Merging Insurance Companies: Yet Another Air India in the Making?

If you do not know where you are going, it does not matter which road you take. Well, this is not exactly what the cat said to Alice in the famous parable, but it captures succinctly the conundrum currently surrounding the merger of general insurance companies in the public sector, namely, Oriental Insurance (Oriental), National Insurance (National) and United India Insurance (UI).

The department of financial services has now taken the first step towards going down the rabbit hole by announcing that two of these, namely, National and UI, will be merged with Oriental by 31 March 2020. The merged entity will start functioning with effect from 1 April 2020 with its head office in Delhi.

According to rough estimates, the capital infusion needed is at least Rs2,000 crore-Rs3,000 crore in each of the companies, and the total collective requirement is close to Rs12,000 crore-Rs13,000 crore. What is perhaps left unasked is: Will this merger, accompanied by the fund infusion, act as a silver bullet, that is, will it make the merged entity viable both in terms of capital adequacy and the return on investment to the principal shareholder, the Indian taxpayer?

The question that arises while making such an open-ended commitment of taxpayers’ money is: whether there has been a robust and transparent debate to evaluate the decision, the process and the likely outcomes? 

Let us start by asking a basic question—what is the objective behind the proposal? Is it to cut costs? Is it to create synergies? Is it to provide for a government owned counterweight to the private sector in the general insurance space, something like the Life Insurance Corporation (LIC) in the life insurance space? The government probably assumes that consolidation will lead to cost rationalisation, marketing synergy, avoidance of wasteful competition and better leveraging of the balance sheet, thereby restoring the profitability of the merged businesses.

The one likely objective—cost cutting - seems reasonably straightforward at first sight and possibly that is what is driving this whole exercise. Merging the companies will eliminate the wasteful expense of these three companies having an office each in the same locality, sometimes in the same building, thus saving on rent and other fixed costs. This will also eliminate the parallel pyramids of staff and officers in the three companies.

However, if the government promises that jobs will be protected, and in the current scenario this is a given, then any attrition of manpower will only happen gradually, by way retirement. The financial strain of a realistic voluntary retirement scheme (VRS) may break the balance sheets of these companies. The second objective might be to create synergy. This is easier said than done.

Integrating the information technology (IT) systems or migrating to a standardised one will be a logistical and financial nightmare. Business operations of these companies will be paralysed while integration is taking place. Although outwardly similar, these three companies have different cultures and practices and integrating them will be a long and painful grind. Even if the elusive goal of synergy is somehow accomplished, what would it achieve? If the market doesn’t really need you, synergy of any kind is a false objective.

Creating a counterweight to private sector?  One large company, New India Assurance, already exists. This is a listed entity and perhaps this factor gets in the way of integrating the four public sector insurance companies, instead of the three unlisted ones, which would have been the most sensible course to take. Yet another giant public sector insurer is unlikely to stand on its own in the market, given the strong presence of private sector companies in almost all nooks and corners of the country. The only thing that is bound to happen is that the business of the three public sector companies will move to the private sector or to New India while the transition is taking place. By the time the merger is fully accomplished, the merged company would have turned into an insignificant entity, presumably a dumping place for unwanted business or to administer government-sponsored schemes.

Here it may be pertinent to examine the seemingly parallel merger of public sector banks. While the drivers may be similar, the operational consequences are different. Bank customers are unlikely to move their banking relationships in a hurry—be it savings or current accounts, or loans.  Juxtapose this with the fact that insurance policies are generally 12-month contracts.  Customers always do forum shopping at the time of renewal. There is every incentive to move one’s policy to another insurer either for a lower premium or for better service. The other parallel that might be drawn is the merger of Mahanagar Telephone Nigam Ltd (MTNL) and Bharat Sanchar Nigam ltd (BSNL). This is a false analogy simply because while ownership of telecommunication assets can be justified as a strategic imperative for the government, there are no such imperatives as regards the non-life insurance space. In any case, hopefully, the one listed insurer, New India, can serve the purpose, if any, behind government presence in the market.

Will the merged entity generate returns for the government? A cursory look at the financial performance of each of these three companies will provide the answer—none of them have made an underwriting profit for the past couple of decades and some of these companies have actually incurred losses even after considering the investment income. The harsh fact is that insurance financial statements, given the reporting standards currently prevalent in our country, are notoriously opaque. The real state of their financials might be far more alarming than the published figures. 

Would the merged entity provide a choice to the insuring public? Given that there are already 27 companies in the market, competing for a customer base, the argument of offering customer choice sounds preposterous. 

Will the merged entity have a strategic rationale for its existence? Is there a gap in the market which a second public sector insurer will fulfil or will it end up as a drag on the other remaining public sector company, New India? It is obvious that the merged entity will act as a direct competitor to New India rather than to other private sector insurance companies. 

The reality is that non-life market is overcrowded and fiercely competitive. Regardless of the projected growth of the economy, the market is unlikely to make room for a new insurer. Make no mistake, the merged entity will be a new entrant given that consumer loyalty is rather flaky. Share of the non-life premium in the gross domestic product (GDP) has barely moved over the years, and with the economy being near-stagnant now, the size of the pie is unlikely to grow at the same pace as was the case in the past couple of decades. The size of the pie and its constituents are probably the subject matter for another article.

Is the merger a prelude to eventual disinvestment? Drawing a parallel with Air India privatisation is possibly not very apt. Air India has international flying rights and airport slots which make it attractive to a potential investor. It is difficult to imagine why any eventual disinvestment or listing of the merged entity will attract any interest from private investors. The best course for the government would be to put the three companies into ‘run-off’ and give a golden handshake to its employees. This is a common practice in all insurance markets where a general insurance company is in terminal decline and is not an attractive proposition for merger or acquisition.

If the merger exercise goes ahead in its present shape and form, the owners, i.e., the government, will have 'another fine mess' on its hands sooner rather than later. The principal reason is that there is no business case or other strategic rationale for the merger. Our experience shows that government ownership simply does not allow the management to run a business like a business.  And it is our money which will be spent time and again.

The additional capitalisation requirement mentioned in the earlier part of this article is merely the starting point; it is very likely that, given the total absence of a business case for the existence of the merged entity, periodic top-ups become inevitable. This is where one worries about 'another Air India' inasmuch as this will amount to throwing good money down the rabbit hole.

Source: Moneylife

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