Indian Insurance Sector: In Pursuit of Value July 2015

Indian Insurance Sector: In Pursuit of Value Table of Contents Foreword

3

Executive summary

5

The value in insurance

6

Shareholder perspective

7

Sources of profit Measuring value in insurance

The India experience

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16

Early expectations

17

The actual versus expected

18

Unlocking extant value: Stake sales

22

The inevitable listing

24

The opportunity still exists: realising the value

26

Business optimisation

26

The right product-price proposition

33

Favourable macroeconomic fundamentals

33

Confidence building

36

Indian Insurance Sector: In Pursuit of Value 1

Foreword Nearly a decade and a half since privatisation, the insurance industry in India today finds itself with a keen sense of anticipation: at the time of going to press, proposed amendments to the Insurance Act have been passed by the Parliament. Although further clarity is still needed on the precise rules governing hike in foreign investment and other provisions of the Act, there is still a palpable nervous energy and restlessness within the industry as it tries to grasp its potential. In the past few years, insurers have gone through testing times and faced increasing competition, a raft of regulatory changes and a prolonged economic slowdown that have all required realignment and adjustment. Nevertheless, many insurers remain upbeat about the industry's prospects and have emerged anew seeking growth, momentum and value. The market is also seeking value from India's insurance business. This report, accordingly titled In Pursuit of Value, considers the industry's experience to date and the extent to which it has been able to deliver stakeholder value, particularly for consumers and providers of insurance. As both stakeholders and practitioners, we must also consider how to realise the extant value that the sector promises. Firstly, we look at insurance at its most fundamental level – that is, the value from pooling and sharing of risks for the individual consumer as well as society at large. Similarly, we aim to identify the sources of profit for the insurance provider: insurance is a unique business, almost idiosyncratic, being perhaps the only industry where, at the time of premium sale, a

company doesn't know for sure the extent to which it has made a profit or a loss on the transaction. It could be months, or even years before the true value from the sale can be identified with any degree of certainty. Consequently, recognition – and more importantly – measurement of value from insurance for an investor (or shareholder) is not always clear cut. We also need to demonstrate the value determination from the insurance sector at a time when there is a likelihood of larger public participation through stock exchange listings. Industry veterans too will find this discussion absorbing, given the raging rebate on the nature and limits for foreign investment and the inevitable flux in ownership with possible consolidations, exits of existing players and entrants making fresh investments in the sector. It's appropriate to look at the tumultuous journey of the insurance industry in India since the turn of the century. The industry was opened for private participation in August 2000 with high expectations from the regulator in respect of ensuring greater market efficiency as well as from the entrants looking for latent business opportunities. We take an in-depth view of the outcomes over the last decade or so and identify both successes and shortfalls relative to such early expectations. Particularly relevant are the increasing regulatory interventions observed in recent years, driven by the fervour to align the regulator's primary objective of ensuring consumer protection in light of market realities.

Indian Insurance Sector: In Pursuit of Value 3

These adolescent experiences are instructive – not least because they must provide invaluable lessons for the future. Despite periods of readjustment, the underlying fundamentals for a robust insurance sector in India remain strong. Macro indicators all point towards

Chandrajit Banerjee Director General CII

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optimistic prospects for the industry, even as micro level challenges of optimising businesses and aligning interests of individual stakeholders remain to be overcome. In our final analysis, we discuss such factors that will help realise the full value of insurance business and seize the opportunities that continue to remain untapped.

Vivek Jalan Director, Risk Consulting Towers Watson India

Vikas Newatia Director and Practice Leader General Insurance Consulting Towers Watson India and South East Asia

Executive Summary The insurance industry in India plays a pivotal role in the economy, providing an essential security cover for individuals as well as organisations. At the same time the industry is able to channel household savings from a large spectrum of the society into the capital markets, acting as an important vehicle of growth. With unhindered growth for the industry over nearly a decade, policymakers have dug deeper in recent years to ensure a more robust framework for regulation that will serve the interests of the country as well as the public at large. Equally, the industry's stakeholders – shareholders, distributors and customers continue to seek increasingly superior outcomes in this intensely competitive sector. Dynamic market forces, the rules of the game evolving with each regulatory update as well as the changing macroeconomic environment and growing use of technology, mean the individual outcomes for stakeholders have varied over time. This report charts where India's insurance sector has come from and then, most importantly, looks to the future – and identifies four fundamental drivers that would help realise the value that this sector promises: l

Business optimisation: the recent challenges faced by the industry have largely been microissues and steps towards overcoming these must inevitably start with the primary stakeholder – the insurance provider itself. We further recognise that for an insurer's ability to successfully meet its objectives, it is necessary to understand the long-term nature of the insurance business and set the right KPIs that drive such value rather than achieving shortterm milestones. Further, it is desirable to incentivise the leadership and people for outcomes that are appropriately aligned.

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The right product-price-process proposition: ultimately, the customer must be at the centre of any sustainable long-term business strategy and this is no different for insurance. Insurers must adopt need-based selling and enhance the customer value proposition by delivering products they need as opposed to products the industry wishes them to have. Coupled with the fact that large sections of society remain underpenetrated by insurance, the right product-priceprocess proposition delivery is sure to provide an overwhelming boost to the sector.

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Favourable macroeconomic fundamentals: India's demographic advantage with a young population, cautiously optimistic market sentiment and recent positive policy announcements by the government provide an ideal industry environment in which insurers can flourish.

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Confidence building: a general concern is that the industry has lost faith with a number of stakeholders and it is vital that concerted efforts are made to ensure confidence in the industry is restored, both from the consumer and investor perspective. Unless acted upon now, it might be too late to repair the damage done by lost reputation.

“Dynamic market forces, the rules of the game evolving with each regulatory update as well as the changing macroeconomic environment and use of technology, mean the individual outcomes for stakeholders have varied over time.”

Indian Insurance Sector: In Pursuit of Value 5

The value in insurance At its core, an insurance contract is a reasonably straight forward transaction: the customer agrees to pay fixed premiums, whose amount and frequency is known in advance, in exchange for a large, possibly catastrophic, loss for the insurer should an unforeseen event occur. Herein also lays the primary utility derived by a consumer of insurance products – that is, the peace of mind derived from the knowledge that the rainy days have been provided for. At the same time there is a clear business opportunity for a risk-seeking entrepreneur insofar as the aggregate of premiums received from a large number of individual customers is greater than the total amounts payable against losses of a smaller proportion that make a claim. In this fundamental form, insurance (as a tool for pooling of risks from a large number of individuals and providing security for misfortunes of a select few) has existed in almost all civilised society – whether as informal social agreements of mutual aid in the ancient world or the legal contracts between an insurance provider and the policyholder as we see today. Modernday insurance, with its reliance on sophisticated statistics and mathematical models of risk calculations, dates back to late 16th century London when the

vagaries of going to sea for trade led to demand for marine insurance. Wealthy traders were attracted by the possibility of large profits and underwrote insurance contracts, charging high premiums that relatively more risk-averse individuals were willing to pay. As customer demands evolved over the centuries, insurance developed from being merely a risk management instrument to also being a savings tool, particularly in the case of long-term insurance where individuals paid regular premiums to be accumulated for future retirement or for building an estate. In this form, insurance has become a critical agent for channelling household savings from individuals towards large-scale capital investments. This vital role can hardly be understated in our resource-constrained economic world. Indeed, in India the total value of funds managed and invested by life insurers alone was in excess of INR19.6 trillion (as of 31 March 2014), nearly a third of the country's total GDP (at factor cost, constant price 2004-2005). It is unsurprising that in the popular imagination, the stateowned behemoth, LIC is popularly quipped to be the ATM of the Government of India!

“Insurance has become a critical agent for channelling household savings from individuals towards large-scale capital investments. This vital role can hardly be understated in our resource-constrained economic world.”

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3.1 Shareholder perspective There are generally two ways in which an insurance company may be set up: either as a mutual or as a shareholder company. In a mutual, individual policyholders provide for their risks collectively and the insurance company is effectively owned by the policyholders themselves. Any profits that arise are distributed back to the policyholders either in the form of bonuses (or dividends) or through reduced future premiums. In India, there are no mutual insurance companies and all insurers are effectively set up as shareholder-owned companies where investors (whether private or the government) own the company stock and partake in any surpluses. Inevitably, the utility to the consumer and value of the sector in the economy aside, a capitalist investor would only become involved in a business so long as they see the opportunity for profit – and this is no different in insurance. As with any other business, the shareholder of an insurance business would look to maximise return on their own investment and seek: l

High return on investment

l

Capital efficiency

l

Increasing profitability with minimal volatility.

This pursuit of return – and, in essence, profit – is predictably regarded very differently depending on the point of view adopted. For policyholders, this ultimately represents a mark-up, perhaps even unwarranted as an insurance policy is ultimately not an economic necessity but simply a comfort. Insurance regulators may adopt varying positions: they would definitely allow an acceptable level of profitability for shareholders and even encourage it where the goal is to develop the sector but they take a dimmer view where they consider profit to be excessive, particularly to the cost of the consumer, and seek to curtail it. On the other hand, distributors and other business partners (on whom the

insurance producer must rely) would likely view this as the larger pie of which they would seek their own rightful slice. But, for the shareholder, the availability and opportunity to maximise this profit must ultimately be the reason to do business in the first place. There are two distinguishing features however, that make recognition and, more importantly, realisation of profit from insurance different to other conventional businesses. First, at the time of writing an insurance contract, the provider does not know for certain the future costs it is likely to incur, particularly with respect to the claims that it has promised to honour. It must rely on estimates of both the severity and timing of such claims, along with further estimates for other operational expenses, policyholder behaviour and desired profit margins, all of which need to be recovered from premiums earned. The impacts of any errors in judgement in such estimates do not show immediately and even where they become evident, it may not be possible to rectify instantly due to the nature of the contracts. Secondly, incomes in the form of premiums are received well in advance of the required outgoings by the insurance provider. This makes it possible for the insurer to invest the proceeds in productive assets that yield a further investment income. At the same time though, given the advance receipt of premiums, the insurer would set aside adequate funds to meet the (uncertain) future liabilities. Invariably, various insurance regulations around the world make this mandatory for insurers. Combining these factors means that realising profit – even from current sales or incomes is necessarily deferred to some point in the future. We have a paradox - when the measure of historical successes depends of the future – things have a tendency to become confusing.

Indian Insurance Sector: In Pursuit of Value 7

3.2

Sources of profit

The characteristics of insurance – the uncertain future costs and the need to rely on estimates together with advance premiums receipts – mean that the two primary sources of profit for an insurance company are: l

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Underwriting profits that emerge when the amounts of actual claims turn out to be lower than that assumed within the premiums charged. This may be partly built into pricing of the insurance contracts by the insurer or emerge as a result of more favourable experiences. Equally, the insurance provider faces the risk that initial estimates of future claims turn out to be too low, resulting in overall premiums being inadequate to pay for the total claims and would likely result in losses for the insurer. Investment profits: The fact that premiums are received in advance gives the insurer the opportunity to invest the premiums. Some of the investment income earned may be passed back to the policyholder – either directly (particularly in the case where savings is an explicit consumer need) or indirectly through lower premiums. Any excess yields earned from the invested premiums that are not passed back to the policyholder accrue to the insurance provider in the form of investment profits.

How these manifest depends crucially on the features of the specific insurance contract as well as on the influence of market forces. An illustration of emergence of such profit margins along with key features of typical insurance contracts predominant in India is provided in Figure 3.1. Competitive compulsions, customer demands and the regulatory environment often play an important role in shaping the overall design of the insurance contract, which in turn determines the manner in which the inherent profits may be realised by the insurer. It is important to understand the key drivers for each source of profit in order to be able to suitably manage the associated risk as well as maximise the available return. This can be demonstrated well by considering each in turn, particularly in light of their relative importance in India. In general insurance, where the contract durations tend to be fairly short term and extend typically up to a

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year, insurers' profit-generating ability hinges heavily on prudent underwriting and tight controls over claims costs as well as operating expenses, including commission/brokerage and management expenses. However, whether the insurer is able to charge the premium it desires depends on market factors. This is best illustrated in the case of motor insurance in India, where a proliferation of providers, high customer awareness and ease of comparisons across products offered by different insurers has resulted in tremendous competitive pressures on pricing. As a result, any available margins are often wafer thin or even non-existent. A further constraint is imposed in the case of motor third-party risks which represents the only remaining line of business still subject to tariff-like controls by IRDA. All other classes of general insurance business were progressively deregulated from FY 2007-08 following de-tariffication. In the presence of such controls, almost the entire general insurance industry is forced to accept risks at under-priced premiums for compulsory motor third-party cover for commercial vehicles, leading to substantial unprofitability from this segment adversely impacting insurers' overall bottomlines. Partially alleviating this is the provisioning requirement that requires insurers to set aside outstanding claims reserves until all claims are fully settled, which in India may take up to 10 years for some motor third-party claims. During this period, insurers may be able to generate investment return on such provisions. Those that have been able to effectively manage their investment portfolios in this way have seen some reasonable returns.

Figure 3.1: Sources of profit in insurance Estimates of likely cost of claims made, together with allowance for operational costs used to determine an appropriate premium to charge

Premiums earned in advance are invested in income generating assets until such time when they are needed

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If price is low => Premiums will not be enough to cover claims and will lead to potential losses If price is high => Surplus left over after paying all claims and other operating expenses (tempered by competitive forces and regulations)

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Profit Margins

l

Underwriting Profits

Investment income shared with customer as dividend/bonus or used to pay some excess claims (may be partly built in to the product design) Any excess income not shared with the policyholder is effectively additional margin

Investment Profits

General Insurance products

Life Insurance products

Motor -

Protection

Includes cover for vehicle, personal accident cover and cover against third party liability A single policy typically lasts for one year, after which it is required to be renewed Underwriting profits a challenge due to price led competition Data availability and analyses critical for pricing and choosing the ‘correct’ risk segments

-

Examples - term assurance, whole of life and other long term insurance providing risk cover Usually attracts low premium rates Underwriting risks (and profits) may be managed through reinsurance arrangements Some investment returns are likely to be built into the premiums due to competitive forces but any excess returns are effectively profit margins

Health

Savings

- Governed by IRDA’s Health Insurance Regulations - Includes cover for medical expenses for in-patient treatments and (limited) out-patient treatments - Mostly one year contracts with renewability options - Profitability driven by underwriting profits; i.e. ability of insurers to correctly price risks and control claims cost - Rising healthcare costs and changing disease patterns are a challenge

-

-

Conventional

Commercial lines -

Examples - Endowment assurance, pension products Address savings needs of customers, whilst providing some risk cover, so customers generally expect a direct reward for the earned investment returns, which may at times be guaranteed Profitability hinges greatly on the investment performance and margins or charges thereof Overall risk may be managed via product designs

Unit-linked -

Fire, Marine Engineering and Liability insurance most common in India Overall commercial lines are no longer significant and contribute less than a third of total general insurance premiums written Typically annual insurance contracts, with mostly underwriting profits that dominate Significant risk to from potential catastrophic claims

-

Non -profit -

Guaranteed pay-out to policyholder based on assumed investment return at the time of pricing, any excess over which accrues as profit margin to the insurer

Direct link between investment returns and policyholder payouts, who also bears investment risk Insurer compensated through application of various charges

With-profit - All sources of profits shared with policyholders through bonuses, with investment returns contributing the major proportion of such profit

Source: Towers Watson analysis Indian Insurance Sector: In Pursuit of Value 9

The interplay of the various sources of profit, together with impacts such as changes in the reserving basis becomes more intricate in the case of life insurance, due to its long-term nature and is heavily determined by the contract design. More importantly, underwriting profits need to be further decomposed into various subcomponents to fully understand the nature and sustainability of profits reported in any given year. The importance of this is illustrated through stylised case studies depicted in Figure 3.2, which demonstrates that apparently paradoxical financial results may be observed from reported accounts of insurers and requires a diligent analyst to see through to the true sources of profits. Thus an analysis of surplus that provides insight into each individual driver of profitability could play a valuable role for both the management as well as the analyst. Included within underwriting profits for long-term insurance products are claims and reinsurance surpluses, expense surplus and surrender surplus – each of which have played an important role in shaping the experience of the industry to date, and discussed in turn below: l

Claims surplus, as in the case of general insurance, represents the extent of the favourable claims experience – typically mortality and morbidity for life insurance – relative to that expected and priced for within premiums. An individual insurer's ability to exploit high margins from this through pricing may be limited due to competitive factors. Moreover, an astute company may be able to leverage beneficial reinsurance arrangements to enhance its own competitiveness, to the extent that the risk premiums charged by the reinsurer are lower than the company's own best estimates of expected claims and providing an additional avenue for margins. In this way, the company charges premiums to the policyholder based on its own (higher) estimates of risk, but pays to the reinsurer (lower) premiums based on the reinsurer's own perceptions. Some insurers in India have been able to exploit this successfully, to the extent that reinsurance arrangements are a source of profit rather than a cost, particularly in the case of pure protection products such as term assurances.

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Surrender profits represent the difference between the cash-value paid to the policyholder in case of early termination of the contract and the accumulated value of the premium proceeds received to date, net of expenses, commissions and risk charges. These depend on the persistency experience as well as the contractual terms offered to policyholders; excessive surrender profits may well be an indicator of unreasonable terms to the policyholders. Indeed, some companies globally adopt the practice of determining surrender terms that are profit neutral for the company, however in India many insurers have witnessed abnormal returns on account of high lapses. The regulator has already taken heed and revised product guidelines for life insurers to specify minimum surrender terms that must be offered.

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Expense surplus (or deficit) is simply the difference between the actual expenses incurred by the life office relative to the expenses assumed and allowed for within the pricing of insurance contracts. Many life insurers in India however have had a woeful experience in managing expenses, with companies still in a position of expense over-runs despite being in operation for a number of years. Some have tried to offset the expense deficit through surrender surpluses although eventually, expense achieving efficiencies ought to be the only viable long-term solution. Indeed companies that have low cost operational structures are able to gain significant competitive advantage over their peers and a few that have conscientiously managed their expenses have seen themselves being rewarded accordingly.

Figure 3.2: Paradox of the Life Insurance P&L Due to the long-term nature of the insurance business as well as specific features of the reporting accounts, judgements based purely on the reported profitability in a given year may at times be paradoxical to the underlying fundamentals of the business. Stylised case studies below illustrate such scenarios, highlighting the need for a robust analysis of surplus to be made available to senior management as well as analysts to fully understand the reported results and drivers of profitability for a life insurance company

Scenario A: Growth in profits, despite lower new business volumes in the year Context: A long-term insurer has been writing high volumes of profitable new business over a number of years. Actuarial provisions are set aside using conservative estimates of future experience, leading to high capital strains in the initial policy years. Over the previous year, new business sales reduced drastically and this has been the worst year so far in the company’s experience in terms of new business volumes, even though renewal premiums from existing business have continued to be earned. Results: The company has reported an increase in profits for the year. In fact, growth in profits has out-stripped that seen in the previous years. Analysis: During the years of high new business growth, the reported profits were muted due to high acquisition expenses and the utilisation of the capital to support setting up prudent provisions for the long-term contracts, that would be expected to be released in the future as profit margins. However, during the current reporting period, this new business strain has been limited due to decline in sales. At the same time, some margins emerge from the business written in prior years. The combined effect of these two results in high profits reported for the year, despite a fundamental weakness in the business during the year. The reported “bottom-line” for the current year would in this case appear to take credit for past successes of the business, but camouflage current challenges!

Scenario B: Stable profits, masked by a change in reserving basis Context: An insurer has been setting aside provisions prudently since the company’s inception. In the past year the company has undertaken a review of its assumptions and methodology to determine actuarial reserves and determined that it is possible to materially reduce the overall amount of provisions held without breaching any regulatory requirements and decides to do so gradually over a period of three years. Results: The company has reported steady profits over the past few years. Profits in the current year are consistent with the previous year and display a marginal positive growth. Analysis: Changes in actuarial provisions have a one-to-one correspondence with the surplus arising in the policyholder’s fund, and if transferred to the shareholder’s fund, would directly impact the reported profits as well. Given a material change in provisions over the year, it would be expected that the release of reserves would increase the reported profitability as a one-off impact. Stable profits in the year indicate that without the one-off change, the overall profitability might have been reduced. However, this would not be apparent without studying the change in reserves appropriately.

Scenario C: High profits, in the face of an economic downturn Context: A long-term insurer has been reporting steady profits. However, the insurer experiences a spike in surrenders during the current financial year due to recessionary conditions in the market. The insurer provides surrender benefits to the policyholders, and honours its commitments as per policy conditions. Results: The company reports a higher profit for the current year as compared to previous years despite poor market conditions. Analysis: A key source of profits for the company in the current year appears to be due to surrenders which outstrip the impact of poor market conditions. At the point of surrender, profits expected to emerge over the life time of the policy are capitalised immediately. As a result, although the accounts will indicate higher reported profits for the current year, this may result in lower profits for future years. In addition, surrenders erode the overall asset base of the insurer and reduce its ability to cover fixed costs efficiently, as a result generally not being favourable for the insurer in the long run. Such business drivers will not be apparent from the reported accounts.

Indian Insurance Sector: In Pursuit of Value 11

3.3 Measuring value in insurance Quantifying the total value of any business entity is important, not just for the shareholders (who would be interested in knowing and understanding the worth of their business) and the management (who can track changes in the value over time to gauge how well management decisions are affecting the business) but also for the larger industry stakeholders, all of whom can evaluate their own role within the industry

(referencing if their actions and interactions with the business enhance or diminish its overall value). Market participants keenly track and observe business valuations. Figure 3.3 illustrates metrics that are commonly used in the valuation of insurance companies.

Figure 3.3: Metrics commonly used in company valuations Based on Primary Accounts

Valuation Metrics

P/E ratio

Earnings Multiples

P/BV or P/NAV

Value Multiples Yields

Dividend/Earning yields RoE or RoAC

Return on Capital

Based on Embedded value P/EV Earnings P/EV RoEV

For general insurance companies, valuations based on primary accounts have been applied successfully and are widely understood. However, in the case of long term life insurance business, such measures based on primary accounts are often insufficient, if not misleading and metrics based on embedded value are recommended. Source: Towers Watson analysis

The nature of long-term life insurance contracts is such that typically insurers need to incur high acquisition costs in the form of initial commissions and expenses, resulting in an initial accounting loss, but are expected to be recouped over time. This, together with the necessity of maintaining prudent reserves for possible future liabilities from premiums received in advance, creates a lop-sided effect of the emergence of profits over the life time of the contract. For new business, while the primary accounts recognise a loss, there is the underlying expectation of future profits emerging from the contract. For existing mature business, while the profits are emerging yearon-year, there is limited future potential as the business runs off (unless it is replenished by more new business). It is very difficult based on primary accounts alone to distinguish between the impact on the valuation from new business and that from existing in-force business as these are often mixed into one overall result. Moreover, valuation metrics based on primary accounts fail to recognise up-front future profits that will emerge over time as prudent reserves are released. Primary accounts also do not differentiate between capital held for regulatory purposes (and is therefore locked in) and capital that is free for distribution to shareholders.

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To overcome such limitations of valuations based on primary accounts, it is recommended that, for long- term insurance companies, principles of “Embedded value” (EV) are used to produce a robust valuation. In its simplest form, EV is the value accrued to the shareholders, calculated as the sum total of net worth and the present value of future profits expected to emerge from the in-force business. EV-based financial metrics are widely recognised and used by insurers and analysts worldwide. Considering EV along with the value of future new business potential provides the overall appraisal value (AV) of the life insurance company. Figure 3.4 provides an illustration of the various components of AV, typically used to value a longterm insurance business.

“To overcome such limitations of valuations based on primary accounts, it is recommended that, for long- term insurance companies, principles of “Embedded value” (EV) are used to produce a robust valuation.”

Less: Adjustments

Structural Value (based on a projection of expected future new business volumes)

Free Surplus Required Capital

Less: Cost of Capital (CoC)

Present Value of Future Profits (PVFP)

Appraisal Value

Expense overruns: Commonly observed where actual expenses are higher than those reflected in projections of future profits, either in respect of new business acquisition expenses or maintenance expenses or both

Adjustments are typically needed for life insurers in India in respect of: l

Deferred taxes: Carry forward of tax losses is permitted for up to 8 years, a recognition of which would typically off-set any tax projections within calculation models.

Profit

Profit

Profit

Time New Business

Time

In-force

Exhibit C: Regular profits emerge from in-force portfolio as business runs off

New Business

Exhibit B: Profit profile from a new business contract for a typical life insurance policy

In-force

Exhibit A: Relative contribution of future new business in profiles increases over time

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Structural value is driven by the company’s perceived ability to generate future new business from its existing infrastructure and brand. This is equivalent to goodwill valuation of which is invariably subjective. In India, insurers have invested significant capital in setting up distribution channels and capability. Consequently, in many valuations contribution of new business forms a significant proportion of the overall projected profits relative to inforce business due to expected new business growth that would leverage existing capabilities (Exhibit A). Initial expenses and capital requirements result in a strain at the time of writing new business, though this is expected to be recouped over life-time of the contract given long term nature of the business (Exhibit B).

Free surplus represents the assets available for distribution to shareholders and is equal to the amount not required to support the in-force business or the required capital. Required capital represents additional capital held over and above the statutory reserves to demonstrate solvency, subject to either the required regulatory minimum or capital held for internal purposes, the distribution of which to shareholders at the valuation date is restricted. An opportunity cost exists if the post-tax return on assets backing “required capital” is lower than the shareholders’ expected return in addition to the investment related expenses of such assets. Expected future profits from the existing in-force portfolio are projected to calculate the PVFP using best estimate assumptions. Profits emerge as the in-force business runs off (Exhibit C) due to release of reserves and capitalisation of underwriting and investment margins. An appropriate discount rate is central to the calculation of the PVFP and approaches vary as to the choice of the discount rate.

Time

Indian Insurance Sector: In Pursuit of Value 13

Figure 3.4: Components of appraisal value

Value of future new business

Adjusted Net Worth (ANW)

Value of in-force business (VIF)

Source: Towers Watson analysis

Embedded Value

In computing the components of appraisal value, several assumptions are made regarding the expected future experience, including economic and operational experience of the insurer. Where the actual experience turns out to be exactly as assumed, the EV in future years will be as per the model projections. In practice however, there will invariably be a degree of variance in experience from expected that makes the projected future profits uncertain. Opinion varies as to the most appropriate “best estimate” assumption depending on individual perception of risk and uncertainty. Consequently, any analysis of EV must be

accompanied by appropriate sensitivities of key parameters and variables affecting future profitability. This will aid users of the EV to make informed judgements on the overall value based on their own perceptions. This is typically achieved by making adequate disclosures of the assumed best estimate rates in the computation of EV, along with the necessary sensitivities. Additionally, further care needs to be taken in interpreting EV computed by different companies as choice of methodology often varies, which is illustrated in Figure 3.5.

Figure 3.5: Methodologies in EV determination EV methodologies and disclosures have evolved over time, with the result that in the absence of an agreed industry standard, different valuation experts approach company valuations differently. Although various attempts have been made to make EV calculations consistent and comparable, companies currently continue to use varying approaches for internal purposes. Some insurers in India have publicly disclosed EV figures to investors and analysts at different points in time. Summarised below are the guiding methodologies adopted by life insurers in India that have published their valuations on or prior to 31 March 2014: ~ TEV

~ EEV

~ MCEV

ü

Bajaj Allianz Life Birla Sun Life

ü ü

HDFC Standard Life ü

ICICI Prudential Life Kotak Life

ü ü

Max Life Reliance Life

~ IEV

ü

Source: Company investor presentations and disclosures

EV Measures: l

Traditional embedded value (TEV): Dominant use among insurers in Asia, EV is calculated using projected cash flows discounted at a constant risk discount rate. No formal principles apply though industry best practices are commonly recognised.

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European Embedded Value (EEV): Driven by principles set out by the CFO Forum in 2004 these principles attempted to formalise, improve consistency and transparency of EV reporting. The main enhancements over TEV were introduction of formal definitions; explicit requirement for allowance of risk and valuation of policyholder options and guarantees; as well as making disclosures consistent across companies.

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Market Consistent Embedded Value (MCEV): Principles published by the CFO Forum as an enhancement to EEV in 2008 and further amended in 2009, MCEV uses a market-consistent, risk-neutral framework for setting economic assumptions with ‘risk-free’ discount rates used for liability valuations. Due to the volatile nature of the valuation (as driven by market conditions), some insurers have been cautious in adoption of MCEV methodologies. Also limited applicability in markets where deep and liquid asset markets do not exist.

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Indian Embedded Value (IEV): Practice standard set out by the Institute of Actuaries of India, to be adopted for valuation of companies looking to come out with an Initial Public Offering (IPO). Largely adopts MCEV principles and sets out additional requirements specific to the Indian context.

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How analysts use EV disclosures

“Balance between P/EV and RoEV reflects whether the insurer's stock is priced cheaply or dearly.”

Investment analysts worldwide, who specialise in insurance, closely monitor the EV disclosures of life insurance companies. Certain ratios and metrics that directly indicate the value potential or performance of the company are of particular interest. These include: l

New Business Margin (NBM), which is measured as the ratio of the value of previous one years' new business (VNB) to Annual Premium Equivalent (APE) over the same period and essentially reflects the profit margins within the new business sales over the year. APE is equal to 100% of new business premium for regular premium paying policies and 10% of single premium for single premium policies, and is used instead of total premium to allow for longer payment periods for regular premium contracts. NBM is typically extrapolated with the analyst's view of future sales volumes to determine expected valuations of companies. This extrapolation is commonly expressed in terms of either a new business multiple, applied to the VNB or an EV multiple.

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Price to EV ratio (P/EV) is commonly used to indicate whether the market value of the company, as observed from traded stock prices, is over or under-stated. In its most conventional sense, the EV reflects fair value of an insurer's in-force business, so any deviations from a unit value of P/EV reflects market perceptions of the company's valuation relative to the fair value.

l

Return on Embedded Value (RoEV) is measured as the change in EV over the reporting period divided by the EV at the start of the period and is used as an earnings measure to determine the percentage return to the shareholders.

A balance between P/EV and RoEV reflects whether the insurer's stock is priced cheaply or dearly. This is presented in Figure 3.6 using illustrative values for life insurance companies.

Figure 3.6: Relative dearness of life insurance company valuations A balance between P/EV and RoEV indicates a fair price relative to the return for a life insurance company. For instance, if a company yields high returns relative to peer’s year on year, the P/EV would be expected to be higher as well, but an unreasonable excess might indicate over-priced valuations. Stylised illustration for possible valuations of life insurance companies in India are depicted below: 2.5

Overpriced 2

P/EV

1.5 1

0.5

Underpriced 0 0%

2%

4%

6%

8%

10%

12%

14%

16%

RoEV Source: Towers Watson analysis

Indian Insurance Sector: In Pursuit of Value 15

The India experience Any account of how the insurance sector in India has added value is innately linked to its historical development (see Figure 4.1). This essentially “began” in 2000 when the sector was opened again for private participation and the narratives largely deal with the triumphs and tribulations of private insurers. The experiences of state-owned enterprises – even though these contribute the lion's share of the total premiums generated – are generally regarded as being separate to the rest. Since privatisation, even though the private players have chipped away at the market share of the stateowned enterprises, these have largely held their own in the face of competition and continue to dominate in both the life and general insurance segment. Over the years, both life and general insurance segments have also witnessed fundamental structural changes in the nature of insurance products and the market dynamics. Among life insurers, the early years following privatisation saw rapid development of the unit-linked market, which subsequently declined following the 2008-09 financial crisis and other changes in the regulatory environment. The share of unit-linked products within life insurance product mix increased from 8% in FY2003-04 to 80% in FY200708 and has since declined back to be nearly 10-12% currently. Similarly, the general insurance sector has also seen a structural shift with the emergence of health insurance as a major line of business and corresponding decrease in contribution from fire insurance. Alongside such structural changes in the industry, the outcomes for individual stakeholders and players have gone through the ebb and flow, influenced heavily by as well as themselves influencing the evolving regulatory environment in which insurers in India operate. 16 towerswatson.com

Figure 4.1: A brief history of insurance in India 1818: The first insurance company in India, Oriental Life Insurance Company established in Calcutta. 1850: Triton Insurance Company begins trading in Calcutta, being the first general insurer in India. 1870: British Insurance Act introduced, followed by inception of the first Indian life insurance company, the Bombay Mutual. 1907: First company to transact all classes of general insurance business, the Indian Mercantile Insurance Limited is established. 1912: The first statutory measure to regulate life insurance business is enacted in the form of The Indian Life Assurance Companies Act. 1928: Indian Insurance Companies Act enacted enabling the Government to collect statistical information about both life and non-life businesses. 1938: Insurance Act consolidated earlier legislations and set out comprehensive provisions for control over insurers. This remains the over-arching insurance regulation to date. 1956: Nationalisation of the life insurance sector with the establishment of Life Insurance Corporation (LIC) that absorbed a total of 245 Indian and foreign insurers, including provident societies. 1957: Formation of the General Insurance Council, that subsequently framed a code of conduct for ensuring fair conduct and sound practices among general insurers in India. 1968: Tariff Advisory Committee formed. 1972: General Insurance Business (Nationalisation) Act led to the consolidation of 107 insurers into four companies: National Insurance, New India Assurance, Oriental Insurance and Union India Insurance. The General Insurance Corporation (GIC) incorporated with its capital subscribed by the Government of India and that of the four companies, by GIC. 1993: Formation of the Malhotra Committee that provided recommendations on reforms in the insurance sector, paving way for re-opening of the sector to private participation. 1999: Insurance and Regulatory Development Authority (IRDA) constituted as an autonomous body to regulate and develop the insurance industry, subsequently incorporated as a statutory body. 2000: Invitation for application for registration of private insurance companies issued, with up to 26% foreign ownership in a company. New registrations awarded to 10 life insurance and six general insurance companies. 2006: Star Health and Allied Insurance set up as the first stand-alone health insurer in India.

4.1 Early expectations Aside from the political ideology of the era that clearly preferred public sector over private enterprise to drive nation-building, another reason for nationalisation of the insurance industry included rampant malpractices and unethical conduct by the then insurers that jeopardised the interests of consumers. The success and performance of the nationalised insurers can hardly be understated – particularly in ensuring secure financial institutions providing an essential service as well as in terms of overall growth and outreach. In the years since its inception, the LIC has transformed into a financial behemoth with a vast network of agents and branches across the length and breadth of the country and serves as an important vehicle for mobilising household savings and channelling these to the capital markets. Similarly, the nationalised general insurance companies have succeeded in providing coverage to different cross sections of society with a diverse product range covering both commercial and personal lines, established a wide network of operating offices and have been able to conduct their business profitably, without straining public finances. At the same time, these state-owned insurers have provided employment to a large workforce. However, despite their successes, the monopolistic (or oligopolistic, in the case of general insurance) nature of the sector hindered innovation and the industry was slow to embrace advancements taking place worldwide. The first Chairman of the IRDA stated in his inaugural annual report that there “grew a feeling of insensitivity to the needs of the market, tardiness in adoption of modern practices to upgrade technical skills coupled with a sense of lethargy which probably led to a feeling amongst the public that the insurance industry was not fully responsive to customer needs”. The clear motivation to open up the sector again for private participation was to ensure that the insurance industry in India also modernises along global lines, as well as to introduce healthy competition in the market.

The nationalised companies had matured enough to be confident of being able to withstand competition from foreign conglomerates. At the same time, proponents of privatisation widely supported the view that, ultimately, competition would be good for the customer; market forces ensure that companies innovate and design products that address latent customer needs. The relative successes of the nationalised insurers, coupled with a hugely underpenetrated market fuelled optimism and the allure for increasing insurance penetration (due to larger number of players and benefits of private enterprise) was clearly too hard to miss. The regulator and policymakers reasonably expected that a greater number of insurance providers should result in wider coverage, particularly in rural areas as well as a wider variety of products and choice for the consumer. There was also an important commercial interest to open up the insurance industry in India. The Malhotra Committee Report on reforms in the insurance sector noted a broad economic policy and thrust towards liberalisation. Specifically, it noted that private enterprise has been operating successfully in the banking sector alongside public sector banks. Consequently private players should also be allowed to participate in insurance, enabling them to reap profitable avenues of growth within the sector. Indeed this opportunity was not lost on the investors either – as of 2014, nearly all major domestic business houses, particularly from the broader financial services sector in India, have an insurance venture and embraced the opportunity to launch their own insurance companies, even where there was no prior experience within the group. The early exuberance in setting up joint ventures with foreign insurers was driven largely by commercial interests of the promoters; the prospects were generally regarded so favourably that foreign entrants were willing to pay high premiums to domestic interest groups to partner with them. This has led to significant capital investment by promoters of private insurance companies in India (Figure 4.2).

“There was also an important commercial interest to open up the insurance industry in India. Private players should also be allowed to participate in insurance, enabling them to reap profitable avenues of growth within the sector.”

Indian Insurance Sector: In Pursuit of Value 17

Figure 4.2: Paid up capital in private insurance companies in India 400

Total paid up capital (in INR billion)

Non-life

Life

Health

“These have included instances of high acquisition costs paid by some insurers for incentivising top-line growth, that have sometimes led to unintentional outcomes for longterm stability and consumer interests.”

300

200

100

FY 2001 FY 2002 FY 2003 FY 2004 FY 2005 FY 2006 FY 2007 FY 2008 FY 2009 FY 2010 FY 2011 FY 2012 FY 2013 FY 2014

Financial year ending 31 March Source: IRDA, Towers Watson analysis

4.2 The actual versus expected The outcomes for the industry stakeholders have varied widely since liberalisation. While in the early 2000s, the pace of growth in insurance matched well with the momentum generated by the initial euphoria, this was not without its excesses. General insurers thrived in the initial tariff-controlled environment that ensured sufficient margins within the premiums to drive profitability as well as aggressive growth strategies. At the same time, life insurers saw multifold increases in premium collection, buoyed by the sales of unit-linked products that saw healthy returns as the stock markets also performed well. However, wrapped within the high-speed thrust of the industry were maladies that have come to plague insurers. These have included instances of high acquisition costs paid by some insurers for incentivising top-line growth, that have sometimes led to unintentional outcomes for long-term stability and consumer interests. The experiences of consumers and distributors – being two key stakeholders in the

18 towerswatson.com

industry – are highlighted in Figure 4.3. The regulator has since clamped down on such excesses of the insurers to rein in the industry back towards a more sober developmental path. As a result, the overall narrative is peppered with readjustments following intermittent regulatory interventions. A continuous stream of new entrants through the first decade of this century, combined with a strategic growth agenda of existing players has ensured that the insurance marketplace today has become extremely competitive and price sensitive. This has been further embellished due to ready availability of information through a technological transformation and emergence of online channels of distribution.

Figure 4.3: The customer is king Privatisation has provided customers with more options in terms of insurance providers, products, delivery channels and most importantly, price as the fierce priceled competition for customer acquisition has led to insurers providing very competitive premium rates, often to the extent that these may be unviable for themselves. This is most starkly seen in the case of general insurance business post de-tariffication, where the premium rates and benefits are directly comparable across companies (which may not always be true in the case of long-term life insurance where product designs may be such that direct comparisons are difficult). Customers have also benefited from significant advances in service levels with improved claims processes (such as access to cashless post-accident repair and cashless treatment at hospitals). In tangible terms, the biggest gainers have probably been large corporate sector clients who have been able to bargain down the premium prices heavily on group schemes for employees as well as their own commercial line insurance. Not all customers have benefited though from the emergence of new products and new channels and greater availability of insurance, particularly retail customers and individuals that rely on advisors for choosing the right product. There has been an increasing number of cases where customers have been misled and purchased a product that was either inappropriate or on the basis of a different understanding than the actual product features. The regulator and the industry have undertaken measures to curb such negative customer experience by increasing efforts on customer awareness. Increased customer awareness, together with pro-active actions from the regulator has resulted in a rise in the reported number of customer grievances (Exhibit A). It is noteworthy that for grievances related to life insurance, the largest proportion of such grievances relate to complaints related to unfair business practices. Exhibit A: Number of public grievances reported to the IRDA has increased significantly in recent years. Insurers need to undertake concerted efforts to ensure these do not result in long-term damage to the goodwill in respect of the insurance sector.

FY 2008-09 FY 2009-10 FY 2010-11 FY 2011-12 -

40,000 Life

80,000 Non-life

1,20,000 1,60,000

Distributor, the courtier The distribution landscape has seen sweeping changes over the past decade and a half. Prior to liberalisation, LIC primarily sold life insurance products through a vast network of tied agents whereas other public sector general insurers mainly utilised their direct sales force supplemented by contributions from agents as well. With new insurers coming in, distribution strategies have been truly revolutionised. Although many companies have undertaken conscientious efforts in developing traditional channels, corporate agents and brokers have also emerged as an important force. The public sector companies have also modernised their own distribution networks in the face of competition. The two biggest game-changing shifts in distribution have been the rise of bancassurance and more recently, emergence of direct online channels. Exclusive distribution tie-ups between insurers and banks have provided insurance providers with a captive customer base that can be targeted with specific products as well as distribution infrastructure that is much cheaper than maintaining their own branch network. Consequently, the bargaining position of banks as distribution agents has strengthened considerably, with tie-ups involving hefty up-front payments made to the banks not being unheard of. A quieter and more recent development has been seen with the rise of online insurance sales – many insurers have launched products that are exclusively sold online, while also making available variants of their offline products on their websites at lower costs for the customer. The online channel has the immediate lure of being cost effective and provides a direct link interface between the customer and the insurer, although its full potential is yet to be realised. Insurance intermediaries on the whole have played their role as advisors to the hilt, courting and pursuing the customers for making sales and being lavishly rewarded when successful. However, as with any courtier, their advice has been driven by vested personal interests at times. Insurers have been generous in providing lucrative incentives – including commission over-rides and other non-financial benefits which, in some cases resulted in perverse outcomes; distributors influenced customers to act in a way that may not have been completely in their own best interest. The regulator appears to have taken note and has implemented a large number of changes to check such malpractices. At the same time, further advances in distribution appear to be in the offing – with active deliberations currently going on regarding the role of banks and introduction of a new channel in the form of insurance marketing firms.

Source: IRDA, Towers Watson analysis

Indian Insurance Sector: In Pursuit of Value 19

For individual insurers, the experience relative to their initial expectation has varied significantly. While some have been able to weather the multiple challenges successfully and have developed robust long- term strategies, many other smaller players continue to struggle in the face of stiff competition and increasing internal pressures for outperformance. The latter has often resulted in short-term decisions that may not necessarily bode well for sustained growth and profitability. We study these experiences of individual life insurers by tracing the outcomes across a range of metrics and comparing these to the initial expectations that promoters of these companies had at their launch. We assimilated these expectations through public statements, press releases and investor communications that the promoters made around the time of starting their insurance ventures and have then tracked the actual outcomes over the years for the same metrics (Figure 4.4). In their pursuit for growth and profitability, many life insurers have seen positive results by selling unitlinked products. The regulator on its part has stepped in to ensure market discipline where it found this to be lacking and introduced product guidelines for both linked and traditional products. These have hit the profit margins of the insurers in the last couple of years. The impact of this has been worsened due to a general downturn in the economy even though now there are signs that the worst of the dip is behind us. While these regulatory changes have impacted life insurers more recently, for non-life insurers, the experience throughout the 14 years since privatisation has largely been underpinned by the regulatory environment – in particular, these critical milestones have had an indelible impact: l

First, the de-tariffication of fire, engineering, workers' compensation and motor own damage classes of insurance and setting up of India Motor Third Party Pool (IMTPIP) from 2007 onwards; and

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l

Subsequent increase in motor third-party pool loss ratio and eventual disbandment of IMTPIP and its replacement with India Motor Third Party Declined Risk Pool (IMTPDRIP)

The fortunes of the non-life insurers can clearly be distinguished before and after these game-changing regulations. Prior to 2007, under tariffed general insurance rates, the profit margins were clearly adequate with little room for insurers to innovate in terms of customer price proposition. As a result, insurers focused on distribution incentives, providing heavy over-ride commissions and driving growth through competitive distributor incentives. This scenario was reversed sharply with de-tariffication when the benefits of price decrease were directly passed on to the customer. However, this has also resulted in important challenges for the companies – particularly related to appropriate risk pricing as historical loss experience remains limited and many insurers have priced aggressively based on short-term gains. In a volatile industry, this might mean heavy losses should claims ratios turn adverse in subsequent years. More recently, the regulator has also supported the promotion of health insurance business and in 2013 issued Health Insurance Regulations providing detailed guidelines for its conduct by both life and nonlife insurers. The insurers themselves have increased their focus on health insurance which is fast emerging as a new growth engine for the industry.

“The regulator on its part has stepped in to ensure market discipline where it found this to be lacking and introduced product guidelines for both linked and traditional products. These have hit the profit margins of the insurers in the last couple of years.”

Figure 4.4: Actual versus expected experiences of life insurers in India

For life insurers, individual companies’ experiences in relation to initial expectation at the time of inception have varied considerably. From an analysis of the actual versus expected outcomes for a selection of insurers across a number of metrics, two things become clear: First, that those insurers that had unrealistic and overly positive expectations have invariably fallen short of their targets. The importance of maintaining re asonable expectations is further borne out by the fact that those that made more humble public statements about their plans and targets have been able to demonstrate successful achievement against plans. Secondly, those with a clear strategy and resolve to follow through on their intent have fared better than the “follow the market” pack that have relied on industry outcomes to frame their own fortunes as well. These are illustrated in the case-studies below:

FY 2006-07: INR (6,489)m

FY 2008-09: FY 2009-10: INR (7,797)m INR 2,580m

Achieved break-even after 4 years of target, more than twice the expected time

Company A: “We are looking at various models, so (break-even point) can change. But it would be around 4-5 years.” (December 2000) Reported profits/(losses) : FY 2004-05: INR (2,116)m

Company B: "Targeting a premium income of USD 1.6b (INR 73b)* by 2010-11; hope to achieve a market share of 5-10% over the next 10 years”.

FY 2008-09: INR 45.7b (2.1%)

FY 2010-11: Agents: 144,573

FY 2010-11: INR 56.7b (1.9%)

FY 2012-13: Agents: 106,823

FY 2012-13: INR: 52.1b (1.8%)

(December 2000)

FY 2008-09: Agents: 164,363

Company B: "In five years, we will have 5000 -6000 agents who will be trained to become advisors“. Reported Total Premium (Market Share in brackets) : FY 2004-05: FY 2006-07: INR 9.1b (1.1%) INR 17.6b (1.1%) Number of agents FY 2006-07: FY 2002-03: FY 2004-05: Agents: 56,490 Agents: 6,179 Agents: 5,288

(1.7%)

FY 2012-13: INR 2,141cr

Achieved agent target well before expected – within the first two years operations, and the company has since seen rapid increase in total agency force. However, the expected premium target and market share is yet to be achieved. By the end of 10 years of operations, actual pr emium income was only three- quarters of what was initially expected, despite impressive growth in number of agents, indicating a sizeable, but an under-productive sales force.

Company C: “Expect India to contribute five percent of the group’s total business in the next few years”. (August 2004)

(0.8%)

Reported Total Premium from the India business (contribution to group’s total premiums in brackets) FY 2008-09: FY 2010-11: FY 2004-05: FY 2006-07: INR 1,993cr INR 2,345cr INR 253cr INR 1,147cr (1.1%) (1.4%) (0.2%)

FY 2007-08: INR 55.8m

FY 2009-10: INR (180.7m)

FY 2011-12: INR 561.8m

FY 2013-14: INR 860.6m

A large multinational insurer, entered the Indian market amongst the second generation new entrants, but the performance of the Indian venture remains well short of expectations, with high costs and poor persistency, such that the group has recently announced intentions of exiting from India.

FY 2005-06: INR 21.8m

Company D: “The company is expecting cash break-even within three years.” (December 2005) Reported profits/(losses) :

FY03-04

FY04-05

FY05-06

FY06-07

FY07-08

FY08-09

FY09-10

FY10-11

FY11-12

FY12-13

FY13-14

A niche player with limited geographical reach, but has been reporting profits from the very first year of operations, demonstrating the benefits of a clear strategy focused at delivering profitability growth despite relatively small scale. FY02-03

Source: Press reports, company public disclosures and Towers Watson analysis

Indian Insurance Sector: In Pursuit of Value 21

4.3 Unlocking extant value: Stake sales Shareholder imperatives and market dynamics have led to the imperative flux of a competitive market, evident by pockets of interest from potential new entrants seeking a foot-in-the-door to exploit the opportunities in the Indian insurance market. This has been observed simultaneously with many existing investors wanting to offload their interests in the insurance ventures. For many first generation investors, particularly domestic partners that have core businesses outside of insurance, the length of their locked-in interests have indeed outlived their initial expectations. This is especially given that the increase in FDI limits, expected from the early 2000s has only just materialised while stock exchange listings, expected after 10 years in operations, are still to materialise. Given such a scenario, we have already seen a fair number of stockholding changes in insurance companies over a short period of time and

based on press reports, an even larger number of shareholders – both domestic and foreign – are keen to sell. While individual motivations and reasons for sale vary, ultimately a stake sale is seen as a classic opportunity to cash-in the value created by the investment. Acquisitions also offer inorganic growth opportunities for buyers – either new entrants looking for a head start in the market or existing players looking to consolidate their positions. Consequently, in attempting to unlock value through stake sale and transfer, it is vital for both the buyer and the seller to understand the key drivers of value to determine the fair price for the transaction. For existing shareholders, this understanding becomes even more important as it points to the key considerations that would enhance the value of their own investments. Figure 4.5 illustrates these most important value drivers, emerging from feedback from the industry captains:

Figure 4.5: Key drivers of enhanced insurance company valuations in India Strength of distribution network Insurers that have demonstrated strong distribution capabilities command premium valuations in a growing market such as India. This is also the primary reason why many banks are bargaining – as tied banks are perceived as valuable low cost and robust distribution channels with captive customer bases. Others with vast agency force or strength in alternative distribution such as online have also been able to distinguish themselves with large valuation multiples attributed.

Brand value Companies’ ability to sustain growth relies heavily on customer perception of being the best-inclass provider in a market where competition is increasingly fierce and the importance of brand value can scarcely be underestimated when the larger component of valuation comes from structural value. This can be further seen in the observed trend where a number of insurers have rebranded joint venture names to give more prominence to the domestic partner.

Quality of talent Due to the unique and technical nature of the insurance business, the ability to attract and retain quality talent can be a unique proposition for companies. In recent times, many companies have struggled in this critical aspect, with a number of changes at the top C-suite levels while other that have had stable long-term executives have invariably performed better, resulting in talent retention being recognised as a key value driver.

Operational efficiency With mounting cost pressures and fierce price competition, having a sleek organisational structure can provide an important competitive edge, which is highly valued by new investors as it enhances long-term value proposition for the company. Additionally, efficient and low-cost operating models lend themselves readily for exploiting further synergies in the case of mergers and consolidations.

Stability in profits As illustrated earlier in this report, insurance company profits can be volatile due to changes in liability reserves as well as often misleading due to new business strains and other one-off items such as surrender profits. Consequently, demonstrating stable profits year-on-year indicates robust business models and is viewed very favourably by investors. Source: Responses to Towers Watson-CII survey of insurance company CEOs

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1

2 3 4

5

Where looking to offer a stake in the market, it is critical for existing shareholders to set realistic and reasonable expectations. In particular, fair valuations need to consider each of the above drivers in addition to EV, as well as the individual shareholder's contribution. Invariably, venture partners that provide a strong distribution network on the back of their other existing businesses command higher bargaining positions in such transactions and valuation premiums. At the same time, individual circumstances and priorities of individual parties at either end of the transaction determine the eventual bargaining outcomes. This is well illustrated in the outcomes

observed from the actual transactions in the Indian insurance sector: while some of these have concluded at high valuations and EV multiples, many have frittered away due to unrealistic expectations from insurance ventures that did little to develop the required critical mass. In Figure 4.6 below, we provide case studies of two contrasting insurance deals in recent years where the effective return on investment (RoI) for the shareholders varied significantly but where the companies weren't so different when incepted. This also illustrates the importance of building core strengths (key drivers in Figure 4.5) and eventual outcomes being shaped by individual circumstances of the parties involved.

“Where looking to offer a stake in the market, it is critical for existing shareholders to set realistic and reasonable expectations.” Figure 4.6: The RoI story: a tale of two companies A and B, both began operations within a year of each other. Both were joint ventures between a large international insurance provider and a private domestic group with multiple business interests but limited or no prior experience in the insurance sector or any other financial services. Both founded their companies initially based on a largely agency driven distribution network. And both, after almost 10 years in operations saw their foreign joint venture partners exiting the insurance business to focus on their respective home country businesses. Despite these similarities at the inception, the outcomes at the time of stake sales were very different for the implied shareholder return from the valuations. A new investor acquired stake in Company A with a reported valuation of the company close to INR100 billion, implying an RoI on capital invested in excess of 25%. (Exhibit A): Exhibit A: Equity capital injections and valuation of Company A

INR mn

INR ~20bn Total equity capital

Time

INR ~100bn Implied valuation

Soon after, Company B also witnessed a share transfer. The implied total value of the transaction was even lower than the total equity capital injection, implying a negative RoI for venture partner that exited (Exhibit B): Exhibit B: Equity capital injections and valuation of Company B

INR ~15bn INR mn

Total equity capital

INR ~10bn Implied valuation

Time

The critical difference in the valuations of the two companies was naturally the individual circumstances and relative bargaining positions of the stakeholders, but equally the high valuation of Company A reflected efforts it had put in prior years in nurturing a productive agency force and fostering long term third party distribution partnerships. Source: Press reports, company public disclosures and Towers Watson analysis

Indian Insurance Sector: In Pursuit of Value 23

4.4 The inevitable listing The IRDA guidelines allow insurance companies to list their shares on the stock exchange and take out an IPO after being in business for 10 years, subject to meeting several other criteria including its history of maintenance of solvency margin, regulatory compliance, compliance with corporate governance guidelines, record of policyholder protection, its embedded value being twice as much as the paid-up capital, and so on. The initial intention in mandating 10 years was to ensure companies mature sufficiently in their conduct of insurance business in India and then to allow the public to also participate in the returns accorded by investment in an insurance business. At the same time, a publicly-listed company would lend itself naturally to closer scrutiny from the larger public including investors, analysts and media as well as be subject to higher standards of compliance including that from the sector regulator, the stock exchange and the capital markets, resulting in an overall better and more transparent management of the insurance business. However, despite many companies being in business for well over the mandated period, no insurance

company in India has come out with an IPO to date. This has largely been due to the industry itself going through various phases of readjustment as a result of which a truly stable state has not yet been achieved that would foster successful outcomes from an IPO. Nevertheless, the expectation currently remains that a listing in the near-term future is inevitable. Given the complex and unique nature of their business, it is essential for insurers to be well prepared when considering to list, as what is involved in an IPO itself is large and complex. A key aspect of preparing for an IPO is building a compelling equity story. For the insurance industry, this would require engagement with the capital markets and analysts from an early stage, and to begin setting standards for what will be considered best-in-class for peer group comparisons. Given the current state of preparedness, successful IPOs of insurance companies in India can be considered at least a couple of years away. It is imperative that insurers take the appropriate steps in this time to ensure that when the market sentiments and appetite for investment are right, they are able to launch successful IPOs in a time bound manner. We believe the time for making a beginning on these is now.

“Given the complex and unique nature of their business, it is essential for insurers to be well prepared when considering to list, as what is involved in an IPO itself is large and complex. A key aspect of preparing for an IPO is building a compelling equity story.”

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The three most important steps insurers must consider taking immediately in preparation for the eventual IPOs:

1

Enhance supplementary reporting, particularly with respect to the company's EV disclosures that would set expectations not just of the markets but also internal stakeholders including the management and the shareholders.

Invest in developing a robust risk management framework: strong governance and a well-developed enterprise risk management framework (ERM) will likely be the single most important differentiator for an individual company when all its peers are also looking to access the capital markets. ERM credentials have been known to not only enhance valuations of insurers worldwide but also build confidence with investors and customers alike.

3

2

Conduct roadshows and education for equity analysts and institutional investors. Insurance remains a virgin industry even for seasoned analysts in India and it is important for companies to ensure that their businesses and key drivers are well understood to avoid risk of misinformed conclusions and adverse opinion of the insurers' equity prospects.

Indian Insurance Sector: In Pursuit of Value 25

The opportunity still exists: realising the value The Indian insurance sector has had a roller coaster journey since 2000. The sector enjoyed phenomenal growth in the first part of this journey on the back of the “India Shinning” story, perhaps even resulting in over-optimism about its future prospects. However, things began going wrong in the latter part of this journey as the phenomenal growth and sky-high expectations nose-dived with the sector actually experiencing negative growth for some of the years. While the downturn was not entirely the insurance sector's fault, linked to the global slowdown, it did highlight some key challenges faced and pitfalls experienced that need to be avoided, which were earlier being glossed over because of the growth. However, with course correction and investors can still derive significant value and the desired returns on their investments from the sector if the insurance businesses are able to get their strategy right and implement it effectively and efficiently. Towers Watson and CII conducted a joint survey on a cross-section of the top management in Indian life and non-life insurance companies and this optimistic view was reflected in the survey results.

5.1 Business optimisation Inefficiency prevalent within the insurance sector is one of the key challenges that needs to be overcome for all stakeholders, including policyholders, investors and distributors, to realise the true potential of the business. Business inefficiencies, like low policy persistency in life insurance, hurts the interests of multiple stakeholders (policyholders, investors and regulators to name just a few), and are a serious threat to the long- term future of the insurance business. Business optimisation is a complex issue given that insurance companies are still in growth phase to attain the critical mass required to reap full benefit from economies of scale. However, it needs to be achieved in an efficient manner to ensure profitability and sustainability of growth. In fact, the inability to balance growth with profits was cited as one of the key challenges faced by non-life companies as per the Towers Watson-CII survey. The future winners in the industry are expected to be those who are able to best crack this code. This claim is backed by operational efficiency being considered as one of the top differentiators by life insurers for generating good valuations for the IPOs.

“The inability to balance growth with profits is cited as one of the key challenges faced.”

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Life

Figure 5.1: Key challenges for the insurance sector

Retention and productivity of agency force

Non-Life

1 Price- led competition

Coping with frequent changes in product portfolio

2 Motor TP liability regulatory environment

Maintaining renewal business and persistency

3 Balance of power in favour of distributors

Managing third party distribution tie ups

4

Recessionary macro environment

Recessionary macro environment

5

Inability to balance growth with profits

Source: Responses to Towers Watson-CII survey of insurance company CEOs

As per the Towers Watson-CII survey, distribution appears to be the area which has provided maximum challenges for the insurance sector (Figure 5.1) in the recent past, as well as continues to be seen as the major driver of value by insurance company shareholders in future. A majority of the bigger challenges faced by life insurers have either been related directly (for example, retention and productivity of agency force and managing third-party distribution tie-ups) or indirectly (for example, managing policy persistency) to distribution channels. Similarly, the balance of power being significantly in favour of the distributors was one of the major challenges faced by the non-life insurance companies as well. Strengthening of agency force, developing third party tie-ups as well as developing alternate distribution channels like online sales came out as the top focus areas in terms of potential value drivers for both life and non-life insurance business from the survey. The importance of distribution channels and strategy is further emphasised by life insurers considering the strength of the distribution network as one of the top differentiator when it comes to valuation for IPOs. The issue of low policy persistency has long plagued the life insurance sector in India and contributed directly or indirectly to a number of strict clamp downs by the insurance regulator as well as a loss in consumer confidence. With the increase in guaranteed surrender values mandated by the regulator, usually

“The importance of distribution channels and strategy is further emphasised by life insurers considering the strength of the distribution network as one of the top differentiator when it comes to valuation for IPOs.” both the life insurance company as well as the policyholder suffer due to poor persistency. Frequent clamp downs by the regulator in the form of regular changes to life insurance product guidelines meant insurers had to continuously revamp their product portfolios. Besides the energies spent on product pricing and approval and setting up of the required administration system, this also required significant effort to re-train the sales staff regularly on the latest products, making this one of the key challenges faced by life insurers in the recent past. This is the reason why, the Towers Watson-CII survey shows, that managing policy persistency is being seen as the most important step towards business optimisation by life insurance companies in the near future. Various strategies can be and are being adopted by life insurers to manage policy persistency including, but not limited to, setting up of specialised persistency units, stronger checks to curb mis-selling, incentivising distribution agents to maintain good persistency records, maximising use of automated payments (ECS) to collect premiums.

Indian Insurance Sector: In Pursuit of Value 27

Overall, it would appear that a lot of changes faced by life insurers can be directly or indirectly resolved by addressing the issues and opportunities in distribution. For example, the primary cause for poor persistency is mis-selling by distribution agents which the insurance companies need to curb. The revised insurance bill also has a provision for making insurance companies liable for mis-selling of their policies by distribution agents which will push insurance companies to find ways to address this issue as priority. A strong and diverse distribution network operating efficiently through need-based selling will meet the objectives of the policyholder, shareholder, regulator and government, and in turn will ensure that the distribution agents benefit in the long run as well.

analysis). Interestingly despite the relatively high expense ratios experienced by a number of life insurance companies, life insurers did not rate high operating expenses and excess capacity maintenance as among the bigger challenges faced by them in the recent past. This might be due to companies viewing the high expense ratios as the effect of other factors, like low policy persistency mentioned above, rather than past causes. However, the survey shows that expense control is now being considered to be one of the top drivers of value for life insurance companies in future.

The average expense ratio of Indian life insurers in 2013-14 (Figure 5.2) was recorded at 19%. Typically developed markets tend to have an expense ratio in the range of 4-12% (according to OECD Insurance Statistics) while emerging markets tend to have expense ratio in the 25-50% range (Towers Watson

Figure 5.2: Expense ratios for private life insurers for FY2013-14

Future Generali Life

Bubble Size : Total premium collection during the period April 2013 to March 2014

35% Reliance Life 30%

Shriram Life

Exide Life 25%

PNB MetLife

Bajaj Allianz Life

Typical range for expense ratios of life insurers in emerging markets

Aviva Life Birla Sun Life

Kotak Life

IDBI Federal Life

Star Union Dai -ichi Life

20% Tata AIA Life Max Life Canara HSBC OBC Life

Sahara Life ICICI Prudential Life

15%

10%

SBI Life

LIC è

IndiaFirst Life HDFC Life

5%

0%



Typical expense ratios of life insurers in developed markets

Ratio of total operating expenses to total premium collection---->

Expense ratios of private life insurers in India 40%

For life insurance companies in India, there is evidence that expense ratios depend on the size of the insurer and contribution of bank distribution channel in the new business written. In the figure above, the size of the bubble depicts total gross premium written by the insurer while the colour of the bubble represents the proportion of bank distribution in new business written. In this figure, bank-led insurers and insurers with banks as the main distribution channel appear in red while insurers depicted by yellow bubbles have negligible proportion of new business sold through banks. We can see that insurers like SBI Life, HDFC Life and ICICI Prudential Life have one of the lowest expense ratios due to a combination of their size and strong bancassurance partners. Also, smaller insurers like IndiaFirst Life and Canara HSBC OBC Life are also able to achieve lower expense ratios by distributing mainly through their bank distribution channels. Based on this, statistics would indicate that the agency channel is generally quite expensive to maintain relative to the bancassurance channel. However, in spite of the costs, strengthening the agency channel is being viewed as a key to business optimisation in future by life insurance companies. This is probably due to the realisation of the requirement of agency channels for the insurance companies to achieve a critical mass and enjoy expense efficiencies. The challenge would be to ensure that both expense controls and strengthening of the agency channel is achieved in cohesion rather than focusing on only one of these.

Based on the survey, there is evidence of life insurers beginning to focus on aggressive investment strategy to gain competitive advantage in the market. However, the survey indicates a relatively low importance being placed on robust risk management which is increasingly being considered as necessary. Ideally, aggressive investment strategy should go hand-in-hand with a strong focus on enterprise risk management. Non-life insurance companies considered the price wars in multiple business segments following the “detarrification” in 2007 as the biggest challenge faced by the sector in the recent past as per the Towers Watson-CII survey. One of the key drivers for accurate and fair pricing is the availability of extensive and reliable data. While the non-life insurance industry has come to realise the importance of using past transaction level data as one of the cornerstones for product development, the extent to which non-life insurers have so far succeeded in getting their data in order varies across classes of business and insurers. There is an immediate need for insurers to invest in suitable skills and technology for data capture, validation, correction, storage, retrieval and usage. This will not only ensure that a competitive advantage is not conceded to competitors with better data management systems, but also lead to the industry in general better assessing the risks and charging appropriate premiums. The recent establishment of the Insurance Information Bureau (IIB) by the regulator should lead to better quality industrywide data for all stakeholders and is a positive step for industry.

“For life insurance companies in India, there is evidence that expense ratios depend on the size of the insurer and contribution of bank distribution channel in the new business written.”

Indian Insurance Sector: In Pursuit of Value 29

The survey shows that quality of services and better claims management are being seen as top drivers of value in future (Figure 5.3). These are expected to be the key areas in terms of business optimisation for non-life insurance companies going forward and can act as a differentiator allowing insurers to command higher premiums than peers. Process improvement has proved to be a game changer here, for example, introduction of a cashless post-accident repair facility at select automobile garages for motor class of business. Unfortunately, such product innovations have been scant in Personal Lines and the industry

needs to focus on this to benefit all stakeholders. A number of these innovations are expected to be driven by technology, with a recently-published research report suggesting that the insurance sector is on the brink of a major technology-driven change. An example of technology led innovation in non-life insurance space is telematics driven usage based car insurance that is gaining ground in many developed markets where insurers working with Towers Watson have introduced a significant product development.

Figure 5.3: Value drivers – business optimisation

Life

Non -Life

Managing persistency

1

Strengthening distribution, developing direct sales

Strengthening agency force

2

Quality of service through systems & process improvements

Expense control

3

Creating new markets

Developing third party tie-ups

4

Suitable product-pricing and portfolio mix

Expanding non-traditional distribution

5

Claims management

Source: Responses to Towers Watson-CII survey of insurance company CEOs

30 towerswatson.com

5.1.1 Setting the right KPIs A key requirement for implementation of business optimisation strategies is ensuring alignment of the KPI of the senior management of insurance companies with the chosen objectives. This ensures that the management is incentivised to run the insurance company in the best long term interest of the shareholders. Ideally, the company's top management ought to sensitise the board about the need for prioritising long term strategic measures over short term tactical gains. Usually, meeting the long-term vision of the shareholders will entail meeting most of the objectives of the other key stakeholders in the insurance business as well. Initially after the liberalisation of the insurance sector, relative success was measured by premium generated, number of policies sold, distributors enrolled and offices opened, and other similar parameters. This was understandable as getting into the market and growing rapidly was a top priority, given the new private insurance companies entered a market having well entrenched incumbent insurers. This approach meant that companies were looking primarily at increasing the top line of the business. It was expected that, over a period of time as the market matures, the initial focus

on sales would need to be tempered by balancing top-line growth objectives with other performance measures. Over the longer term this would ensure profitable growth to create higher value for the insurance companies. We have already seen that profits on the accounts of insurance companies (especially life insurers) are not a good indicator of long-term business value. Therefore, it becomes even more important that a board of directors build KPIs related to sustainable growth and profitability in the long run in their top management's performance metrics. The survey indicates that in respect of non-life insurance companies, the KPIs used by top management (Figure 5.4) have a fair mix of business growth and profitability measures. This is consistent with the shareholders' dual seemingly conflicting objective of market share and return on capital employed revealed in the survey. It was also observed that while sales continues to be considered as the most important function by non-life insurance companies in general, there is an increasing importance being attached to other departments like underwriting, claims, operations finance and actuarial. In fact, multiple non-life insurers indicated in the survey that they considered one of these departments more important than sales.

“A key requirement for implementation of business optimisation strategies is ensuring alignment of the KPI of the senior management of insurance companies with the chosen objectives.”

Indian Insurance Sector: In Pursuit of Value 31

Figure 5.4: KPIs of top management at non-life insurance companies

Market Share Profitability: Return on Capital employed

Combined loss ratio

2 2 3

11

Incurred loss ratio

44

Source: Responses to Towers Watson-CII survey of insurance company CEOs

Similarly for life insurance companies, we found that while KPIs (Figure 5.5) (against which the performance of top management is measured) continue to be weighted heavily in favour of top-line growth, other parameters related to expense controls, managing persistency, profitability and compliance are also increasingly being taken into account while setting the KPIs. This is consistent with the drivers of value as seen by the life insurance companies in the near future. The current high weighting of KPIs towards new business volumes is, as per the survey, in line

with life insurance companies considering structural value on the basis of strength of the distribution network to be the major driver of valuations for IPOs, as opposed to embedded value. In fact, embedded value earnings, which is generally considered an important KPI for life insurance companies is currently not given much weightage by Indian insurers. One would expect the weighting of KPIs to shift from topline growth to overall profitability and operational efficiencies gradually in future as the market matures.

Figure 5.5: KPIs of top management at life insurance companies

New business premium growth Total Premium Income

2 1

Value of new business

Declared profits

3 4 5

Source: Responses to Towers Watson-CII survey of insurance company CEOs

32 towerswatson.com

Persistency

5.2 The right product-price proposition As with all industries, customer (also known as the policyholder) is central to the insurance industry. The fact that insurance, especially life insurance, is a push product makes it even more important to ensure that the products are designed to meet customer requirements, to avoid forced and mis-selling of products by the distributors. The Towers Watson-CII survey indicates that life insurance companies are viewing product innovation as an increasingly important driver of value in the near future. For this to be successful, it is important to ensure appropriate training of the distribution agents so that they are capable of and willing to understand the customer needs and offer products best suited to meet these needs. On the non-life side, as mentioned, competitive pricing has been the key challenge faced by the industry in the recent past and companies can gain significant advantage through product as well as service differentiation improving the overall customer experience and satisfaction. Also, though insurance is based on the concept of pooling of risks, it is important to charge policyholders based on their individual risk profile as far as possible, for which extensive and reliable data is a key requirement as discussed earlier. There is significant room for product development in a number of retail classes that have significant growth potential, for example personal accident, homeowners' insurance, shopkeepers' insurance and travel insurance. An interesting case study would be of the ongoing development of health insurance as a class of independent standalone business, given it has not received serious attention in the past. The intensity of price-led competition in the non-life insurance industry immediately after de-tariffication in 2007 was beginning to turn almost all classes unprofitable when the first set of new standalone health insurers entered the market. Until this time, health insurance was

“The Towers Watson-CII survey indicates that life insurance companies are viewing product innovation as an increasingly important driver of value in the near future. For this to be successful, it is important to ensure appropriate training of the distribution agents so that they are capable and willing of understanding the customer needs and offering products best suited to meet these needs.”

predominantly group based and retail individual was relatively small. Both the streams of health insurance, that is, individual and group, were unprofitable. Over a period of time, non-life insurers started seeing improvements in business growth brought about by the introduction of new products that were found to be suitably priced with user-friendly claims processes by customer- leading intermediaries to start pushing these hard. Appropriate pricing, suitable selection of the provider network and better claims management led to improvements in profitability as well. Most insurers continue to strive for further product development in health insurance by introducing enhanced features like 2-3 year policy periods, inclusion of limited outpatient coverage, disease management and elements of wellness. Micro-insurance is another area which is extremely cost sensitive. However, if the insurers are able to find the right product-price proposition the potential is significant based on the sheer volumes in India. If dealt with correctly, this is an area that will not only be beneficial for the shareholders, but for the insurance sector in general including policyholders, government, regulator and a number of other stakeholders.

5.3 Favourable macroeconomic fundamentals The recessionary macro environment was cited as one of the key challenges faced by the insurance industry in the recent past on both the life and nonlife side, as per the Towers Watson-CII survey. The growth of the insurance sector is intrinsically dependent on the overall growth of the economy. However, the survey indicates that the industry in general has a positive outlook for the economy in the short to medium term and believes this expected economic recovery will be the key macro-economic factor driving growth in the insurance sector. Early signs of improvements in macroeconomic fundamentals are already visible with the stock market indices touching record highs and a general optimism in the market. The survey also suggests that both the non-life and life insurance industry are pinning their hopes on a favourable legislative and regulatory environment which will help the insurance sector to thrive again. The new government at the centre is generally viewed with great optimism by the industry with expectations of significant reforms to drive businesses forward. Some positive changes for insurance, like the

Indian Insurance Sector: In Pursuit of Value 33

increased tax-free limit for investment in long-term savings and increase in FDI limit have already been introduced. The hike in foreign investment to 49% in the insurance sector (a composite limit for both FDI and FII) is expected to be hugely beneficial for both relieving capital constraints on growth, as well as providing shareholders a route to unlock value. The inclusion of personal accident and life insurance cover in the recently announced financial inclusion programmes perhaps indicates the government appreciating the need for insurance, with the prime minister also expressing a keenness to implement a comprehensive health care programme along the lines of “Obamacare” in the US. Non-life insurers are hopeful of amendments in Motor Vehicles Act that has the potential to drastically bring the claims costs for mandatory motor third party risk segment. The market and population demographic of India is another key contributor to the optimism about the future of the insurance sector. Even nearly 15 years since the insurance sector was opened-up, the Indian market remains hugely under-penetrated compared to its more developed counterparts. Given the large and

34 towerswatson.com

“Despite micro-level challenges, the macrofundamentals of the economy remain strong with insurance sector poised for growth.” economically diverse population of India, it might be unrealistic to expect penetration levels similar to other developed countries unless micro-insurance picks up in a big way. However, even ignoring microinsurance (a huge opportunity in itself), there is a significant untapped insurance market in India which can sustain double digit growth of the sector for a number of years. In addition, the population demographic is tailor-made for insurance companies with a young and growing population and an everexpanding middle class. With an estimated 90% of the Indian population working in the unorganised sector, which does not have any sort of pension cover, there is a big group of self-employed people who need to make arrangements for funding their retirement, presenting a significant opportunity to the insurers operating in this space.

Figure 5.6: Strong macro-fundamentals supporting growth of insurance in India

37

%

25

Middle class segment in total population in India by 2025-26

%

%

5.8

Projected Household savings Rate as a percentage of GDP in 2016-17

Expected population aged 65 years and above in 2014

21 19 0.7 11 %

Five year CAGR (2008-13) of Fixed broadband Internet subscribers per 100 people in India

%

Five year CAGR (2008 13) of Mobile cellular subscriptions per 100 people in India

%

8.7

Number of Hospital Beds per 1,000 people in India (2007-12)

Five year CAGR (2007-12) of number of Motor Vehicles registered in India

%

8.5

1 Year Bond Yield for India (2014)

%

10 Year Bond Yield for India (2014)

2035

Age grouping (in years)

2015

2050

100+ 95-99 90-94 85-89 80-84 75-79 70-74 65-69 60-64 55-59 50-54 45-49 40-44 35-39 30-34 25-29 20-24 15-19 10-14 5-9 0-4 80

60

40

20

0

20

40

60

80

80

60

40

Number in million

20

0

20

40

60

80

Number in million

Female

80

60

40

20

0

20

40

60

80

Number in million

Male

Sources: · · · · · ·

World Population Prospects: The 2012 Revision; http://esa.un.org/wpp/ India’s middle class population to touch 267 million in 5 years, Economic Times, Published on February 6, 2011, http://articles.economictimes.indiatimes.com/2011-02-06/news/28424975_1_middle-class-householdsapplied-economic-research (accessed on August 29, 2014) OECD Economic Outlook 95 database (http://www.oecd.org/eco/outlook/economicoutlookannextables.htm) World Development Indicators Investing.com Transport Research Wing, Ministry of Surface Transport

Indian Insurance Sector: In Pursuit of Value 35

5.4 Confidence building There is a general concern in the industry that insurance has so far been unable to build faith among multiple stakeholders. Negative growth in business in recent years combined with some significant operational issues has meant that investor confidence has taken a hit. Although the global economic slowdown was primarily responsible for multiple foreign insurers either exiting or indicating to exit the Indian insurance market in recent years, the reduced shareholder optimism did not help matters either. Market reports in the recent past would indicate that apart from shareholders, even the confidence of potential investors in the insurance sector has fallen with much reduced valuations and significantly lower interest shown by new foreign insurers to enter the market. In addition, instances of alleged mis-selling on the life insurance side coupled with the negative publicity in the press in recent years has meant that policyholder confidence in life insurance products is probably at an all-time low as well. However, due to the change in product guidelines and steps taken by the regulator, confidence has started building again. The level of trust in the relationship between the life insurers and the insurance regulator is also not where the insurers would want it to be for similar reasons. It is imperative that the insurance companies work towards restoring the confidence in the sector to be able to realise the full value and potential of their business. Embedding Enterprise Risk Management (ERM) in the overall governance as well as within each functional segment of the insurance company is one of the most

“Embedding Enterprise Risk Management (ERM) in the overall governance as well as within each functional segment of the insurance company is one of the most important steps that can be taken towards restoring confidence in the sector.”

36 towerswatson.com

important steps that can be taken towards restoring confidence in the sector. The concept of ERM, in simple terms, relates to ensuring that the shareholders are fully aware of the risks being taken and have signed up to the “risk versus reward” proposition being offered by the business. Detailed risk identification, tight controls, diligent monitoring, selective risk mitigation, informed and pro-active governance and detailed documentation are some of the principles on which ERM is based. ERM has particularly gained ground following the 2009 financial crisis and is actually being forced upon the financial sector by the regulator in multiple countries. The Indian insurance regulator had also mandated the appointment of a Chief Risk Officer as a key position. While some insurance companies are looking towards building and implementing a comprehensive ERM framework for their organisations, based on our survey results we understand that this is currently not seen as an important driver of value by the insurance sector in general. ERM, if implemented properly, can be an extremely useful tool to rejuvenate shareholder, investor and regulator confidence in the insurance industry. Informative supplementary reporting, strengthening sales practices and ensuring need-based selling are some of the other steps discussed earlier which would help rebuild investor, policyholder and regulator confidence. Brand value was cited in the Towers Watson-CII survey as one of the top drivers of value for IPOs by senior management of insurance companies and building confidence in the company and the brand is an integral part of this.

Confederation of Indian Industry

The Confederation of Indian Industry (CII) works to create and sustain an environment conducive to the development of India, partnering industry, Government, and civil society, through advisory and consultative processes. CII is a non-government, not-for-profit, industry-led and industry-managed organization, playing a proactive role in India's development process. Founded in 1895, India's premier business association has over 7400 members, from the private as well as public sectors, including SMEs and MNCs, and an indirect membership of over 100,000 enterprises from around 250 national and regional sectoral industry bodies. CII charts change by working closely with Government on policy issues, interfacing with thought leaders, and enhancing efficiency, competitiveness and business opportunities for industry through a range of specialized services and strategic global linkages. It also provides a platform for consensus-building and networking on key issues. Extending its agenda beyond business, CII assists industry to identify and execute corporate citizenship programmes. Partnerships with civil society organizations carry forward corporate initiatives for integrated and inclusive development across diverse domains including affirmative action, healthcare, education, livelihood, diversity management, skill development, empowerment of women, and water, to name a few. In its 120th year of service to the nation, the CII theme of 'Build India – Invest in Development, A Shared Responsibility,' reiterates Industry's role as a partner in national development. The focus is on four key enablers: Facilitating Growth & Competitiveness, Promoting Infrastructure Investments, Developing Human Capital, and Encouraging Social Development. With 64 offices, including 9 Centres of Excellence, in India, and 7 overseas offices in Australia, China, Egypt, France, Singapore, UK, and USA, as well as institutional partnerships with 300 counterpart organizations in 106 countries, CII serves as a reference point for Indian industry and the international business community.

Confederation of Indian Industry The Mantosh Sondhi Centre 23, Institutional Area, Lodi Road, New Delhi – 110 003 (India) T: 91 11 45771000 / 24629994-7 F: 91 11 24626149 E: [email protected] W: www.cii.in

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Reach us via our Membership Helpline: 00-91-11-435 46244 / 00-91-99104 46244 CII Helpline Toll free No: 1800-103-1244

Towers Watson has the strongest global network in the people, risk and financial management consulting business, with nearly 16,000 associates in 38 countries. We have been putting clients first for more than 136 years and trace our roots to the oldest actuarial firm in the world, formed in 1878. Our first client – from 1878 – is still our client today. Towers Watson has more actuaries and chartered enterprise risk analyst (CERA) designations serving the insurance industry than any other professional services company. Fortune magazine has included Towers Watson on its list of the World’s Most Admired Companies for the past four years. Towers Watson India The firm has been operating in India since 1996 and covers the length and breadth of the country with offices in 4 cities – Mumbai, Delhi, Bengaluru and Kolkata. Our services include Risk and Financial Services, Benefits and Talent & Rewards. Risk and Financial Services

Talent and Rewards

As companies struggle to improve business performance, many want to combine risk management with their overall financial management within a unified framework. Towers Watson understands the crucial links among risk, capital and value for insurers concerned about capital management, senior managers trying to manage value creation, and investment committees seeking to balance risk and return.

Aligning your talent and reward strategy with your business strategy is crucial for long-term success. We rely on data, analytics and experience to pinpoint the talent and workforce needs that are vital to your overall performance. We develop strategies, and design and implement programs that address these needs, boost performance and ensure the right return on your investment in people.

Our risk and financial solutions include: • Insurance industry consulting • Investment • Risk software solutions

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Our benefit solutions include: • Health and group benefits • International consulting • Retirement • Technology and administration solutions

Our M&A solutions include: • Due diligence • HR readiness • HR program management office • Integration planning • Integration execution

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90%

of life Insurance companies

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About Towers Watson Towers Watson is a leading global professional services company that helps organisations improve performance through effective people, risk and financial management. With more than 16,000 associates around the world, we offer consulting, technology and solutions in the areas of benefits, talent management, rewards, and risk and capital management. Learn more at towerswatson.com. The information in this publication is of general interest and guidance. Action should not be taken on the basis of any article without seeking specific advice.

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