New Delhi: Sustainable growth and focus on building consumer trust has been the focus of his reforms, says J. Hari Narayan, who stepped down as chairman of the Insurance Regulatory and Developmental Authority (Irda) last week. In an interview, he explains the reasons behind the tough stance he took on the life insurance industry. Edited excerpts:
What impression of the industry did you have in June 2008 when you took charge as the regulator? Did you have a mandate in mind?
I didn’t come with any mandate. I found it exceedingly complex and the quality of personnel struck me as very bright. About products, it took me a while to understand. During the first year, I was learning and listening and only then did I figure out the contours of the industry.
It’s said that regulations started when the Securities and Exchange Board of India (Sebi) laid claims on unit-linked insurance plans (Ulips).
Just as well because by then I was able to understand what these products were all about. Yes, it is right in the sense that our understanding of the product was quickened by the Sebi issue. Two things happened at that time. Apart from Sebi’s issue, there were lots of articles in the media about what was wrong with insurance products. So Sebi was the departure point. It gave us much greater insight into the practices being followed by the insurance companies, product designs, the downsides of it and so on. After that I found there was a lot to be done in the product space itself which was not being addressed. And we needed to do that. I didn’t want to do all that at one go. It started with Ulips because that was the matter at hand and then pension plans and then products in general.
Pension products saw a lot of changes in guidelines. Don’t you think there was too much back and forth? The industry found it difficult to cope with.
Not too many. You see this is the nature of regulations. You keep digging around until you get the right fit. I don’t think it made much of a difference to them. You see the biggest shock to them was that the regulator would mandate the boundaries within which a product could be designed. That was the awakening for the industry.
But even in terms of product approvals there was a pattern. For instance, first Irda cleared products that guaranteed the highest net asset value and then later realized these products were being mis-sold.
I think there was a process of understanding even at Irda and I don’t think the then member actuary was really so clearly focused on policyholders’ welfare as he ought to have been. So it took some time to really figure it out. But such products are all over the world and you may ask why is the product working everywhere but not here. I would say that there is a lot going on in the world of insurance products and regulators all over the world are very chary of regulating products. And they normally have two reasons to do that. One is that it stifles innovation and it doesn’t allow free market play. I think the reasons are much deeper. I think there is a philosophical problem. I think the regulators are probably closer to the industry than they ought to be. It is only recently at the IAIS (International Association of Insurance Supervisors) I was able to convince them that they need to look at product design and that is something they agreed only a few months ago. There is still a lot of work to be done but at least I could get it on the agenda.
You not only held your ground in the face of stiff opposition from the insurers in terms of product design but you also didn’t hesitate to express your disapproval when the government sought to increase the equity investment limits.
It’s not a question of budging to the insurer or to the government. You have a responsibility to discharge and you either do that or you don’t. Even the issue with the government and the LIC, my view was the government did not have the power to do that. They were quoting a section of the law which was introduced in the Act (LIC Act, 1956) at the time of nationalization and our reading was quite different. Section 43(2) says the central government as soon as may exercise controls over LIC. So this Act says as soon as may after this Act. This Act started in 1956. So it means “as soon as” may because you have just nationalized it and if you want to change something go ahead and do it but within reasonable time and not forever. And then when Irda was constituted in 2000, it clearly says from the commencement of Irda, the corporation shall hereafter carry on in accordance to the provisions of the Insurance Act. So my point was the power to change the investment limits had long ceased and fundamentally they didn’t have the power to do that.
We have also seen a surge in penalties. Not only has the quatum of fine gone up, the charges have become much more elaborate. Does that mean you are well staffed to scrutinize companies with greater detail?
We have built up an inspection department and it is fairly well staffed but it is not yet staffed to the extent it needs to be. I wanted every single regulated entity to be inspected at least once during the term of its licence. Apart from which we wanted to have a set of focussed inspection as and when issues arose and then we also wanted the capacity to inspect certain grounds for complaints. We have not really built up that capacity but we are getting there.
A common thread in penalties is that insurers have overpaid their corporate agents. Insurers say that these payments are towards training and skill building and are within the limits on expenses of management. And that it has not been paid towards procurement of policyholder and hence should not be seen as commissions.
These payment are more than what the Act permits and it particularly punishes when you are going to pay this to promoter. This is a very incestuous kind of a thing which is why we came down heavily on this. There is an absolute limit on expenses which they constantly breach. Not dramatically though.
The sum total of expenses is of two types—one is commissions and the other is management expenses such as advertisment. They are confusing the two when saying why do you need a cap on the commissions when there is a cap on the expenses.
Your regulations have been consumer-centric. Have you been able to institutionalize the changes?
I hope so. There is certainly, to my mind, a greater need to look at everything from the prism of policyholder welfare. I think to some extent it has seeped through the industry. Insurance industry won’t have a future if they don’t build trust with the customers.
But until now insurers have breached that trust and yet made money through lapsed profits. Regulations, however, have plugged that by reducing the surrender charges and similar suggestions are made for traditional products as well. Reducing the surrender charge has seen a big push back from the industry.
I don’t think these are unreasonable guidelines. I think it has to do with the attitude of the managers of the life insurance companies. And this has to change. Several of them are bankers and they don’t really understand insurance and I think the shareholders also don’t understand what they are in for. Insurance is a long-term business and for the first ten years investors go on investing. The nature of the business is like that. So if you are going to see returns in insurance, you have to wait for 15-20 years. Some of the investors anyway didn’t have that appreciation. When the industry got privatized in 2000, people in the non-life side were those who had been in the non-life sector before. Because they came from the state-owned non-life companies but in the life-side, the bulk of the management were bankers. They had no understanding of insurance. So anecdotally there were several cases wherein chief executive officers told their boards that in three years they would be bigger than LIC. So they had no idea what they were doing. It’s only now that they understand. This business is long term.
A fall out of cost caps in Ulips was that commissions dropped and agents left the industry in droves. Then the pace of regulations stifled product innovation. So it can be said that regulations in the past years have contributed to the negative growth of the life insurance industry. Do you agree?
It may be true. But the question is whether those regulations were needed or not needed. After all Irda is there to protect both sides of the equation. Yes there has been a flattening. In the last two years, the growth has been flat. So the question is whether we want growth at any price or we want healthy and a sustainable growth. I believe what we have put in place will enable a more sustained growth.
The industry has complained of delay in product approval. Why was that? Is there shortage of manpower?
Not at all. The problem lay entirely with companies. They would define the product so poorly that most of the time the office and companies would go on exchanging notes. And at times it was so gross that the company didn’t have an idea of the product they were filing. So one of the reasons I wanted to come out with guidelines in products was this. There should be a clear statement of what is it we don’t want and want to see in products. That way we are not wasting time. And these companies should ask their foreign partners what’s the time taken for product clearance in say the UK or Australia. In Australia, I know it takes a year.
So filing a product and immediately getting it cleared makes little sense. One should ask oneself what is this? Why are you churning your products like that? So I think even the industry got it wrong. I think they wanted more products not because it was much different from the previous product but to enable the premium churn. So there was a lot of learning to be done.
Some of the regulations have taken a long time to come through. For instance the new guidelines on product design were initiated last year but it still hasn’t seen the light of the day.
First traditional products are far more complex than Ulips. There are many types in traditional plans. There was also fundamental lack of clarity among insurers. The fundamental cut in insurance is products that are participating products and non-participating products. You can’t confuse the two. So quite frequently they would have a non-participating product but would insist it be treated as a participating product. Because participating products are more opaque and you don’t know what’s going on in that product. And it took a long time for the industry to accept that. But even then the process of regulation is procedure bound. The product guidelines are ready and should be out anytime now. There is a process of gazetting.
A big impact of regulations has been the focus on persistency. But when you look at the incentive structure, it’s front loaded. So when agents are driven by the first year commissions, how will they ever focus on persistency? Even structure of commissions or a clawback should help.
The understanding of insurance commissions is not correct. The first year commission is capped at 35% and then 7.5% in the second and third year and then 5% subsequently. The Act only prescribes the maximum that you can pay but the flow can be managed by insurers. Look at it like this—over the life of the product this is the total commission you can give. The question is how you are going to use this. Persistency in India is abominable and you can’t have an insurance industry based on such low levels you may work some kind of non-life industry but not life. Life insurance depends on a steady flow of income which is how you meet the shocks that takes place.
In the draft guidelines on product design, you have infact given further caps on commissions.
We have seen that policy term does not correspond to the premium paying term. Life cover may be for 20 years but premium payment term is just seven years. Now all those innovation may be great ideas but they distort the purpose of the Act so you need rejig that. So lower the premium payment term, lower are the commissions.
Coming to bancassurance, the finance minister recommended that banks wanting to sell products of more than one insurance company should consider being brokers. In the draft guidelines you have now given three options: status quo (one bank one insurer), geographical differentiation (multiple insurers in different states) and broker. Don’t you think this geographical distinction is painful when the committee recommended banks be allowed to sell products of two insurance companies?
Distribution in India is a tied agency system. It has been around for almost 100 years. So an agent can’t say that he will be agent for two insurance companies at the same time. That makes no sense. If we allowed that for banks then why not individual agents? We will undermine the entire tied agency system. So the debate is whether you want a tied agency system or not. The insurance companies are quite confused and so are the banks.
Why are the bancassurance guidelines still in the draft stage?
There was an issue and I had to send it back to the insurance advisory committee. The issue was that insurance companies who were promoted by banks felt they had the right to the entire bank as their bancasssurance channel and the same insurancs companies felt they also had the right to tie up with another bank. So the suggestion was that bank-promoted companies should prima facie not be allowed to tie up with any other bank if they wish to tie up on an all-India basis. If the owner bank agrees to tie up with other insurance companies then it’s fine for the insurer to tie up with other banks. You can’t be a dog in the manger. You can’t say I will hold my bank captive and I will poach on other banks. The second issue was that out of 80,000 branches of banks, insurance were sold only in 13,000-14,000 branches. So we wanted the right to be vested with the authority to require banks to tie up with somebody else to make use of those branches. What happened is these two interventions came up during the discussions with the board. The system we follow is that we go to the council then the IAC and then the board. We have decided we will go back to the advisory committee for their suggestions.
Shifting focus to data, you brought in some very important public disclosures such as the persistency ratio. Even for a common insurance metric such as persistency ratio the industry does not follow a standard practice. Why is that?
Persistency is calculated in three contexts. One it is calculated to determine the solvency margin. The second persistency that we require the companies to disclose, the third is the persistence of policies of agents. What I found was that different companies were interpreting and calculating persistency differently. So what we have done is work on a definition of persistency that will be consistent across all companies. So we will have to mandate it. The draft paper is ready. Otherwise they will keep calculating persistency the way they like. These companies are being very clever. Persistency is a significant metric for the insurance industry and has been so for a 100 years. Nowhere in the world is there a confusion on persistency, but in India. Because insurers are too clever, they will calculate persistency that will give a better picture. So when you have this kind of nonsense going on, you will have to be cleverer and bring out a regulation. But they have a point. I mean if you are not going to spell it out then they are fair to choose.
What is your comment on the level of data availability?
Information is very poor and sketchy. For instance you really don’t know where the insurance money is coming from. For instance I don’t know which state is the first year premium coming from. Then I don’t know from who is the premium coming. Then to go further, what is the income set that buys insurance. Right now we are only hunching. If you look at any other consumer product, the sales people will know all of this. What is Wall Mart’s strength? Their data analytics is so good they know what kind of people will buy what. We haven’t got that kind of data. Mind you it’s not that this data is not mandated. In the proposal forms you fill all this information but it’s a different matter that the data is no collated and the data is not valued. Consequently it’s inaccurate.
So unless you are going to look at data, the quality is not going to improve. This data will help in understanding the shape of insurance in India.
But data that will help the consumers is not available. For instance look at health insurance. I don’t see published data on claim settlement of insurers just like it is there for life insurance companies.
You can get this data from the insurance information bureau (IIB). I constituted the IIB, it is no doubt the creature of Irda but I have constituted as an arm’s length kind of a body. All claims are reported here. That is all the transaction data come here and now it has a fairly wealthy data. I constituted this bureau in 2009 and it started to capture data in motor insurance. Then we moved to health and now we are moving to life.
What are the areas you would want your successor to focus on?
I think there are two more areas of basic work which needs to be done. One is catastrophe insurance. That’s a major thing and we shouldn’t ignore that because if we have another Mumbai-type flood, several of these insurance companies are going to find it problematic. The second issue which I have not been able to get a grip on but we need to and I hope my successor will is re-insurance. You can’t do catastrophe insurance if you don’t have a sound re-insurance system. I was looking at far more basic things because I wanted to get it out of the way.