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
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