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With effect from December 31, 2006, most segments in the general insurance industry are likely to be de-tariffed. This is likely to increase competition in profitable business segments such as fire and engineering, translating into lower returns in terms of premium generated from these segments. In contrast, returns from severely loss-making segments such as motor third-party (motor TP) insurance are likely to improve, as industry players increase premium rates to cover future expected claims more efficiently than the current practice. CRISIL's analysis of the expected scenario post de-tariffing reveals that overall, underwriting losses will increase from the current levels as the benefits from the increase in Motor TP premium are not expected to be sufficient to completely offset the impact of the reduction of premium levels in the profitable segments. Thus CRISIL expects the core business operations of industry players to remain unprofitable over the medium term. Nevertheless, the strong capitalisation levels of general insurance companies will continue to support their business and financial profiles in a de-tariffed regime. This will enable them to meet unexpected losses and service large claims that may devolve on them. The Indian General Insurance Industry: An Overview
| Historically, the domestic general insurance industry has been dominated by a few public sector players. Private sector players, who entered the market as recently as in 2001-02 , had garnered a sizable market share of about 26.6 per cent of the domestic gross premia by 2005-06.Despite this intensifying competition, public sector players continue to dominate the Indian general insurance market, given their long track record, extensive reach, and robust capitalisation levels. The entry of private sector players, however, has contributed to a significant growth in the domestic market; the domestic gross premia registered a 15 per cent compounded annual growth rate (CAGR) during the last five years. Despite this growth, insurance penetration levels in India remain much lower than global averages, providing a vast potential to be tapped. CRISIL believes that the growth prospects for the Indian general insurance industry, over the medium to long term, are strong. | The tariffed structure: the story so far
Over 70 per cent of net premium in the domestic general insurance industry is generated under tariffed lines of business. All insurance segments, except personal lines of business (health and personal accident) and marine cargo insurance, fall under the tariff structure of the Tariff Advisory Committeel (TAC). The unpredictability of underlying risk events and cap rates for certain large business segments translate into sizable underwriting losses for general insurance companies. CRISIL's analysis reveals that the motor insurance segment, the largest one in terms of gross premia generated (48 per cent of gross premia generated in 2004-05), also accounts for the largest share of losses in the domestic general insurance industry. This is primarily due to a preponderance of fraudulent and overstated claims in motor TP insurance, the primary sub-segment in the motor insurance business; the average claims ratio (net claims as a proportion of net premium) in the motor TP segment stood at over 200 per cent in 2004-05. The overall claims ratio in the domestic motor segment, however, was lower at about 96 per cent in 2004-05; this was due to the profitable operations of the motor own-damage (motor OD) business, the other sub-segment of motor insurance. Compared with public sector players, private sector players have been able to maintain better control over losses generated from motor insurance; stringent internal control mechanisms and processes have kept the net claims ratio for private sector companies at relatively low levels (see Chart 1). Nevertheless, the average claims ratio for the industry in the motor segment continues to remain above 90 per cent, indicating the high incremental devolvement of claims as a proportion of premium received. CHART 1: NET CLAIMS RATIO FOR MOTOR INSURANCE
 
In contrast, other tariffed segments (for which the Tariff Advisory Committee prescribes floor rates) such as fire and engineering have remained profitable over the years; in 2004-05, the average claims ratios for the industry were 39.5 per cent and 52.5 per cent for these segments respectively. Impact of de-tariffing on profitability levels
With effect from December 31, 2006, most business segments under the domestic general insurance industry are likely to be de-tariffed. Consequently, the stipulated cap / floor on the premia that general insurance companies charge in these segments will be removed. CRISIL believes that this regulatory move to de-tariff is likely to make segments such as fire and engineering less profitable, due to lower premiums as a result of intensifying competition among existing players (existing floor rates in these segments make them hugely profitable for general insurers). The ensuing pricing pressures will reduce insurers' net premium income. In contrast, the returns from loss-making segments like Motor TP insurance are likely to improve, as industry players attempt to cover future expected claims more efficiently by increasing the premia charged from customers; in CRISIL's opinion, the premium rates for motor TP insurance may increase somewhat from the current levels. The increase, however, would still not align the premium levels to the risks in this business, as in CRISIL's opinion the sensitive nature of motor TP premium and its widespread impact would restrict the level of premium increase in this segment. The increase in premiums in the motor TP segment could also be staggered or phased out by the regulator. Consequently, CRISIL believes that most insurance companies will continue to make underwriting losses and the extent of these losses can go up after de-tariffing. If, however, insurance companies can significantly raise motor TP premium levels the extent of underwriting losses can actually come down from the current scenario. CRISIL's recent study of 12 public and private sector companies, on the impact of de-tariffing on the underwriting profitability of these players, supports this view. CRISIL's analysis reveals that a 10 per cent reduction in fire, engineering, and motor OD premia, accompanied by a 20 per cent increase in motor TP premia, will increase the industry's underwriting losses from Rs. 17.71 billion currently to Rs. 20.70 billion in the near future (see Table 1). Table 1
Impact on overall profitability levels in a de-tariffed regime - motor TP premia increasing by 20%
| Segments | Change in premium rates | | | Scenario #1 | Scenario #2 | Scenario #3 | | Fire |  10% | 15% | 20% | | Engineering | 10% | 15% | 20% | | Motor OD | 10% | 15% | 20% | | Motor TP |  20% | 20% | 20% | | Underwriting profits/(losses) Rs.billion | (20.70) | (24.07) | (27.43) | | Change in underwriting profits over 2004-05 Rs. Billion | 2.99 | 6.35 | 9.72 | However, if the insurers are able to significantly enhance their motor TP premium levels, the underwriting losses can even be reduced from the current levels. CRISIL's analysis reveals that a 10 per cent reduction in fire, engineering, and motor OD premia, accompanied by a 100 per cent increase in motor TP premia, will reduce the industry's underwriting losses from Rs17.71 billion currently to Rs5.74 billion in the near future (see Table 2). Nevertheless in CRISIL's opinion, this scenario is not very likely given the sensitive nature of motor TP premium and its widespread impact which would restrict the level of premium increase in this segment. Table 2
Impact on overall profitability levels in a de-tariffed regime - motor TP premia increasing by 100% | Segments | Change in premium rates | | | Scenario #1 | Scenario #2 | Scenario #3 | | Fire | 10% | 15% | 20% | | Engineering | 10% | 15% | 20% | | Motor OD | 10% | 15% | 20% | | Motor TP | 100% | 100% | 100% | | Underwriting profits/(losses) Rs.billion | (5.74) | (9.10) | (12.47) | | Change in underwriting profits over 2004-05 Rs. Billion | 11.98 | 8.61 | 5.25 | In sum, CRISIL believes that, whatever be the scenario that unfolds in a de-tariffed regime, the core business operations of general insurance companies will remain unprofitable. However, over the long term, margins in the fire and engineering segments are likely to stabilise and move up as the industry matures, thus supporting overall profitability levels.
Conclusion: Resilience to underwriting losses to continue
Despite continued underwriting losses in a de-tariffed scenario, the financial profiles of domestic public sector non-life insurance companies are not likely to be affected. This is due to their continued strong capitalisation levels including large reserves from un-booked profits on investments. Technical reserves are significantly high for the four largest players in the sector, all of which are government-owned. Of these, National Insurance Company Limited, New India Assurance Limited, and Oriental Insurance Limited, have financial strength ratings of 'AAA/Stable' from CRISIL. CRISIL includes the fair market value of insurers' equity portfolios in its analysis of adjusted solvency. Equity prices have appreciated significantly over the last three years, and there is a risk of solvency ratios reducing from current levels if the market were to fall. However, CRISIL's analysis reveals that, even if one were to ignore capital market gains since March 2003, the adjusted solvency ratios for Oriental Insurance Limited and New India Assurance Limited would remain comfortable (see Chart 2). In CRISIL's opinion, high adjusted solvency margins and strong capitalisation levels will enable insurance sector companies to meet ongoing claims and service unexpected losses over the medium term. Chart 2
 Adjusted Solvency Ratio includes fair value change accounts (marked to market gains on investment portfolio along with the base net worth. @Assuming mark to market gains in equity portfolio for last 2 financial years are ignored CRISIL's analysis further reveals that, despite the impact on profitable business segments in a de-tariffed regime, the reduction in the available adjusted solvency margin for the industry will be manageable from a systemic perspective. Therefore, in terms of capitalisation, CRISIL believes that India's bigger non-life insurance companies will still be well placed to manage their business dynamics after the removal of tariff limits on insurance premia. Glossary of terms: 1. Motor TP- Motor Third Party insurance
2. Motor OD- Motor Own Damage insurance
3. Tariffs- For certain lines of general insurance (Fire, Engineering, Marine (Hull) and workmen's compensation), the premiums that insurers can charge on policies are defined by tariff orders given by the Tariff Advisory Committee. These are called tariffs and the lines of business are referred to as tariffed lines of business
4. Solvency margin- Available or required solvency margin. Available solvency margin is the sum of the excess of policy holders' assets over policy holders' liabilities and the excess in the shareholders funds account. Required Solvency margin is calculated in accordance with IRDA guidelines on solvency margins. Required solvency margin is a function of segment wise net premiums and net incurred claims
5. Solvency Ratio- Available Solvency Margin/ Required Solvency margin (as per IRDA regulations)
6. Technical reserves- Sum of claims reserve and reserve for unexpired risks
7. Underwriting losses- Net Premium after reinsurance less incurred claims less operating expenses. CRISIL does not consider income from investments or capital gains from investments while calculating underwriting losses |
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