India Insurance: Turning 10, Going on 20

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1 India Insurance Turning 10, Going on 20 India Insurance: Turning 10, Going on 20 A

2 The Boston Consulting Group (BCG) is a global management consulting firm and the world s leading advisor on business strategy. We partner with clients in all sectors and regions to identify their highest value opportunities, address their most critical challenges, and transform their businesses. Our customized approach combines deep in sight into the dynamics of companies and markets with close collaboration at all levels of the client organization. This ensures that our clients achieve sustainable compet itive advantage, build more capable organizations, and secure lasting results. Founded in 1963, BCG is a private company with 71 offices in 41 countries. For more information, please visit Federation of Indian Chambers of Commerce and Industry (FICCI) is India s apex chamber representing over 500 industry associations and over 2,50,000 business units small, medium and large employing around 20 million people. FICCI works closely with Central and State governments and Regulatory bodies for policy change.

3 India Insurance Turning 10, Going on 20 Alpesh Shah Pranay Mehrotra Ruchin Goyal April 2011 bcg.com

4 The Boston Consulting Group, Inc All rights reserved. For information or permission to reprint: Please contact BCG at: E mail: bcg info@bcg.com Fax: , attention BCG/Permissions Mail: BCG/Permissions The Boston Consulting Group (India) Private Limited Nariman Bhavan 14 th Floor Nariman Point Mumbai India Please contact FICCI at: E mail: finance@ficci.com Website: banking.com Fax: , attention FICCI/Permissions Tel: Mail: Federation of Indian Chambers of Commerce & Industry Federation House 1, Tansen Marg New Delhi India

5 Contents Executive Summary 4 Insurance Critical to the Economy 6 The Past The Decade Gone By: FY 2001 FY The Current Insurance Industry Facing Challenging Times 14 The Future Crystal Ball Gazing: Going Through the Teens 22 Note to the Reader 36 India Insurance: Turning 10, Going on 20 3

6 Executive Summary Insurance is a Critical Part of Any Economy It contributes to economic development on four key dimensions. First, by pooling risks and smoothing incomes, it helps avoid excessive and costly bankruptcies and facilitates lending to businesses. Second, the availability of insurance enables individuals and entrepreneurs to undertake activities with higher risk and higher return than they would otherwise consider, thus promoting higher productivity and growth. Third, due to the long term nature of their liabilities, with predictable premiums, life insurers also serve another important function, acting as providers of capital to infrastructure and other long term investments. Finally, insurance has a big role to play in providing support to the poorer sections of the society. In the absence of risk pooling mechanisms, setbacks in incomes can permanently damage a poor family s prospects. Insurance can help prevent these setbacks and provide support to the society. The Insurance Industry in India has Come a Long Way Since the opening up of the sector in 2001, the industry has undergone a major transformation. There is enhanced penetration, increased coverage of lives / property, more customer friendly products, rapid growth of multiple channels (agency, bancassurance, broking, direct, corporate agency, etc.), enhanced reach, and increasing competitiveness of the market. The total penetration of insurance (premium as percentage of GDP) has increased from 2.3 percent in 2001 to 5.2 percent in In addition there has been a vast increase in the coverage of insurance. The number of life policies in force has increased nearly 12 fold over the past decade and health nearly 25 fold. This progress has been aided by the dramatic shift in the availability of products, for example: better term, ULIPs, whole life, maximum NAV guarantee, auto assistance, auto pay per km insurance, disease management, wellness, etc. Similar progress has been made on the channel front with the emergence of five distinct channels bancassurance, broking, corporate agency, direct and auto dealers to complement the existing third party agency and in house salaried sales force. Along with the emergence of multiple channels, the distribution reach has increased manifold, nearly 6 fold for life, and 1.5 times for non life. During the same time, the Indian market has evolved from a monopoly to a truly competitive market. The market has moved from 5 incumbents (1 life, 4 non life) to nearly 45 today (across life and non life). Currently, the Insurance Industry is Facing Challenging Times While the industry has come a long way over the past decade, the big challenge with the industry is profitability. Private life insurers have accumulated losses of over `16,000 crores till March Similarly, the non life industry has cumulative underwriting losses of nearly `30,000 crores. There are multiple elements that contribute to this profitability challenge for insurers: Agency is looking for the elusive profitable operating model, for both life and non life insurers. Economics of all other channels are also challenged, be it bancassurance, brokers, auto dealers, corporate 4 The Boston Consulting Group

7 agency or in house salaried sales force. Insurers fascination for top line growth at any cost has resulted in inefficient operating models and hence inferior opex ratios as compared to global benchmarks, in both life and non life. The claims cost in the case of non life are very high arising from four key reasons third party liability claims, health loss ratios (group health cross subsidy), fraud in the case of auto and health and lack of supplier (hospital/garage) management by insurers. There is limited focus on the end customer and the intermediary is being given a more prominent position by insurers, with insufficient focus on maximizing value from existing customer. Lastly, the recent regulatory changes on commission caps, caps on surrender changes and minimum guarantee return for pension products have turned the world upside down and tightened insurer margins. However, the India Growth Story Expected to Continue Unabated Inspite of all the recent upheaval, BCG expects the insurance industry to continue outpacing the rapid economic growth. The insurance industry will be ~US $ billion in premium income by 2020, making India a top 3 life insurance market and a top 15 non life insurance market by Insurers and Regulator / Government Will Have to Work in Tandem to Ensure a Sustainable and Healthy Industry BCG has defined a six point action agenda for the life insurers journey ahead: Fix the agency operating model Build strategic, long term non agency partnership Incubate, experiment and develop alternative channels Develop a customer centric operating model Target customer / product white spaces Go lean lean is in Similarly, for non life insurers, BCG has also defined a six point agenda for the path to a sustainable profitable business: Create optimal product portfolio Innovate to target product/customer white spaces Move towards risk based pricing Develop next generation claims management processes Go direct build alternate channels for retail products Define and enhance agency sales force operating model Lastly, in addition to the insurers, the regulator / government has a huge role to play in enabling the journey of the insurance industry to sustained profitability. The regulatory / government agenda will need to cover: Relax ownership norms Define IPO norms Enhance banca distribution through multi tie ups Enable direct channel Refine outsourcing guidelines Enable electronic statements of insurance Refine investment norms Define flexible norms to enable Indian insurers to go international Build depth in debt / bond / derivative market Ensure appropriate taxation policies India Insurance: Turning 10, Going on 20 5

8 Insurance Critical to the Economy The Merriam Webster dictionary defines insurance as: (a) the business of insuring persons or property; (b) coverage by contract, whereby one party undertakes to indemnify or guarantee another against loss by a specified contingency or peril. In the modern economy, however, insurance means a lot more than what the above standard definition describes and, in fact, insurance contributes significantly to the development of the economy. Role of Insurance in Economic Development Evidence suggests that insurance contributes materially to economic growth by improving the investment climate and promoting a more efficient mix of activities than would be undertaken in the absence of risk management instruments. Insurance serves a number of valuable economic functions that are largely distinct from the functions served by other types of financial intermediaries. This contribution is amplified by the complementary development of banking and other financial systems. Insurance contributes to economic development on four key dimensions: 1. Facilitate lending to businesses The indemnification and risk pooling properties of insurance facilitate commercial transactions and the provision of credit by mitigating losses as well as measuring and managing non diversifiable risk more generally. Typically, insurance contracts involve small periodic payments in return for protection against uncertain, but potentially severe, losses. Among other things, this income smoothing effect helps to avoid excessive and costly bankruptcies and facilitates lending to businesses. This is one of the reasons most banks encourage, and, on occasions, even insist on small and medium size enterprises buying fire and property insurance to protect against uncertain, but severe, losses. Without insurance, the higher potential risk of bankruptcy would increase credit pricing and make business growth more difficult. 2. Promote higher productivity and growth by enabling risk averse individuals to take higher risk Fundamentally, the availability of insurance enables risk averse individuals and entrepreneurs to undertake activities with higher risk and higher return than they would otherwise consider, thus promoting higher productivity and growth. The management of risk is a fundamental aspect of entrepreneurial activity. Entrepreneurs manage the risk of accidental loss by weighing the costs and benefits of each alternative. In a structured risk management process, this involves: Identifying the exposures to accidental loss Evaluating alternative techniques for treating each loss exposure Choosing the best alternative Monitoring the results to refine the choices Even those who do not apply a structured process make decisions about risk, although by default rather than by design. 6 The Boston Consulting Group

9 The scope of an economy s insurance market affects both the range of available alternatives and the quality of information to support decisions. For example, a manufacturer might produce only for the local market, forgoing more lucrative opportunities in distant markets, to avoid the risk of losing goods in shipment. Transport insurance can mitigate this loss exposure and enable the manufacturer to expand his business. Such expansion provides larger scale and additional stability for the business. Thus, insurance products clearly enable stronger and more robust businesses. Similarly, to avoid the risk of total loss from drought, a commercial farmer may keep half his seeds in reserve. Instead of incurring the cost of holding half the seeds in reserve, the farmer could buy crop insurance for a small premium, protect himself against drought, and plant all his seeds. Therefore, public policies that encourage insurance operations improve the economy s productivity by broadening the range of investments. Insurers also have an incentive to control losses. By offering discounts for seat belts, smoke detectors, or other measures that reduce the frequency or severity of losses, they lower their eventual claims costs. In the process, they help save lives and reduce injuries, thus offering a significant social benefit. 3. Provide capital for long term needs such as infrastructure On the investment side, the long term nature of their liabilities, sizable reserves, and predictable premiums allow life insurance providers to serve an important function as institutional investors. Apart from providing capital, they can also provide professional oversight to infrastructure and other long term investments. Of course, these benefits are fully realized only in markets where insurance providers invest a substantial portion of their portfolios in the domestic market. India has an extremely large and critical need for investments in infrastructure. The demand for infrastructure funding and debt is estimated to increase from the existing about 6 lakh crores to about 20 lakh crores by 2015 and about 45 lakh crores by The tenure of funding for these infrastructure projects normally ranges from 10 to 15 years. The insurance industry needs to be one of the primary sources for these funds. An analysis of the financial savings pool in India, and specifically household financial savings, shows that insurance funds can be the long term savings pool that can fuel infrastructure growth. As Exhibit 1.1 illustrates, the only money pools with a longer tenure than life insurance savings are the provident fund and pension money, and these are already directed by the government. Life insurance funds have tenure greater than 7 years and would be the closest fit with the approximate tenure requirement of 10 to 15 years for infrastructure projects. In fact, infrastructure investments are ideal for asset liability matching for life insurance companies given their long term liability profile. 4. Offer societal support for poorer sections of the society to continue development Insurance has a big role to play in providing support to the poorer sections of the society. In the absence of risk pooling mechanisms, a sudden drop in incomes due to death, disability, or adverse agricultural outcomes often translates into substantial decreases in consumption and investment that can permanently set back a poor family s ability to better their lives. When drought or floods lead to low agricultural yields, critical health interventions could be delayed, education of the younger members of a household could be put on hold indefinitely, and land, livestock, or equipment could be permanently forfeited. Insurance can help prevent these setbacks and thus offers support to the society. Due to the catastrophic consequence of such losses, and in the absence of formal insurance, there is extensive evidence that suggests that poor households and communities attempt to self insure through a combination of asset building and diversification of income sources. The most likely result is investment in a set of lower risk but also lower return activities, and even this degree of self insurance is highly incomplete. As explained above, insurance has a critical role to play in the economic development of a country. In that context, it is only appropriate to look at the insurance industry in India through the same lens. The following chapters focus on the decade gone by and the evolution of the insurance industry in India, the challenges facing the industry, and the journey ahead, especially in terms of the agenda for the industry. India Insurance: Turning 10, Going on 20 7

10 Exhibit 1.1: Household financial savings share HH financial savings Estimated tenures 6.3 Others 3 ~ MFs, shares and debentures Life insurance Bank deposits Currency Total %oftotal financial saving (2009) Source: RBI; BCG analysis. Note: Data pertains to FY ¹Based on bank portfolio of deposits. ²Industry estimate. ³Others include provident and pension funds, investment in government securities, investment in small savings, etc. #of years 8 The Boston Consulting Group

11 The Past The Decade Gone By: FY 2001 FY 2011 A decade after the insurance industry was opened up, a remarkable transformation has taken place. The changes may go unnoticed from month to month, or even year to year, but if one takes a step back and compares the industry landscape of 2001 to that of 2011, the difference is more than striking. In the last decade, the insurance industry has moved forward on multiple fronts. There has been progress in terms of enhanced penetration, increased coverage of lives / property, more customer friendly products, a rapid growth of distribution channels (agency, bancassurance, broking, direct, corporate agency), enhanced reach, and increasing competitiveness of the market. Customers Going Wide and Deep The total penetration of insurance, measured by premium as a percentage of GDP, has increased from 2.3 percent in 2001 to 5.2 percent today. While there has been a substantial jump in penetration in the past decade, all of it has come from life insurance (increasing from 1.8 percent in 2001 to 4.6 percent in 2010). Non life insurance penetration has remained more or less flat, increasing marginally from 0.5 percent in 2001 to 0.6 percent in As a result, life insurance in India compares favorably with the rest of the world (United States 3.5 percent; United Kingdom 10 percent; France 7.2 percent; Germany 3.3 percent; Japan 7.5 percent; Brazil 1.6 percent; China 2.3 percent). Non life insurance in India is still significantly under penetrated, and has some way to go (United States 4.5 percent; United Kingdom 3 percent; France 3.1 percent; Germany 3.7 percent; Japan 2.1 percent; Brazil 1.5 percent; China 1.1 percent). Along with the increase in penetration, there has been a massive increase in the number of people covered. In life insurance, the number of policies in force has increase from approximately 20 million in 2001 to approximately 230 million in 2010, a nearly 12 fold increase. The other big increase in coverage is in the health insurance space. The number of lives covered through health insurance has increased from just 2 million in 2001 to nearly 55 million in 2010, a nearly 25 fold increase. Product From a Seller s Market to a Buyer s Market There has been a remarkable shift in the availability of products over the past decade as well. Products that were hardly known or not available earlier are now quite popular as they offer real value to customers. Take life insurance for example. Term insurance, which was never pushed by the channel earlier, is now an extremely attractive product for both customers and insurers. The change in pricing of the term product over the past few years illustrates the product s attractiveness and the manner in which the market has evolved. For a 30 year old, non smoking male, for example, the premium for a 25 year term has come down drastically from about 70 bps in 2001 to about 20 bps today an almost 70 percent reduction in price for the customer. Add to that the plethora of Unit Linked Insurance Policies (ULIPs), whole life products, and maximum Net Asset Value (NAV) guarantee products and the movement to a buyer s market is clear. Similarly, for other insurance products, the options for customers have gone up dramatically. For example, the India Insurance: Turning 10, Going on 20 9

12 auto insurance market has moved away from a standard commodity product and is now offering products with assistance services, such as replacement vehicles, towing services, and emergency support services. Some companies are also exploring innovative products such as pay per kilometer offerings. The same is true in the case of health insurance. From offering hospitalization reimbursement as the only product and that too with a low cap on the total quantum covered the health insurance industry has progressed enough to have many products with large caps, including outpatient department and dental coverage, as well as disease management and wellness offerings. Distribution From Agency Alone to Multichannel Distribution is the most critical element of the insurance value chain from the customer experience point of view, and the Indian market has evolved dramatically over the past few years along this dimension. Before 2001, in the pre privatization phase of the insurance industry, there were only two channels of distribution third party agency and direct (in house salaried sales force.) Third party agency accounted for more than 80 percent of the sales in life insurance and approximately 75 percent in non life insurance. The last decade has seen the emergence of five distinct channels to complement the existing two agency and direct (as shown in Exhibit 2.1): I. Bancassurance: A distribution channel that has been extremely large in European countries for a long time, bancassurance has now also become substantial in the Indian market over the last few years. In fact, the bank channel now contributes approximately 25 percent of the new business for private companies in life insurance, and approximately 15 percent of the Gross Written Premium (GWP) for private companies in non life insurance (bank plus some corporate agency). The primary value that banks bring to the insurance business is customer trust and a wide reach. II. Broking: This is a very large channel for non life insurance globally. This channel s proposition to the customers is that brokers represent the customers, not the insurance company, and will advise them on Exhibit 2.1: Channel mix ( ) Life insurance Non life insurance % 8% 22% 12% 14% 24% 11% Other corporate agents and brokers Banks and referrals Direct % 2 15% 14% 15% 20% 15% 11% Corporate agency and others Brokers Banks and referrals % 58% 51% Agency % % 25% % 17% 2010 Own sales Agency Industry Private players Industry Private players Source: IRDA, Company public disclosures. ¹Including own sales force, tele and online. 2 Including all other channels. 10 The Boston Consulting Group

13 the best product / solution to meet their requirements. While India has seen growth in this channel, India has a long way to go in this dimension. So far, the biggest selling point for brokers in India has been their ability to negotiate discounted rates based on the volume of business. They have now begun to move to a full advisory role. Brokers today account for approximately 20 percent of the GWP for non life insurance and just about 3 percent of the life insurance new business. III. Corporate agency: This includes two categories of channels: outsourced agency, at times also known as MLM (Multilevel Marketers); and existing distribution networks. The second category offers a lot of opportunity and value for the economy. The idea here is to leverage existing distribution channels, push more through the same channel infrastructure and hence improve efficiency, just as in the case of bancassurance. For private companies, this channel has already become significant, accounting for about 10 percent of the new business for private companies in both life and non life insurance. IV. Direct : This includes sales through the internet and call centers. Products that lend themselves to easy comparison are easier to sell through such channels and hence term insurance, auto insurance, and health insurance are the products currently being sold through the internet and phone channels. V. Auto dealer channel: This is a point of sales channel that has become substantial in the past few years. Auto dealers leverage the opportunity when customers walk into their dealerships to buy cars to offer auto insurance as well. Auto dealers started with new cars and, realizing the value at stake, many of the larger dealers have now started outbound calling to increase renewals. The auto dealer channel now accounts for nearly 10 to 15 percent of auto insurance and approximately 5 to 6 percent of total non life insurance. This is, however, recorded as premium under the agency / corporate agency heads as shown in Exhibit 2.1. The evolution of these five new distribution channels has been rapid. These channels had zero share of business in 2001, and have grown remarkably, to now account for approximately 35 percent of new business for private companies in life insurance and approximately 45 percent of the business for private companies in non life (as shown in Exhibit 2.1). Reach Multiplying the Reach 3 5x Along with the emergence of the multiple channels described above, came the rapid expansion of distribution reach. As private companies rolled out their businesses, with limited or no regulatory controls on the opening of outlets, the number of office / branches multiplied. This was especially true for life insurance, where insurers built comprehensive office networks to stake out a position in the market. The number of offices / branches increased 6 fold in the past nine years, going up from about 2,200 in 2001 to more than 12,000 in 2010 (as shown in Exhibit 2.2). At the same time, the growth in the number of agents kept pace, increasing from about 0.6 million in 2001 to about 3 million in Last year, after some regulatory changes, more than 1,000 branches were shut down and over 400,000 agents were released by private companies to manage the economics of the agency channel. Similarly, there has been an expansion in reach in non life insurance too, though nowhere to the same extent as in life. This is because even though the agency channel is large in non life, a large part of that agency operations is actually on site. This holds true, for example, in the auto insurance market, with the auto dealers accounting for a large part of the business. The number of offices / branches has increased from approximately 4,700 in 2001 to approximately 6,200 in Competition From a Monopoly to a Competitive Market The Indian insurance market has evolved from a monopoly to a truly competitive market. As the industry opened up after 2001, the market saw the entry of 12 companies in life insurance and 8 in non life insurance in the first 2 years, making a total of 20 new companies and 5 incumbents. The success of many first generation entrants attracted the second generation of competitors, most of them in 2007 and 2008, leading to a total of 45 insurers, including life and non life, in India, with a few more still keen to enter (as shown in Exhibit 2.3). Over time, the new entrants have been taking share away India Insurance: Turning 10, Going on 20 11

14 Exhibit 2.2: Insurer s reach ( ) Life insurance Non life insurance Branches 12,500 10,000 12,018 Branches 12,500 10,000 7,500 5,000 2, ,373 2,199 3,150 3, ,186 3,000 2, ,768 3, Private Public 7,500 5,000 2, , , , ,160 1,662 4,009 4,009 4,009 4, Private Public # agents ~0.6Mn ~1.2Mn ~2.0Mn ~3.0Mn Source: IRDA; Company web sites. ¹Estimated. Exhibit 2.3: Increasing competitive intensity ( ) Life Non life Health Source: IRDA. 12 The Boston Consulting Group

15 Exhibit 2.4: Share of life insurance ANBP and non life insurance GWP ( ) Life % 4% 2% 7% 11% 24% 85% 67% 6% 6% 13% 10% 24% 36% 60% 45% Other private Next 5private Top5private LIC 0 # private players Share of private players FY 2001 ~0% FY % FY % FY 2010 FY 2011 (10 months) % 40% Non life % 1% 5% 8% 86% 9% 2% 9% 10% 10% 10% 24% 22% 22% 65% 59% 58% Other private Next 3private Top3private PSUs 0 FY 2001 # private players Share of private players ~0% FY % FY % FY % FY 2011 (10 months) 13 42% Source: IRDA. from the incumbents, as one would expect. In the case of life insurance, as shown in Exhibit 2.4, the share of private companies has increased from virtually zero in 2001 to about 55 percent of Annualised New Business Premium (ANBP) in However, recent regulatory changes have had a big positive impact for Life Insurance Corporation of India (LIC), which has resulted in the share of private companies falling to 40 percent for the first 10 months of Interestingly, the biggest loss in market share has been for the top five private companies, with their share coming down from about 36 percent to about 24 percent. The smaller companies have not lost as much market share. Similarly, as can be seen in Exhibit 2.4, the share of private companies in non life insurance has increased from nothing in 2001 to 42 percent in There is large concentration in market share among the 13 private companies, with the top three private companies accounting for about 22 percent share, the next three accounting for about 10 percent share, and the remaining seven accounting for the last 10 percent. As is obvious, the insurance market has come a long way in the past decade, transforming along all dimensions, be it products, channels, customer, distribution reach, or competition. India Insurance: Turning 10, Going on 20 13

16 The Current Insurance Industry Facing Challenging Times The big challenge before the Indian insurance industry today is profitability. The industry was privatized a decade ago, but profitability/ returns are still tough for most insurers, both in life and non life. The life insurance industry has been struggling to achieve profitability in the face of high operating losses. Cumulative losses for private companies in life insurance are in excess of `16,000 crores, as shown in Exhibit 3.1. Almost 75 to 80 percent of the capital requirement has been to fund operating losses and not for solvency requirements. Increasing pressure from shareholders to limit additional capital contribution, has forced the industry to change its focus to enhancing profitability. Tightening regulation has further increased this pressure. Non life companies in India face a similar challenge. The combined ratio (operating expenses + claims + commissions as a percentage of net earned premiums) of all the non life insurance companies for the past five years has been around 120 percent (refer to Exhibit 3.2). The cumulative underwriting losses of the industry, since Exhibit 3.1: Cumulative losses of top 10 private players ( ) Cum. losses ( ` Crore) ,400 1,024 2,100 2,800 2,674 2,028 1,603 1,464 Total losses of all private players in excess of ~ `16,000 crores 3,500 3,439 Source: IRDA annual reports; company disclosures; BCG analysis. 14 The Boston Consulting Group