EXECUTIVE SUMMARY

Insurance sector in India is booming up but not to the level is booming comparative with the developed economies such as Japan, Singapore etc. Also with the opening of the insurance sector to the private players have provided stiff competition resulting into quality products. Also there is a need to restructure the Indian Government owned Life insurance Corporation of India so as to maximize revenue and in turn profits. IRDA regulations and norms for the allocation of funds need to have a comprehensive look. In the phase of declining interest rates and rising inflation the funds need to be applied in productive areas so as to generate high returns. Also in terms of clients servicing areas such as premium payments, after sales service, policy dispatch, redressal of grievances has to beamended. In the current scenario, LIC has to provide flexible products suited to the customers requirements. Also a proper and systematic risk management strategy needs to be adopted. After the increase in terrorism and destructive events around the global world such as September 11 attack on World Trade Centre, US Taliban war, US Iraq war etc. An alternative to reinsurance such as asset backed securities is emerging out in the developed economies. A catastrophe bond is one of the alternatives for reinsurance. Finally some policies such as pure term and pension schemes needs to be addressed massively at both the urban and the rural segment so as to generate high premium income which will help in the development and growth of the economy.

INTRODUCTION :
Insurance may be described as a social device to reduce or eliminate risk of loss to life and property. Under the plan of insurance, a large number of people associate themselves by sharing risksattached to individuals. The risks which ca n be insured against include fire, the perils of sea, death and accidents and burglary. Any risk contingent upon these, may be insured against at a premium commensurate with the risk involved. Thus collective bearing of risk is insurance.

DEFINITION: General definition: In the words of John Magee, Insurance is a plan by which large number of people associate themselves and transfer to the shoulders of all, risks that attach to individuals. Fundamental definition: In the words of D.S. Hansell, Insurance may be defined as a social device providing financial compensation for the effects of misfortune, the payment being made from the accumulated contributions of all parties participating in the scheme. Contractual definition: In the words of justice Tindall, Insurance is a contract in which a sum of money is paid to the assured as consideration of insurers incurring the risk of paying a large sum upon a given contingency. Characteristics of insurance: Sharing of risks Cooperative device Evaluation of risk Payment on happening of a special event The amount of payment depends on the nature of losses incurred

INSURANCE SECTOR A PREVIEW

The insurance sector in India dates back to 1818, whenOriental Life Insurance Company was incorporate d at Calcutta.Thereafter; few other companies like Bombay Life AssuranceCompany, in 1823 and Triton Insurance Company, for General Insurance, in 1850 were incorporated. Insurance Act was passed in1928 but it was subsequently reviewed and comprehensivelegislation was enacted in 1938. The nationalization of life insurance business took place in 1956 when 245 Indian and Foreign Insurance provident societies were first merged and then nationalized. It paved the way towards the establishment of Life Insurance Corporation (LIC) and since then it has enjoyed a monopoly over the life

insurance business in India. General Insurance followed suit and in1968, the insurance act was amended to allow for social control over the general insurance business. Subsequently in 1973, nonlifeinsurance business was nationalised and the General InsuranceBusiness (Nationalization) Act, 1972 was promulgated. The General Insurance Corporation (GIC) in its present form was incorporated in 1972 and maintains a very strong hold over the non-life insurance business in India. Due to concerns of 1. Relatively low spread of insurance in the country. 2. The efficient and quality functioning of the Public Sector insurance companies 3. The untapped potential for mobilizing long-term contractual savings funds for infrastructure the (Congress) government setup an Insurance Reforms committee in April 1993. The Committee submitted its report in January 1994, recommended a phased program of liberalization, and called for private sector entry and restructuring of the LIC and GIC. But now the parliament has given a nod to the Insurance Regulatory and Development Authority (IRDA) bill with some changes in the original structure.

How big is the insurance market?

Insurance is a Rs.400 billion business in India, and together with banking services adds about 7% to Indias GDP. Gross premium collection is about 2% of GDP and has been growing by 15-20% per annum. India also has the highest number of life insurance policies in force in the world, and total investible funds with the LIC are almost8% of GDP. Yet more than threefourths of Indias insurable population has no life insurance or pension cover. Health insurance of any kind is negligible and other forms of non-life insurance are much below international standards. To tap the vast insurance potential and to mobilize long-term savings we need reforms which include revitalizing and restructuring of the public sector companies, and opening up the sector to private players. A statutory body needs to be made to regulate the market and promote a healthy market structure. Insurance Regulatory Authority (IRA) is one such body, which checks on these tendencies.

INDIVIDUAL LIFE INSURANCE COVERAGE INDEX, 1994 COUNTRY NO. OF POLICIES PER 100 PERSONS Indonesia 2.0 Philippines 5.6 India 12.4 Thailand 14.7 Malaysia 35.5 Hong Kong 69.4 South Korea 70.5 Taiwan75.2 Singapore 112.6 Japan 198.4 Source:

WHY OPEN UP THE INSURANCE INDUSTRY?

An insurance policy protects the buyer at some cost against the financial loss arising from a specified risk. Different situations anddifferent people require a different mix of risk-cost combinations.Insurance

companies provide these by offering schemes of different kinds. Unfortunately the concept of insurance is not popular in our country. As per the latest estimates, the total premium incomegenerated by life and general insurance in India is estimated ataround a meager 1.95% of GDP. However Indias share of world insurance market has shown an increase of 10% from 0.31% in 1996-97 to 0.34% in 1997-98. Indias market share in the life insurance business showed a real growth of 11% thereby outperforming theglobal average of 7.7%. Non-life business grew by 3.1% againstglobal average of 0.20%. In India insurance spending per capita was among the lowest in the world at $7.6 compared to $7 in the previous year. Amongst the emerging economies, India is one of the least insured countries but the potential for further growth is phenomenal, as a significant portion of its population is in services and the lifeexpectancy has also increased over the years. The nationalizedinsurance industry has not offered consumers a variety of products.Opening of the sector to private firms will foster competition, innovation, and variety of products. It would also generate greater awareness on the need for buying insurance as a service and notmerely for tax exemption, which is currently done. On the demand side, a strong correlation between demand for insurance and per capita income level suggests that high economic growth can spur growth in demand for insurance. Also there exists a strong correlation between insurance density and social indicators such as literacy. With social development, insurance demand will grow.

Future course of Insurance Business:

One of the main differences between the developed economies and the emerging economies is that insurance products are bought in the former while these are sold in latter. Focus of insurance industry is changing towards providing a mix of both protection / risk over and long-term investment opportunities. Some of the major international players in the insurance business, which might try to enter the Indian market, are Sun Life of Canada, Prudential of the United Kingdom, Standard Life, and Allianz etc. Although the insurance sector isofficially open to private players, they still need a license from the IRDA, which will announce its guidelines in May 2000. Following might be the future strategies of insurance companies. 1. The new entrants cannot compete with the state owned LIC on price alone. Due to its size, LIC operates at very low costs and their premia on policies that offer pure protection are on par

with comparable schemes across the globe. What the new insurance companies will probably offer is higher returns than the annualized 9- 10% one can hope to earn from LICs policies. This will put pressure on LIC to offer more attractive returns
2. Consumers can also expect product innovations. For instance, at present, LIC provides c o v e r f o r permanent disability and what the new companies could offer is t e m p o r a r y disability insurance as well. 3. Apart from the basic term insurance, most insurance products worldwide are sold as long-term investment opportunities with the protection component being clearly spelt out in the scheme. 4. LICs policies are not flexible according to the customers needs. New entrants have planned to offer universal life and variable life insurance products that allow the holder flexibility in deciding how his premia are split between protection and savings. New products would also enable product combinations that allow greater customization

5. Private insurers would compete furiously on the service platform. These would not only include faster

claims settlement and other after-sales service but there agents would better qualified in assisting be trained in pre-sales interaction to usher in a customer-oriented approach. They would be clients in financial planning.
6. Foreign companies would also use superior software (likeAPEX) that will give them an edge over the in-house LIC software. This technology will help private insurers in product development and customizing products to suit individual needs. 7. The foreign players will probably introduce a lot of innovation and competition on Surrender value. LIC pays surrender value only after three years but private insurance companies are likely to offer sops by way of better and timely surrender value to clients.

8. Access to insurance too will probably become more widespread. Role of intermediaries would decrease and sale of insurance through direct channels and banks would increase. Simple products like term insurance might be sold through the telephone or direct mail to high net worth clients. 9. In reaction to foreign players strategies one might expect LIC to react and drop its premia and upgrade its services.

BOTTLENECKS GOVERNMENT / RBI REGULATIONS:

The IRDA bill proposes tough solvency margins for private insurance firms, a 26% cap on foreign equity and a minimum capital of Rs.100 crores for life and general insurers and Rs. 200 crores for reinsurance firms. Section 27A of the Insurance Act stipulates that LIC is required to invest 75% of its accretions through a controlled fund in mandated government securities.LIC may invest the remaining 25% in private corporate sector, construction, and acquisition of immovable assets besides sanctioning of loans to policyholders. These stipulations imposed on the insurance companies had resulted in lack of flexibility in the optimization of risk and profit portfolio. If this inflexibility continues, the insurance companies will have very little leverage to earn more on their investments and they might not be able to offer as flexible products as offered abroad. The government might provide more autonomy to insurance companies by allowing them to invest 50 % of their funds as per their own discretions. Recently RBI has issued stiff guidelines, which had dealt a severe blow to the plans of banks and financial institutions to enter the insurance sector. It says that nonperforming assets (NPA) levels of the prospective players will have to be 1% point lower than the industry average (presently 7.5%). RBI has also stipulated that all prospective entrants need to have a net worth of Rs. 500 crores.

These guidelines have made it virtually impossible for many banks to get into the insurance business Also banks and FIs who are planning to enter the business cannot float subsidiaries for insurance.RBI has taken too much caution to make sure that the new sector does not experience the kind of ups and downs that the non-bank financial sector has experienced in the recent past. They had to rethink about these guidelines if Indias strong banks and financial institutions have to enter the new business. The insurance employees union is offering stiff resistance to any private entry. Their objections are: A. That there is no major untapped potential in insurance business in India; B. That there would be massive retrenchment and job losses due to computerization and modernization; and C. That private and foreign firm would indulge in reckless profiteering and skim the urban cream market, and ignore the rural areas.

But all these fears are unfounded. The real reason behind protests is that the dismantling of gover nment monopoly would provide a benchmark to evaluate the governments insurance services.

OPENING UP OF INSURANCE SECTOR:

Indian History: Time to turn the clock back-and open up insurance. For two years, around 30 foreign insurers have eagerly explored the nationalized Indian insurance market, preparing to leap in when private participation is allowed. But it seems they have an endless wait before the sector is opened up. That's ironical: in 1947, many of these insurers were firmly established here. BAT subsidiary Eagle Star, for example, opened offices in Calcutta in 1894. By 1921,it was doing business with Brooke Bond and the Birlas. Prudentials first Asia office was opened In India in 1923. Fifty years ago, India had a bustling, if somewhat chaotic, entirely private insurance industry. The year after Independence, 209 life Insurance companies were doing business worth Rs712.76 crores (which grew to an amazing Rs 295,758 crores in 1995-96). Foreign insurers had a large market share 40 per cent for general insurance but there were also plenty of Indian companies, many promoted by business houses like the Tatas and Dalmias. The first Indian-owned life insurance company, the Bombay Mutual Life Assurance Society, was set up in1870 by six friends. It Insured Indian lives at the normal rates instead of charging a premium of 15 to 20 percent as foreign insurers did. Its general insurance counterpart, Indian Mercantile Insurance Company Ltd., opened in Bombay in 1907. A plethora of insufficiently regulated players was a sure recipe for abuse, especially because there was no separation between business houses and the insurance companies they promoted. The Insurance Act, 1938, introduced state controls on insurance, including mandatory investments in approved securities, but regulation remained ineffective. In 1949, Purshottamdas Thakurdas, chairman of the Oriental Assurance Company, admitted: "We cannot deny that, today, there is a tendency on the part of insurance companies in general to make illicit gains.

Can we overlook the cutthroat competition for acquiring business?

And still worse is the dishonest practice of adjusting of accounts." After a 1951 inquiry, the government was dismayed that companies had high expense and premium rates, were speculating in shares ,and giving loans regardless of security. No wonder that between 1945 and 1955, 25 insurers went into

liquidation and 25transferred their business to other companies. This reckless record stoked the pronationalization fires. The 1956 life insuranceNationalisation was a top-secret intrigue; for fear that unscrupulous insurers would siphon funds off if warned. The government resolved to first take over the management of life insurance companies by ordinance, then their ownership. The ordinance transferred control of 245 insurers to the government. LIC, established eight months later, took over their ownership. General Insurance had its turn in 1972, when 107 insurers were amalgamated into four companies headquartered in the four metros, with GIC as a holding company. Nationalization brought some benefits. Insurance spread from an urban-oriented, high-end business to a mass one. Today, 48 per cent Of LIC's new business is rural. Net premium income in general insurance grew from Rs.222 crores in 1973 to Rs.5,956 crores in 1995-96. Yet, rigid controls hamper operational flexibility and initiative so both customers service and work culture today are dismal. The frontier spirit of the early insurers has been lost. Insurance companies have also been timid in managing their investment portfolios. Competition between the four GIC subsidiaries remains illusory.

WHOS GOING WITH WHOM?

Indian company Kotak Mahindra Tata group Sundaram Finance Sanmar Group M A Chidambaram Bombay Dyeing DCM Shriram Dabur Group Godrej ITC S K Modi Group CK Birla Group Ranbaxy Alpic Finance 20th Century Finance Vyasa Bank Cholmandalam SBI HDFC ICICI IDBI Max India Foreign partner Chubb,US AIG,US Winterthur, SWITZERLAND GIO of Australia MetLife General Accident, UK Royal Sum Alliance, UK Liberty Mutual Fund, USA J. Rothschild, UK Eagle star, UK Legal and General, Australia Zurich Insurance, Switzerland Cigna, US Allianz, GERMANY Canada Life ING Guardian Royal Exchange, UK Alliance Capital Standard Life, UK Prudential, UK Principal New York Life

The privatization of the insurance sector would open up exciting new career options and new jobs would be created. A few insurers estimated a figure of 1lakh, after comparing the work forces in India and the UK. At present, life products comprise a big chunk, or 98%,of LICs

business. Pension comprises a mere 2%. Now with increase in life expectancy rate, people have to start planning their retirements. Hence pension business is expected to grow once the industry opens. The demand for healthcare is growing due to population increase, greater urban migration and alarming levels of pollution. Healthcare insurance is more important for families with smaller savings because they would not be able t o absorb the financial impact of adverse events without insurance cover. Foreign insurance companies like Aetna (worlds largest healthcare insurance provider)and Cigna have been providing Managed Care services across the globe. Managed Care integrates the financing and delivery of appropriate health care services to covered individuals.

WHY LIBERALIZE, WHAT MARKET STRUCTURE TOHAVE FINALLY, WHAT ROLE FOR REGULATOR?
Introduction:
The decision to allow private companies to sell insurance products in India rests with the lawmakers in Parliament. These are the passage of the Insurance Regulatory Authority (IRA) Bill, which will make IRA a statutory regulatory body, and amending the LIC and GIC Acts, which will end their respective monopolies. In 1994 the government appointed a committee on insurance sector reforms(which is known as the Malhotra Committee) which recommended that insurance business be opened up to private players and laid down several guidelines for orchestrating the transition. In particular, we do not address many other related questions such as whether foreign (and not just private) players should be allowed, what cap should there be on foreign equity ownership, whether banks and other financial institutions should be allowed to operate in the insurance business, whether firms should be allowed to sell both life and -non-life insurance, and so on. The three questions that we address are a. Why should insurance be opened up to private players? b. If opened up, what should be the appropriate market structure(many unregulated players or a few regulated players); and finally, c. What is the role of the regulator in insurance business?

Why allow entry to private players?

The choice between public and private might amount to choosing between the lesser of two evils. An insurance contract is a "promise to pay" contingent on a specified event. In the case of insurance and banking, smooth functioning of business depends heavily on the continuation of the trust and confidence that people place on the solvency of these financial institutions. Insurance products are of little value to consumers if they cannot trust the company to keep its promise. Furthermore, banking and insurance sectors are vulnerable to the "bank run" syndrome, wherein even one insolvency can trigger panic among consumers leading to a widespread and complete breakdown. This implies the need for a public regulator, and not public provision of insurance. Indeed in India, insurance was in the private sector for a long time prior to independence. The Life Insurance Corporation of India (LIC) was formed in 1956, When the Government of India brought together over two hundred odd private life insurers and provident societies, under one nationalized monopoly corporation, in the wake of several bankruptcies and malpractices'. Another important justification for Nationalization was to raise the much-needed funds for rapid industrialization and self-

reliance in heavy industries, especially since the country had chosen the path of state planning for development. Insurance provided the means to mobilize household savings on a large scale. LIC's stated mission was of mobilizing savings for the development of the country. The non-life insurance business was nationalized in 1972 with the formation of General Insurance Corporation (GIC). Thus the fact that insurance is a state monopoly in India is an artifact of recent history the rationale for which needs to be examined in the context of liberalization of the financial sector. If traditional infrastructure and semi-public goods" industries such as banking, airlines, telecom, power, and even postal services (courier) have significant, private sector presence, continuing a state monopoly in provision of insurance is indefensible. This is not to deny that there are some valid grounds for being cautious about private sector entry. Some of these concerns are: a) That there would be a tendency of private companies to "skim" the markets; thus private players would concentrate on the lucrative mainly urban segment leaving the unprofitable segment to the incumbent LIC. b) That without adequate regulation, the funds generated may not be deployed in sectors (which yield long-term social benefits), such as infrastructure and public goods; similar without regulation, private firms may renege on their social sector investment obligations. Meeting these concerns requires a strong regulatory body. Another commonly expressed fear is that there would be massive job losses in the industry as a whole due to computerization. This however does not seem to be corroborated by the countries' experience'. Moreover, apart from consideration based on theoretical principles alone, there is sufficient evidence that suggests that introduction of private players in insurance can only lead to greater benefits to consumers. This can be seen from the fact that the spread in insurance in India is low compared to international benchmarks. The two convention measures of the spread of insurance are penetration and density. The former measure (premiums per unit) of GDP, and the latter, premiums per capita. Less than 7% of the population in India has life insurance cover. In Singapore, around 45 per cent of the people are covered and in Japan, this is close to 100 per cent. In the US, over 81 per cent the households have insurance cover. India has the biggest life insurance sector in the world if we go by the number of policies sold, but the number of policies sold per 10 persons is very low. The demand for insurance is likely to increase with rising per-capitaincomes, rising literacy rates and increase of the service sector, ashas been seen from the example of several other developingcountries. In fact, opening up of the insurance sector is an integral part of the liberalization process being pursued by many developing countries. After Korean and Taiwanese insurance sectors wereliberalized, the Korean market has grown three times faster than GDP and in Taiwan the rate of growth has been almost 4 times that of its GDP. Philippines opened up its insurance sector in 1992. There are several other factors that call for private sector presence. Firstly, a state monopoly has little incentive to innovate or offer a wider range of products. This can be seen by a lack of certain products from LlC's portfolio, and lack of extensive risk categorization in several GIC products, such as health insurance. In fact, it seems reasonable to conclude that many people buy life insurance just for the tax benefits, since almost 35 per cent of the life insurance business is in March, the month of financial closing. This suggests that insurance needs to be sold more vigorously.

More competition in this business will spur firms to offer several new products, and more complex and extensiverisk categorization. The system of selling insurance throughcommission agents needs a better incentive structure, which a state monopoly tends to stifle. For example LIC pays out only 5 per cent of its income as commissions, whereas this share in Singapore is 16 per cent, and in Malaysia it is close to 20 percent. Private sector presence will also mean that the current investment norms, which tie-up almost 75 per cent of insurance funds in low yielding government securities, will have to go. This will result in more proactive and market oriented investment of funds. This needs to be tempered by prudential regulation to ensure solvency'. Of course, this also implies that cross-subsidizing across policyholders of different types that is seen both in life and non-life insurance will diminish. Since public sector firms are required to sell subsidized insurance to weaker sections of society, a separate subsidy mechanism will have to be designed. The India Infrastructure Report (GOI, 1996) estimates that the funds required in the next two decades are more than Rupees4000 billion. Finally, private sector entry into insurance might besimply a fiscal necessity. Since large scale funds form long term contractual savings need to be mobilized, especially for investment in infrastructures the option of not having more (private) players in the insurance sector is too costly.

WHAT SHOULD BE THE MARKET STRUCTURE?

Individuals buying an insurance contract pay a price (called the premium") to the insurance company and the insurance company in turn provides compensation if a specified event occurs. By making such contractual arrangements with a large number of individuals and organizations the insurance company can spread the risk. This gives insurance its "social" character in the sense that it entails pooling of individual risks. The price of insurance i.e., the premium is based onaverage risk. This premium is too high for people who perceivethemselves to be in a low risk category . If the insurer cannotaccurately determine the risk category of every customer and prices insurance on the basis of average risk, he stands to lose all the low risk customers. This in turn increases the average risk, which means premia have to be revised upwards, which in turn drives away evermore customers and so on. This is known as the problem of "adverse selection". Adverse selection problem arises when a seller of insurance cannot distinguish between the buyer's type i.e., whether the buyer is a low risk or a high type. In the extreme case, it may lead to the complete breakdown of insurance market. Another phenomenon, the problem of "moral hazard" in selling insurance, arises when the unobservable action of buyer aggravates the risk for which insurance is bought. For example, when an insured car driver exercises less caution in driving, compared to how he would have driven in the absence of insurance, it exemplifies moral hazard. Given these problems, unbridled competition among large number of firms is insurance considered detrimental for the insurance industry.

Furthermore, even the limited competition in insurance needs to be regulated. Insurance companies can differentiate among various risk types if there is a wide difference in risk profile of the buyers insuring against the strong insurers. It also called for keeping life insurance separate from the general insurance. It suggested the regulation of insuranceintermediaries by IRA and the introduction of brokers for better professionalisation'.

THE ROLE OF IRA:

(a) The protection of consumers interest, (b) To ensure financial soundness of the insurance industry and (c) To ensure healthy growth of the insurance market. These objectives must be achieved with minimum government involvement and cost. IRAs functioning can be financed by levying a small fee on the premium income of the insurers thus putting zerocost on the government and giving itself autonomy.

( a ) Protection of Customer Interests: IRAs first brief is to protect consumer interests. This means ensuring proper disclosure, keeping prices affordable but also insisting on some mandatory products, and most importantly making sure that consumers get paid by insurers.

Ensuring proper disclosureis called Disclosure Regulation. Insurance contracts are basicallycontingency agreements. They can be full of inscrutable jargon and escape clauses. An average consumer is likely to be confused by them. IRA must require insurers to frame transparent contracts. Consumers should not have to wake up to unpleasant surprises, finding that certain contingencies are not covered. The IRA also hasto ensure that prices of products stay reasonable and certainmandatory products are sold. The job of keeping prices reasonable is relatively easy; since competition among insurers will not allow anyone company to charge exorbitant rates. The danger often is that prices may be too low and might take the insurer dangerously close to bankruptcy. As for mandatory products, those that involve commonand well-known risks, certain standardization can be enforced. Furthermore; IRA can insist that for such products the prices also be standardized. From the consumers point of view the most important function of IRA is ensuring claim settlement. Quick settlement without unnecessary litigation should be the norm. For example, in motor vehicle insurance, adopting no-fault principle can speed up many settlements. Currently, LIC in India has a claims settlement ratio of 97%, an impressive number by any standards. However, it hides the fact that this settlement is plagued by long delays, which reduce the value of settlement itself. If consumers have a complaint against an insurer they can go to a body formed by association of insurers. The decision of such a body would be binding on the insurers, but not on the complainant. If complainants are not satisfied, they can go to court. Some countries such as Singapore have such a system in place.

This system offers a first and quicker choice of settling out of court. IRA can encourage the insurers to have such a grievanceredressal mechanism. This system can serve the function of adjudication, arbitration and conciliation. The second area of IRAs activity concerns monitoring insurer behavior to ensure fairness. It isespecially here that IRAs choice of being a bloodhound or awatchdog would have different implications. We think that an initial tough stance should give way to a more forbearing and prudential approach in regulating insurance firms. When the industry has a few firms there is some chance of collusion. IRA must be alert to collusive tendencies and make sure that prices charged remain reasonable. However, some cooperation among the insurance companies couldbe considered desirable. This is especially in lines where claimexperience of any one company is not sufficient to make accurate forecasts. Collusion among companies on information sharing and rate setting is considered fair. IRA must have severe penalties in case of fraud or mismanagement. Since insurance business involves managing trust money, in some countries the appointment of senior managers and key personnel has to be approved by the insurance regulatory agency.

( b ) Ensuring Solvency of Insurers :

There are basically four ways of ensuring enough solvencies. First: is the policy of a price floor. Second :is the restriction on capital and reserves, i.e., on what kindof investments and speculative activities firms can make. Third :is putting in place entry barriers to restrict the number of competitors. Fourth: is the creation of an industry financed guarantee fund to bailout firms hit by unexpectedly high liabilities. Entry restrictions of the IRA are implemented through a licensing requirement, which involves capital adequacy among other things. Since there are economies of scale and scope in insurance operations it might be better to have only a few large firms. There is however no magic number regarding the optimal number of firms. Restricting competition provides a scope for higher profit to the companies thereby strengthening their solvency position. After qualifying, the entrants are continuouslysubjected to restrictions on reserves and investments, which ensure ongoing solvency. Additionally, a guarantee fund, created by mandatory contributions from all insurance companies is used to bailout any insurance company, which might be in financial trouble. This guarantee fund does not imply that firms can charge whatever they wish to their consumers. All insurance companies would have an incentive to monitor the activities of their rival peer firms. This is because insolvency of any insurance company would entail a price, which all the insurance companies would have to shoulder. Peer review of accounts can also be institutionalized.IRA can have several ways for early detection of a potential insolvency. For example, in the USA there is an Insurance regulatory information system (IRIS) that regularly computes certain key financial ratios from financial statements of firms. If some of these ratios fall outside given limits the company is asked to take corrective action. Insolvency can also arise out of reinsures abandoning insurance companies in the lurch, as witnessed in the USA in 1980s.Reinsurance is a bigger business dominated by large internationalreinsurers. Such litigation between reinsurer and insurancecompanies involves cross boundary legalities and can drag on for years. IRA must evolve a set of operational guidelines to deal with reinsurance matters. Insurance intermediaries Such as agents, brokers, consultants and surveyors are also under IRAs jurisdiction. IRA has to evolve guidelines on the entry and functioning of suchintermediaries. Licensing of agents and brokers

should be required to check against their indulging in activities such as twisting, rebating, fraudulent practices, and misappropriation of funds. IRA can alsoconsider allowing banks to act as agent s (as opposed tounderwriters) of insurers in mass base types of products. Given their wide network of branches and their customer base, the banks can access this market for insurance products and also earn commission income. The incremental cost of providing such insurance products would be much lower. (c ) Promoting Growth in the Insurance Industry : A society experiences many benefits from the spread of insurance business. Insurance contributes to ec onomic growth byenabling people to undertake risky but productive activity. In the past, growth of trade has been facilitated by the development of insurance services. One only needs to look at the history of insurance to see how evolution of insurance helped trade flows along various trade routes. Promotion of insurance also provides for long-term funds, which are utilized to fund big infrastructure projects. These projects typically have positive externalities, which benefit society at large. IRA can ensure growth of insurance business with better education and protection to consumers, and by making the insurance business a level playing field. They can also support Indian insurance companies in the international field. IRA thus has to frame the rules, design procedures for enforcement and also make operational guidelines. All this with virtually no relevant historical data makes the task very difficult. An initial conservative approach (the bloodhound) is justified since there is no prior experience to fall back on, and it would be prudent to err by regulating more rather than less. As experience accumulates, the IRA can relax its initial harsh stance and adopt a more accommodating stance (the watchdog). Regulation is always an evolutionary process and experience constantly has to feed into policy making. Care must be taken so that this process does not slow down and cause regulatory lags. IRA can also consider allowing banks to act as agents (as opposed to underwriters of insurers in mass base types of products. Given their wide network of branches their customer base, the banks can access this market for insurance products and also commission income. The incremental cost of providing such insurance products would be much lower. Such a move of allowing banks to operate insurance business and vice versa is consistent with a worldwide trend of greater integration of banking and insurance. The major insurance markets in South andEast Asia are in varying degrees opposite. This range fromcomparative free markets of Hong Kong an d Singapore toincreasingly more liberal markets of South Korea and Taiwan to more densely regular insurance sectors of Thailand and Malaysia.

LIBERALISATION OF INSURANCE INDUSTRY : While no aspect of the reform process in India has gone smoothly since its inception in 1991, no individual initiative has stirred the proverbial hornets' nest as much as the proposal to liberalize thecountry's insurance industry. However, the political debate thatfollowed the submission of the report by the Malhotra Committee has presumably come to an end with the ratification of the Insurance Regulatory Authority (IRA) Bill both by the central Cabinet and the standing committee on finance. This section traces the evolution of the life insurance companies in the US from firms underwriting plain vanilla insurance contracts to those selling sophisticated investment contracts bundled with insurance products. In this context, it brings into focus the importance of portfolio management in the insurance business and the nature and impact of portfolio related regulations on the asset quality of the insurance companies. It also provides a rationale for the increased autornatisation of insurance companies,and the increased emphasis on agent independent marketingstrategies for their products. If politicized, regulations have potentialto adversely affect the pricing of risks, especially in the non-

lifeindustry, and hence the viability of the insurance companies. Finally, the backdrop of US experience provides some pointers for Indian policymakers.

Introduction:
The insurance sector continues to defy and stall the course of financial reforms in India. It continues to be dominated by the two giants, Life Insurance Corporation of India (LIC) and the General Insurance Corporation of India (GIC), and is marked by the absenceof a credible regulatory authority. The first sign of governmentconcern about the state of the insurance industry was revealed in the early nineties, when an expert committee was set up under the chairmanship of late R.N.Malhotra. The Malhotra Committee, whichsubmitted its report in January 1994, made some far-reachingrecommendations, which, if implemented, could change the structureof the insurance industry. The Committee urged the insurancecompanies to abstain from indiscriminate recruitment of agents, and stressed on the desirability of better training facilities, and a closer link between the emolument of the agents and the management and the quantity and quality of business growth. It also emphasized the need for a more dynamic management of the portfolios of thesecompanies, and proposed that a greater fraction of the fundsavailable with the insurance compani es be invested in nongovernment securities. But, most importantly, the Committee recom-mended that the insurance industry be opened up to private firms,subject to the conditions that a private insurer should have aminimum paid up capital of Rs. 100 crore, and that the promoters stake in the otherwise widely held company should not be less than26 per cent and not more than 40 per cent. Finally, the Committee proposed that the liberalized insurance industry be regulated by an autonomous and financially independent regulatory authority like the Securities and Exchange Board of India (SEBI). Subsequent to thesubmission of its report by the Malhotra Committee, there wereseveral abortive attempts to introdu ce the Insurance RegulatoryAuthority (IRA) Bill in the Parliament. It is evident that there was broad support in favour of liberalization of the industry, and that the bone of contention was essentially the stake that foreign entities were to be allowed in the Indian insurance companies. In November 1998,the central Cabinet approved the Bill which envisaged a ceiling of 40 per cent for Non Indian stakeholders: 26 per cent for Foreign collaborators of Indian promoters, and 14 per cent for Non resident Indians (NRIs), Overseas corporate bodies(OCBs) and Foreign institutional investors (FIIs). However, in view of the widespread resentment about the 40per cent ceiling among political parties, the Bill was referred to hestanding committee on finance. The committee has sincerecommended at each private company be allowed to enter only one of the three areas of business life insurance, general or non life insurance, and reinsurance and that the overall ceiling for foreign stakeholders in these companies be reduced to 26 per cent from the proposed 40 per cent. The committee has also recommended that the minimum paid up share capital of the new insurance companies be raised to Rs. 200 crore, double the amount proposed by the Malhotra Committee.

Economic Rationale:
The insurance industry is a key component of the financial infrastructure of an economy, and its viability and strengths have far reaching consequences for not only its money and capital markets, but also for its real sector. For example, if households are unable to hedge their potential losses of wealth, assets and labour and nonlabour endowments with insurance contracts, many or all of them will have to save much more to provide for events that might occur in the future,

events that would be inimical to their interests. If a significant proportion of the households behave in such a fashion, the growth of demand for industrial products would be adversely affected. Similarly, if firms are unable to hedge against "bad" events like fire and the job injury of a large number of labourers, the expected payoffs from a number of their projects, after factoring in the expected losses on account such "bad" events, might be negative. In such an event, theprivate investment would be adversely affected, and certainpotentially hazardous activities like mining and freight transfers might not attract any private investment. It is not surprising; therefore, that economists have long argued that insurance facility is necessary to ensure the completeness of a market.

ORGANISATIONAL STRUCTURES AND THEIR IMPLICATIONS:

Insurance companies can be broadly divided into four categories: Stock companies, mutual companies, reciprocal exchanges, and Lloyds companies. The former two are thedominant forms of organisational structures in the US insuranceindustry. A stock company is one that initially raises capital by issue of shares, like a bank or a non bank financial institution; andsubsequently generates more funds for investment by sellinginsurance contracts to policyholders. In other words, there are three sets of stakeholders in a stock insurance company, namely, the shareholders, , managers and the policyholders. A mutual company, on the other hand, raises funds only by selling policies such that the policyholders are also partners of the companies. Hence, a mutual company has only two groups of stakeholders, namely, thepolicyholder cum part owners and the managers.