REFORMS IN THE INSURANCE SECTOR

REFORMS IN THE INSURANCE SECTOR

 The New Economic Policy initiated in the early 90s, threw open the banking and the mutual fund segments of the financial system to private participation. As a consequence of this endeavor, a great need was felt for the opening up of the insurance sector too, as insurance is also an integral part of the financial system. Therefore, Government of India appointed a Committee on Reforms in the Insurance Sector in 1993. The committee (known as Malhotra Committee) recommended the opening up of insurance sector to competition stating that introduction of competition will result in better customer service and the Committee recommended the following steps to be taken immediately for more equitable product pricing:

a) Claims costs should be controlled by improved application of loss control and risk management techniques;

b) Concerted efforts should be made to comprehensively review and reduce management expense ratios;

c) Motor premium rates should be raised in light of persistently growing adverse motor claims experience;

d) More frequent reviews of rates in all classes of business in light of changing experience in various classes of risks.

 For this purpose, the companies need to set up R&D Cells and upgrade statistical information and technology support to their present product pricing mechanisms. One of the main objectives for recommendation for the opening up of the sector was to provide the consumer of insurance services wider choice so that he can get the benefits of competition in terms of range of insurance products, lower price of insurance covers and better customer service. The Malhotra Committee in its Report also recommended for opening of the insurance sector to private players with an independent regulator towards development of a competitive market. Consequently, on April 19, 2000 Insurance Regulatory and Development Authority bill was passed creating IRDA to protect the interest of the policyholders, to regulate, promote and ensure orderly growth of the insurance industry and amended the Insurance Act, LIC Act and General Insurance Business Nationalisation Act thereby ending an era of exclusive privilege of the state owned companies from doing insurance business in India. New private players thereafter were licenced to enter the market and it was expected that with their innovative approaches and better use of distribution channels and technology, they would make a mark along with established public sector companies in the Indian Insurance Market for better service and faster growth.

The era of tariffs The price of an insurance product is generally linked to the scope of the cover. The tariff mechanism provides floor rates for various insurance products based on estimates of average of all losses across insurance companies, average administrative costs including commissions and average expected profit. In India, the Tariff Advisory Committee (TAC) established under the Insurance Act, 1938 was vested with the functions of administering the rates, terms, advantages and conditions in the general insurance business which are under tariff. The major classes of general insurance business under tariff regime as in 2006 before detariffing of the market were Fire, Petrochemicals, Engineering and Motor. Upto 1972, some data was being received at TAC from the insurers. After nationalization in 1972, the data flow reduced. Further, there was no system of dissemination of data to the public. Even the four public sector insurers were not able to publish consolidated data on each class of insurance. Thus, scientific rating became a casualty. As a result pricing of different classification of risks was done in an ad-hoc manner. This resulted in cross subsidization among different class of risks and also within a class the better risks subsidizing the loss making risks.

Apart from this, the insurer in a regulated market did not have the flexibility in pricing or innovation of products as they had to adhere to the terms and conditions of the tariff in letter and spirit. With the standardization of covers, freezing of rates, terms and conditions, there was little choice available to the insuring public in terms of products and prices. Thus, while the parameters or risk factors fixed in the tariff were adhered to for rating purposes, new and emerging risk factors could not be dove-tailed into the tariff for want of data on those factors. On the customers’ side, there was a perception that the better risks were being charged as much premium if not more than those for the high risk ones. In short there was no distinction between good risks and bad risks as the same rate applied to all. Post IRDA Act, 1999 The IRDA Act was enacted with the objective to protect the interests of insurance policy holders and to regulate, promote and ensure orderly growth of the insurance industry. Even after the opening up of the sector, although benefits of liberalization could be seen with increase in volumes of premium, there was little innovation in the tariff driven General Insurance business. Even after the opening up of the insurance sector, the general insurance business was predominantly governed by the tariffs prescribed by TAC. Considering prevalence of such tariffs against the principles of competition, there was a constant demand from insurers and other industry experts to abolish the tariffs. However, the authority felt that sudden removal of tariffs could result in unhealthy price-wars thereby affecting the solvency of the company itself. In other words, need for sustainable growth on scientific lines and enhanced customer satisfaction was the need of the hour. Hence the IRDA decided to initiate the process of detariff in a phased manner slowly as noted in the following paragraphs.

Motor Insurance: The Loss making portfolio in a regulated set up Generally the countries with a tariff regime and with a controlled market tend to have higher premium than those of the free market. In India, however the situation is different. The motor premium rates were among the lowest in the world. The average motor premium ranges from 2 to 3 per cent of the value of the vehicle as compared to 8 per cent in western countries. The reason is due to the absence of data in the Indian market to support a justifiable pricing mechanism. The older insurers, who had a market share of more than 80 per cent were unable to generate adequate database to enable scientific calculations for risk assessment and rating of different groups of vehicles. Therefore, underwriting in the transport sector was perceived to be a losing proposition, with claims well over 120 per cent of the gross premium income. The net result was that the administered pricing became flawed in the absence of data. For the same reason, the commercial vehicle operators, users, lobbyists, Government or the Courts could not be convinced to approve increase in rates even in the wake of deterioration of claims experience of the insurers.

Traditionally, the following lines of business were governed by tariffs prescribed by Tariff Advisory Committee (TAC): S. NO. Department Policy 1. Fire All India Fire Tariff Industrial All Risks Tariff CL (Fire) Tariff Petrochemical Tariff 2. * Marine Hull * Tariff for Ocean-Going vessels * Tariff for Dredgers * Tariff for Fishing Vessels/Trawlers * Tariff for Sailing Vessels * Tariff for Jetties / Cranes / Pontoons Insurance * Tariff for Builders. Risk Insurance * Tariff for Ship Repairers. Liability * Tariff for Charterers. Liability * Tariff for Ship Breaking Insurance 3. **Marine Cargo **Tariff for Marine Cargo 4. Engineering Erection All Risks/Storage-cum-Erection Tariff Contractors. All Risk Insurance Tariff Machinery Breakdown Tariff Boiler Pressure Plant Tariff Civil Engineering Completed Risk Tariff Contractors. Plant and Machinery Tariff Electronic Equipment Insurance Tariff Deterioration of Stocks (Potatoes) Tariff

All India Motor Tariff Act Policy Private Car Package Policy Motorized Two Wheelers. Package Policy Commercial Vehicle Package Policy Motor Trade Package Road & Transit Risks only Policy Motor Trade Internal Risks only Policy.

EVOLUTION OF DE-TARIFFING CONCEPT

 As discussed earlier, in a competitive market, the products need to be priced equitably based on their individual risk experience which was not practiced due to tariff restrictions. It was alleged that tariffs were rigid based on out-dated statistical data, and that premium rates were not revised in response to the market dynamics. It resulted in heavy cross subsidy of premium for those lines of business which had persistent high claims ratio, for e.g. Motor Third Party. Further, the private players refrained from underwriting the loss making areas such as stand alone liability policy and on the other, they clamoured for detariffing of motor portfolio. They also had in place sophisticated IT set ups and systems capable of statistical analysis of various risk factors over and above the ones prescribed by the motor tariff. The awareness among customers in the wake of liberalization also resulted in a movement towards risk based rating rather than a rigid tariff structure. Representations were received too by the IRDA that insurers were not willing to offer Mandatory Third Party Liability cover and that there were loading the own damage policies. The Authority therefore considered moving to a tariff free regime in a phased manner. It constituted a Committee under the Chairmanship of Justice T.N.C. Rangarajan to examine the various aspects of motor underwriting including de-tariffing and pooling arrangements.

RANGARAJAN S. COMMITTEE ON MOTOR INSURANCE

 The Committee assisted by members representing the insurance companies, automobile manufactures, car owners, truck operators consumers, policyholders, surveyors, an advocate and a representative of the Government of India has studied at length on the issues and difficulties faced by various interests of the industry. Third party liability insurance being the only way of funding social security, worldwide, the system of compulsory vehicle insurance is followed. The report has mentioned the advantages, of, and fears, that were expressed on the projected de-tariffing. The advantages projected were: - Competition will improve efficiency - Efficiency will lead to reduction of premia and benefit policyholders - It is part of the reforms towards liberalized economy. The fears apprehended were: - De-tariffing may make insurance unavailable at reasonable premia - Companies may form cartels and jack up the premia - Free market may lead to insolvency of companies and loss of protection for policyholders.

The problems relating to the own damage portion of the motor tariff were examined by a committee. Suggesting for de-tariffing, the committee stated that liberalization means allow the market to function in the competitive environment. It expressed hope that competition would improve efficiency and consumers will benefit by not only price reduction but also value addition while industry may benefit by introduction of newer technology and innovation. It also added that by de-tariffing, companies would be interested in marketing their products innovatively and with cost cutting may reduce the premia to gather a wider market share. However, de-tariffing requires safeguards for uninsurable vehicle owners. There should be a mechanism for an appeal to an insurance pool which would consider proposals rejected by the companies and grant insurance on premium loaded according to risk perception. At the end of their study, the Committee recommended that the IRDA may: a) Quarantine the Third Party liability insurance business and its accounting in insurance company’s books; b) Request the Government of India to review the statutory liability for third party liability for motor vehicle accidents; c) Set up an independent data bank under TAC and compel the companies to supply the data to the bank, and draw on the bank data to justify proposed tariffs; d) De-tariff the own damage business of motor portfolio under a competitive premium setting model by a file and use procedure with a time frame for the change over.

Steps taken by IRDA (For Motor)

 As the committee after examining various alternatives finally concluded that the initial step in regard to de-tariffing of the premium structure could be undertaken in the case of the own damage portion of the motor insurance, a meeting of all CEOs of the general insurance companies was held in Hyderabad on 6th of May, 2003. The meeting agreed unanimously to usher effective 1st of April, 2005 a system of free pricing on the own damage portion of the motor liability. As a follow up of the recommendations made in the report of Justice Rangarajan Committee, Authority constituted a committee under the chairmanship of Shri S.V. Mony for preparing a roadmap to detariffing of the premium structure of Own Damage portion of the Motor Insurance. However, in order to derive the rates in a scientific manner based on market dynamics, it is essential to have accurate data on the different lines of business, which was abysmal in the general insurance industry. The insurers were unable to generate adequate database to enable scientific calculations for risk assessment and rating of different groups of vehicles. For free-pricing of products, data base relating to different.

classes of risks had to be collected, compiled, disseminated and analysed which was a time consuming activity. Hence, the detariffing of Motor OD Business could not take off on 1st April, 2005, as proposed earlier and the general insurers expressed that the de-tariffing should take place across the board for all business portfolios instead of Motor (OD). A small beginning Pending the issue of de-tariffing of motor (OD) insurance, Tea Crop Insurance (2) Cardamom Insurance (3) Coffee Insurance (4) Rubber Insurance (5) Package policy for exporters under Duty Exemption Scheme were de-tariffed w.e.f. 01/04/04 and all the non-life insurance companies were advised to file the products with IRDA under file and use procedures of Authority. De-tariffing of Marine Hull Insurance Continuing the spirit of competition, all general insurers who wish to write marine hull class of business were allowed to go out of the tariff from 1.4.2005. However, it was mandated that they shall follow the existing policy wordings, terms and conditions including clauses such as the Institute clauses till further orders. Data Collection To fill up the gap of non-availability of accurate data for proper pricing, as a first step, IRDA in consultation with the insurers devised new formats for collection of past data as well as future data in the field of motor and health insurance. New formats were devised taking into account various risk factors hitherto not considered by the rigid tariff structure.

For instance, the salient features of the new format for collection of motor data were the introduction of various code masters. The code masters relate to i) Insurer ii) Policy iii) Class of vehicle iv) Make of vehicle v) Zone vi) Cubic Capacity (CC)/ Passenger Carrying Capacity (PCC)/ Gross Vehicle Weight (GVW) vii) Nature of loss viii) Nature of goods

Road Type xi) Driver Type xii) Driver Age xiii) Driver experience xiv) Driver education xv) Incurred claims experience xvi) Claims History of the vehicle xvii) Nature of injury xviii) Occupation xix) Reasons for Court Hearing and xx) Type of Summons These formats covered the details on driver, geographical zone of driving and the vehicle which are indispensable for rate fixing in equitable manner in a detariff regime.

Road map for a tariff free regime With the intention to ensure that there is an orderly movement from tariff regime to the future set up, on 23rd September, 2005, IRDA circulated a detailed note to all general insurers outlining the various steps to be taken by insurers for movement to a tariff-free market. Considering the existence of tariffs contrary to free-market forces, the road map has emphasized the need for strengthening internal capabilities of insurers. IRDA enunciated the various steps to be taken by insurers in the following areas: i) Underwriting ii) Rating of risks iii) Policy terms and conditions iv) Corporate governance Exposure Draft Guidelines on File & Use procedures After notifying the road map, the Exposure draft on File & Use guidelines prepared by IRDA was placed on the website of IRDA seeking comments of insurers and industry for filing of products, to be filed once de-tariffing takes place. The guidelines were discussed at length and the responses were consolidated for finalizing of the guidelines