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 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 the year 2000 when the Insurance Regulatory and Development Authority of India (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 organisation 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 high 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 were 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 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’.
The initial years of private sector life companies were characterised by high lapse ratio, to the extent that some of the companies were able to show an overall profit by virtue of lapsed policies whose premiums could be appropriated to the bottom-line!
The regulator eventually wised up to this practice and fairly stringent regulations were introduced to check mis-selling and policy conditions relating to lapsing.
The prevalent narrative is to blame the poor performance of the government companies on management incompetence and corruption. This is simplistic and misses the woods for the trees. The reality is that some of the most competent and dedicated employees work in government companies.
The mechanics to check corruption actually work to demotivate the honest and fail to catch the real rogues. Conduct rules and procedural safeguards mirror those applied to civil services. The real reason for the poor performance of government companies is the government ownership. Whether it is Air India, nationalised banks or insurance companies, they are hamstrung by the very fact of government ownership.
It is simplistic to assume that mere tightening of regulatory oversight will help improve the fortunes of the public sector insurance companies. These companies operate in a radically different internal environment due to governmental ownership. In theory, these are board-managed companies but in practice the government nominee, mainly one of the senior officials in the finance ministry, calls the shots, in the belief, and rightly so, that he or she represents the owner.
The management has little strategic autonomy. Human Resource (HR) policies, such as recruitment, compensation and promotions must follow the departmental pattern. Disciplinary framework follows civil service rules. Thus, the management has little leeway to reward the good or punish the non-performers. Mandatory periodic transfers get in the way of professional and organisational excellence.
Insurance business works on trust and, at times, insurance companies have to find a way to pay a claim in the best interest of the business and to avoid undue hardship to the insured. This is near impossible in a set up where the spectre of the Comptroller and Auditor General (CAG) and vigilance haunts all decision makers.
At times, the ‘investigative’ regime gets so onerous that many senior officials become victims of a witch-hunt on the eve of their retirement. Contrast this with the fact that most of the private sector managers not only enjoy generous rewards for performance but can also look forward to a generous nest egg upon retirement in the form of share options or deferred bonuses! It is a miracle that management of nationalised companies chugs along regardless.
Government-owned companies can hardly be expected to hold their place in such an environment. No regulator in the world can supervise every action or audit every spreadsheet. When the business environment becomes untenable, wisdom lies in cutting one’s losses. That the policymakers have tacitly acknowledged this is evident by the decision to privatise Air India.
However, such a strategy is unlikely to meet with success in the case of the three nationalised insurance companies. The primary reason is that it is difficult to ascertain the hole in their finances. The attractiveness of their brands and infrastructure is questionable. Customer base in this business is transient. The best way is to let them wither away.
The foregoing analysis leads to the inevitable conclusion that the buck for poor performance of nationalised insurance companies stops a at the owner’s table, the government. This is unlikely to change so long as the government continues to exercise its ownership, partially or fully. It is also unrealistic to expect that these companies will be allowed the autonomy that is needed for a turn-around.
Although the government has recently announced a privatisation policy for public sector enterprises, pumping capital in these companies in the hope of recouping the investment via eventual privatisation would mean throwing good money after bad. Under the circumstances, the question remains: How appropriate is it to pin the blame on the regulator?
(Shrirang V Samant has worked in senior leadership roles in the General Insurance Industry, both in public and private sectors, in India and abroad. He has been privy to the transition of this industry from public to private sector in the country and was the founding CEO of a multinational insurance joint venture- JV in India.)