Missing the wood for the trees

It is well known that we are great hero-worshippers. Both in our social and political lives, we set great store by heroes. Unfortunately, this trend seems to be establishing itself in our economic life also, particularly in the financial sector.

We think that some policymakers will automatically produce great improvements wherever they go. Completely lost sight of are the structural factors pertinent to policy issues.

A case in point is the hype which surrounded the arrival of a new Finance Minister in August 2012 and the flurry of “announcements” about “improving” various sectors — such as insurance, banking, mutual funds, pensions, capital markets, and so on — which followed. Since the structural impediments in various sectors were ignored (if at all they were recognised), we have not seen any material change on the ground.

Nor does such change seem like happening anytime soon. Witness the latest “resolve” to increase the automatic FDI limit in insurance to 49 per cent from 26 per cent — subject to Parliament’s nod. Automatic FDI means investment proposals need not go through the FIPB (Foreign Investment Promotion Board). But, is that alone sufficient?

Micro focus

The announcements — both now and in 2012 — regarding the life insurance industry are a good example of how we focus on the micro issues and lose sight of the big picture.

The 2012 “life industry” meeting took place in the backdrop of a sustained deceleration (over the previous three years) in new business performance of the entire life industry.

So, one would have thought that the meeting would focus on the structural factors which can aid the growth of life insurance. Those factors can then be addressed through macro-financial and economic policy, which could well involve other policymakers such as the Reserve Bank of India.

But what did the meeting look at? It talked about product approval procedures of IRDA (Insurance Regulatory and Development Authority), KYC norms, norms on management expenses, norms on bank/insurance distribution tie-ups, group insurance procedures, and so on.

Are these bread-and-butter issues for the industry? One would think not. They are important in their own right, but in the larger picture, they are clearly operational and procedural issues which need not garner so much policy-maker attention.

What is the big conceptual picture which should have been focused on?

Comparing balance-sheets

One would think that the policymaker should focus on how different an insurance balance-sheet is from that of a banking balance-sheet; and understand how those differences (if any) could be playing a critical role in the overall growth of the industry itself. It is such concept-based thinking that one expects from the top policymakers.

More so, as the Finance Ministry is well placed to take in the macro picture and focus on creating an enabling economic environment for the long-term growth of the industry.

A key difference can be immediately noted between bank and insurance balance-sheets, going beyond even the different liquidity characteristics of assets and liabilities on the respective balance sheets (see table).

Life insurance growth — in terms of expansion of policy coverage and policy liabilities — is almost wholly dependent on the financial performance of the asset portfolio. In other words, growth in one variable is completely determined by the growth/performance of the other variable. That is also what is being proved in the last four years of growth deceleration in the industry.

On the contrary, a bank balance-sheet can still grow for some time and, to some extent, even if one of the variables slackens.

For instance, endogenous deposit growth (by creating high demand for money balances as a part of asset portfolios) through “appropriate” levels of interest rates can expand the banking balance-sheet. Conventional asset growth will inevitably slacken in such a scenario, but that is inevitably the process of (monetary) policy acting with a larger economic objective. After growing for some time and to some extent, the overall balance-sheet growth will then adjust to the new economic scenario.

The reverse situation also has been playing out in India for quite some time now. Asset growth has ruled much higher than deposit growth for a long time now — with the funding deficits being financed by the RBI through its daily lending to the system.

The situation is quite different in the case of life insurance. Life insurance is not a pure investment or savings product, but contains a significant component of risk protection.

Different clientele

To sell risk protection to a population which does not have even widespread conventional financial services (say, a bank deposit or loan) is difficult, to put it very mildly. The performance of the asset portfolio then becomes highly critical in pushing insurance.

And, what do we have here? Pathetically negative real interest rates which can put off even the bank depositor, not to speak of the insurance buyer.

The bank depositor, though, is captive to the system and has to necessarily put his monies in a bank account even if he is financially repressed and suffers negative rates. The insurance buyer is under no such compulsion. He has to be enlightened about the need for life insurance — which in the current milieu has become even a social security imperative. Positive real interest rates (and sustaining them on a long-term basis) would be a key help in this situation. (The different liquidity characteristics of bank and insurance liabilities are pertinent here).

As for Indian stocks, they are known to be highly volatile. The average return on stocks is quite attractive at some 15 per cent, but we have a risk measure of something like 35 per cent. Is that conducive to widespread retail market participation through equity-linked insurance? How can we reduce structural volatility in our stock markets?

That is the big picture focus required from our policy-makers. Relative trivia such as product approval procedures should not hog the limelight.

(The author is a Chennai-based financial consultant.)

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