Report No.

PA 15 of 2008

Chapter 1

Growth of insurance industry

1.1 Introduction

The beginnings of the insurance industry in India date back to the nineteenth century
when the first life insurance company was established at Kolkata in 1818. Subsequently,
the first general insurance company commenced operations at Kolkata in 1850. Over the
years the industry expanded, with numerous entities operating in both life and general
insurance segments. The insurance business is normally classified into two segments viz.
life and non-life. General insurance is part of the non-life segment and refers to fire,
marine and miscellaneous insurance. The term “miscellaneous insurance” includes
engineering, motor vehicle insurance, health insurance, etc. Significant milestones in the
development of the insurance sector are described in Box 1.1.

Box 1.1

Insurance in India: Milestones

¾ 1938- Enactment of the Insurance Act, 1938, replaced earlier legislation and
consolidated the law relating to both life and general insurance.
¾ 1956- Nationalization of the life insurance business by enactment of the Life
Insurance Corporation Act, 1956.
¾ 1968- Amendment of the Insurance Act, 1938 providing for, the establishment of
the Tariff Advisory Committee (TAC) to fix, control and regulate premium rates
and conditions of policies.
¾ 1971- The Central Government took over the management of general insurance
companies under the General Insurance (Emergency provisions) Act, 1971.
¾ 1972- Enactment of the General Insurance Business (Nationalization) Act, 1972,
paving the way for the formation of the General Insurance Corporation of India
(GIC) along with its four subsidiaries viz. the United India Insurance Company
(UIIC), the New India Assurance Company Limited (NIAC), the National
Insurance Company Limited (NIC) and the Oriental Insurance Company Limited
(OIC). These companies were given the exclusive privilege of carrying on general
insurance business in India.
¾ 1994- The Committee, headed by Shri R.N. Malhotra, submitted its report on the
structure of the insurance industry making significant recommendations like
allowing domestic and foreign operators entry into the sector and setting up an
independent insurance regulatory authority.

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¾ 1999- The Insurance Regulatory and Development Authority (IRDA) Act, 1999
was enacted with the objectives of protecting the interests of holders of insurance
policies and to regulate, promote and ensure the orderly growth of the insurance
industry. The IRDA Act also amended the Life Insurance Corporation Act, 1956
and the General Insurance Business (Nationalization) Act, 1972, withdrawing the
exclusive privilege of the LIC and GIC and its subsidiaries of carrying on life and
general insurance business.
¾ 2002- The General Insurance Business (Nationalization) Act, 1972 was amended.
Consequently, the four subsidiary companies of GIC became independent
companies wholly owned by the Government of India. The role of GIC was
restricted to the business of reinsurance.

1.2 Legislative and regulatory framework

The Insurance Act, (the Act) 1938, which came into effect from 1 July 1939, was the
cornerstone of the legislative framework underpinning the insurance industry in India.
The Act consolidated and amended the law relating to the insurance business, both life
and general insurance and increased the supervision of all entities engaged in the
insurance business. The Act established the control of the Central Government over the
conduct of insurance business in India and created the office of the Controller of
Insurance.

The Act contains provisions for regulating the following aspects of the functioning of
insurance companies:
• Investments,
• Managerial Expenses,
• Registration, licensing and remuneration of agents and other intermediaries,
• Solvency margins,
• Receipt of premium and inception of risk,
• Reinsurance, and
• Annual accounts and audit.

The Act was amended in 1968 to establish greater control on assets and investments as
also to regulate tariffs, through the medium of the TAC which was established to regulate
the rates, the advantages, terms and conditions that could be offered by insurers in respect
of general insurance business.

Marine (Cargo) and Marine (Hull) tariff was deregulated from 1 April 1994 and 1 April
2005, respectively. However, a significant development in the insurance industry was the
removal of tariffs with effect from 1 January 2007. Subsequently, tariffs have been
entirely deregulated with effect from 1 January 2008 with the exception of Motor Third
Party premium. The current de-regulated scenario would lead to considerable change in
the insurance markets.

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With the enactment of the IRDA Act, 1999 and the changing environment of the
insurance industry, the IRDA now performs the functions earlier vested with the
Controller of Insurance. In pursuance of its primary objectives of regulating, promoting
and ensuring the orderly growth of the insurance industry as also protecting the interest of
policy holders, the IRDA issued various Regulations relating to specific aspects of the
insurance business. The details of Regulations issued are contained in Annexure I.

1.3 Insurance industry in India

When the IRDA Act was enacted in 1999, there was only one life insurer viz. LIC and
five public sector non-life insurers. In addition, there was one specialised institution -
Export Credit Guarantee Corporation of India. However, by August 2007, there were
sixteen life insurers and fifteen non-life insurers in operation (Box 1.2). This is indicative
of the change that has swept the insurance sector in the past few years. (The GIC is now
only involved in the reinsurance business as the national reinsurer or “National Re”).

BOX 1.2
Life insurers Non-Life insurers

Bajaj Allianz Life Insurance Company Limited Bajaj Allianz General Insurance Company Limited

Birla Sun Life Life Insurance Company Limited ICICI Lombard General Insurance Company Limited

HDFC Standard Life Insurance Company Limited IFFCO Tokio General Insurance Company Limited

ICICI Prudential Life Insurance Company Limited National Insurance Company Limited

ING Vysya Life Insurance Company Limited The New India Assurance Company Limited

Life Insurance Corporation of India The Oriental Insurance Company Limited

Max New York Life Insurance Company Limited Reliance General Insurance Company Limited

Met Life India Insurance Company Limited Royal Sundaram Alliance Insurance Company Limited

Kotak Mahindra Old Mutual Life Insurance Limited Tata AIG General Insurance Company Limited

SBI Life Insurance Company Limited United India Insurance Company Limited

Tata AIG Life Insurance Company Limited Cholamandalam MS General Insurance Company Limited

Reliance Life Insurance Company Limited HDFC-Chubb General Insurance Company Limited

Aviva Life Insurance Company Limited Export Credit Guarantee Corporation of India Limited

Sahara India Life Insurance Company Limited Agriculture Insurance Company of India Limited

Shriram Life Insurance Company Limited Star Health and Allied Insurance Company Limited

Bharti Axa Life Insurance Company Limited

(IRDA website)

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However, considerable potential for growth existed given the current levels of general
insurance density and insurance penetration in India, in comparison to global levels.
Insurance density is the percentage of premium to total population while insurance
penetration is an expression of the ratio of total premium to Gross Domestic Product
(GDP). The Table 1.1 indicates the comparative figures.

Table 1.1
Year-wise comparison – general insurance density and insurance penetration
Insurance density Insurance penetration
Year
World India World India
2003 202.5 3.5 3.48 0.62
2004 220.0 4.0 3.43 0.65
2005 219.0 4.4 3.18 0.61
(IRDA Annual Reports)

While there had been a steady growth in premium income for the four public sector
insurers in the four years up to 2006-07 there was a decline in market share, with the
entry of private insurers. This is illustrated in Table 1.2.

Table 1.2
Public Sector Insurers’ premium growth and declining market share

(Rs. in crore)
Year Total PSU Percentage to Private Percentage to
premium total premium total premium

2003-04 15595 13337 85.52 2258 14.48

2004-05 17481 13973 79.93 3508 20.07
2005-06 20359 14997 73.66 5361 26.34
2006-07 25003 16286 65.13 8717 34.87
(Annual Report of IRDA/Report Card March 2007)

1.4 Performance of the Public Sector General Insurers

The overall performance of the four public sector general insurance companies were
assessed using certain key indicators like the retention ratio, the incurred claims ratio,
operating profits or losses in different business segments as also the costs of procuring
business which is represented by commission payouts. These indicators are briefly
discussed below.

The Insurance companies pass on or cede a part of the risk covered by them to reinsurers.
For this protection, a pre-determined portion of the premium is ceded to the reinsurers.
Similarly, companies accept part of the risk of other insurers for which they receive a pre-
determined portion of the premiums of the ceding companies called "acceptances". The
portion of the premium that relates to the accounting year is known as net earned

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premium. The retention ratio measures the premium retained by the insurer after cessions
to reinsurers, to the gross premium, which includes acceptances. Table 1.3 gives details
of gross premium received, net earned premium and the retention ratios.
Table 1.3: Public Sector Insurers’ gross premium receipt and retention
(Rs. in crore)
2002-03 2003-04 2004-05 2005-06 2006-07

Gross Premium including acceptances

NIA 5083 5146 5418 6008 6405

NIC 2976 3469 3906 3636 3880

UIIC 3095 3164 3045 3217 3573

OIC 2990 3009 3196 3691 4128

GIC* 4515 4641 5122 4881 7404

Net Earned Premium

NIA 3297 3589 3767 4121 4535

NIC 1966 2388 2664 2763 2768

UIIC 2109 2137 2163 2194 2373

OIC 1856 1972 2123 2356 2691

GIC* 3186 3992 4374 4459 5264

Retention Percentage (Net Premium divided by Gross Premium including acceptances)

NIA 73 74 76 77 80

NIC 74 74 74 76 75

UIIC 70 70 73 71 72

OIC 66 70 72 69 72

GIC* 85 90 90 87 87
* represents premium on reinsurance accepted

The net incurred claims represent the claims paid and payable that had not been ceded to
reinsurers. The net incurred claims ratio indicates the extent to which the ‘net premium’
is to be applied to meet this obligation and is a measure of the risk retained by the insurer.
This enables an assessment of profitability of underwriting operations and reinsurance
arrangements. The Incurred Claims Ratio (ICR) of the five companies, over the five year
period ending March 31 2007, is given in Table 1.4.

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Table 1.4: Public Sector Insurers’ incurred claims ratio

(Rs. in crore)
2002-03 2003-04 2004-05 2005-06 2006-07

Net Incurred claims

NIA 2699 2713 2905 3632 3644

NIC 1620 2110 2263 2830 2394

UIIC 1905 1842 1998 2043 2142

OIC 1466 1588 1908 2065 2359

GIC 2744 2895 3703 4573 3622

Net Incurred claims percentage to Net Earned premium

NIA 82 75 77 88 80

NIC 82 88 85 102 86

UIIC 90 86 92 93 90

OIC 79 80 90 87 88

GIC 86 73 85 103 69

The cost of procuring business had registered a steady increase over the last five year
ending 2006-07. Commission expenses of all four companies had risen, reflecting the
current competitive nature of the insurance markets as indicated below:
Table 1.5: Public Sector Insurers’ commission expenses
(Rs. in crore)
2002-03 2003-04 2004-05 2005-06 2006-07

Commission

NIA 418 453 529 611 607

NIC 199 245 273 296 315

UIIC 167 202 203 244 266

OIC 151 192 228 280 302

GIC NIL NIL NIL NIL NIL

The operating results of the companies, in different business segments, are detailed in
Table 1.6. It will be noted that the miscellaneous segment, which includes the Motor
portfolio, continued to register negative or poor results. This was attributed to the high
incidence of claims in the Motor Third Party business.

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Table 1.6: Operating Profit/Loss (Net of income from investments)

(Rs. in crore)
Company/ 2002-03 2003-04 2004-05 2005-06 2006-07
Business segment
NIA
Fire 32 167 107 -155 17
Marine 45 52 4 -16 35
Misc. -639 -907 -793 -1072 -708
Net operating profit -562 -688 -682 -1243 -656
NIC
Fire 133 147 98 -34 48
Marine -2 74 0 -5 -38
Misc. -432 -748 -633 -1050 -618
Net operating profit -301 -527 -535 -1089 -608
UIIC
Fire 139 150 111 27 -69
Marine 38 8 -15 -16 -53
Misc. -619 -702 -841 -943 -648
Net operating profit -442 -544 -745 -932 -770
OIC
Fire 127 76 53 -26 81
Marine 8 18 -14 -18 -53
Misc. -384 -556 -649 -634 -564
Net operating profit -249 -462 -610 -678 -536
GIC
Fire 110 276 61 -85 -182
Marine -6 -6 -90 -60 -172
Misc. -593 -289 -542 -1117 275
Net operating profit -489 -19 -571 -1262 -79

Income from Investments is the critical source of revenue for all the companies and
accounts for their overall profits, as evidenced from Tables 1.7 and 1.8.

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Table 1.7: Income from investments and other income

(Rs. in crore)
Company 2002-03 2003-04 2004-05 2005-06 2006-07
NIA 805 1030 1128 1422 1557
NIC 419 508 505 606 627
UIIC 545 676 742 858 864
OIC 413 536 741 642 735
GIC 844 1033 1158 1225 1309

Table 1.8: Profit before tax

(Rs. in crore)
Company 2002-03 2003-04 2004-05 2005-06 2006-07
NIA 313 648 798 856 1614
NIC 139 73 141 -60 456
UIIC 214 393 318 453 520
OIC 176 454 472 334 630
GIC 343 1277 800 443 1790

1.5 Combined Ratio

The Insurance companies publish various performance indicators/ratios in their Annual

Reports to facilitate appreciation of their overall performance. The Combined Ratio
correlates expenses of management and claims paid out to the gross premium earned.
The ratio reveals whether premium earned was adequate to meet expenses of
management and claim payouts. The ratios as computed and reported by the Companies
for the period 2002-2003 to 2006-2007 are detailed in Table 1.9:
Table 1.9: Details of Combined Ratios
(Figures in percentage)
Company 2002-03 2003-04 2004-05 2005-06 2006-07
NIA 75 82 80 87 81
NIC 81 99 98 115 107
UIIC 91 93 106 127 116
OIC 87 97 102 121 99
Combined Ratio = Expenses of Management + Claims paid
Gross Premium (Direct)

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However, while computing expenses of management, commission paid is not included

though it represents the cost of procurement of business. Sec. 40C of the Insurance Act,
1938, while prescribing limits on expenses of management, includes commission as part
of expenses. Such inclusion of commission is also standard international practice. A
more accurate picture would emerge if commission pay out is also taken into account
while computing the combined ratio as given in Table 1.10.

Table 1.10: Details of Combined Ratios after considering commission paid

(Figures in percentage)
Company 2002-03 2003-04 2004-05 2005-06 2006-07
NIA 72 93 92 100 102
NIC 96 100 104 122 114
UIIC 98 101 117 134 122
OIC 97 99 97 109 94
Combined Ratio = Expenses of Management + Claims paid + Commission
Total Premium (including acceptances)

When the combined ratio exceeds 100 per cent, the implication is that the company had,
during the year, not been able to raise adequate earnings to meet these expenses. It will be
seen that NIC and UIIC consistently suffered operating losses for three years. The four
PSU insurers had operated on low margins or at a loss during the five years.

The pre-tax profits have largely been generated by income from investments. The
inadequate operating profits would indicate that either premia were inadequate or efforts
to contain expenses of management need to be strengthened.

1.6 Scope and objectives of the performance audit

A performance audit was undertaken between March and August 2007, focusing on the
operations and performance of the public sector insurance companies viz, NIA, UIIC,
NIC and OIIC and the designated Indian reinsurer, the GIC.

The performance audit was limited to four specific aspects of the functioning of the
public sector insurance companies viz Motor Third Party claims, reinsurance, claims
settlement and grievance redressal procedures, and agency and brokerage commission. In
respect of GIC, acceptances and reinsurance arrangements were examined as the
company undertakes only reinsurance business. The audit focused on transactions for the
period 2004-2005 to 2006-2007.

The broad objectives of the performance audit were to assess and examine the
effectiveness of systems established by the companies for:

• reinsurance operations which ensured mitigation of losses and improve

underwriting capacity;

• mitigation of losses in Motor Third Party claims;

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• settlement of claims and grievance redressal, thereby enhancing customer

satisfaction; and

• compliance with the procedures and regulations governing payments to

intermediaries like brokers and agents.

While the broad objectives of the audit have been outlined above, specific audit
objectives for each of the four areas reviewed and examined are discussed in the
appropriate chapters.

Entry conferences were held with the senior management of all five companies in March,
2007, where the scope and objectives of the audit were explained to them. Ministry of
finance had forwarded the replies of the Companies on 10 January 2008. Detailed
discussions on the audit findings and recommendations were held with the Ministry of
Finance and the senior management of the companies on 24 January 2008. The view
point of the Ministry/Companies have been considered and included appropriately at the
time of finalisation of this Report.

1.7 Audit methodology

The four general insurance companies have a national presence and widespread
operations. Each company has several regional offices, which control divisional offices
and branch offices. In order to ensure a representative sample, random sampling was
adopted for selecting divisional offices, adopting the ICR as the criterion. Where
divisional offices had branches, one branch was covered in this audit. In all, 32 regional
offices, 160 divisional offices and 128 branch offices of the four companies were audited.
Audit of reinsurance activities was conducted at the GIC and the Head Offices of the four
general insurance companies. The details of the units audited are given in Annexure II.

1.8 Audit criteria

While conducting the audit, the criteria applied included the companies’ own policies,
guidelines and operating procedures. In addition, the operations of the companies were
also examined with reference to the Regulations issued by the IRDA, governing specific
aspects of the insurance business.

Cases and records, pertaining to the period under review, were selected using sampling
techniques. The databases of the companies were directly queried, certain data extracted
and analysed, as appropriate. The audit methodology and the sample size are detailed in
Annexure III.

1.9 Acknowledgement

The assistance and cooperation extended to audit by the Management and staff at various
levels of the five companies is acknowledged.

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