A well- known feature of life insurance in India is the dominant focus on equity market investments. In the past five years (Equity) market linked insurance has propelled growth of private sector insurance companies which now accounts for close to 50 per cent of all annual incremental business. The rapid buildup in incremental business has enabled the private sector to capture, just in a span of 8-9 years, a quarter of the overall insurance market. The sharp growth in linked insurance is reflected in the fact that (equity) investments comprise close to 80 per cent of the total investments of private insurance companies.

Moreover, (equity) market linked insurance continues to be the order of the day, despite the image dent suffered by these products in the wake of the steep losses in the stock markets during CY 2008. Indeed, the ‘euphoric’ rise in local stock markets from the middle of March this year should only have reinforced the trend and momentum for markets- linked insurance. It is possible, therefore, that the deceleration in fresh business growth which private insurance companies experienced in 2008-09 is reversed during the course of this year and next. (For the record, private companies posted average annual growth of 80 per cent + in the 3 years to 2007-08 but registered essentially no growth in fresh premium collection in 2008-09. For public sector LIC, the going was more difficult – it registered a decline of 10per cent in fresh premium collection in 2008-09 compared to 2007-08).

Equities and ULIPS have their pluses

To be sure, unit-linked insurance, particularly equities-oriented investments, does have its pluses. All said and done, Indian equities have delivered something in the range of 15per cent to 20 per cent pa on a long-term basis, after factoring the much higher level of (structural) volatility they have been subject to over the years. A 15-20 per cent rate of return on long-term investments indeed is a fair, reward. Such a level of returns on insurance – which by definition is a long-term financial contract designed primarily for risk cover- is all the more relevant.

Going beyond their ability to deliver positive real or inflation- positive rates of return over the long term, markets-linked insurance are favoured also on account of their greater levels of transparency (in policy administration) and flexibi-lity. After plugging in the charges under various heads such as premium allocation, fund management and / or switching charges (apart, of course, from mortality charges), linked insurance does provide enhanced flexibility for the insured vis-à-vis conventional insurance.

Unit or markets-linked insurance is favoured from the life insurer's point of view also. For one, the market risk on the investments portfolio is borne entirely by the insured. This could potentially help to limit the liability of the insurer on an on-going valuation basis. Further, under current IRDA guidelines, solvency margin requirements are more favourable for the insurer under linked insurance than under non-linked insurance.

Combining with these structural reasons, the secular boom in the Indian stock markets from the early years of the decade and up to late 2007 meant that both the demand for and supply of markets-linked insurance was extremely strong. The predominance of linked business in the overall business portfolio of the private sector – as much as 75-80 per cent is well-explained.

Cross country experience

It is not that linked insurance has found favour only in India. Many of the structural reasons which produced high growth in linked insurance in India in the past few years were also behind the strong performance of unit or markets linked insurance in other key countries advanced and emerging.

The important difference to note, though, from the experience of other major insurance markets – such as the US or the UK
– is that conventional or non-linked insurance has not been that significantly sidelined during the growth phase of linked insurance as has happened in India in the past few years.

Why the US-UK experience?

Despite being an emerging market, India should find the US or UK experience in the development of life insurance more relevant for an important reason. Indian financial markets are more advanced than most other emerging markets such as China or Indonesia. In terms of institutions, products, instruments and market practices, India would more closely resemble the UK or the US than other emerging markets.

In the UK, in fact, the proportion of life insurance companies' assets held in equities has even registered a notable decline in the past few years. Equities, which formed close to 60 per cent of large life insurers’ total investments around the turn of the decade (2000), accounted for a reduced 40 per cent of their assets by 2007. Correspondingly, life insurance companies which held as much as 20 per cent of all UK equities in 2000-01, now own only around 12- 13 per cent of UK equities. The shift has been into fixed income securities-particularly corporate bonds.

The US experience is also quite interesting – for its balanced focus on both the linked and non-linked businesses. In 1997, corporate stocks accounted for 24per cent of the total assets of US life insurance companies. Government securities and corporate bonds accounted for 16per cent and 42 per cent respectively of the total.

Fast forward to 2007-08 – the interim period having seen strong bull runs in the equity markets (of course, marked by the dot.com induced collapse of 2000-01). As of end 2007, corporate stocks accounted for 33 per cent of the total assets while government securities and corporate bonds formed 11 per cent and 38 per cent respectively of the total asset portfolio.

It is clear from the above figures that though there have been increased investments in corporate stocks, it has not been at the cost of any significant dilution of exposure to the government securities / corporate bonds market. US life insurance companies continue to take fairly high exposures to fixed income assets – the staple of conventional or non-linked insurance. Conventional or non-linked insurance, therefore, continues to find favour – both from a demand and supply perspective in the US, globally the largest insurance market.

Other investment avenues

The potential for conventional and fixed income oriented insurance in India appears to be considerable in this backdrop. Not only is the present market structure – in terms of the size of the Government securities market, products, instruments and market practices – favorable in this respect. The recently announced guidelines on stripping government securities into their principal and interest components could further boost the potential of conventional insurance.

A robust market in ’stripping’ could create a sizeable and active market in zero coupon bonds - an instrument which eliminates re-investment risk for the insurer. That, in turn, could lay the foundation for developing a good market in guaranteed income products - for example in pensions and annuities or even in conventional endowment.

The scope for pensions and annuities business appears to be particularly significant given (a) the low penetration made in this segment so far – pensions and annuities sum assured accounts for less than 5 per cent of total sum assured for both LIC and the private sector (b) the strong latent demand for stable, long-term retirement income products in the backdrop of a rising retiree population (c) increased volatility in interest rate markets and consequently increased variability in retirees' income flows and (d) both government and non-government employers decisively moving away from defined benefits pensions to defined contribution pensions.