, December 2011
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 (%)
Source: IRDA Annual Report FY 2012-13, December 2013
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
Source: IRDA Annual Report FY 2012-13, December 2013
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)
Source: IRDA Annual Report FY 2012-13, December 2013
Fig.1.7
Insurance Density in Select Countries
Source: IRDA Annual Report FY 2012-13, December 2013
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.