foreign direct investment in insurance sector

FOREIGN DIRECT INVESTMENT IN INDIAN INSURANCE

INDEX:

CHAPTER TOPIC PG.

NO.

1 INTRODUCTION TO INDIAN ECONOMY AND FOREIGN

DIRECT INVESTMENT (FDI)

1

2 TYPES OF FOREIGN INVESTMENTS (FDI & FPI),

MEANING, DEFINITION AND NOTES RELATED TO FDI

4

3 FDI – A HISTORICAL PERSPECTIVE IN INDIA 8

4 FDI IN INDIA – AN OVERVIEW 11

5 INDIAN INSURANCE SECTOR – INTRODUCTION, ROLE,

PRIVATISATION, OVERVIEW AND OPPORTUNITIES

20

6 TYPES OF FDI

TYPE OF FDI IN INDIAN INSURANCE SECTOR

28

7 ENTRY ROUTES FOR FDI IN INDIA

ENTRY ROUTES FOR FDI IN INDIAN INSURANCE SECTOR

LIST OF FOREIGN ENTRANTS IN GENERAL & LIFE INS.

35

8 FDI REGULATION IN INDIA 39

9 FDI POLICIES 41

10 INDIA’S FEATURES AS A HOST COUNTRY FOR FDI AND

BUSINESS COMPLAINTS

44

11 ADVANTAGES AND DISADVANTAGES OF FDI

ADVANTAGES OF FDI IN INDIAN INSURANCE

51

12 EMERGING TRENDS IN INSURANCE DUE TO FDI /

(POSITIVE IMPACTS OF FDI)

56

13 GOVERNMENT PROPOSAL TO LIFT FDI CAP TO 49% IN

INDIAN INSURANCE

63

14 IMPACT OF FDI AND LIBERALISATION ON INSURANCE

SECTOR / (NEGATIVE IMPACTS OF FDI)

– AS SUBMITTED BY LEFT PARTIES TO UPA

64

15 CONCLUSION 72

1


PHASES OF INDIAN ECONOMY POST 2000:

Political Coalitions have started providing stable governments.

Government to get out of owning and managing businesses: Disinvestment

Policy.

Gradual relaxation in the FDI Policy.

TYPES OF FOREIGN INVESTMENT:

Capital flows come in three primary forms:

Portfolio equity investment, which involves buying company shares, usually

through stock markets, without gaining effective control.

Portfolio debt investment, which typically covers bonds and short- and long-

term borrowing from banks and multilateral institutions, such as the World

Bank.

Foreign direct investment (FDI), which involves forging long-term

relationships with enterprises in foreign countries.

DIFFERENCE B/W FDI AND PORTFOLIO INVESTMENT:

FDI Foreign Portfolio Investment (FPI)

Investment in physical assets Investment in financial assets

Tends to be long term Tends to be short term

Difficult to withdraw Easy to withdraw

2


Does not tend be speculative Tends to be speculative

Expectation of technology transfer No Expectation of technology transfer

Direct impact on employment of labour

and wages

No direct impact on employment of

labour and wages

Abiding interest in management. Fleeting interest in management.

FOREIGN DIRECT INVESTMENT (FDI) - MEANING:

FDI refers to an investment made to acquire lasting interest in enterprises operating

outside of the economy of the investor. Further, in cases of FDI, the investor´s

purpose is to gain an effective voice in the management of the enterprise. The

foreign entity or group of associated entities that makes the investment is termed the

"direct investor". The unincorporated or incorporated enterprise-a branch or

subsidiary, respectively, in which direct investment is made-is referred to as a

"direct investment enterprise". Some degree of equity ownership is almost always

considered to be associated with an effective voice in the management of an

enterprise.

Once a direct investment enterprise has been identified, it is necessary to define

which capital flows between the enterprise and entities in other economies should be

classified as FDI. Since the main feature of FDI is taken to be the lasting interest of a

direct investor in an enterprise, only capital that is provided by the direct investor

either directly or through other enterprises related to the investor should be classified

as FDI. The forms of investment by the direct investor which are classified as FDI

are equity capital, the reinvestment of earnings and the provision of long-term and

short-term intra-company loans (between parent and affiliate enterprises).

A direct investment enterprise is an incorporated or unincorporated enterprise in

which a single foreign investor either owns 10 per cent or more of the ordinary

3


shares or voting power of an enterprise (unless it can be proven that the 10 per cent

ownership does not allow the investor an effective voice in the management) or

owns less than 10 per cent of the ordinary shares or voting power of an enterprise,

yet still maintains an effective voice in management. An effective voice in

management only implies that direct investors are able to influence the management

of an enterprise and does not imply that they have absolute control. The most

important characteristic of FDI, which distinguishes it from foreign portfolio

investment, is that it is undertaken with the intention of exercising control over an

enterprise.

DEFINITION:

Foreign direct investment (FDI) is defined as "investment made to acquire lasting

interest in enterprises operating outside of the economy of the investor." The FDI

relationship consists of a parent enterprise and a foreign affiliate which together form

a transnational corporation (TNC). In order to qualify as FDI the investment must

afford the parent enterprise control over its foreign affiliate.

In other words, FDI refers to “Net inflows of investment to acquire a lasting

management interest in an enterprise operating in an economy other than that of the

investor. It is a sum of equity capital, reinvestment of earnings other than long term

capital and short term capital as shown in the balance of payment.”

According to WTO,

“Foreign Direct Investments (FDI) occurs when an investor based in one

country (home country) acquires an asset in another country (host country)

with the intent to manage that asset”. The management dimension is what

distinguishes FDI from Portfolio Investment in foreign stocks, bonds and other

financial instruments because the PI has no intent about managing the asset.”

4


IMPORTANT NOTES RELATED TO FDI:

FDI does not necessarily imply control of the enterprise, as only a 10 percent

ownership is required to establish a direct investment relationship.

FDI does not comprise a “10 percent ownership” (or more) by a group of

“unrelated” investors domiciled in the same foreign country—FDI involves

only one investor or a “related group” of investors.

FDI is not based on the nationality or citizenship of the direct investor—FDI is

based on residency.

Borrowings from unrelated parties abroad that are guaranteed by direct investors are

not FDI.

5


FDI - A HISTORICAL PERSPECTIVE IN INDIA:

It is misleading to suggest that India is new to foreign capital. Foreign capital had a

substantial presence in Indian industry prior to 1947, and was mostly concentrated in

the primary sectors and services. Foreign firms, mostly British, dominated India’s

mining, plantations, trade and much of the fledgling manufacturing base. Further FDI

flows played an important role in the early post- Independence years, as India turned

abroad for both technology and capital. By the late 1950s, the Indian government

invited foreign capital in many sectors, including pharmaceutical drugs, aluminium,

heavy electricals and chemicals.

During the 1960s inflows concentrated on manufacturing, especially the technology-

intensive industries. By the end of the 1960s, around 60 per cent of all foreign direct

capital was concentrated in the manufacturing industries.

However, in the aftermath of two famines and the devaluation of the Rupee in the

1960s, there was a hardening of policy. Foreign oil majors were nationalized in the

early 1970s. The government did not rule out new foreign investment but now

wanted it on restrictive terms. The Foreign Exchange Regulation Act (FERA) of 1973

introduced a clause that required firms to dilute their foreign equity holdings to 40 per

6


cent if they wanted to be treated as Indian companies. There were new restrictions

on technology imports, with a preference for licensing over financial collaboration,

and restricted rates of royalty payment. Intellectual property rights were severely

curtailed by a revised Patents Act in 1970: product patents were abolished in

industries such as pharmaceuticals and chemicals.

By the mid-1980s, growing concern about stagnation and technological

obsolescence in Indian industry led to a push for economic reform and deregulation.

To encourage exports, export-intensive firms were granted exemptions from the

usual FERA limits on foreign equity ownership. In an attempt to modernise

manufacturing industry, restrictions on technology transfers and royalty payments

were relaxed. However, despite official claims, foreign investment projects were still

very vulnerable to bureaucratic discretion. Foreign equity inflows remained paltry

and, to a large extent, Indian industry came to rely on foreign debt capital to meet its

foreign exchange needs.

The 1990s began with a major crisis. In the wake of the Gulf War, and the

consequent expulsion of Indian expatriate labour from the Middle-East, foreign

exchange remittances fell. As the balance of payments position deteriorated, a

panicked withdrawal of funds deposited in India by Non Resident Indians

exacerbated the problem. The real possibility that India might default on its external

obligations led to a downgrading of India’s credit rating. As part of the reforms

agreed with the IMF, the Rupee was devalued, and fresh attempts were made to

liberalise the trade regime and the regulatory framework.

Industrial licensing was abolished in all but a handful of industries. Foreign direct

investment was now permitted in many sectors from which foreign capital had been

excluded in the past. These included the infrastructure sectors previously

monopolised by state enterprises: power generation, highway and port construction,

telecommunications, oil and natural gas exploration. The services sector, where

foreign capital had been eliminated as a matter of deliberate policy, was reopened:

fresh investment was approved in financial services, retail banking, insurance, and

recently in the media and retailing. The cap on foreign equity participation was raised

7


to 51 per cent for most industries, and even 100 per certain some cases. Restrictions

on the use of international brand names were removed. Reforms in the technology

policy provided greater recognition of intellectual property rights.

On the whole, in the nearly six decades since Independence, policy towards private

foreign capital has moved closely with exigencies of India’s external payments

position. Nevertheless the changing policy environment had a direct effect on the

extent of foreign capital in Indian industry and its contribution to the economy.

Athreye and Kapur (2001) studied the long-term relative performance of multi-

national and domestic firms in India, using company-level data collected by the

Reserve Bank of India. They found that multinationals were dominant in many

sectors (electricals, chemicals, rubber, cigarettes, aluminium, automotive

components) even during the restrictive phase. They found that foreign-controlled

firms had higher profit margins than domestic firms throughout the period, possibly

due to their technological strength, access to global marketing networks and brand

names that gave them a clear edge over domestic firms.

8


FOREIGN DIRECT INVESTMENT IN INDIA – AN OVERVIEW:

Liberalization of the Indian economy in the early 1990s boosted the inflow of Foreign

Direct Investments (FDI) to India. It also helped to open Indian markets to foreign

direct investment. Further the government of India simplified the procedures for

foreign direct investment in the country in order to encourage the foreign investors to

invest in the country. Foreign direct investment in India, came from non resident

Indians, international companies, and other foreign investors. FDI inflows to India

grew significantly over the years and assumed significant importance.

INDIA’S INCREASING FDI INFLOW:

Notwithstanding to the global financial credit squeeze, resulting into the liquidity

crunch, India has witnessed the unforeseen increase in the foreign direct

investment(FDI), which has shoot up by 259 per cent to reach at $2.56 billion as

compare to previous year. As per the official statement issued by the government,

the foreign direct investment inflows has registered at $17.21 billion, which is the rise

of over 137 per cent at $7.25 billion, of the same period in the last year. The Union

Commerce and Industry Minister, Kamal Nath has asserted that "Despite troubles in

9


the world economy, India continued to attract FDI and the target of $35 billion for

2008-09 fiscal would be achieved."

The graph besides shows that the flow of foreign direct investment in India has

grown at a very fast pace over the last few years. The various forms of foreign

capital flowing into India are NRI deposits, investments in the commercial banks of

India, and investments in the country's debt and stock markets.

10


COUNTRY SOURCES OF FDI IN INDIA:

11


COMMENTS:

12


Mauritius cornering a huge chunk ( approx. 44%) of total FDIs into India is a direct

consequence of the Indo-Mauritius Double Taxation Avoidance Treaty (DTAT)

signed in 1982, under which Mauritian companies are exempted from income tax on

capital gains made on investments in India.

Expectedly, 2nd and 3rd spots are occupied by the Singapore (8.04%) and United

States (7.58%); this demands little explanation beyond stating the fact of abundant

availability of surplus, investible funds in these economies.

13


FDI WITHIN INDIA:

COMMENTS:

Unsurprisingly, Maharashtra – mostly Mumbai – and Delhi are the most favoured

destinations for FDIs. They are followed by two other states with prominent

metropolitan cities & financial hubs, viz. Karnataka (Bangalore) and Tamil Nadu

(Chennai).

TOP 5 DESTINATIONS OF APPROVED FDI AMONG INDIAN:

State No. of FDIs Approved Approved FDI ($ Million)

Maharashtra 2015 11135.9

Delhi 1226 9226.7

Karnataka 1078 5247.1

Tamil Nadu 1223 5073.8

Gujarat 458 3129.6

Others 3119 19476.4

14


SECTOR – WISE FDI IN INDIA:

15


COMMENTS:

The service sector topped the list (21.68%), which have successfully able to attract

more than $2.34 billion foreign investment.

The FDI Inflows to Service Sector has helped the development of several industries

in the service sector of the Indian Economy. This includes mainly Financial services

(Insurance and banking) and Tele Communication, Hotel &Tourism,etc.

Since the onset of the liberalization of the Indian economy in 1991, the country has

experienced a huge increase in the inflow of Foreign Investments. The service

sector in India has tremendous growth potential and as such it has attracted

huge Foreign Direct Investments (FDI).

SECTORS OFINDIAN ECONOMY:

1990 2007

Indian service sector has grown tremendously in the last few years. Today it has

been globally recognized for its high growth and development. The fact that in the

last 5 years this sector has been growing at an annual rate of about 28 % speaks

volumes of its success. At the moment service sector contributes nearly 55% of

16


India's GDP. The government of India is taking major steps to give a boost to this

sector. The service sector also contributes heavily on India's foreign exchange. By

2012, it is expected that service exports is also going to be around 6% by 2012, if the

annual growth rate of 28% is maintained.

SOME REASONS FOR HUGE FDI IN SERVICE SECTOR ARE:

skill intensive and high value-added services industries

low costs

deep technical and language skills

Mature vendors and supportive government policies.

Services Location.

Availability of skilled workforce and business environment.

SERVICE SECTORS WITH HIGH FDI FLOWS IN INDIA:

The major service sectors of the Indian economy that have benefited from FDI in

India are:

Financial sector (banking and non-banking).

Insurance

Telecommunication

Hospitality and tourism

Pharmaceuticals

Software and Information Technology.

FDI in India has increased over the years due to the efforts that have been made by

the Indian government. The increased flow of FDI in India has given a major boost to

the country's economy and so measures must be taken in order to ensure that the

flow of FDI in India continues to grow.

17


REASONS FAVORING FDI IN INSURANCE:

Experience of other countries shows that insurance has attracted

significant FDI.

FDI would bring technical know-how and skill.

It would speed up the growth of insurance sector by setting up new

distribution channels, IT etc.

Joint ventures would ease capital constraints of existing insurance

players.

Domestic insurers would get access to global best management

practices.

Sourcing from India would increase.

There will be more investment

Competition would drive down prices (premiums).

Protection leads to inefficiency.

FDI would lead to development of different and innovative products.

18


INTRODUCTION TO INDIAN INSURANCE SECTOR:

The insurance sector in India has come a full circle from being an open

competitive market to nationalization and back to a liberalized market again.

Tracing the developments in the Indian insurance sector reveals the 360-degree

turn witnessed over a period of almost 190 years.

The life insurance business, which started in 1818 with the establishment of the

Oriental Life Insurance Company of Calcutta, was nationalized in 1956 when

the central government took over 245 Indian and foreign insurers and provident

societies.

Additionally, the LIC was formed by an Act of Parliament (LIC Act 1956), with a

capital contribution of Rs 50 m from the Indian government.

The general insurance business in India started with the formation of the Triton

Insurance Company Ltd of Calcutta in 1850. This was also nationalized,

although much later than the life insurance sector, with effect from January 1,

1973.

In 1973, 107 general insurers were amalgamated and incorporated into the

General Insurance Corporation of India ('GIC'), which had four subsidiaries - the

National Insurance Company Ltd, the New India Assurance Company Ltd, the

19


Oriental Insurance Company Ltd and the United India Insurance Company Ltd.

These four subsidiaries were spun off from the parent as independent

companies in 2000, when the government liberalized the insurance sector,

both life and general, bringing the private sector back into the market.

Additionally, GIC was designated the national re-insurer.

At this time, the government also allowed foreign players into the market.

With this the concept of Foreign Direct Investment (FDI) in Indian Insurance

sector came into picture.

Foreign Direct Investment or FDI is the investment in a country by some foreign

country. It is usually a physical investment like building a factory or an office. It

usually includes a parent company (from home country), who in the effort of

expanding establishes its office as a permanent company in a foreign country. In

this way the parent company gets the level of Multinational Company and its

investment is known as FDI for the host country. Importance of expansion is very

necessary for all nature of businesses to sustain long term survival but FDI is

very important for the host country as well. For example, developing countries

are the most attractive growing markets for almost all kinds of businesses

therefore; if a company makes FDI in developing country then it will give benefit

to the company and the country both. Benefits usually increase high profits for

the company, and increase in employment, economic growth etc. for the country.

In addition to that there are a number of risks which are always there in FDI for

both the country and the company.

The Indian insurance industry currently comprises 28 players 14 each in the life

and non-life business sectors, of which only five (all Indian private sector

players, though in joint ventures with different foreign partners) are involved in

both the life and non-life business.

20

http://www.blurtit.com/q213341.html





ROLE OF INSURANCE SECTOR:

Insurance industry in today’s uncertain environment has assumed

paramount importance.

Today people have become very conscious about their future and so they are

spending nearly 6 times on life insurance than they did before. The number of

life insurance policies in India is the largest in the world and this sector

contributes nearly 4 % in the GDP. The Indian insurance companies

recorded a growth nearly 20% in premium in dollar terms, compared to the

world market growth rate 0f only 3%.

Insurance would assist businesses to operate with less volatility and risk of failure and provide for greater financial and societal stability from the growth pangs of an estimated growth rate over 8 % in GDP

Government has arranged for disaster management and for funds. NGOs and public institutions assist with fund raising and relief assistance. Besides government provides for social security programs. There is considerable impact upon government in these respects. Insurance substantially steps in to provide these services. The effect would be to reduce the strain on the tax payer and assist in efficient allocation of societal resources

Facilitates trade, business and commerce by flexible adaptation to changing risk needs particularly of the mushrooming Services sector.

Like any other financial institution insurance companies generate savings from the insurance sector within the economy and make available the same in well directed areas of the economy deserving investments ; a sector with potential for business as is the case with Indian insurance provides incentive to develop it all the more faster

21


It enables risk to be managed more efficiently through risk pricing and risk transfers and this is an area which provides unlimited opportunities in the Indian context for consulting, broking and education in the post-privatization phase with newer employment opportunities

The insurance industry of its own accord is interested in loss minimization. Its expertise in understanding losses assists it to share the experience across the economy thus enabling better loss control and preservation of national assets

In its risk pricing and investment decisions the insurance industry sets the tone for investment by others in the economy. Informed assessment by the insurance companies thus signals allocation of resources by others contributing to efficiency in allocation. In India visibility of LIC and GIC have been dwarfed by governments’ actions and other high profile institutions like ICICI, IDBI and UTI. Of late AIG is visible in the media and its investment announcements are being followed keenly by institutional investors in India. ING Savings Trust and Zurich are active in asset management and are being keenly followed by retail investors.

22


PRIVATISATION OF INSURANCE SECTOR:

Insurance is the fastest growing sector in India since 2000 as Government allowed

Private players and FDI up to 26%. Life Insurance in India was nationalised by

incorporating Life Insurance Corporation (LIC) in 1956. All private life insurance

companies at that time were taken over by LIC.

In 1993 the Government of Republic of India appointed RN Malhotra Committee to

lay down a road map for privatisation of the life insurance sector.

While the committee submitted its report in 1994, it took another six years before the

enabling legislation was passed in the year 2000, legislation amending the Insurance

Act of 1938 and legislating the Insurance Regulatory and Development Authority

Act of 2000. The same year that the newly appointed insurance regulator -

Insurance Regulatory and Development Authority IRDA -- started issuing licenses to

private life insurers.

23

http://www.irdaindia.org/

http://en.wikipedia.org/wiki/Life_insurance

http://en.wikipedia.org/wiki/956


INDIAN INSURANCE INDUSTRY - OVERVIEW AND OPPOTUNITIES:

OVERVIEW:

SIZE:

Insurance is a US$41-billion industry in India, and grew by 36% in 2006-07

over the previous year

o Life Insurance - US$35 billion industry with US$24 billion accounting

for First Year Premium (inclusive of Single Premium)

o Non-Life Insurance - US$5.6-billion industry; motor and health segments account for

56% of total business

STRUCTURE:

Indian Insurance market was opened to private and foreign investment in

1999-2000

The Indian Insurance industry consists of a total of 34 players

o Life: 1 public sector player; 16 private players

o Non-life: 6 public sector players; 11 private players

Major international players like AIG, Aviva, MetLife, New York Life, Prudential,

Allianz, Sun Life, Standard Life and Lombard are already present with minority

stakes in joint ventures with Indian companies for both Life and Non-life

segments

24


The Life Insurance market is still dominated by Life Insurance Corporation

(LIC) - a public sector company which had 75% share of first year premium in

2006-07

In non-life, private sector companies (almost all are joint ventures with foreign insurers)

accounted for 34% of the market in 2006-07

POLICY:

FDI up to 26% is permitted under the automatic route subject to obtaining a

license from the Insurance Regulatory and Development Authority (IRDA)

o Intention to increase FDI up to 49%

Insurance Regulatory Development Authority (IRDA) is the regulator for the

Insurance industry

In a landmark move the government detariffed the General Insurance business on 1st

January, 2007

OPPORTUNITY:

25


Many international players have

entered the Indian Insurance market

Non-Life penetration is low in India - a

potential growth area of the future

OUTLOOK:

The Indian Insurance market is expected to be around US$52 billion

by 2010

o Expected CAGR of over 30% p.a.

POTENTIAL:

Largely untapped market with 17% of the world’s population

o Nearly 80% of the Indian population is without Life, Health and Non-life

insurance

o Life Insurance penetration is low at 4.1% in 2007-08

o Non-life penetration is even lower at 0.6% in 2007-08

o The per capita spend on Life and Non-Life Insurance is US$33.2 and

US$5.2 (2006-07), respectively compared to a world average of

US$330 and US$224

26


o Strong economic growth with increase in affluence and rising risk

awareness leading to rapid growth in the insurance sector

Innovative products such as Unit Linked Insurance Policies are likely to drive

future industry growth

Investment opportunities exist in both life and non-life segments

o Total estimated investment opportunity of US$14-15 billion

TYPES OF FDI:

1. BY DIRECTION:

a. Inward

Inward foreign direct investment is when foreign capital is invested in local

resources.

b. Outward

Outward foreign direct investment, sometimes called "direct investment abroad", is

when local capital is invested in foreign resources.

2. BY TARGET:

27


a. Greenfield investment

It is the direct investment in new facilities or the expansion of existing facilities. It is

the principal mode of investing in developing countries.

Greenfield investments are the primary target of a host nation’s promotional efforts

because they create new production capacity and jobs, transfer technology and

know-how, and can lead to linkages to the global marketplace. The Organization for

International Investment cites the benefits of Greenfield investment (or insourcing)

for regional and national economies to include increased employment (often at

higher wages than domestic firms); investments in research and development; and

additional capital investments. Criticism of the efficiencies obtained from Greenfield

investments includes the loss of market share for competing domestic firms. Another

criticism of Greenfield investment is that profits are perceived to bypass local

economies, and instead flow back entirely to the multinational's home economy.

Critics contrast this to local industries whose profits are seen to flow back entirely

into the domestic economy.

b. Mergers and Acquisitions

It occurs when a transfer of existing assets from local firms takes place; the primary

type of FDI. Cross-border mergers occur when the assets and operation of firms

from different countries are combined to establish a new legal entity. Cross-border

acquisitions occur when the control of assets and operations is transferred from a

local to a foreign company, with the local company becoming an affiliate of the

foreign company. Unlike greenfield investment, acquisitions provide no long term

benefits to the local economy-- even in most deals the owners of the local firm are

paid in stock from the acquiring firm, meaning that the money from the sale could

never reach the local economy. Nevertheless, mergers and acquisitions are a

significant form of FDI and until around 1997, accounted for nearly 90% of the FDI

flow into the United States. Mergers are the most common way for multinationals to

do FDI.

c. Horizontal FDI

Investment in the same industry abroad as a firm operates in at home.

28


d. Vertical FDI

Backward Vertical FDI

Where an industry abroad provides inputs for a firm's domestic production process.

Forward Vertical FDI

Where an industry abroad sells the outputs of a firm's domestic production.

3. BY MOTIVE

FDI can also be categorized based on the motive behind the investment from the

perspective of the investing firm:

a) Resource-Seeking

Investments which seek to acquire factors of production that are more efficient than

those obtainable in the home economy of the firm. In some cases, these resources

may not be available in the home economy at all (e.g. cheap labour and natural

resources).

b) Market-Seeking

Investments which aim at either penetrating new markets or maintaining existing

ones. FDI of this kind may also be employed as defensive strategy; it is argued that

businesses are more likely to be pushed towards this type of investment out of fear

of losing a market rather than discovering a new one. This type of FDI can be

characterized by the foreign Mergers and Acquisitions in the 1980’s Accounting,

Advertising and Law firms.

c) Efficiency-Seeking

Investments which firms hope will increase their efficiency by exploiting the benefits

of economies of scale and scope, and also those of common ownership. It is

29


suggested that this type of FDI comes after either resource or market seeking

investments have been realized, with the expectation that it further increases the

profitability of the firm. Typically, this type of FDI is mostly widely practiced between

developed economies; especially those within closely integrated markets.

d) Strategic-Asset-Seeking

A tactical investment to prevent the loss of resource to a competitor. Easily

compared to that of the oil producers, whom may not need the oil at present, but look

to prevent their competitors from having it.

OTHER TYPES OF FDI:

1. WHOLLY OWNED SUBSIDIARY:

A Wholly Owned Subsidiary is an entity that is controlled completely by another

entity. The controlled entity is called a company, corporation, or limited liability

company, and the controlling entity is called its parent (or the parent company). The

reason for this distinction is that an individual cannot be a subsidiary of any

organization; only an entity representing a legal fiction as a separate entity can be a

subsidiary. While individuals have the capacity to act on their own initiative, a

business entity can only act through its directors, officers and employees. The most

common example of a wholly owned subsidiary in India is LG that was set up in 1997

as LG EIL (LG Electronics India Ltd.)

Sectors for FDI up to 100% in form of wholly owned subsidiaries:

Most manufacturing activities, Non-banking financial services, Drugs and

pharmaceuticals, Food processing, Electronic hardware, Health related & social

services, etc.

2. JOINT VENTURES:

A large number of recent foreign investments in most countries are associated with

joint venturing with local entrepreneurs. Joint Venture is coming together of two or

more corporations to form a new corporation. The classic example in case of India

30


context is the JV between ICICI Prudential Life Insurance : ICICI Prudential Life

Insurance Company is a joint venture between ICICI Bank - one of India's foremost

financial services companies - and Prudential plc - a leading international financial

services group.

Sectors for FDI in form of Joint Ventures:

Insurance Industry, Car industry, etc.

TYPE OF FDI IN INDIAN INSURANCE INDUSTRY:

JOINT VENTURES:

In certain sectors having a joint venture (JV) is a must for making an entry into

India as 100% investment is not allowed in these sectors.

Insurance is such type of sector in India.

JV offer a low risk option to entering a newer market like India.

JV provides the partners an opportunity to leverage their core strengths.

Most private insurers in India are through Joint Ventures.

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ADVANTAGES OF JOINT - VENTURE:

maximizing profit while minimizing risk

Limited liability

Market Penetration

sharing of resources

allowing host country to gain technology and create jobs

circumventing trade barriers

local Partner’s Expertise and Experience

local partner's political connections

DISADVANTAGES OF JOINT – VENTURE:

conflict with partner

sharing of profit

loss of control

difficulty in terminating relationship

VITAL CONSIDERATIONS FOR JOINT - VENTURE :

Choice of Joint Venture Partner

Clearly defined agreement

Terms of the Shareholders’ Agreement

Share Transfer Restriction

Non-disclosure of confidential information post termination

FOREIGN ENTRANTS / JOINT – VENTURES IN INDIAN INSURANCE:

LIST OF PRIVATE COMPANIES IN GENERAL INSURANCE:

Name of the Private General Insurance Company

Per cent of Foreign Equity

Name of the Foreign partner

32


Royal Sundaram Alliance Insurance Co. Ltd 26 Royal Sun Alliance

Reliance General Insurance Co. Ltd Nil

IFFCO-Tokio General Insurance Co. Ltd 26 Tokio Marine

Tata-AIG General Insurance Co. Ltd 26 AIG

Bajaj Allianz General Insurance Co. Ltd 26 Allianz

ICICI Lombard General Insurance Co. Ltd 26 Lombard

Cholamandalam General Insurance Co. Ltd Nil

HDFC-CHUBB General Insurance Co. Ltd 26 CHUBB

FOREIGN ENTRANTS / JOINT – VENTURES IN INDIAN INSURANCE:

LIST OF PRIVATE COMPANIES IN LIFE INSURANCE:

Name of the Private Life Insurance Company Per cent of Foreign Equity

Name of the Foreign partner

Allianz Bajaj Life Insurance Co. Ltd. 26 Allianz

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Birla Sun Life Insurance Co. Ltd. 26 Sunlife

HDFC Standard Life Insurance Co. Ltd. 18.60 Standard Life

ICICI Prudential Life Insurance Co. Ltd. 26 Prudential

ING Vysya Life Insurance Co. Ltd. 26 ING

Max New York Life Insurance Co. Ltd. 26 New York Life

MetLife India Insurance Co. Ltd. 25.99 Metlife

Om Kotak Mahindra Life Insurance Co. Ltd. 26 Old Mutual

SBI Life Insurance Co. Ltd. 26 Cardiff

Tata-AIG Life Insurance Co. Ltd. 26 AIG

AMP Sanmar Life Insurance Co. Ltd. 26 Sanmar Life Insurance Co.

Dabur-CGU Life Insurance Co. Ltd. 26 CGU Life Assurance Company

ENTRY ROUTES FOR FOREIGN DIRECT INVESTMENT (FDI) IN INDIA:

INVESTING IN INDIA – ENTRY ROUTES:

34


1) AUTOMATIC ROUTE: No prior Government approval is required if the investment

to be made falls within the sectoral caps specified for the listed activities. Only filings

have to be made by the Indian company with the concerned regional office of the

Reserve Bank of India (“RBI”) within 30 days of receipt of remittance and within 30

days of issuance of shares

The Entry Process: Automatic Route

All items/activities for FDI investment up to 100% fall under the Automatic Route

except the following:

o All proposals that require an Industrial License.

o All proposals in which the foreign collaborator has a previous venture/ tie up in

India

o All proposals relating to acquisition of existing shares in an existing Indian

Company by a foreign investor.

o All proposals falling outside notified sectoral policy/ caps or under sectors in

which FDI is not permitted.

2) PRIOR PERMISSION:

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FIPB ROUTE: Investment proposals falling outside the automatic route would

require prior Government approval. Foreign Investment requiring

Government approvals are considered and approved by the Foreign

Investment Promotion Board (“FIPB”). Decision of the FIPB usually

conveyed in 4-6 weeks. Thereafter, filings have to be made by the Indian

company with the RBI.

FIPB Approval

o For all activities, which are not covered under the Automatic Route

o Composite approvals involving foreign investment/ foreign technical

collaboration

o Published Transparent Guidelines vs. Earlier Case by Case Approach

CCFI ROUTE: Investment proposals falling outside the automatic route and

having a project cost of Rs. 6,000 million or more would require prior approval

of Cabinet Committee of Foreign Investment (“CCFI”). Decision of CCFI

usually conveyed in 8-10 weeks. Thereafter, filings have to be made by the

Indian company with the RBI.

o Investment proposals falling within the automatic route and having a project

cost of Rs. 6,000 million or more do not require to be approved by CCFI

SERVICES SECTOR WITH 100% FDI UNDER AUTOMATIC ROUTE:

Advertising and films, Computer related services, Research and development

services, Construction and related engineering services, Pollution control and

Management services, Urban Planning and Landscape services, Architectural

services, Health related and social services, Travel related services, Road transport

services, Maritime transport services, Internal waterways transport services

SERVICE SECTORS WITH RESTRICTIONS ON FDI:

Sectors with limits on FDI Caps

Private Banking (49%)

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Insurance (26%)

Domestic Airlines (40%)

Basic and mobile services (49%)

Print Media (26%)

Defence production (26%)

SECTORS WHERE FDI IS PROHIBITED:

Gambling, betting, lottery; Retail Trade; Agriculture Plantation, except tea plantation

ENTRY ROUTES FOR FDI IN INDIAN INSURANCE SECTOR:

FDI up to 26% allowed on the automatic route

37


However, license from the Insurance Regulatory & Development Authority

(IRDA) has to be obtained

There is a proposal to increase this limit to 49%

In the insurance industry, foreign investment was first permitted in 2000, with the

lifting of the Indian state-owned insurance company’s monopoly, allowing

competition from both domestic and foreign-owned private firms. During the 2000–01

fiscal year, 16 privately owned firms entered the Indian market, most as 26 percent

joint ventures between globally competitive foreign insurers and Indian firms.

FDI REGULATION IN INDIA:

38


Although Indian business regulation principally falls under the jurisdiction of federal

law, state governments are empowered to design and regulate their own FDI

policies. Consequently, the regulatory burden on foreign investors tends to be higher

at the state level where application and approval procedures can vary widely across

states. Moreover, FDI projects already approved at the central government level tend

to bottleneck as they proceed since nearly 70 percent of the approvals and

applications needed for eventual FDI implementation are obtained from state

governments. State-level impediments to FDI can be severe, to the point that

companies have been known to abandon FDI projects mid-way through

implementation due to issues such as onerous zoning, land-use, and environmental

regulations.

In addition to difficult compliance procedures, such as the example mentioned,

regulatory burden can take other forms in India. These can include long delays in

getting new connections from public sector utilities, frequent visits by government

inspectors, and the payment of bribes to avoid bureaucratic red tape. As a result, the

federal government has made efforts to establish independent regulators in sectors

such as insurance (IRDA), telecommunications and securities (SEBI) in order to

streamline supervision below the federal level.

Many economists in the country have now realized the advantages of FDI to India.

While the achievements of the Indian government are to be lauded, a willingness to

attract FDI has resulted in what could be termed an “FDI Industry”. While

researching the economic reforms on FDI, it was discovered that there exists a

plethora of boards, committees, and agencies that have been constituted to ease the

flow of FDI. A call to one agency about their mandate and scope usually results in

the quintessential response to call someone else. Reports from FICCI and the

Planning Commission place investor confidence and satisfaction at an all time high;

citizens too deserve to be clued in on the government bodies are doing.

The four major bodies that have been constituted and could provide data pertaining

to FDI are:

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1991 FOREIGN INVESTMENT PROMOTION BOARD (FIPB):

Consider and recommend Foreign Direct Investment (FDI) proposals, which do not

come under the automatic route. It is chaired by Secretary Industry (Department of

Industrial Policy & Promotion).

1996 FOREIGN INVESTMENT PROMOTION COUNCIL (FIPC):

Constituted under the chairmanship of Chairman ICICI, to undertake vigorous

investment promotion and marketing activities. The Presidents of the three apex

business associations such as ASSOCHAM, CII and FICCI are members of the

Council.

1999 FOREIGN INVESTMENT IMPLEMENTATION AUTHORITY (FIIA):

Functions for assisting the FDI approval holders in obtaining various approvals and

resolving their operational difficulties. FIIA has been interacting periodically with the

FDI approval holders and following up their difficulties for resolution with the

concerned Administrative Ministries and State Governments.

2004 INVESTMENT COMMISSION:

Headed by Ratan Tata, this commission seeks meetings and visits industrial groups

and houses in India and large companies abroad in sectors where there was dire

need for investment.

INSURANCE REGULATORY AND DEVELOPMENT AUTHORITY (IRDA):

FDI in Indian Insurance is allowed up to 26% through automatic route. However,

license from IRDA has to be obtained as IRDA being apex regulating institution for

Insurance Sector in India.

FOREIGN DIRECT INVESTMENT POLICIES:

40


Foreign direct investment (FDI) has become a key battleground for emerging markets and some developed countries. Government-level policies are needed to enable FDI inflows and maximize their returns for both investors and recipient countries.

Foreign direct investment (FDI) policies play a major role in the economic growth of developing countries around the world. Attracting FDI inflows with conductive policies has therefore become a key battleground in the emerging markets.

Developed countries also seek to bring in more FDI and use various policies and incentives to attract overseas investors, particularly for capital-intensive industries and advanced technology.

The primary aim of these policies is to create a friendly business environment where foreign investors feel comfortable with the legal and financial framework of the country, and have the potential to reap profits from economically viable businesses. The prospect of new growth opportunities and outsized profits encourages large capital inflows across a range of industry and opportunity types.

Investors tend to look for predictable environments where they understand how decision-making processes work. Governments therefore are incentivized to build up a track record of rational decision making. The business environment often requires work to remove onerous regulations, reduce corruption and encourage transparency. Governments often also seek to improve their domestic infrastructure to meet the operational needs of investors.

Providing fiscal incentives for attracting FDI is a subject of controversy – analysts have argued both in favor and against the idea. A general consensus is developing in favor of certain incentives which have been proven historically to grow profits and therefore foreign investments.

When policies are effective, significant FDI investments are injected into countries that help the domestic economy to grow. Different countries and regions offer various kinds of fiscal incentives, with a related variance in the level of FDI investments attracted.

Governments are increasingly setting up promotional agencies to foster foreign direct investment. These agencies promote FDI-friendly policies, identify prospective sectors and investors, and structure specific deals and incentives for major foreign investors such as multi-national corporations (MNCs).

Global trade associations also play a major role in some of these investment activities. These associations are tasked with creating a positive environment for foreign direct investors and ensuring that both investors and recipient countries enjoy a favorable environment.

The formation of human capital is vital for the continued growth of FDI inflows. To enable the most beneficial, technology and IP-driven FDI, highly skilled personnel are necessary. Governments must therefore enact policies to provide training and

41


skills upgrading to develop their workforce and meet the employment needs of foreign investors.

A GOVERNMENT KEEN TO ENSURE FDI SHOULD FOLLOW THE FOLLOWING

POINTS:

Clear the way for free entry and exit in domestic markets by creating

competition in products, services and labor markets and incentives to upgrade

productivity and to prevent exploitation of consumers, employees and

workers.

Promote education, employee training, and infra

Structure to increase domestic capacity to absorb and diffuse good new

practices introduced by foreign investors.

Create a policy framework that encourages the adoption of appropriate social

and environmental standards in corporate practices.

INSURANCE AND STEPS TAKEN BY GOVERNMENT TO PROMOTE

INSURANCE SECTOR:

The Indian Insurance sector is having a dream run. Today people have become very

conscious about their future and so they are spending nearly 6 times on life

insurance than they did before. The number of life insurance policies in India is the

largest in the world and this sector contributes nearly 4 % in the GDP. The Indian

insurance companies recorded a growth nearly 20% in premium in dollar terms,

compared to the world market growth rate 0f only 3%.

According to a study, the life insurance market premiums is like to be around

US$100 billion by 2012, and its contribution to GDP is likely to rise by 6%. The

general Insurance Company has also grown to nearly 12% in 2007. Meanwhile the

government has also taken few measures to boost this industry. Some of such

measures are:

FDI up to 26% has been permitted.

Some state governments have also taken the initiatives to promote this

sector. The government of Andhra Pradesh has decided to issue health cards

42


to 18 million people living below poverty lines. As a result nearly 60 million

people of the state will have insurance cover.

INSURANCE SECTOR RECOMMENDATIONS:

There is scope for greater FDI inflow in the insurance sector if the cap of 26 per cent

foreign equity is raised. The experience of opening up of this sector to FDI has set at

rest the fears that were expressed earlier regarding the effect of such opening. The

public insurance monopolies have responded to private entry by trying to increase

their efficiency and effectiveness. This process would be enhanced and sustained by

more effective competition. The regulatory system is in place and the Insurance

Regulatory Authority (IRDA) is functioning effectively. Therefore, the present

scenario highlights that foreign equity cap can now be raised to 49 per cent.

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INDIA’S FEATURES AS A HOST COUNTRY FOR FDI:

FACTORS AFFECTING FDI IN INDIA:

Rate of interest

Speculation

Profitability

Costs of production

Economic conditions

Government policies

Political factors

WHAT ARE FOREIGN INVESTORS LOOKING FOR?

Good projects

Demand Potential

Revenue Potential

Stable Policy Environment / Political Commitment

Optimal Risk Allocation Framework

ADVANTAGES INDIA HAS TO OFFER:

Stable democratic environment over 60 years of independence

Large and growing market

World class scientific, technical and managerial manpower

Cost-effective and highly skilled labour

Abundance of natural resources

Large English speaking population

Well-established legal system with independent judiciary

Developed banking system and vibrant capital market

Well developed accountancy, legal, actuarial and consultancy profession

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INDIA – LAND OF OPPORTUNITIES:

STRONG MACRO-ECONOMIC PERFORMANCE:

Sustained Economic growth;

o 7% - Current Year

o 8% - decade

o Over 6% - Next 50 Years – Goldman Sachs

Exports growth - over 19 % in 2002-03;

Non Oil imports growing at 31%-Economic vibrancy

Positive balance of trade with USA and China

FII Investment – over US$ 5 billion so far this year

Developed Banking system moving rapidly towards ICT integrated core

banking/net banking

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Mature Capital Market – NSE third largest, BSE fifth largest in terms of

number of trades

ECONOMIC LIBERALIZATION IN INDIA:

1. FISCAL POLICY REFORMS :

a. Stable tax regime with just 3 rates for both Excise as well as Customs

duties

b. Full National treatment for foreign Cos. incorporated in India

2. INDUSTRIAL POLICY REFORMS :

a. Capacity licensing dispense with

b. Compulsory licensing only in 6 sectors: restrictions on grounds of

national security, public health, public safety

c. FDI policy being progressively liberalized

3. TRADE POLICY REFORMS :

a. Most items on Open General License, Quantitative Restrictions lifted;

4. MONETARY POLICY AND FINANCIAL SECTOR REFORMS :

a. Interest rates brought down – Bank rate/Prime lending rate lowered

b. Banking Sector reforms – prudential norms stiffened

c. Securatization Act for better security for creditors

d. Competition law enacted. Competition Commission constituted

e. Independent regulators in place for Insurance sector (IRDA) and

Capital Markets (SEBI)

5. EXCHANGE CONTROLS RELAXED;

a. Profits and dividends can be freely repatriated.

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FDI FEATURES:

OPENNESS Largely automatic;

small negative list;

FDI in most sectors;

uniform application of policy;

ownership restriction in a few sectors;

no min. cap in most sectors;

freely repatriable;

M&A policy considered restrictive

FDI LEGISLATION Covered under Foreign Exchange Management

Act (FEMA)

TECHNOLOGY

COLLABORATION

Most liberal (rated No.1 in terms of ease of

licensing)

EMPOWERED BODY Foreign Investment Promotion Board (Small set

to service FIPB)

Rated as the best BPO destination.

Best technology licensing regime

Rated among the most favourite investment destinations.

Major destination for foreign venture capital funds.

Sixth most attractive investment destination.

Also among the top 10 Tourist Destinations.

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INSURANCE:

FDI up to 26% allowed on the automatic route

However, license from the Insurance Regulatory & Development Authority

(IRDA) has to be obtained

There is a proposal to increase this limit to 49%

INDIA - THE BACK OFFICE HUB:

India has become the most preferred destination – Outsourcing trend

increasing

o GE,TI, Intel, CISCO, Microsoft, Dell, Sun Micro, Oracle, LG, Ford, American

Express and other financial sector companies.

Customer needs are being met

o Large pool of skilled English speaking workforce – skills and scalability, 24x7

support

o Productivity and quality enhancement

o Conducive policy environment and Government support

o Highly improved telecom infrastructure

o Call center career is aspirational unlike a low choice in the West

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WHY DOES INDIA ATTRACT MAXIMUM FDI INFLOWS?

India is potentially active in terms of investments and provides a galore of

opportunities to the foreign players into the market. Foreign companies who aspire to

become a global player would grab the opportunities, India provides in terms of

investments. The foreign companies enjoy the rights to set up branch offices,

representative offices, and also carry out outsourcing activities in terms of various

developmental programmes in India. All these have opened up innumerable options

for the foreign investors to expand their businesses at a global level. This is clearly

noticeable from below presented graph showing FDI flows in India:

49


BUSINESS COMPLAINTS:

Excessive government interference

High tariffs and excessive indirect taxes

Differential tax rates for foreign companies

Restrictions on foreign investment

Substandard Infrastructure

Questions about sanctionity of contract

Weak enforcement of intellectual property

rights

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ADVANTAGES AND DISADVANTAGES OF FDI:

This is a very subjective question. It will depend on the country that is being invested

in, the industry where the investment is being made, the firm that is making the

investment and amount of investment that is being made.

1. FOR HOME COUNTRY / FOREIGN INVESTORS:

ADVANTAGES:

The advantages of the Foreign Direct Investments are that the majority victorious

domestic companies, particularly those with only one of its kind compensation,

spend abroad. The second advantage to be considered to be is the direct investment

that makes companies more victorious internally. Companies with Foreign

investment generally tend to be most profitable as well as it is to have a more stable

sales and earnings.

Jumping the tariff wall (and other non- tariff barriers)

Securing access to minerals and other resources located in the host country

Lower wage in host developing countries for labour.

Protection of market shares in exports if MNC's competitors also have

established plants in the area.

DISADVANTAGES:

The disadvantages of foreign direct investments are cost of travel and

communications abroad. It also does not very much relate to local business tax laws,

business atmosphere in particular and other government regulations. Another

disadvantage could be the language and culture differences.

More costly travel/communications abroad.

51





Not having a close familiarity with local business tax laws, business scene in

general, and various government regulations.

The MNCs face risks such as exchange rate changes, expropriation by the

government, and other actions that can be taken against them.

Language and culture differences

Higher wages/benefits must be paid to the personnel going abroad.

2. FOR THE HOST COUNTRY / INDIA:

ADVANTAGES :

The pros of foreign direct investment are the flow of cash into the country. It will

obviously stimulate economic activity in the country. Employment numbers will go

up. Existing domestic producers will have to pull up their socks due to the onset of

high quality competition. The international community will sit up and take notice. The

Government will be taken seriously in the international summits because the number

of stakeholders in the country has increased.

Increased productivity: due to technology transfer or due to improved

managerial, technical skills.

Employment will increase in the host country.

Possibility of earning foreign exchange with sale/export of FDI produced

goods abroad (generally, foreign investors may help introduce and integrate

the economy of the host country in to the global market place).

Weakening the power of domestic monopolies at home.

causes a flow of money into the economy which stimulates economic activity

it may give domestic producers an incentive to become more efficient

the government of the country experiencing increasing levels of FDI will have

a greater voice at international summits as their country will have more

stakeholders in it

DISADVANTAGES:

52



The cons of foreign direct investment are most visible in cases where the industry

could have national secrets. The defense sector could be at risk if it allows FDI.

Foreign policies may be enforced that do not go down well with domestic employees.

Some MNCs are larger/more powerful than the countries they invest in

The danger of a foreign monopoly power.

Only low level skill development in the host country.

Profits of MNCs are repatriated.

Inflation may increase slightly

Domestic firms may suffer if they are relatively uncompetitive

If there is a lot of FDI into one industry e.g. the automotive industry then a

country can become too dependent on it and it may turn into a risk that is why

countries like the Czech Republic are "seeking to attract high value-added

services such as research and development (e.g.) biotechnology)"

ADVANTAGES OF FDI IN INDIAN INSURANCE:

Attracting foreign direct investment has become an integral part of the economic

development strategies for India. FDI ensures a huge amount of domestic capital,

production level, and employment opportunities in the developing countries, which is

a major step towards the economic growth of the country. The incorporation of a

range of well-composed and relevant policies will boost up the profit ratio from

Foreign Direct Investment higher. Some of the biggest advantages of FDI enjoyed by

India have been listed as under:

Economic growth:

This is one of the major sectors, which is enormously benefited from foreign direct

investment. A remarkable inflow of FDI in various insurance companies in India has

boosted the economic life of the country.

More job opportunities

Opening of the insurance sector to the foreign investors has led to a renaissance in

the Indian economy. Job opportunities show bright signals. The people working in

53




insurance sector in India are approximately the same as in the UK, which is 1/7th of

Indian population. There is the new concept of 'bancassurance' that has paved the

way for more job opportunities in the financial sector. There is a growing demand for

specialists in the area of marketing, finance and human resource management apart

from the demand for technical expertise from professionals in underwriting and

claims management subjects.

Inflow of foreign capital

There has been a huge inflow of funds into the country with foreign capital splurging

in the Indian insurance companies as startup capital.

Indigenous reinsurance

Even the reinsurance sector looks for magnificence with global players like Swiss

and Munich Re keen on entering into insurance in India.

The technology transfer

Apart from the above monetary aspects there would also be revolution in the transfer

of technologies and knowledge from the global participants in the fields of training,

risk management, underwriting, introduction of new policies etc.

With more participants in the market, there has been a healthy competition with

increased advertisement expenditure for brand building. There would be scientific

pricing methods.

Linkages and spillover to domestic firms:

Various foreign firms are now occupying a position in the Indian market through Joint

Ventures and collaboration concerns. The maximum amount of the profits gained by

the foreign firms through these joint ventures is spent on the Indian market.

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55


56


EMERGING TRENDS IN INSURANCE DUE TO FDI (POSITIVE IMPACTS OF FDI):

Insurance is one sector whose contribution to GDP has been quite significant. Post

independence, the Indian Government nationalized the private life insurance

companies with a view to raise funds for the infrastructure developments, which

lagged behind pathetically. The scatter of general insurance companies was brought

under one umbrella - the General Insurance Company in 1972.

Nationalization, however, brought with it the public sector bureaucracies,

cumbersome procedures and inefficiencies but still these nationalized companies

managed to have millions of policyholders, who had no other options.

While the early 90s brought forth liberalization on all major economic fronts, the

insurance was left untouched. But before long, the passage of IRDA bill in 1999

paved the way for the liberalization of Indian insurance sector.

Why open door policy became inevitable

57

During the last three decades, global insurance penetration as a percentage of the gross domestic product has more than doubled from around 3.5 per cent in 1970. The insurance sector thus has grown more strongly than the overall economy. Insurance is one sector whose contribution to GDP has been quite.


The insurance premium in India accounted for a mere 2 per cent of GDP as against

the world average of 7.8% during 90s. The insurance premium as a percentage of

savings in India is 5.95% as compared to 52.5% in UK. The nationalized insurance

companies could barely unearth the vast potential of the Indian population since the

policies lacked flexibility and the Indian life insurance products were not linked to the

contemporary investment avenues. However, Claim settlement ratio of LIC stood at

95% and GIC at 74% which was much higher than the global average of 40%.

THE CHALLENGES BEFORE INSURANCE INDUSTRY:

But the other side of the coin, say observers, gives a low picture. Large-scale

operations and bureaucracies entangled in the public sector companies were the

main areas of concern of the nationalized insurers. The state owned insurance

companies, experts say, have not shown much initiative to venture into the rural

areas to sell crop insurance or any other personal insurance.

Insurance majors are yet to venture deep into the rural areas. Other areas,

which require in-depth study, are the pension segment and health insurance.

More liberalized actions are needed not only to drive the Indian economy

towards an annual growth rate of 7% to 8% but also to sustain the growth.

A faster growth would attract foreign direct investment (FDI) inflow of $10

billion every year as against the current FDI in the range of 3 billion.

58

An insurance area whichrequires an in-depth study, is the pension segment. Indian demand for pension products is huge, keeping in mind the lack of comprehensive socialsecurity system.


A Report on Infrastructure points out that 85% of investible funds for infrastructure

have to be generated indigenously and the study revealed that India would require

$100 billion over the next five years to meet its infrastructure needs.

Given the saving scenario in India, there is much more growth potential and the

liberalized insurance sector is likely to mobilize the long-term funds for infrastructural

investments.

Multinational insurers are keenly watching the transformation of Indian insurance

sector, mainly because the domestic markets have become saturated for the

respective insurers. International insurers capture a significant part of their business

from their multinational operations only. UK' largest life and non-life insurers acquired

40% to 60% of their total premium from their multinational operations. The foreign

investors are finding the Indian market more attractive because even a small share

of a growing market looks lucrative. For examples, the Korean insurance market, the

30th largest market in the world premium volume in 1971 obtained the 6th position in

1996, the reason being its multinational operations.

Global investors prefer Indian insurance markets

The other reason as to why the global insurers are interested in investing their funds

is the nature of the operations over a wide geographical area would eliminate

sudden dips in earnings due to the unexpected risk spread.

A report presented by the world's second largest reinsurer Swiss Re on global

insurance, reports complete saturation of international market.

59


Foreign investors are finding Indian market more attractive because even a

small share of a growing market looks lucrative.

Os

GLOBAL INSURANCE COMPANIES OPT FOR INDIAN BPOs:

The Associated Chambers of Commerce and Industry of India had recently

conducted a research on the BPO activities in India and reported 15% annual growth

for indigenous BPO demand. The report also revealed that the BPO industry is

growing at an astounding rate of 70% per annum with employment opportunities to

over 100,000 people.

By 2009, the BPO is estimated to employ one million people with a revenue flow of

$17 billion.

INSURANCE SECTOR FLOWS IT BPOs FOR CLIENT SERVICING:

The Insurance sector thus is in the process of outsourcing business opportunities.

Insurance sector find more potential for outsourcing business operations owing to

the nature of voluminous transactions like claims processing, loan processing and

customer servicing. Insurance companies with large volumes and repetitive

transactions around the world are working towards lowering the cost and upgrading

the service quality to their customers and business partners.

INSURANCE BPOS AND INDIA:

60

Private insurers have already proved their success by way of performance during last financial year by way of more than 70% growth in the premium income.


Working towards an effective cost control management, the insurance companies

are on the lookout for outsourcing the service agencies for the purpose. All the

related activities such as new business prospects, policy administration, claims

management and customer service are carried out by the BPOs.

The insurance sector is no exception to BPOs.

T

CHANGING PATTERNS OF INSURANCE AND TECHNOLOGY:

The insurance industry has assimilated a number of changes since the last few

years. All these changes were the result of certain clearly noticeable external

influences. For one, the changing socio-economic and political scenario formed the

perfect setting for these developments to take shape. The worldwide trend

towards convergence, consolidation and globalization had its impact on the

insurance industry as well. Fast changing technology, new and widening

patterns of distribution and the changing profile of the customer were

powerful drivers of change. The growing trend towards deregulation in many

Asian countries further increased the pace of change.

61

Norwich Union, the UK insurance company already has BPOs set up in

New Delhi and Bangalore or processing general insurance claims. Aviva

operates in India with 1200 employees. The time difference between

Greenwich and India provides scope for the India operations to work round

the clock, 365 days. Aviva has 350 centers for servicing the British

customers. 2000 employees are engaged in back office functions and for

handling British insurance claims.


Investors worldwide are keeping their fingers crossed as they make strategies,

hoping the Government will announce increase in FDIs (26% to 49%) in Indian

Insurance companies.

LOOKING BEYOND CONVERGENCE AND GLOBALIZATION:

All this time the insurers strongly believed that size matters as it was perceived as

the key to market domination and lower costs. It was soon clear that in the globalised

environment to industrial group will have the kind of capital required for global

domination and no single group can emerge a winner of all business sectors.

BRAND BUILDING BY INSURERS:

In a marked departure from the past financial services, organizations are now

focusing on brand building.

This is on account of the realization that we now live in a lifestyle society in which the

brand image is as important as the product. Global insurance majors like Allianz,

AXA and ING have already done much in this direction and are building awareness

about their brands.

It is now a major challenge for the domestic brands, who have to build a global brand

before the global majors take over.

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SHAREHOLDER VALUE:

In the past, insurers were giving more importance to maintenance of their solvency

margin rather than making profits. American and European insurers now find its

approach difficult, when they have to compete for capital with companies engaged in

other industries. So the emphasis is shifting now to shareholder value and return

through better capital management. Insurance companies like Swiss Re and Chubb

have proved highly successful in increasing shareholder value.

FURTHER SCENARIO:

Global players with strong brands in the insurance industry today set up their back

office operation in low cost countries, manage capital on a global basis, make use of

their special skills worldwide and use their superior managerial ability to secure

leadership positions in the industry. Such companies find opportunities for growth in

Asian countries like India where they may soon have to compete with global Asian

majors in the industry.

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In this fast developing scenario it will not be enough if the companies have futuristic strategies. Implementation of the strategies, effectively adapting them to ongoing changes can spell success.


GOVT. PROPOSAL TO LIFT FDI CAP TO 49% IN INDIAN INSURANCE:

The Indian government has proposed to increase FDI in the insurance sector to

49%. Currently, only up to 26% FDI is allowed in the Indian insurance sector under

the automatic route subject to obtaining a license from Insurance Regulatory

Development Authority (IRDA). According to “Booming Insurance Market in India

(2008-2011)”, a recent report from RNCOS, the Indian insurance market, particularly

life insurance sector, will get a strong boost from the proposed FDI hike. Increasing

limit to 49% is expected to raise the FDI in life insurance sector by around 2.5 times

from the present level of approx Rs 2,500 Crore.

The senior insurance industry analyst at RNCOS opined, “The proposed increase in

FDI will attract more foreign inflow into the Indian economy and strengthen the

country’s insurance industry. This increase (in FDI) will bring more capital and help

the sector in maintaining the growth momentum. The insurance sector has been in

strong need of the capital investment, in fact, the requirement has increased

dramatically due to recent losses on unit-linked products with weak stock market.

Also, being a capital intensive sector, the insurance sector requires huge

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investments over a prolonged period of time, and therefore, there is constant need

for capital infusion that can be met through FDI.”

Increasing FDI limit will also encourage the insurance sector to come up with more

innovative distribution channels, enrich the current product portfolio, upgrade

technology, and bring best global practices into the country. Beside this, raising FDI

cap would also help insurers to expand their coverage to rural and micro-insurance

segments as penetration in rural and remote areas require additional capital infusion.

( NOTE: RNCOS, incorporated in the year 2002, is an industry research firm. It has a

team of industry experts who analyze data collected from credible sources. They

provide industry insights and analysis that helps corporations to take timely and

accurate business decision in today's globally competitive environment.)

IMPACT OF FDI AND LIBERALISATION ON T H E I N S U R A N C E S E C T O R

(NEGATIVE IMPACTS OF FDI)

(AS SUBMITTED BY THE LEFT PARTIES TO THE UPA)

The Finance Minister, while presenting the first Budget of the UPA government, has

proposed to raise the FDI cap in three sectors. Three sectors of the economy fully

meet this description. They are insurance, telecommunications and civil aviation.

The specific proposal for the insurance sector is to raise the FDI cap from 26 to 49

percent. The argument about this move is unjustifiable on several grounds.

PRIVATE PLAYERS, FOREIGN EQUITY AND PROFITABILITY:

The Union Government had opened up the insurance sector for private participation

in 1999, also allowing the private companies to have foreign equity up to 26 per cent.

Following the opening up of the insurance sector, 12 private sector companies have

entered the life insurance business. Apart from the HDFC, which has foreign equity

of 18.6%, all the other private companies have foreign equity of 26 per cent. In

general insurance 8 private companies have entered, 6 of which have foreign equity

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of 26 per cent. Among the private players in general insurance, Reliance and

Cholamandalam does not have any foreign equity.

The following table gives an aggregate picture of the current scenario of the

insurance sector in India.

Accord

ing to the Annual Report of the IRDA, 9 out of the 12 private companies in life

insurance suffered losses in 2006-07. The aggregate loss of the private life insurers

amounted to Rs. 38633 lakhs in contrast to the Rs.9620 crores surplus (after tax)

earned by the LIC. In general insurance, 4 out of the 8 private insurers suffered

losses in 2006-07, with the Reliance, a company with no foreign equity, emerging as

the most profitable player. In fact the 6 private players with foreign equity made an

aggregate loss of Rs. 294 lakhs. On the other hand the public sector insurers in

general insurance made aggregate after tax profits of Rs. 62570 lakhs. Not only are

the public sector insurance companies more profitable than the private ones, the

private insurer which is most profitable (Reliance) is one which has no foreign equity.

If profitability is taken to be an important indicator of efficiency, it is clear that the

case for further hike in the FDI cap in the insurance sector cannot be made on

efficiency grounds.

QUESTIONABLE REPUTATION OF THE FOREIGN PARTNERS:

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The record of some of the foreign companies who have started operating in India is

being questioned abroad. A recent article published in The Economist (May 4, 2006)

on ‘AIG’s Accounting Lessons’ (AIG is Tata’s partner in India) came with the

screaming headline which said it all: “The world’s largest insurance company shows

how to polish profits statement”.

The Prudential Financial Services (ICICI’s partner in India) is facing an enquiry by

the securities and insurance regulators in the U.S. based upon allegations of having

falsified documents and forged signatures and asking their clients to sign blank

forms (New York Times, May 31, 2006 and Wall Street Journal, May 31, 2006). This

follows a payment of $2.6 billion made by Prudential to settle a class-action lawsuit

attacking abusive life insurance sales practices in 1997 and a $ 65 million dollar fine

from state insurance regulators in 1996.

It is evident that the questionable activities of these insurance companies are not

prevented by state imposed penalties and litigations. The financial health of many of

the foreign insurance companies operating in India is also a cause of serious

concern. The Economist (April 1, 2006) reports the sorry plight of Standard Life of

UK (HDFC’s partner in India), which is unable to remain afloat without the possibility

of raising money in debt or equity markets. Royal Sun Alliance also shut down their

profitable businesses in 2002.

According to the Mercer Oliver Wyman Report the German, Swiss, French and

British insurers suffer from severe capital inadequacy, which is a result of

undertaking risky investments in equity and debt instruments in the past. Several

issues of Sigma, a reputed Swiss journal on insurance, have reported that the U.S.

and Europe based insurance companies are faced with gloomy growth prospects in

the advanced country markets, with several companies experiencing negative

growth in the recent past. Moreover, tighter capital adequacy norms and other

regulations that are currently being imposed in the advanced countries are forcing

these insurance companies to seek less regulated markets in developing countries

to undertake their high-risk ventures. Raising the FDI cap in India at this juncture

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would expose our financial markets to the dubious and speculative activities of the

foreign insurance companies at a time when the virtues of regulating such activities

are being rediscovered in the advanced countries.

COMPETITION IN THE INSURANCE SECTOR:

Even after the liberalisation of the insurance sector, the public sector

insurance companies have continued to dominate the insurance market,

enjoying over 90 per cent of the market share. In fact, the LIC, which is the only

public sector life insurer, enjoys over 98 per cent of the market share in Life

insurance.

Market Share of Life and Non – life Insurance sectors(as % of total premium underwritten by insurers)

Insurance Sector 2005-06 2006-07

Life Insurance Private Sector Public sector

0.54

99.46

1.99

98.01

General Insurance Private Sector Public sector

3.68

96.32

8.64

91.36

Source: IRDA Annual Report 2007 - 08

Given the huge market share enjoyed by the public sector companies, the argument,

which is often made by advocates of greater liberalisation, that the entry of private

players would bring down the cost of insurance due to enhanced competition, does

not seem to be convincing. The price making capacity of the market leaders in the

public sector is likely to remain intact for the time being. The foreign insurance

companies do have the reputation of charging less premium compared to the risks

involved and promising abnormally high returns, in order to grab greater market

share. Such competition, however, although capable of bringing down the

‘cost’ of insurance for a while, has often led to gigantic frauds and

bankruptcies.

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Moreover, as is the case in other markets, the initial flurry of entries into the Indian

insurance market would invariably be followed by a phase of mergers and

acquisitions that would lead to cartelization, precluding the possibility of competition

driving down the costs in the medium run. In the long run, other forms of non-price

competition like aggressive advertisement wars are likely to lead to increasing costs,

eventually harming the interests of the consumers. These phenomena in the

insurance market have been observed in several advanced countries. If the public

sector companies start imitating the strategies of the foreign insurance

companies in order to defend their market shares, it would be at the cost of

undermining their important social objectives, which they have been fulfilling

so impeccably till date.

IMPLICATIONS FOR RESOURCE MOBILISATION:

A major role played by the insurance sector is to mobilize national savings and

channelise them into investments in different sectors of the economy. However, no

significant change seems to have occurred as far as mobilizing savings by the

insurance sector is concerned, following the liberalisation of the insurance sector in

1999. Data from the RBI show that the trend of the savings in life insurance by the

households to GDP ratio, while showing a clear upward trend through the 1990s

signifying increasing business for the insurance sector, does not show any structural

break after 1999 (since liberalization) (see chart below). It can be inferred therefore

that the foreign capital which flowed in after the opening up of the insurance sector

has not been accompanied by any technological innovation in the insurance

business, which would have created greater dynamism in savings mobilization.

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95 96 97 98 99 2000 01 02 03

Years

Source: Handbook of Statistics, Reserve Bank of India

Far from expanding the market for the insurance sector, the business activities of the

private companies are limited in urban areas, where a fairly good market network of

the public sector insurance companies already exists. The glaring evidence for this is

the composition of agents operating in the insurance sector. According to the IRDA

Annual Report the number of insurance agents in urban and rural India was in

100:76 ratio in the public sector companies, in 2006-07. For the private

insurance companies this ratio was 100:1.4. Due to their urban-biased operational

activity, the private insurance companies can neither increase the insurance base of

the economy significantly, nor lead to substantial employment generation. Given this

scenario, further increase in foreign participation is only going to lead to intensified

competition for the urban insurance markets, rather than leading to a growth in

overall savings.

While the proposals for hike in FDI were placed, the arguments advanced were that

FDI will continue to be encouraged and actively sought, particularly in areas of

infrastructure, high technology and exports.

ARE THESE ARGUMENTS TENABLE?

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No new technology or product is brought into the country: The issue of foreign equity

is often linked with induction of new technology and products. The private insurance

companies have nothing to offer in this respect. In the insurance sector, there is

no technology needed to be brought in from other countries, leave alone high

technology. The mortality rates and other principles of insurance are based on the

Indian conditions, because the policyholders are from this country. The products of

LIC are being renamed by the private insurance companies and are sold as

their own products. Hence, foreign expertise is also not involved in this sector.

So there is no justification even on this count. It was also argued that competition will

expand market and the foreign insurers will bring better products. This has simply

not happened. The size of the market has remained by and large the same and

from this market the private companies are picking up the creamy sections in

the metros seriously eroding the ability of public sector to cross subsidizes its

products in the rural areas.

FLOW OF FUNDS FOR INFRASTRUCTURE A MYTH:

Life insurance is all about mobilising the savings for long term investment in social

and infrastructure sectors. It was also argued that opening up of insurance market

would enable huge flow of funds into infrastructure. The record of private companies

on this is dismal. More than fifty percent of the policies they sell are unit-linked

insurance where the decision on investment of savings element in insurance

is taken by the policyholders. In fact as per a press report, ninety five percent of

policies sold by Birla Sun Life and over 80 percent of policies sold by ICICI

Prudential were unit-linked policies during 2006-07. Under these schemes, nearly 50

percent of the funds are invested in equities thus limiting the fund availability for

infrastructural investments. As against this, the LIC has invested Rs.40, 000

crores as at 31.3.2007 in power generation, road transport, water supply,

housing and other social sector activities.

The Law Commission of India released a consultation paper on 16th June 2003 on

the revision of the Insurance Act, 1938. The consultation paper proposes a suitable

amendment to Section of 27C of Insurance Act allowing insurers especially carrying

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on general insurance business to invest funds outside India. So, once the law is

amended to allow insurers to invest funds abroad, the exports that these

private companies would generate, would be the export of savings of the

people.

Raising the FDI cap also does not seem justifiable as far as channelizing savings

into investments are concerned. The life insurance sector invested a total of Rs.

31335.89 crores in the infrastructure sector in 2006-07. Out of this the contribution of

the LIC was Rs. 30998.16 crores, which was 98.92 per cent of the total investment in

infrastructure by the entire life insurance sector. The figures provided by the IRDA

Reports further suggest that the share of the public sector life and non-life insurance

companies in investment in infrastructure is greater than their market share. Despite

the FDI cap being set at 26%, the investment from the insurance sector to the

infrastructure sector was predominantly from the public sector companies.

Therefore, the argument that raising the FDI cap in the insurance sector would

help in mobilizing resources for infrastructure does not hold.

It is also worth mentioning that the only insurance company involved in insuring

Indian exports is the Export Credit Guarantee Corporation of India, which provides

insurance cover to export credit. The ECGC has been in existence since 1957. It is

functioning under the United India Insurance Co. No private player with foreign

partnership has ventured into this area. Moreover, the LIC and other public sector

units are the only ones to undertake overseas operations, as reported by the Annual

Reports of the IRDA. Foreign participation has also not helped in marketing

Indian insurance products abroad.

CONCLUSION:

Governments of the advanced countries like the U.S. continue to apply pressure on

developing countries to open up their insurance sectors. China, for instance was

pressurized to open up its insurance sector, in return of its entry into the WTO.

However, the unilateral move to further liberalize the insurance sector in India is

unjustifiable. Events over the decade of the 1990s have borne out the fact that

financial liberalisation does not contribute positively to investment and economic

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growth. Countries which enthusiastically opened up their financial sectors in

order to attract capital inflows often experienced enhanced volatility in their

financial markets and speculative attacks on their currency.

Further opening up of the insurance sector to foreign capital, which serves as

a vital financial intermediary of the national economy, is therefore not

warranted.

CONCLUSION:

As evidenced by analysis and data the concept and material significance of FDI has

evolved from the shadows of shallow understanding to a proud show of force. The

government while serious in its efforts to induce growth in the economy and country

started with foreign investment in a haphazard manner. While it is accepted that the

government was under compulsion to liberalize cautiously, the understanding of

foreign investment was lacking. A sectoral analysis reveals that while FDI shows a

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gradual increase and has become a staple for success for India, the progress is

hollow. FDI has become a game of numbers where the justification for growth and

progress is the money that flows in and not the specific problems plaguing the

sectors like insurance.

On present projections, FDI flows are likely to remain only a small fraction of gross

capital formation in the Indian Insurance sector (only 26% FDI is allowed). Hence,

their potential contribution is not likely to be quantitative but qualitative. Foreign

investment is likely to be not an engine of growth but a catalyst for growth. If so, the

quality of foreign investments than quantity that enters the country matters. Some

insurance companies invest in India to benefit from better availability of human

resources, including the growing practices of outsourcing and off-shoring. Others are

attracted by the large market and the potential profits in that. Ideally, India would like

to attract efficiency-seeking FDI and exclude profit-seeking FDI, though from

practical or regulatory points of view, it is not easy to distinguish between the two

types of FDI.

FDI is a major source of technology transfer in a developing country like India.

Besides this, it has given boost to various developments in insurance sector. It has

created employment and increases competition in market. It has helped country

grow potentially and at a faster pace. India Insurance has observed the positive

effects of FDIs in the recent times. Major concerns are the policies which will help in

attracting more penetration in rural markets. Hence India should keep in mind all the

pros and cons of FDIs while deciding the policies, which will end up in country’s

future growth.

It is hard to deny that Indian industry needs fresh investment but the hope that

openness to FDI alone can achieve this is misplaced. With FDI accounting for only a

small fraction of gross capital formation in Indian Insurance, its direct contribution to

the growth rate be marginal in the near future. In the Indian context, growth-led FDI

is more likely than FDI-led growth. To that extent, foreign capital is neither necessary

nor sufficient for growth in India. Greater openness to foreign capital (there is a

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proposal to raise FDI cap from 26 to 49%) may be desirable but it does not

guarantee penetration into unexplored areas left by public insurers.

Thus the impact of liberalization and Foreign Direct Investment on the Indian

insurance sector and general economy presents a mixed picture. All of the key

players in insurance have tremendous responsibility to balance the varying priorities,

to enable a sustainable future. Foreign insurers should grasp this opportunity to

achieve best practices as a win-win situation for all concerned.

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foreign direct investment in insurance sector

Documents

impact of fdi

types of fdi type of

fdi policy

fdi policies41

fdi regulation

cases of fdi

direct investment enterprise

foreign direct investment