The RBI recently proposed to reduce the ownership by banks over insurance companies at a maximum of 20 per cent from a present 50 per cent.
This move is to be welcomed, as the close inter-relationship of banks with the insurance sector and other financial investment companies, causes opaque monopolies that distort the market and concentrate risks dangerously for the bondholders, lenders, depositors, home borrowers, persons taking out an insurance claim and shareholders. The recent takeover of Reliance Capital by the RBI is an example of where the sector as a whole should not be heading.
Insurance and banking are at their core two very different businesses. Insurance is a ‘long term’ stand-alone business in which companies have to wait for long periods to break even and make profits. It is liquidity rich. Capital gets locked up for longer cycles than banking. Insurers do not usually raise debt to purchase financial assets to cover claims.
It is a business that is required to be responsive to its customer base. Despite the need for skilled leadership, the Boards of insurance companies tend to be populated with the nominee members of promoters, investors and owners.
Banks, in contrast, are institutionally interconnected through the interbank market and are more exposed to liquidity risk. Banks’ interest in lending and credit-creation is not conducive to the cash flow dynamics of the insurance companies.
Banks as corporate agents, obtaining commissions, are interested in selling the insurance packages to customers who are frequently unaware of the terms and conditions, leading to the closure of the policy within a short time though the premiums are not returned. The conflicts in objectives have an impact on the ability of those sitting on the Board of insurance companies to make optimal decisions about reliably selling insurance, making investments and managing cash flows.
Fair competition
Fair competition is another principle to be thrown out of the window, in favour of encroachment, so this window must be closed. For instance, banks serve as an important channel for selling insurance. This creates a binding structure where the channel of sales is owned by the banks themselves.
The bank that provides the credit serves as the channel providing insurance and also as the owner of the insurer who provides the risk coverage. The customer does not get to choose the insurance service provider. The bank’s interest to insure is limited. Issues arising out of ‘under insurance’ puts the insured at high risk.
The insurance regulator has mandated that a bank acting as a corporate agent has three tie-ups in each of the areas of life insurance, general insurance and health if it serviced these areas.
Yet very few of them have complied with the rules – only 3.6 per cent of the insurers as of March 2020. The compulsory inclusion of domain and insurance industry experts on the Boards of the insurance companies would go a long way in breaking the unhealthy linkages that exist.
The practice of “connected lending” between banks and non-bank interests with political backing must be curbed. Reforms in the banking sector such as independent directors as Chairs also make sense for the insurance sector. Distinct measures for the insurance sector would also be investment limits and changes to the design of the insurance contracts for greater transparency.
This naturally leads to the question of whether limiting the ability of banks to be interlocked with insurance companies would create a shortage of capital. This is unlikely to be the case as the regulations have upped the limit to 74 per cent for foreign investments in the insurance sector.
The potential of the Indian insurance market is well known and the utilisation of FDI was, in March 2020, only at 2.36 per cent of the overall FDI in the service sector. We can attribute this to wait and watch the approach of many overseas investors or discomfort with the unfamiliar regulatory and market set-up.
These issues can wear off with time. Regulations that strictly keep the insurance sector as a professionally-run sector will also assist in making the sector more attractive to foreign as well as domestic capital.
The author is Partner, Surana & Surana International Attorneys