Draft Report of the High Level Group on Services Sector

6.2.2 Insurance

The insurance sector in India has witnessed rapid development since its liberalization in 2000. The entry of new private sector players has helped to catalyse growth and introduce innovation in products and channels. The key recommendations for reform in the insurance sector are:

1. 
   Liberalization of products and rates in the sector: In order to encourage market players to develop products that meet customers’ needs, all insurance products should be de-tariffed subject to appropriate regulatory oversight. This would especially encourage growth in the non-life sector. For example, in the case of third party motor vehicle insurance, the present administered pricing system is causing serious distortions and heavy losses to the insurance industry. In this segment, users should pay the cost of insurance based on actuarial determination instead of the current cross subsidisation.
   

2. 
   Review of capital requirements and related regulations: The present capital regulations governing insurance companies require maintenance of available solvency margin at 150% of required solvency margin, leading to high capital requirements. The prescribed solvency margins in themselves constitute a prudent solvency capital standard even without the additional 50% capital requirement. For instance, a 1% solvency requirement has been prescribed for the unit-linked life insurance business where the investment risk is wholly borne by the policy holders. The higher capital requirement restricts growth and increases the cost of insurance for the policy holders after considering the minimum return on capital required by shareholders. It is therefore recommended that the capital requirement be set at 100% of the solvency margin requirement. The excess capital thus held for existing business need not be repaid but can be used to support future growth.
   

Further, currently only common equity/ share premium and retained earnings qualify as capital. Given the high growth scenario, scarcity of equity capital and higher return expectations of equity investors, alternative forms of capital, such as preference shares, subordinated debt and hybrid instruments that have fixed cost as well as some risk/ loss absorption characteristics, may be evaluated and permitted, as has been permitted for the banking sector.

A related issue is that of foreign ownership limits in private sector insurance companies. Insurance in India is in a high growth phase with substantial investment requirements over a number of years before the new insurance companies achieve stable profitability. In this scenario, permitting foreign investors to own a larger share may be considered. This would also be in line with the higher levels of foreign ownership permitted in the asset management sector and in private sector banks.

3. 
   Rationalising taxation, including incentivisation of long-term savings: Currently, savings by individuals are incentivised through tax exemption under Section 80(C) of the Income-tax Act. However, this clubs short-term and long-term savings instruments under the same fungible exemption limit. A separate exemption limit is therefore recommended for long-term life insurance and pension/ annuity products. A similar provision may be considered for investment in dedicated close-ended infrastructure mutual funds and long-term bank deposits.
   

Service tax is not payable by providers where the taxable service value is less than Rs. 0.8 million, provided the tax is paid to the government directly by the service provider and not by the service receiver. Life insurance companies are required to pay service tax on the auxiliary services provided by insurance agents, even if the taxable service value is lower than the threshold limit. This may be rectified by giving the benefit of the threshold irrespective of the actual tax paying entity.

4. 
   Diversification of investment portfolios: The investment pattern of life insurance companies is prescribed by regulation. Only 15-25% of the corpus may be invested in “other than approved” investments. A number of long-term, high yielding investments fall into the “other than approved” category, and some, such as asset-backed securities, are not permitted at all. The investment regulations may be reviewed on an ongoing basis to enhance the ability of insurance companies to invest in emerging instruments and derivative products, to optimally manage their portfolios.
   

5. 
   Reinsurance: The more mature general insurance companies have capital in excess of their current solvency requirements. In order to ensure efficient utilization of capital on a system-wide basis, they may be permitted to take on risks originated by other players. As recommended for other insurance companies, FDI restrictions on re-insurance companies should be removed. Foreign re-insurance companies should be allowed to set up their representative offices and function in India through a network of branches and divisions, thus creating conditions for the development of a buoyant reinsurance market.
   

6. 
   Rationalization of laws: The insurance sector is governed by several statutes such as the Insurance Act, 1938, the Insurance Regulatory & Development Authority Act, 1999, the Life Insurance Corporation Act, 1956, the General Insurance Business Nationalisation Act, 1971 and so on, as well as rules and regulations issued thereunder. There is a need for a simple unified legislation that sets out the key principles and statutory provisions, with several aspects currently defined by statute being moved into regulations.
   

7. 
   Increased disclosure norms: In keeping with greater liberalization, increased disclosure norms to report both gross and net level incomes, liabilities and reserves would be needed. Reinsurance activities would need higher degree of scrutiny and disclosure.
   

8. 
   Addressing market convergence and regulatory overlap: The insurance and asset management sectors have substantial overlap in terms of the products offered, such as in the area of unit linked insurance plans vis-à-vis mutual funds. However, these are regulated differently. Similarly, the asset management and banking sectors have product overlap such as in the area of the short term debt-oriented mutual funds vis-à-vis bank deposits, but these again differ in terms of regulation and tax treatment. It is recommended that the regulatory and other treatment of similar products offered by different segments of the financial sector may be reviewed to ensure appropriate alignment.
   

9. 
   Encouraging the creation of catastrophic insurance: Natural disasters and catastrophes have historically affected economic assets in India severely. There is a need to develop disaster insurance by mandating it in certain zones prone to frequent losses, setting up insurance pools, and providing tax concessions for reserves set apart by corporates and insurance companies for meeting losses associated with natural disasters.
   

10. 
    Facilitating penetration of health insurance: In order to increase penetration of health and other personal non-life insurance products, especially in rural areas, premia associated with these insurance products may be made eligible for tax exemptions.
    

11. 
    Facilitating agriculture insurance: Despite several attempts agriculture insurance has not taken off in India. Given the importance of risk mitigation in agriculture, and the need to promote private investment in this high risk and long gestation business, it is recommended that an appropriate policy framework, including consideration of fiscal incentives, be developed to promote commercially sustainable development of agricultural insurance.