At the heart of the complex web of bits and bytes that is the modern financial system is the ability to exchange and transfer capital (money) between various participants in an economy. Borrowers, lenders, investors and entrepreneurs form the four corners of this very busy square. Traffic flow and participants can either be controlled and owned by the government as it was in India till 1991, or it can be regulated by a set of independent regulators appointed by the government, as it is today in 2021.
When we see the hectic activity in the Indian financial system today, we tend to forget what it was like just 30 years ago — in terms of scale, products, efficiency, cost and service. The sole job of a financial system is to trundle money around to find its optimal use in terms of returns at a low-cost and safety of transactions. But the centrally planned Indian economy used the state-owned financial institutions such as banks and insurance companies to gather household savings for its own use, hard coding this into the reserve ratios in banks and investment guidelines in insurance firms.
Insurance companies are in focus as the Insurance Regulatory and Development Authority of India (IRDAI) has received complaints about COVID policies not being offered and renewed. Atul Sahai, CMD of the New India Assurance Company and Monika Halan, Author of Let’s Talk Money shared their views.
“As far as New India Assurance is concerned, I don’t see this happening. This could be the approach adopted by some of the companies but in the wake of COVID, no new guidelines have been issued as far as we are concerned,” said Sahai.
“The need for health insurance has suddenly increased for most people. The new insurance buyer has got afraid that something may happen and is now running to buy insurance. Globally, insurance companies are struggling to understand this risk and to price this into premiums. So, different companies approach the cooling-off period differently. COVID-19 pandemic is a new event and everyone is struggling to find their balance with it and people seeking health insurance cover for the first time post COVID are in for a little bit of a rough ride unfortunately,” Halan added.
“This is a great time for the government and the regulator to set things right in terms of insurance,” Halan mentioned.
According to Halan, higher loading is expected for the new policy entrants.
“The companies will have to probably increase the premium for the entire age bucket. The price rise will be across the board and not specific to a person,” she mentioned.
Incurred Claim Ratio (ICR) is used to gauge whether this market is fair or not. The number is obtained by total claims paid divided by the total premium.
While explaining the current market condition, Halan shared, “If the net number is at 100 percent, then we are seeing a fair marketplace where after profit and cost, insurance companies are neutral.”
“According to data, the private insurance companies’ ICR is 53 percent, the standalone insurance companies’ number is 56 percent, and the PSUs are 92 percent, which means they are doing well. I think it is a complete regulatory failure because you are not being able to ensure that there is no gouging of the customer,” she further mentioned.
“We are not going to increase the premium till we tide over this crisis,” Sahai shared.
The number of policyholders is 30 crore. Assets under management are Rs 27.6 lakh crore (to see this in context, understand that the annual budget of India for FY 22 is Rs 34.8 lakh crore). An annual premium pipeline of Rs 3.4 lakh crore. A household name that for decades has meant life insurance in India. When such a behemoth goes to market, there are bound to be concerns, worries and plenty of politics. The drama has just begun.
The Life Insurance Corporation of India (LIC) disinvestment should finally happen in 2021-22. I say this with confidence because the background work is now done and the Department of Investment and Public Asset Management (DIPAM) has put in the amendments to the 1956 LIC Act (you can see them in the Finance Bill 2021) that will clear the decks for a stake sale by the government, who is today a 100% owner. The 318-page Finance Bill 2021 has 75 pages devoted to rewriting the 22-page 1956 LIC Act.
There are six big take-aways from the amendments to the LIC Act. And then there are some concerns. The take-aways first.
One, the basic constitution of the entity will be changed by changing Section 4 of the 1956 Act. The new rules make the corporation aligned to Companies Act 2013. There will be 15 board members, with one place kept for a woman. Additionally, insurance agents, intermediaries or anybody working for another insurance firm anywhere in the world cannot be a director on the board. An upto 10% owner can have one board seat, between 10 and 25% shares can have two seats and more than 25% can have three seats. The rest belong to the government and there are rules in place as to how these will get filled.
Two, Section 5 has been amended so that the capital of LIC will now reflect its size and has been hiked from the current Rs 5 crore to Rs 25,000 crore, split into 2,500 crore shares of Rs 10 each. There are provisions for partly paid up, preference shares, for bonus and rights issues and for private placement. Embedded into the new Act will be the provision that LIC will always have the government as the majority shareholder and will not disinvest more than 49% shares. But there is a glide path for this. The initial sale can only be upto 25% of the shares. It is only after five years of this can the government sell more of its shares. This means that for five years after the first disinvestment, the government will continue to hold 75% stake. After five years, it can disinvest such that it still has a 51% share. This is important because Section 37 has been left unchanged. This section says that the sum assured by all policies issued by LIC, including any bonuses are guaranteed in cash by the Central Government. So, policyholders need not worry on this count.
If shares are sold at a premium to the face value (and they will of course get a hefty premium), it will be kept in a share premium account. This money will be used for future bonus shares to shareholders, for the payment of costs of the IPO and for the discount to policyholders on the shares they buy and for future buy backs on own shares and other shares. So potentially the premium money can be used to buy shares in other firms.
Three, existing policyholders of LIC to get shares at a 10% discount for upto 10% of the issue size. For example, if the government disinvests 10% of its 2,500 crore shares, then the shares available for policyholders will be 25 crore out of the 250 crore shares that make 10% of the shares to be disinvestment. Policyholders will not get an allotment of a value more than Rs 2 lakh. This can go upto Rs 5 lakh in case the reserved part of the shares are undersubscribed. What I understand is that a person with multiple policies (many people have 20-30 policies) will not be able to get allotment per policy, but one demat account will facilitate shares to be sold on any one policy of the policyholder. Expect the demat account openings to skyrocket.
Four, the two-line Section 24 on “Funds of the Corporation” is replaced with a 6-page detailed list of how LIC will have to segregate its funds. LIC will now have to segregate its pool of funds into a participating fund and a non-participating fund. I have written earlier on how to understand par and non par products and their pools here. Currently the money goes into one pot, though there is some form of segregation, but it is not water-tight. LIC has one year (there is a carve out for a three-year glide path to create this) after the disinvestment to split the common pool into two. Receipts and payments will be made from the respective pools. Today there is a cross subsidization possible between two very different products. But an escape door has been given in Section 24B(9) that says: that the government can exempt LIC from complying with the provisions of this section in “public interest”. Basically, if the unions agitate too much, they will go back on the clean-up. Or if they find something really unexpected when the pools of funds are opened up, there is an exit door that can be used to get out of this. This is a key part of the disinvestment process since investors coming in will not want to buy into an opaque pool. The government must not go back on pool segregation.
Five, the three-para Section 26 is being replaced with much tighter rules on what will be audited. For example, auditors will now have specific oversight on the lending book of LIC. Auditors will now be able to have oversight on whether loans made have been properly secured, whether the terms are in favour of LIC (this is to take care of conflicted lending, if any), if securities have been sold for less than they were bought, if loans and advances have been shown as deposits, if personal expenses have been charged to the revenue account.
Six, Section 28 has been replaced. Section 28 says that a minimum of 95% of the surplus is to be shared with policyholders. This will change to 90% after the amendment. Till the LIC fund is split into par and non par, the sharing is 90% of the entire fund. 10% of the surplus will be kept in a special fund or moved to reserves – this will be a board decision.
Once the par and non par pools are split (there is a window of three years to do this), then, a minimum of 90% of the surplus is given to (or reserved for) par policyholders. A maximum of 10% goes to shareholders in a reserve fund or any other way that the board decides. 100% of the surplus of the non-par fund will be given to the shareholders – in a reserve fund or a separate account – to be decided by the board. Policyholders in a non par product by definition do not share in the profits, but get a guaranteed return, therefore there is no sharing of the surplus. Currently there is little visibility on which policyholder is paying for whose surplus.
This surplus can be used for declaring and/or paying dividend, issue of bonus shares. The amendment also prevents the payout of dividend from any unrealized profits, notional gains (remember UTI?), revaluation of assets.
Concerns
It seems that just getting a base level of hygiene amendments was very tough. From my experience of serving in Swarup Committee (2009) and Bose Committee (2015) and dealing with LIC in particular and insurance industry in general, breaking through the clouds of insurance obfuscation is a very difficult task. Just getting the company to break the funds into par and non par pools was a tough battle, it seems, before this could go into the Finance Bill. And my worry is that this battle is not over yet. Not only has the government given a three-year window to LIC to do this, but there is an exit door that allows the government to step back from this reform. There is a problem in pooling money the way it is done now. There is historic money pooled together (an old policyholder who gets 8% guaranteed return is paid out of the same pool that pays a new policyholder who gets a 4% return), but the money of two very different products (par and non par) are mixed up.
The next concern is of the unions and the Left lobby inciting trouble over the IPO. We have seen what farmer-friendly laws can be whipped into by anti-reform lobbies. Although the government is doing this very carefully and slowly (keeping the sovereign guarantee in place, keeping the profit share in par policies at 90% and giving a glide path for splitting pools of money), there is a internal unwillingness for change. I fear that the 100% surplus handover in non par policies will be used by lobby groups to say how the government is ripping off poor policyholders. Of course, they will miss the point that these are non-participating policies. They do not get a share of the profits by their very nature.
What will help the government is the 10% of the issue at a 10% discount kept for policyholders. It remains to be seen how the LIC IPO narrative is built and how many steps back the government will have to take to bring this giant to market.
I will be tracking the LIC IPO closely. So watch this space.
Monika writes on household finance, policy and regulation.
It is almost as if you can see the conflict: there is the desire to do the right thing by the customer, but the DNA of an institution that does not believe in consumer rights comes in the way. The insurance regulator is torn with this dichotomy, of watching its capital market counterpart take giant strides in investor protection and disclosures, wanting to do the same, but not being able to. Insurance industry insiders say that the Insurance Regulatory and Development Authority of India (Irdai) chairman is keen to bring about change in favour of the consumer but is hampered by the tight ring of bureaucracy of a PSU monopoly mindset that thrived in a supply-starved market of the 1970s of a socialist India.
Two moves that should have brought accolades need to do much more in policyholder interest, but are good announcements of a regulator beginning to think about customers rather than agents, brokers and firms. One, the idea of a standard term life cover that can be bought off the shelf with standard features and no frills. Each insurance firm from 1 January 2021 will have to launch a standard pure term (only insurance cover, no investment) cover called Saral Jeevan Beema (read the circular here: bit.ly/37I6ii8). Great move, but it is unclear why there is a ₹25 lakh upper limit for the sum assured, and then the asterisk that firms can offer more cover if they like. It seems that firms will have to offer a cover of up to ₹25 lakh and can offer a higher one if they choose to. Pure covers have a rule of thumb of 10 times your income. So, an income of ₹2.5 lakh a year will need a ₹25 lakh cover. To me it looks like a carve out for insurance firms so that they don’t really have to offer a policy to the market that is actually buying term covers—those covers are of a much higher value— ₹50 lakh or more.
The Securities and Exchange Board of India has become the first financial regulator to settle the debate regarding the classification of advisors and agents when it comes to financial instruments. Personal finance expert Monika Halan explains Sebi’s solution, comparing advisors to doctors, and agents to chemists. Agents are only supposed to sell products which customers seek, while advisors will make recommendations after assessing various factors related to the buyer. Meanwhile, other regulators like the Insurance Regulatory and Development Authority, and the Reserve Bank of India are still lagging behind. Is it time for the government to intervene? Monika Halan is consulting editor, Mint, and author of the book ‘Let’s Talk Money’.
The year 2018 was when we all learnt some hard money lessons. We learnt that stock prices that go up very fast can zoom down too. We learnt that debt funds are not fixed deposits and returns are not assured. We learnt that real estate revivals can take years and years, and 2018 was not that year. We learnt that governments can change the rules of the game around taxation making it better or worse for you. 2018 was the year in which we learnt the meaning of risk.
There were four kinds of risks that we took home this year. First, the risk of chasing high returns. Many of you may be holding a portfolio that has mostly small- and mid-cap funds. That’s because you saw the 40% plus one year returns in 2017 and went all out to harvest that return. I can remember plenty of conversations with first-time mutual fund investors who had jumped right into the deep end with all their money in the risky part of the market. Warnings would fall on deaf years as the return chasers thought the SIP was their safety belt. 2018 saw a bloodbath in both the mid- and small-cap categories. Investors are staring at an average loss of 12% in mid-caps and around 18% in small-caps. The worst small-cap funds have lost almost a third of the invested value—or ₹1 lakh has become ₹70,000. If you had your entire money in small- and mid-caps, your portfolio is bleeding. But if you had a mix of large-cap, multi-cap and ELSS funds, the red will be less stark. Just buying last year’s winner is not a good strategy for mutual fund investors. 2018 told us that. Understand what a ‘diversified portfolio’ means and implement it in your money box.
eading the Irdai (Insurance Regulatory Development Authority of India) draft on updating regulations for unit-linked insurance plans and traditional policies, you get the impression that somebody gave an aspirin when what was needed was a heart surgery. Product structures in finance are taking on a new importance globally because mis-selling and unsuitable sales can be reduced by taking the tricks and traps out of these products. This simply means that the costs and benefits are better defined and marked so that investors are able to understand the features of the products properly. Product structure rules also deal with early exits and their costs so that investors are not trapped in products they buy.
Both anecdotes and data seem to suggest that Indian health insurance polices that are bought by us as individuals don’t pay up as much as they should. As we listen to the stories of our friends and family about the run around given by hospitals and medical insurance firms to pay up claims of a hospital bill, we quietly send up a prayer—please let me not be the one whose claim is rejected if I ever need to use my policy. There is increasing distrust in the medical insurance market for privately bought covers. Covers bought by corporations, called group covers, seem to have less problems of claims getting rejected.
The anecdotes are supported by data. A May 2018 working paper, titled Fair Play in Indian Health Insurance has done a deep dive into the sector. The big findings are two. One, claims are not paid as much as they should be. Two, India has the highest complaints rate when compared with other countries.
For the more than 25 crore policyholders of Life Insurance Corporation of India (LIC), the LIC-IDBI Bank headlines are very upsetting. LIC will use up to ₹ 13,000 crore of policyholder money to buy up to a 51% stake in IDBI Bank, an asset nobody wants to touch. With stressed assets of ₹ 55,588.26 crore and bad loans a huge 28% of the total loan book, IDBI Bank is probably the worst of the bad banks of India. With its own paid-up capital at just ₹ 100 crore as on 31 March 2017, LIC will use policyholder money entrusted to it to make this equity investment.
LIC has been the gilt-edged long-term safety net for most of post-Independence middle India. “LIC kara lo” is a refrain heard in Indian homes the minute the first salary of the young adult of a family begins to come in. There is public anger when this security of savings comes under threat. There are lots of reasons the policyholders are worried. They are worried about the safety of their money—what if the entire money goes down the drain. They are worried about this being a precedent to more such toxic asset purchases. They are worried about the haste with which the insurance regulator has interpreted a rule to allow this sale—insurance firms are not allowed to hold more than a 15% equity stake in a single firm to prevent concentration of risk.
The news of the appointment of Subhash Chandra Khuntia as the insurance regulator on 1 May 2018 came as a surprise to most financial sector watchers. Of the eight people shortlisted for the final round of screening, Khuntia was the only bureaucrat, the rest were insurance industry insiders, including the serving Life Insurance Corp. of India chairman V.K. Sharma, New India Assurance chairman and managing director (CMD) G. Srinivasan, member Life at Insurance Regulatory and Development Authority of India (Irdai) Nilesh Sathe, and K. Sanath Kumar, CMD, National Insurance. The choice of a person with limited domain knowledge over others who have spent their entire careers working in this very technical industry was the surprise. Remember that it took an earlier outsider, J. Hari Narayan, the first three years of his five-year term to understand the sector. In fact, by the time he demitted office, he understood the sector so well that it went against the then government’s own agenda to allow him to continue. So what has gone into the decision to appoint an outsider as the head of a regulatory body that watches over Rs28 trillion of household savings and over Rs2.2 trillion of general insurance money?
Monika Halan's blog 