LIC's operating cost is far lower than the international standard

Source: Business Line

LIC's operating cost was 6.58 per cent of premium in 2009-10 which is far lower than the international standard of 10-15 per cent.

With cost-consciousness and divergent distribution channels, more insurers are likely to make profits and the industry may head for brighter days ahead.

Life insurance sector has witnessed rapid growth in the past decade with private players entering the fray. Assets managed by the insurers have grown manifold in this period, even outpacing the mutual fund industry and the insurers have become a force to reckon with even in stock market. When the life insurance sector was opened up in 2000, the premium collected to the gross domestic product (GDP) was 1.77 per cent; this has risen to 4.6 per cent by 2009-10.

LIC, the only player in the life insurance sector in 1999-2000, collected Rs 34,897 crore that year. According to the Insurance Regulatory and Development Authority (IRDA), total premium underwritten by the life insurance sector was Rs 2,65,450 crore in 2009-10.

Although the topline of the insurers grew at double-digit till 2009-10, the bottomline of several private insurers are in the red, despite a decade of operation. The total accumulated losses of private life insurers was over Rs 20,143 crore by March 2010.

However, the silver lining is that according to
the I–Save.com report, as many as 12 out of the total 23 insurers turned the corner and made profits for the year ended in 2010-11.

Distribution

For any business, distribution is the key to success. Prior to 2000, LIC operated only through the tied agency (individual agents) model and individual agents continue to account for more than 90 per cent of the business currently. Private insurers too banked on individual agents to market their product, but over time they diversified their distribution channel to bancassurance (insurance sold through banks), brokers and corporate agents. Currently, tied agency accounts for just 50 per cent of the overall business of private players.

This is likely to go down further mainly on account of the regulatory changes which rationalised the commission structure for the agents. Recent IRDA guidelines that came into effect from July 2011 stipulate that agents which fail to achieve a persistency rate of 50 per cent will lose their licences. Two years from now, agents will have to ensure that at least three fourth of their policies sold in the previous year are renewed to qualify for a licence renewal.

This regulation will pave way for only serious agents to stay in the business. Going forward, the bancassurance channel is likely to contribute a chunk of new business premium. This, in turn, will reduce the operating expenses and may aid profitability for these companies.

Regulatory changes

Unit-linked insurance products or ULIPs are perhaps the most widely discussed and written about financial product. After their launch, the insurance industry witnessed phenomenal growth. However, IRDA has brought about many regulatory changes in this product.

Till the 2008-09 equity market crash, ULIPs accounted for more than 90 per cent of the products sold by some insurers, but due to stiffer regulation, volatile equity markets, cut in the agent commission and cap on charges for the ULIPs, the industry has been forced to reduce its dependence on ULIPs and it currently accounts for 55-60 per cent of the overall sales. Now, the product mix is slowly drifting in favour of traditional insurance products, which are yet to face the scrutiny of the regulator.

Profitability

After chasing the new business premium for several years, insurers have recently turned their focus on profitability rather than topline growth. The major reason for poor profitability was the higher operating expenses of life insurers. Agent commissions, generally perceived to be the lion's share of expenses, accounted for 6.85 per cent of the premiums collected while the other operating expenses accounted 10.85 per cent.

Life insurance companies' operating efficiency is measured by the ratio of operating expenses to gross premium income. According to the IRDA, in 2009-10, operating expenses of private life insurers was down to 20.86 per cent of the premium collected against 25.99 per cent incurred in 2008-09. Although the operating expenses moderated, the ratio remains in the band of 15-30 per cent for individual insurers.

Private insurers which have focussed on building distribution channels, branch offices and other infrastructure have had to bear higher expenses. Among the private players, SBI Life's operating expenses is among the lowest at 6.3 per cent.

In contrast to private sector insurers, LIC's operating cost was 6.58 per cent of premium in 2009-10 which is far lower than the international standard of 10-15 per cent. However with an average cost ratio of 21 per cent, other Indian private insurers are a long way off from meeting international norms.

By reducing operating costs, already eight of the 23 private players such as SBI, ICICI Prudential, Bajaj Allianz, Max New York Life and Aviva India have turned profitable in 2009-10. However, the sustainability of profits depends on persistency. Persistency is the per cent of policies that are continued for a specified period that varies between 13 months and 25 months. Persistency is denoted in conservation ratio.

The conservation ratio (renewal premium collected current year to total new business premium plus the renewal premium of last year) of top five private life insurers is, however, not encouraging and according to I–Save.com 2011 report, SBI Life's conservation ratio is at 47.9 per cent, Birla Sun Life's 56.3 per cent and ICICI Pru's, HDFC Life's and Bajaj Allianz's were all below 70 per cent.

Way forward

For life insurance companies, having multiple offices in metros is unnecessary since customer footfalls occur mainly for paying renewal premiums. After spending huge money on office infrastructure, several insurers are now moving towards rationalisation of the offices.

In the last two years, offices of the private insurers have decreased to 8,768 from 8,785. Since opening up of the sector in 2000, this is the first time that negative growth was observed in the number of branch offices.

Consolidation is visible in the insurance industry in the form of private players ceding stakes to foreign partners. The Bharti group has already reached agreement to sell its business to Reliance Industries.

On the other hand, Reliance Capital sold a 26 per cent stake in its insurance arm to Nippon Life for over Rs 3000 crore. Max New York Life sold 4 per cent stake to Axis Bank and had a marketing tie up.

After witnessing double-digit growth for most part of last decade, the industry witnessed negative growth in the early part of 2011. But the changes that will have the greatest impact on cost are the use of technology to offer products online and expanding the products mix by launching health insurance products.

Non-life insurance, which currently accounts for 0.6 per cent of GDP, offers great potential for life insurance companies.

With cost consciousness and divergent distribution channels, more insurers are likely achieve profits and the industry may head for brighter days ahead.