Insurance Sector Woes: Can We Nail the Blame on the Regulator, IRDAI?

Having discussed the flaws in the government proposal to firstly merge three of the four public sector general insurance companies and the subsequent proposal to recapitalise them, it was interesting to read an article “A case for scrapping IRDAI” in Business Standard on 16 July 2020 on the issue. While highlighting the need for greater regulatory intervention, this article raises a fundamental question: where does the buck stop?

Since the said article focuses on the regulatory oversight of the nationalised non-life insurance companies, it may be useful to understand that government ownership of these companies has a bearing on their management and supervision and thus on their performance. In our country, all regulators are in substance extended arms of the government and therefore, it is somewhat naïve to assume that the regulators can afford to disregard the government’s wishes, formal or informal. The fate of a couple of high-profile banking regulators is a case in point.

When examining the role of the regulator, it is important to remember that all over the world, regulators are one step behind the market. In India, initially the insurance regulator viewed its task as ensuring successful opening of the market, as evidenced by the number of new entrants. There were hardly any senior regulatory officials with prior exposure to the competitive behaviour of the key constituents of a liberalised market, namely insurers and intermediaries.  The entire regulatory proposition was based on the vestigial learnings of the previous three decades when the nationalised insurers operated in a controlled environment. Little did the policymakers realise that once the market opens up, changed market realities will challenge the assumptions on which the regulatory framework was built.

What was the defining characteristic of the controlled environment mentioned above? Before the opening of the insurance sector in year 2000 when the Insurance Regulatory and Development Authority (IRDAI) began the process of licensing private sector companies, the four public sector companies operated in a regime of administered prices. 

In insurance parlance this is known as tariff. The price for each class of insurance was set by an industry body called the tariff advisory committee which took into account the loss experience for various types of insurance covers, added acquisition and administrative costs to these and then arrived at a price.  In such an environment profitability should have been assured despite which the nationalised companies made underwriting losses mainly because a broad spectrum of risks had to be underwritten by one or the other company, and because of heavy establishment costs. However, their investment income cushioned the underwriting losses and overall profitability was assured, safeguarding their capital base.

As the private companies began entering the market, it was expected that they would make headway relying primarily on better service and lower establishment costs. The regulatory authorities overlooked one fundamental aspect of competition – price. It was assumed that the new entrants would stick to administered prices since that would be beneficial to them.  It was naively assumed that the new entrants would need the cushion of an administered price regime! However, most of the private companies started an unofficial price war as they were keen on gaining market share. Insurance in India is a cash and carry business - premium must be paid before a risk can be accepted. 

Private companies rightly recognised that acquiring market share will give them enough volume to cover their establishment costs and the investment income on the cash flow will cover underwriting losses. Theoretically this was illegal, but the regulator left the policing to the tariff advisory committee which was a toothless tiger. This body could only impose fines, which it did when the instances of breach were brought to its notice, but the private companies calculated that their market share gains will far outweigh the fines. 

Nationalised companies were unable to commit flagrant breaches of tariff and bled market share rapidly. Thus, we have the scenario that while the nationalised companies were losing market share, they were unable to rationalise their costs. This was the prefect prescription for financial disaster. Eventually the administered pricing regime in quite a few classes of business was dismantled and tariff advisory committee was closed down, but by then the market had tasted blood and the damage to the top and bottom lines of the insurance companies was done. Another important asymmetry was in the area of intermediary commission paid to brokers and agents. An upper limit on the intermediary commission was in force for various classes of business. This made sense in a government company regime, where the intermediaries had limited choice of suppliers, i.e. insurers.  

Following the opening up, when there was nearly a dozen private sector non - life companies, the role of intermediaries became crucial. Since products were generally standardised, that is, the policy wordings were same or similar, two things happened. The first was that the intermediaries started bargaining with the insurance companies for higher commission. Secondly, they started pushing for lower prices. In several classes of insurance, where administered price still existed at least on paper, intermediaries gave business to companies that paid highest commission. 

Initially this went on under the regulatory radar, but when complaints about commission rate violations reached a crescendo, the regulator tried to step in via audits and fines. This gave a distinct advantage to the private sector insurers who were adept at accounting juggleries to hide the unofficial pay-outs under various other heads such as marketing and promotional expenses. The public sector companies enjoyed no such leeway and consequently lost a lot of good business. 

The situation wasn’t much different in the life insurance industry. While the Life Insurance Corporation (LIC) operated through its office network, private sector companies relied mainly on bancassurance arrangements. They tied up with several banks for selling life policies. Initially these were their promotor group banks but recognising the scope of risk-free income, other banks too jumped on the bandwagon.  Just like non-life business, there were ceilings on intermediary commission in life business as well. However, barring a few honourable exceptions, both insurance companies and banks found a way around this. ‘Incentivisation’ became the buzzword. 

LIC would not have been able to follow similar tactics, despite which it has been able to hold on to a respectable market share as compared to its counterparts in the non-life sector. The other major challenge was rampant mis-selling. In an atmosphere of low consumer awareness, this was easy. This took various forms but two examples should suffice. Without considering a customer’s need or the ability to pay, investment products were sold as insurance. This meant that the pure life component of the cover was low, and annual premium commitment was high. Invariably, when the customer was not able to keep paying the annual premium in the ensuing years, policies were treated as ‘lapsed’.