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CHAPTER - II
LIFE INSURANCE - BASICS AND GLOBAL TRENDS
2.1
DEFINITION OF RISK
Insurance essentially is an arrangement where many, who are exposed to similar
risk, share the losses experienced by a few. Insurance is a device for risk sharing and
risk transfer. When someone states that there is a risk in a particular situation, it means
that in the given situation there is an uncertainty about the outcome and the possibility
exists that the outcome will be unfavourable also. This loose intuitive notion of risk,
which implies a lack of knowledge about the future and the possibility of some adverse
consequence, is satisfactory for conventional usage, according to Vaughan, (2003). If
the outcome of an event can be predicted with certainty then there is no risk and the
existence of risk means that there are at least two possible outcomes of which one is
undesirable.
The term risk is variously defined as 1) the chance of loss 2) the possibility of
loss 3) uncertainty 4) the dispersion of actual from the expected results and 5) the
probability of any outcome different from the one expected. Vaughan, (2003) has defined
risk as a condition in which there is a possibility of an adverse deviation from a desired
outcome that is expected or hoped for. According to Rejda, (2004) risk is defined as
uncertainty concerning occurrence of a loss.
According to NIA Pune (Online learning), risk is said to exist if there is a
possibility of getting an outcome other than the one desired for and
a. It is a combination of circumstances in the external environment over which a
person has very little control.
b. The probability is between zero and one.
c. The extent of adverse outcome may not be measurable before risk takes place.
Although the terms peril and hazard are used interchangeably with each other
and also with risk, each of them is distinct. Peril is a cause of a loss. Fire and Hurricane
are classic examples of peril. On the other hand hazard is a condition that may create or
increase the probability of loss that arises out of a peril. Hazard can be classified as
Physical hazard, and Moral hazard
Physical hazard arises out of physical properties
that increase the chances of loss. For example storage of highly inflammable fluid
increases the probability of loss due to fire in a work place. Moral hazard refers to the
increase in loss arising out of dishonest behaviour or nondisclosure on the part of an
insured individual.
Moral hazard is present in all forms of insurance including life
insurance.
2.2
RISK CLASSIFICATION
Risk can be classified into several categories but considering the relevance to
insurance, it can be classified into
•
Fundamental and particular risk
•
Pure and speculative risk
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2.2.1
FUNDAMENTAL AND PARTICULAR RISK:
Fundamental risks are those that affect the entire economy or large numbers of
persons or groups within the economy (Rejda, 2004). Fundamental risks involve losses
that are impersonal in origin and consequence. The risk of natural disaster arising out of
hurricanes, earthquakes and floods is a fine example of fundamental risk that involves
losses to large groups. On the other hand, particular risks involve losses that arise out of
individual events and are felt by Individuals only. Particular risk is a risk that affects only
the individual and not the entire community. Risk arising out of car theft or fire in a
dwelling unit is an example of particular risk.
2.2.2
PURE AND SPECULATIVE RISK:
The term pure risk is used to designate those situations that involve only the
chance of loss or no loss. In a pure risk the possible outcomes are loss or no loss.
A
person buying a car has the risk of damage due to accident, fire or theft, where the
probable outcome of the risk is loss or no loss. Speculative risk describes a situation
where there is not only a possibility of loss but also a possibility of gain. Gambling is a
good example of speculative risk. The distinction between pure and speculative risks is
an important one, because normally only pure risks are insurable. Speculative risk is
voluntarily accepted because of its two dimensional nature, which includes the possibility
of gain. (Vaughan, 2003)
Not all pure risks are insurable, and a further distinction between insurable and
uninsurable pure risks may be also made. An uninsurable pure risk may also exist.
"War-risk exclusion" inserted by Life Insurance companies in times of war, exclusion of
terrorist attack cover to airlines after 9/11 are fine examples of uninsurable pure risks.
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Pure risk that exists for individuals and business firms can be classified as
personal risk, property risk, liability risk and risks arising from failure of others. Personal
risks are risks that directly affect an individual or his dependants. It consists of the
possibility of loss of income or reduction in financial assets as a result of the loss of the
ability to earn income. Premature death, dependent old age, sickness or disability and
unemployment/loss of employment are perils associated with personal risk. Personal
risk is the subject matter in life insurance business. The risk of having the property
damaged or lost from several causes leads to property risks for a property owner.
Liability risks arise out of unintentional injury to other persons or damage to their
property through negligence or carelessness. When a person’s failure to meet his
obligation may result in a financial loss for an individual and this risk arising out of the
person’s failure can be termed as risk arising from failure of others. (Rejda, 2004).
Risk causes financial loss to an individual or to the society at large or to both.
The financial loss can be a direct loss or a consequential loss. It is always prudent to
take appropriate steps or manage risk to reduce the impact of the risk or reduce or limit
the loss arising out of a risk.
2.3
RISK MANAGEMENT
According to Vaughan, (2003) risk management is a scientific approach to
dealing with pure risks by anticipating possible accidental losses and designing and
implementing procedures that minimize the occurrence of loss or the financial impact of
the losses that do occur.
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Risk can be managed by the following ways:
•
Risk avoidance
•
Risk retention
•
Risk reduction
•
Risk transfer
Risk avoidance has been described as a method of managing risk, which
involves ceasing to undertake the activity, which creates the risk, or performing it in
another way or at some other place (Insurance Institute of India). In risk retention, the
individual or business retains or owns all or part of the risk and has voluntarily or willingly
subjected himself or herself to the loss arising out of the risk. Risk reduction covers all
methods employed to reduce either the probability of loss producing events occurring or
the potential size of losses that do occur. Risk transfer can take the shape of physical
transfer, wherein the activity, which creates the risks, may be outsourced or contracted
out through a specialist. This method is called as non-insurance transfers or transfer of
risk by contract. Secondly through a contract the financial loss arising out of risk can be
transferred.
Insurance is the most preferred way of transferring the impact of risk.
Purchasing an insurance contract is a primary approach to risk transfer.
2.4
INSURANCE
Insurance is a complicate and intricate risk transfer mechanism and it has two
fundamental characteristics.
a) Transferring or shifting risk from individual to a group
b) Sharing losses, on some equitable basis, by all members of the group
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Insurance as a risk management tool is available only for pure risk. From the
point of view of the insurer, there are certain requirements to be fulfilled before the
insurance is provided and these requirements are normally known as elements of
insurability of risk
2.4.1
ELEMENTS OF INSURABLE RISK
Vaughan, (2003), lists the following as elements of insurable risk.
•
Presence of large number of exposure units
•
Loss produced must be definite and measurable
•
Loss must be accidental
•
Loss must not be catastrophic
There must be a sufficiently large number of homogeneous exposure units to
make the losses reasonably predictable. A large number of similar units exposed to the
risk help the insurer in estimating the probable loss in financial terms. The purpose of
this requirement is to enable the insurer to predict the loss on the law of large numbers.
The loss produced by the risk must be definite and measurable and it means that
the loss should be definite as to cause, time, place and amount. Life insurance in most
cases meets this requirement easily.
The loss must be fortuitous or accidental and unintentional. The loss should be
beyond the insured’s control. Loss must be the result of a contingency, that is, it must be
some thing that may or may not happen. There are two main reasons as to why the loss
must be accidental. Firstly if intentional losses were to be paid, moral hazard would
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substantially increase as a result of which premium would rise.
Secondly the loss
should be accidental because the law of large numbers is based on the random
occurrence of events. A deliberately caused loss is not a random event. This leads to
prediction of future experience highly inaccurate.
Rejda (2004) mentions that for insurance to work successfully the loss must not
be catastrophic and it means that a large proportion of the exposure units should not
incur losses at the same time. Pooling is the essence of insurance. If most or all the
exposure units in a certain class simultaneously incur a loss, then the pooling technique
breaks down and becomes unworkable.
Personal risks relate to the loss of ability to earn income and include premature
death, dependant old age, sickness or disability and unemployment. A well-designed risk
management program for an individual must take care of the biggest risk for self and
family that is the loss of income. The principal objective of managing personal risks is to
avoid the deprivation of the individual and those dependent on him or her in the event of
a loss that causes the termination of income. Achieving this objective generally means
making arrangements to replace the income that would be lost as a result of death,
retirement, disability or unemployment. Insurance is a common approach to replacing
such income.
2.5
DEFINITION OF INSURANCE – DIFFERENT PERSPECTIVES
Insurance, defined from the individual’s point of view, is an economic device
whereby the individual substitutes a small certain cost (the premium) for a large
uncertain financial loss (the contingency insured against) that would exist if it were not
for the insurance.
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INSURANCE – ECONOMIC AND LEGAL PERSPECTIVE
According to Life Insurance Underwriting (Online learning of NIA, Pune)
Insurance can be defined under two different perspectives, economic and legal.
Economic Perspective – Insurance is a financial intermediation function by
which individuals exposed to a specified contingency each contribute to a pool from
which covered events suffered by participating individuals are paid.
Individuals
purchase the right to collect from the pool if the insured contingency occurs. Insurance
then is a contingent claim contract on the pool’s assets.
Legal Perspective – Insurance is an agreement (the insurance policy or the
insurance contract), by which one party, like policy owner, pays stipulated consideration,
called premium, to the other party called Insurer in return for which the insurer agrees to
pay a defined amount of money or provide a defined service if a covered event occurs
during the policy term.
The term, insurance has also been defined as the device in which a sum of
money as a premium is paid as consideration of the insurer’s incurring the risk of paying
a large sum upon a particular eventuality. Insurance is a contract between one party i.e.
the insurer or the insurance company and the other party. I.e. Insured
2.6
LIFE INSURANCE
Life insurance is a plan by which a group of people can pool their money to share
risks. It is a protective measure, and it can be a way to build savings. Premiums are paid
to an insurance company. The policy states what the company will do and when, and
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tells how much money the company will pay the policyholder or the beneficiaries under
various conditions (Stephenson J, 2000).
In most lines of insurance, an attempt is made to put the individual back in
exactly the same financial position after a loss as before the loss. This is called law of
indemnity. This principle of indemnity is not possible in life insurance business for
obvious reason that we cannot place a value on a human life nor we can get a dead man
alive. What a life insurance product aims to achieve is to put the family back on a similar
financial position.
In India, Life Insurance Business is defined under Section 2(11) of Insurance Act
1938, which reads as follows:
“Life insurance business” means the business of effecting contracts of insurance
upon human life, including any contract whereby the payment of money is assured on
death (except death by accident only) or the happening of any contingency dependent
on human life and any contract which is subject to payment of premium for a term
dependent on human life and shall be deemed to include - the granting of
a) Disability and double or triple indemnity accident benefits, if so provided in the
contract of insurance;
b) Annuities upon human life; and
c) Superannuation allowances and annuities payable out of any fund applicable
solely to the relief and maintenance of persons engaged or who have been
engaged in any particular profession, trade or employment or of the
dependents of such persons.
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2.7
PRINCIPLES UNDERLYING LIFE INSURANCE
The specific or unique principles that are of paramount significance to life
insurance contract, as per Life Insurance Underwriting, NIA Pune are
•
Law of Large Numbers
•
Principle of Indemnity
•
Principle of Insurable Interest
•
Principle of Utmost good faith
2.7.1
LAW OF LARGE NUMBERS
Insurance and more particularly Life Insurance relies on the law of large numbers
to minimize the losses and make it viable. The law of large numbers, shows that, in
insurance the greater the number of similar exposures to a peril, the less observed loss
experience will deviate from the expected loss experience. The Law of Large Numbers
does not suggest that the losses to particular individual will become more predictable.
Rather it suggests that the larger the group (of people) insured, the more predictable will
be the loss experience of the entire group, other things being similar.
2.7.2
PRINCIPLE OF INDEMNITY
Insurance contracts provide compensation for an insured’s loss. Indemnity
means the insured should be in the same financial position after as before the insured
loss. But life insurance is an exception to this rule, as the economic value of a human
life cannot be measured precisely. One could not be put precisely in the same financial
position occupied before the loss. Nevertheless, life insurance underwriting takes care
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not to overinsure by preventing insures from acquiring more life insurance than their
financial position justifies.
2.7.3
PRINCIPLE OF INSURANCE INTEREST
It is the interest that the owner of the insurance has on the continuance of the life
insured. If the person does not have any interest in the life that is insured, it becomes
gambling. Insurable Interest can also be termed as the financial loss that the insured’s
dependent will suffer in case of the death of the life insured. This insurable interest
should exist at the time of purchase of the life insurance policy. People are presumed to
have unlimited insurable interest in their own lives. A husband and wife have unlimited
insurable interest on each other’s lives. Similarly, insurable interest can be present in
close family relationships such as parents – children. Beyond such close relationships,
insurable interest exists in financial relationship. For example creditors have insurable
interest on the lives of debtors to the extent of the debt outstanding. Partners have
insurable interest on the basis of each other, employers on the lives of key employees.
2.7.4
PRINCIPLE OF UTMOST GOOD FAITH
A person buying life insurance is deemed to have the highest standard of
honesty in dealing with the insurer. The insurance contract depends upon various facts
about the life to be insured which are known only to the insured and not the insurer.
Hence contracts of insurance are termed as contracts of Utmost Good Faith. The
penalty for lesser level of truthfulness is the insurer’s right to void the contract.
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2.8
RISK EVALUATION CONCEPTS IN LIFE INSURANCE
There are two main approaches to evaluate the risk of premature death as per
Life Insurance Underwriting (Online learning, NIA Pune), which are,
1. HUMAN LIFE VALUE
2. NEED ANALYSIS
Human life value concept deals with human capital, which is a person’s income
potential. Human life value concept goes beyond the numbers and into considering the
entire impact caused by the loss of a human being.
Dr. S.S. Huebner, a distinguished professor of insurance at the Wharton School,
University of Pennsylvania, and Chairman of the Department of Insurance, regarded as
the father of insurance education in the United Sates, had the following concerning the
obligation to insure:
“From the family stand point, life insurance is a necessary business proposition
which may be expected by every person with dependents as a matter of course, just like
any other necessary business transaction which ordinary decency requires him to
meet. The care of his family is man’s first and most important business. The family
should be established and run on a sound business basis. It should be protected
against needless bankruptcy. The death or disability of the head of this business should
not involve its impairment or dissolution any more than the death of the head of a bank,
railroad or store. Every corporation and firm represents capitalized earning capacity and
goodwill. Why then, when men and women are about to organize the business called
family should there not be capitalization in the form of life insurance policy of the only
real value and goodwill behind the business? Why is it not fully as reasonable to have a
life insurance policy accompany a marriage certificate, as it is to have a marine
insurance certificate invariably attached to a foreign bill of exchange? The voyage in the
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first instance is, on the average, much longer, subject to much greater risk and in case of
wreck, the loss is of infinitely greater consequence”. (NIA Pune)
The growth of life insurance implies an increasing development of the sense of
responsibility. The idea of providing only for the present must give way to recognition of
the fact that a person’s responsibility to his family is not limited to the years of survival.
Emphasis should be laid on the “crime of not insuring” and the finger of scorn should be
pointed at any man, who although he has provided well while he was alive, has not seen
fit to discount the uncertain future for the benefit of a dependent household. Life
Insurance is a sure means of changing the uncertainty into certainty and the opposite of
gambling. He who does not insure gambles with the greatest of all chances and if he
loses makes those dearest to him pay for forfeit.
2.8.1 THE HUMAN LIFE VALUE CONCEPT
The Human Life Value (HLV) concept is a part of the general theory of human
capital. While Human Capital is the production potential of an individual, HLV is a
measure of the actual future earnings or values of services of an individual – that is, the
capitalized value of an individual’s future net earnings after subtracting self maintenance
cost such as food, clothing and shelter. From the standpoints of one’s dependents, an
individual HLV is the measure of the value of benefits that the dependents can expect
from their breadwinner or supporter. Similarly from the viewpoint of an organization, the
HLV of an employee is the value of his/her services to the firm. Thus there is not
necessarily one single HLV. A given HLV is a function of its purpose and value to
others.
The insurable value of an individual’s economic possibilities is the monetary
worth of the following qualitative forces in that individual: (i) ethical behaviour (ii) good
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health (iii) willingness to work (iv) willingness to make an investment in the mind and (v)
creative ability and judgment.
The HLV may be defined, quantitatively as the present value of the expected net
earnings of an individual. The appraisal of an individual’s potential earnings involves
taking the present value of future projected earnings.
The following are the limitations of Human Life value approach in measuring the
correct amount of life insurance cover. (Rejda, 2004). Firstly, HLV does not take into
account other sources of income other than salary.
Secondly, in a simple HLV
approach, the earnings and expenses are assumed to remain constant. Thirdly the
amount of income allocatable to the family is a critical factor in determining the value.
This amount is subjected to several factors like birth or death in the family, divorce etc.
Fourthly, the appropriate discount value assumption is critical. The amount of provision
can change significantly, only by the change in discount value used, even though all the
other key family specific factors are kept constant. Finally HLV ignores the effect of
inflation on earnings and expenses.
2.8.2
NEEDS ANALYSIS
Needs analysis focuses on the income and cash needs that must be met
following an individual’s premature death and compares those needs to resources
already available. According to Stephenson J (2000) families usually purchase life
insurance for financial protection. If an insured wage earner dies, the insurance money
can provide financial security for the surviving family members. When both husband and
wife are wage earners, life insurance may be needed for both. If there are young
children to be cared for, a fulltime homemaker may consider life insurance. There is
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seldom, if ever, a good reason to purchase life insurance on children. First consideration
should be given to a policy that protects the family against possible loss of income.
Building savings for future needs should come after buying this loss-of -income
protection for the family.
Stephenson J (2000) also mentions that the type and amount of financial
protection a family needs from life insurance will be largely determined by:
•
Family income
•
Other resources available
•
Family plans and objectives
•
Size and composition of the family, and
•
Stage in the family life cycle
Life insurance needs change with time. A typical family's needs begin when the
first child is conceived and reaches a maximum amount when the last child is conceived.
The insurance need drops to zero several years before the expected retirement age. An
insurance policy should provide this lifetime pattern of insurance coverage. That is, it
should provide a maximum amount of protection while the family is growing and taper
off, as the family gets older and smaller.
2.9
LIFE STAGES ANALYSIS
The life insurance needs vary for different individuals and it is depended interalia
on the income, number of dependants and current life style.
An individual will
necessarily travel through various stages of life (Figure 2.1) and the time of incidence of
which may be different for different individuals. Similarly the nature of insurance also
changes as the individual travels through different stages in life. In the initial years of
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married life, he needs life insurance cover that graduates into long-term savings related
products and culminates to pension and annuities.
Figure 2.1: Life stages of an individual
Source: ICFA Program guide, CII, London
Figure 2.2: Trends of needs and resources for family
Source: Mary J Stephenson (2000)
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Figure 2.2 describes the need for insurance, security / insurance provision for an
individual. The need for dependency for insurance decreases as the individual starts
savings and makes investments and the need is the highest at the time of birth of
children and when the children grow old and become independent, the quantum of life
insurance cover reduces significantly.
2.10
IMPACT OF LIFE INSURANCE ON AN INDIVIDUAL
Life insurance products have manifold impact on the economic well being of the
customer and his family. The benefits to an individual can be classified into the following:
(Bodla, et al 2003)
•
Risk cover
•
Compulsory savings
•
Credit protection
•
Savings for a need
•
Tax relief
Any life insurance product is aimed at addressing two most important risks in
human life i.e. risk of early death and the risk of living longer. Life risk cover provided by
a life insurance policy ensures that the insurance company pays the full sum assured to
the dependants of life assured. The availability of a corpus helps the dependants to
continue to maintain their life style.
Life insurance contracts are normally taken for longer term with a commitment
from the individual that he is agreeable to pay the premium every year. This condition
brings in a compulsion and ensures that the individual pays the premium or does the
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savings year after year. Non-payment of premium leads to cessation of the policy and
cessation deprives the most valuable life protection.
Life insurance can be taken to cover the exposure of credits or borrowings. In the
event of death of the borrower, the life insurance policy benefit payout can settle the
outstanding borrowing and can save the family from a potential bankruptcy.
Being of long term in nature, life insurance can be used for accumulating savings
for specific long-term needs like money for higher education, marriage and retirement
planning.
In addition, in a few countries like India, premium paid also entails an
individual to certain tax benefits under the Income tax regulations.
2.11
IMPACT OF LIFE INSURANCE ON THE ECONOMY
Life insurance has a significant impact on the macro economy of a country. The
impact can be classified into the following (Bodla, et al 2003)
•
Savings and insurance
•
Capital formation
•
Insurance as a financial intermediary
•
Economic development
2.11.1 SAVINGS AND INSURANCE
The internal savings of a country flows from three sectors (Table 2.1).
•
Household sector
•
Private corporate sector and
•
Public sector
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The savings from the household sector constitutes a significant proportion of the
total savings in the country (Bodla, et al 2003). Household savings comprises of physical
savings and financial savings. Physical savings refers to savings by household to
purchase physical assets like gold, land, buildings etc. Financial savings means savings
in financial instruments like deposits, bonds, shares, mutual fund, insurance and small
savings. 46.7 percent of household financial savings are made in bank deposit. (Table
2.2)
Indian economy continues to have high savings rate and from the table given
below (2.3), it can be observed that GDS has always been higher than 24 percent since
2000-01. Life insurance constitutes one of the most important components in the
financial savings for households and it is above 13 percent of the household financial
savings. (Figure 2.3).
Table 2.1: Sectorwise Domestic Savings (at current prices)
Sectorwise Domestic Savings (at current prices)
Household Sector
(Rs in Crores)
Public
Sector
Gross
Domestic
Savings
Net
Domestic
Savings
Financial
Savings
Physical
Savings
Total
Private
Corporate
Sector
1999-00
206602
210124
416726
87234
-16659
487301
300652
2000-01
215219
231098
446317
87017
-37062
496272
293540
2001-02
247476
255198
502674
81669
-46377
537966
316805
2002-03
253256
312152
565408
99767
-16181
648994
413392
2003-04P
316444
332190
648634
120852
28026
797512
540942
2004-05E
320777
366302
687079
150947
69390
907416
612658
Source: IRDA Reports
P- Provisional, E-Estimates
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Table 2.2: Composition of Gross Financial Assets of the household sector (in
percentages)
2005-06#
2004-05P
2003-04P
2002-03P
2001-02P
2000-01
8.8
8.5
11.2
8.9
9.7
6.3
46.7
36.4
37.4
38.3
36.8
38.1
Non-banking Deposits
0.8
0.8
1
2.7
2.6
2.9
Life Insurance Funds
14.2
16
13.7
16.1
14.2
13.6
Provident and Pension
Funds
10
12.9
13.6
15
16.1
19.3
Claims on Government
14.7
24.4
23
17.4
17.9
15.7
Shares and Debentures
4.9
1.1
0.1
1.7
2.7
4.1
Total
100
100
100
100
100
100
Currency
Bank Deposits
Source: ICRA Report, May 2003.IRDA ANNUAL REPORTS
P- Provisional, #-estimates
Table 2.3: Percentage contribution of components of Gross Domestic Savings
1999-00
2000-01
2001-02
2002-03
2003-04P
2004-05E
GDS as a % of GDP
25
24
24
27
29
29
Household sector savings
as a % of GDS
86
90
93
87
81
76
50
48
49
45
49
47
12
14
14
16
14
16
Financial Assets as a % of
Household savings
Life Insurance Fund as a
% of Financial assets of
Household
Source: RBI Reports, P- Provisional, E-Estimates
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Figure 2.3: Life insurance premium as a percentage of household savings
Source: RBI Report P- Provisional, #-estimates
2.11.2 CAPITAL FORMATION
Capital formation envisages three essential steps, which are
1. Real savings
2. Mobilisation and channelising of savings through financial intermediaries
to be placed at the disposal of investors
3. The act of investment.
Contribution of insurance in the process of capital formation appears at all these
stages. Insurance services act as a tool to mobilize savings and function as financial
intermediary.
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2.11.3 INSURANCE AS A FINANCIAL INTERMEDIARY
Financial intermediaries carry out the function of mobilization of savings and
placing them at the disposal of investors.
In a large economy, act of savings is
performed by a very large number of entities/ individuals scattered across the country.
Insurance as an intermediary helps in mobilizing such small savings and direct them to
appropriate investment avenues.
2.11.4 ECONOMIC DEVELOPMENT
In life insurance, since the time horizons for investments are long-term, the
savings can be tied up for a long time and hence can be made available for capital
expenditures. These savings can be made available to the private sector or to the
government for the purposes of infrastructures, which are essentially long term in nature.
The capital investment decisions by the private and the government, lead to
increase in the level of employment and increase in the standard of living across the
economy.
Increase in the productive base of the economy results in rise of exports
leading to improving the balance of payment.
As the percentage of savings by household increases, then by definition they will
be consuming less. This reduced consumption will help to lower the inflationary
pressures that might exist within the economy. This inflation reducing benefit will clearly
be greater within an economy where consumption is tending to squeeze out potential
capital expenditure. With the increase in domestic savings, the dependency on foreign
investment comes down.
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The figure 2.4 gives a graphical representation of the role that life insurance
companies play in the mobilization of savings, investment of the savings in the capital
market and the resulting impact on the wider macro economy.
Figure 2.4: Economic contribution of life insurance industry
Life insurance policies
bought by customers
Capital investment by the owners
of the life insurance company
Capital Subscribed
Claims payments
Premium
Dividends
Life Insurance companies
Encourages savings and life
insurance in particular by
household and insurance
Investment in capital market
Capital Market
Finance available for
Private Sector
Government
Increase in the number
of companies listed in
the
market
and
increase in market
prices
GDP of the economy increases
Higher employment
More potential of increase in
domestic consumption
Increase in exports, balance of
payment
Source: Dickinson, 2000
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2.12
GLOBAL INSURANCE TRENDS
Global experience shows that life insurance markets tend to take time to develop,
often developing later than banks and non-life insurance companies. According to
Dickinson (2000), long term savings across the population as a whole increases as
standards of living rise and as standards of living rise, longevity also increases.
The pattern of the growth of national life insurance markets tends to follow an ‘S’
shaped curve pattern, depicted in the figure 2.5.
As the GDP per head within an
economy remains low, spending on life insurance remains low, often growing at a rate
less than the growth of GDP. But when the GDP per head increases beyond a certain
threshold, spending on life insurance begins to accelerate. At very high level of GDP per
head, the rate of acceleration tends to slow, partly due to the fact that the wealthier
economies tend to have older populations who begin to draw down their savings during
retirement.
There is a strong correlation among economic, political, cultural and commercial
factors at work which vary from country to country, which affect the life insurance market
and life insurance products (Dickenson, 2000). The products purchased by the
customers in any life insurance market also keep changing with the economic and
demographic development of the country. Life insurance markets start slowly, due to
lower consumer awareness and individual income constraints.
34
Figure 2.5: Growth of life insurance markets
Source: Dickinson, 2000
Figure 2.6: Life insurance product development & economic development
Source: Dickinson, 2000
Firstly, as the economy grows, the life insurance products tend to move from
having a primary emphasis on insurance protection towards a greater savings role,
especially saving for retirement purposes. Secondly, there is a move away from simple
products sold either on an individual and group basis to a more complex products sold
35
mainly on individual basis. This relation between emergence of different products and
the level of economic development is presented in figure 2.6.
2.13
INDICATORS OF INSURANCE DEVELOPMENT
Two indicators, which help to distinguish the current and potential states of an
insurance market, are insurance density and insurance penetration (percentage of
insurance premiums in GDP.
Insurance density is measured as the ratio between total premium income and
population. Insurance density indicates the current state of the market, which is highest
in industrialized nations. For example, both the United States (US) and Japan, the
world’s most industrialized countries, have the highest premium density ranking, with
over $800 per capita. China and India, in contrast, are represented by single-digit
figures. The high insurance density implies that the insurance market is fully actualized
and therefore has less room to grow. (Beck et al 2002)
Insurance penetration, on the other hand, can be used as a rough indicator of
growth potential. Insurance penetration can be computed as
The numerator of the right hand side of the equation, insurance premiums/capita, can be
described as the insurance expenditure per household. The denominator of the right
hand side of the equation, GDP/capita, can be described as the production per
household. When combining the two parts, insurance penetration can be viewed as the
relationship between insurance expenditures and economic production per household. In
contrast to the relatively flat rate of growth exhibited at the low and high ends of the GDP
36
spectrum, the demand for insurance grows significantly faster than wealth in transitional
markets (South Korea, Taiwan, Singapore and Hong Kong). When income rises above
the minimal level, people begin to accumulate personal assets and an awareness of the
value of insurance develops. Insurance consumption then rises rapidly to fill gaps of
need. Transitional markets thus demonstrate highest growth potential.
The adjoining figure 2.7 compares the penetration of life insurance with the
economic development. It can be observed that in general the emerging markets or the
developing economies figure in the growth phase of the trend line and as the economy
matures to become a developed or industrialized country the growth tapers off.
Developing economies like India, China, Brazil and Russia are in the nascent lower end
of the trend line and developed economies like Japan, US, Switzerland are in the upper
end of the trend line. United Kingdom has the maximum life penetration percentage
amongst the developed economies.
It can also be observed from figure 2.7 that there is a positive relationship
between wealth (measured as gross national income per capita in purchasing power
parities) and a country’s insurance penetration. Higher wealth tends to result in a rising
penetration in Life as well as in Non-Life (i.e. the insurance market is growing faster than
the overall economy). In general, the increase is stronger in emerging markets than in
industrialized countries.
Existing deviations of individual countries from the “Global trend line” shown in
the graph are due to differences in Life insurance market environments across countries
(e.g. degree of old-age pension systems being based on social security), and wealth
alone does not explain the state of a country’s Life insurance market.
37
Figure 2.7: Relation between wealth and life insurance penetration in global
economies in 2002
Source: Reiche, 2004.
Figure 2.8: Share of each continent in the worldwide life premium income
Africa
2%
Oceania
1%
Asia
29%
America
28%
Europe
40%
Source: CEA report 2005
38
2.14
GLOBAL LIFE INSURANCE MARKET
According to the Swiss Re analysis (Sigma No.5/2006), in 2005 the worldwide
life business generated a total premium income of US$1999bn, an increase of 5.1%
compared to 2004. With more than 40% of this amount and a growth rate above 10%,
the European market is the world’s leading market in terms of premium income and
growth (Figure 2.8). Just behind Europe, the American market represents 28% of the
world life business and experienced a negative growth of 3.3% in real terms. This
slowdown, essentially due to the US market, is related to lower sales in individual life
and annuity products, which suffered from “low return rates and increased competition
from bank savings products” (Swiss Re – Sigma No 5/2006). North America has the
highest insurance density in the world and it stood at US $1686.3 during 2005 (Table
2.4)
The Asian market represents 29% of world business and has shown a positive
growth of 5.1 percent, which actually conceals different developments across the
continent. On the one hand, with almost US$380bn, Japan is the largest Asian life
insurance market but recorded a moderate growth of 2.3 percent, essentially due to the
success of annuity products. On the other side, the South and East Asian life insurance
market has grown by 11.6 percent in 2005 (9.1 percent in 2004), reflecting the economic
boom in the region. This success is driven by participating universal life products and
also by annuity products, which are supported by governments in order to supplement
state pension schemes. Behind these three leading continents, Africa and Oceania each
represent less than 1.5% of the world business and recorded growth rates of 6.5% and 4.9% respectively and these economies also have low insurance density. (Table 2.4)
39
Table 2.4: Continentwise insurance density and insurance penetration
Insurance Density (US $)
Insurance Penetration (% )
2002
2003
2004
2005
2002
2003
2004
2005
1563.8
1565.7
1617.2
1686.3
4.48
4.25
4.12
4.05
29.1
30.0
37.2
42.0
0.92
0.94
1.01
0.93
Europe
620.4
726.9
848.1
911.8
4.83
4.64
4.68
4.69
Asia
128.1
140.1
147.2
149.6
5.81
5.74
5.58
5.16
21.5
26.1
30.3
30.7
3.28
2.93
3.41
3.33
Oceania
668.7
750.7
851
885
4.48
3.99
3.75
3.16
World
247.3
267.1
291.5
299.5
4.76
4.59
4.55
4.34
North America
Latin
American &
Caribbean
Africa
Source: IRDA reports
2.15
LIFE INSURANCE IN ASIA
The premium distribution and maturity of Asian insurance markets vary
considerably by country. According to Chu, (2001), broadly, Asian insurance markets
can be stratified into three levels: fully mature, transitional, and incipient. Japan is the
only fully mature market, accounting for over 75% of the insurance premiums in Asia.
Transitional markets include countries like South Korea, Taiwan, Singapore, and Hong
Kong and the two major incipient markets are China and India, which are the world’s two
most populated countries.
Fully mature. (Japan) - The life insurance industry is characterized by the
sophisticated liability insurance for protection of personal wealth and advanced risk
management structure for large commercial firms. Japan’s well-developed economy can
sustain the full range of modern insurance products. Japan has an insurance density of
US $ 2956.3 during 2005 and is the highest among all Asian economies (Table 2.5)
40
Transitional. (South Korea, Taiwan, Hong Kong, and Singapore) - Customers in
these developing economies are becoming aware of the importance of protecting
personal wealth, but may not have the full appreciation to warrant an ultra-sophisticated
approach. Incidentally Taiwan with 11.17% has the highest insurance penetration among
its Asian neighbours.

Incipient. (China, India, Vietnam) - Customers in countries like India and China
are mainly concerned with preserving what they have acquired through hard work.
Insurance policies with a savings mechanism will attract people by offering an
accumulation of wealth rather than expenditure.
Table 2.5: Comparison of Asian economies on insurance density and insurance
penetration
Insurance Density (US $)
Insurance Penetration (% )
2002
2003
2004
2005
2002
2003
2004
2783.9
3002.9
3044.0
2956.3
8.64
8.61
8.26
8.32
821.9
873.6
1006.8
1210.6
8.23
6.77
6.75
7.27
India
11.7
12.9
15.7
18.3
2.59
2.26
2.53
2.53
China
19.5
25.1
27.3
30.5
2.03
2.30
2.21
1.78
118.7
139.8
167.3
188.0
2.94
3.29
3.52
3.60
5.2
6.4
7.5
10.5
0.66
0.66
0.63
0.82
925.1
1050.1
1494.6
1699.1
7.35
8.28
11.06
11.17
Pakistan
1.0
1.1
1.5
1.9
0.24
0.24
0.28
0.27
Sri Lanka
4.5
5.3
6.2
6.9
0.55
0.55
0.60
0.62
128.1
140.1
147.2
149.6
5.81
5.74
5.58
5.16
Japan
South Korea
Malaysia
Indonesia
Taiwan
Asia
2005
Source: IRDA Annual Reports
41
2.16
JAPAN – LIFE INSURANCE MARKET
Japan continues to suffer from sluggish economic growth and as a result
Japanese life insurance companies are being forced to take various initiatives (Ryotaro
2004). As of the end of March 2001, statistics measuring the scale of the life insurance
market in Japan, including postal life and Japanese Agricultural Mutual Society’s
business, are as follow:
1.
Life insurance in force is around 378 million policies and amounts to ¥2,298
trillion (roughly US$17.7 trillion)
2. Annual premium income amounts to ¥47.6 trillion (more than US$366 billion)
3. Total assets exceed ¥350 trillion (which is around US$2.7 trillion)
According to Ryotaro (2004), Japan accounts for about 26% of the world’s total
life insurance premium income and as such ranks among the top tier of countries with
major life insurance markets. Annual life insurance premium income per capita is No.1 in
the world. As measured by the above, the diffusion of life insurance in Japan is pretty
high as measured on a global basis, although the life insurance industry currently
operates in a very severe economic and business environment.
The first challenge facing the life insurance industry is demographic change.
According to the estimates by the National Institute of Population and Social Security
Research, Japan, the Japanese population should have reached a peak by 2006 before
it begins to decline. In 2015, 26 % of Japanese will be 65 years old or over. The aging of
society and the drop in the birth rate are progressing rapidly. Demographic change such
as this will of course affect the population’s ultimate demand for life insurance, but it is
important to also understand that this trend will change the kind of products needed as
well. In the past, protection products featuring large amounts of coverage accounted for
a large percentage of total products sold. However, the rapidly changing demographics
have recently been encouraging demand for medical and nursing care products as well
42
as retirement related products. A sustained high growth rate in annuity related products
can be observed as against negative or single digit growth in life premiums. (Table 2.6).
Table 2.6: Life insurance business in Japan
Fiscal year
2002
2003
2004
Life companies' premium (JPY bn)
25,434
25,911
26,957
Life premium growth (%)
-2.5
1.9
4
Life companies' individual annuity
3,021
4,638
6,293
premium (JPY bn)
Annuity Premium growth (%)
41.5
53.5
35.7
Individual annuity market share within
11.9
17.9
23.3
life companies (%)
Life companies' share of the insurance
73.9
74.6
75.4
market (%)
Source: www.limra.com
2005
28,284
4.9
7,585
20.5
26.8
77.4
The second challenge facing the industry is the severe economic environment.
The Japanese economy is still struggling to fully recover from the recession that began
following the bursting of what is called as the “bubble economy”. The recession is
keeping household budgets under pressure, and as a result, private life insurance
companies’ new business and business in force in the individual sector declined for 5
consecutive years from 1997 to 2001. Additionally, years of historically low interest rates
have generated a negative yield gap between the assumed interest rate on older policies
and actual investment return. Because of this, life insurance companies, particularly
those that are longer established, are suffering from this spread. Due to the adverse
nature of the economic environment, 7 Japanese life insurers have unfortunately failed
since 1997 and not only many of those failed, but also now a few other Japanese life
offices were bought by the foreign companies. The involvement of Kampo (the Postal
Life insurance system) and the co-operative movement (especially the many small
unregistered and unregulated co-operatives - Kyosai) in life and annuity business has
significantly reduced the market that has been available to the traditional insurance
43
companies. The life premium income of Kampo and the regulated co-operatives
combined is approximately 90% of the individual business of the traditional private life
companies.
2.16.1 DISTRIBUTION CHANNELS IN JAPAN
In Japan, since the end of the World War II, life insurers have used female sales
agents as their main sales channel as a part of the revitalization process of life insurance
business and these female sales agents showed vigorous power under the debit system
which was extensively introduced in late 1940’s according to (Ryotaro, 2004). Currently
some Japanese life insurance companies, including many of the foreign-based life
companies are heavily relying on male sales agents. The position of the sales agents as
the main channel is expected to remain. However, sales through independent agencies
and banks, as well as mass marketing such as direct mailing and sales through Internet
will play a more important role than ever. Furthermore, the cross selling of life and nonlife insurance products and cross selling of life and banking or securities products should
gradually increase in the market. Meanwhile, due to the increase in the variety and
flexibility of insurance products, career sales agents, the main channel of life insurance
sales, are currently being required to learn more advanced techniques so as to improve
their sales abilities as consultants. As a result, to improve sales and after service, sales
agents’ usage of notebook computers with advanced software is increasing.
44
2.17
KOREA LIFE INSURANCE MARKET
The Asian economic crisis, which reached Korea in late 1997, provided the
landscape for restructuring that allowed some Korean companies to excel while forcing
others to close down (Hong, 2004). Strong growth in exports, due in part to the
depreciation of the Korean currency, resulted in a remarkable recovery in the Korean
economy. The government has accumulated significant foreign currency reserves and
paid off International Monetary Fund (IMF) bailout loans in advance according to
Milliman Global Insurance report of September 2001.
As stated earlier, the Asian economic crisis gave the impetus for restructuring the
Korean life insurance industry. In 1995, there were 33 Korean life insurance companies
and there were 23 in 1999, with the prospect of fewer companies by the end of 2001.
The following table 2.7 gives the details of the life insurance premium income of the
Korean market. From the table it can also be observed that female agents dominate the
distribution of life insurance products.
Table 2.7: Life insurance premium and number of agents in Korea
Fiscal year
Life company premium Number of solicitors
(KRW bn )
(Agents)
% of female solicitors
2005
61,472.20
123,702
83.7
2004
53,750.60
136,947
84.7
2003
50,392.50
143,498
86.7
2002
49,066.70
151,064
88.2
2001
47,364.30
171,505
91
2000
51,791.40
214,793
-
1999
46,757.60
241,429
-
Source.www.limra.com
Milliman Global Report of March 2004 states that about one-third of Korean
domestic life insurers declared bankruptcy due to the financial crisis, which swept major
part of Asia, in 1997. While some were successfully merged into or acquired by other
45
insurers, some were eventually merged into a life insurer under the custody of the
government. Any joint venture partnerships between failed local companies and foreign
insurers were dissolved. They are now under a single ownership or management. Korea
also saw the entry of multinational insurance companies entering the country by either
buying out the troubled local life insurance company or setting up their own subsidiaries.
There are currently 23 life insurance companies, of which 10 are multinational life
insurance companies with a recorded business (Face Amount) as of September 2003
amounting to 139,905 billions of Won (Korean currency).
It is worth noticing the
strengthened position of the foreign insurers in the market. They will play an important
role in future market development, becoming market makers rather than market
followers, by introducing advanced and innovative products to the market.
2.17.1 MARKET TRENDS
Most Korean life insurers have shifted their leading life products from savings
type to protection-type products, as demonstrated in Table 2.8.
Table 2.8: Shifts in new business products in Korea
Face Amount (in %)
New Business
Premium Income (in %)
Existing Business
New Business
Year
Savings
Protection
Savings
Protection
Savings
Protection
1999
30
70
35
65
73
27
2000
34
66
32
68
29
71
2001
14
86
25
75
55
45
2002
15
85
22
78
49
51
2003(2Q)
12
88
20
80
46
54
Source: Hong, 2004
Among the protection-type products, a significant increase in sales is due to
whole life policies. The proven success of whole life policies by foreign insurers has
46
motivated domestic insurers to sell the policies through their female tied-agency forces
and newly established professional sales forces.
2.17.2 ALTERNATIVE DISTRIBUTION CHANNELS
Table 2.9: Life insurance companies and alternate channels of distribution in
Korea
DISTRIBUTION CHANNEL
LEADING INSURANCE COMPANIES
Independent Brokerage
Kyobo, PCA
Independent financial adviser
Samsung
Direct marketing
AIG
Telemarketing
LINA, AIG, Shinhan, MetLife
Cyber marketing
All companies for lead
Worksite/affinity marketing
Samsung, Kyobo
Bancassurance
AIG, ING, Tongyang, Shinhan,
Samsung, PCA
Source: Hong, 2004
While the tied agency system, from female solicitors to professional sales force,
is well established in the market, insurance companies have made a limited commitment
to developing alternative distribution channels. Currently, available distribution channels
and channels in development along with the names of the insurance companies focusing
on the channels are listed in table 2.9. According to market observers of Korean life
insurance industry, only a few companies are actively developing new channels. Most
small to medium sized domestic companies are currently focusing on developing
professional sales forces rather than developing alternative distribution channels.
47
2.18
TAIWAN
The Taiwan life insurance market has experienced tremendous growth since the
market was opened in 1987 (Sun, et al 2004). As would be expected, the foreign
companies and other new entrants have grown at a more rapid pace than the general
market. Foreign companies reported large statutory losses in 1999 mainly due to their
high growth, the conservative accounting on certain items in Taiwan and the low interest
rate environment, although each particular company’s situation may be different. Current
issues facing the industry are lower interest rates (and therefore lower spreads),
expansion to Mainland China, appointed actuary regulations and risk based capital rules.
2.18.1 Growth Potential
Since the Taiwan government opened the market in 1987, the Taiwan life
insurance industry has seen significant growth, whether measured in terms of total
assets, total premiums or new business premiums. Historically, for cultural reasons, life
insurance had been a taboo subject with the Taiwanese. However, Table 2.10 shows the
growing acceptance of the life insurance concept over the period 1986 – 1999. This
table (2.10) shows the ratio of the number of life insurance policies in force to the total
population. The Taiwanese population is now very receptive to the idea of buying life
insurance as a result of the life insurance industry’s relentless education and promotion.
Total premium in Taiwan stands at US $ 41.26 billion during 2006. (Table 2.11)
Table 2.10: Ratio of number of in-force policies to total population in Taiwan
Year
1986
1991
1995
1999
% ratio of number of
policies to population
16
36
62
99
Source: Sun and Affleck (2004)
48
Table 2.11: Life insurance premium in Taiwan
Year
Premium Income
(US $ billions)
2002
2003
2004
2005
2006
20.71
27.46
33.2
38.79
41.26
Source: www.limra.com
Table 2.12: Growth in life insurance industry assets and premiums in Taiwan
Annualised Growth Rates (in
Values in NT$ billions
Percentage)
1986 1991 1995 1999
1986-96
1991-93
1995-99
Assets
141
520
1127
2171
30
21
18
Total Premiums
62
168
310
558
22
16
16
New Premiums
21
47
77
128
17
13
14
Source: Sun and Affleck (2004)
In spite of this rapid recent growth (Table 2.12), steady premium growth of 10
percent to 15 percent per annum is expected to continue. Three factors, which will fuel
future growth of life insurance market in Taiwan, are economic growth, life insurance
products and insurance density. First, the overall Taiwan economy has been growing at
6-8% in recent years. Second, the products in the Taiwan life market are heavily
concentrated on savings type products. As the economy grows, the Taiwanese
population will have more disposable income to be invested in life insurance products.
Thirdly, the ratio of life insurance premium to total GDP was about 6.7% in Taiwan in
1999. Compared with the 9 to11% in Korea and Japan, it is believed that there is still
room for further penetration because both the general culture and life insurance practice
in Taiwan are very similar to those in Korea and Japan.
49
2.19
CHINA
The Chinese government has agreed to open up the insurance market gradually
upon accession to the WTO, which was formally approved on 11 December 2001. There
will be no fixed quota on insurance licenses. Foreign life insurers are currently
technically permitted to provide services in Shanghai, Guangzhou, Dalian, Shenzhen
and Foshan. Within 2 years, foreign life insurance companies were permitted to expand
to Beijing, Chengdu, Chongqing, Fuzhou, Fuzhou, Xiamen, Ningbo, Shenyang, Wuhan
and Tianjin. All geographical restrictions require to be lifted on foreign-invested life
insurers over a period of time. In fact, in 2002 Sun Life Everbright and AIA commenced
business in Tianjin and Beijing respectively, which demonstrates some flexibility to
negotiate on a case-by-case basis.
2.19.1 MARKET POTENTIAL
Table 2.13: Life insurance premium income in China
Year
2001
2002
2003
2004
Premium Income (US
$ billions)
Growth Rate (%)
15.67
2005
25.14
32.76
34.37
39.6
60
30
5
15
Source: www.limra.com
The China life insurance industry achieved tremendous growth over the past
decade, with a cumulative annual growth rate (CAGR) over 23% since 1997 (Paul et al
2002). Total insurance premiums are projected to grow at 12% per annum for the next
five years, and life insurance premium growth is expected to be in the range 15% - 20%
per annum in this period. In 2005, the total life insurance premium income was over US$
39.6 billion (Table 2.13) and despite the impressive growth rates, by international
standards, the Chinese insurance market remains relatively under-developed and hence
still represents a great potential opportunity. In terms of insurance density, measured by
50
insurance premiums as a percentage of GDP, the ratio for China is only 1.8% compared
to around 6% in Taiwan, 9% in Japan and 10% in South Korea.
Besides the low
penetration rate, there are other drivers for this significant growth. The savings rate in
China is very high, over 40%, compared to approximately 30% in Japan and less than
20% in the United States. One reason for this phenomenon is the lack of investment
vehicles in China. Most people in China keep their money in bank deposits. Even a small
portion of the country’s total savings could generate a considerable volume of funds
flowing into the life insurance market and with bank deposit rates so low, competition for
bank savings is intense. Furthermore, increasing affluence, financial education and
awareness of insurance contribute to the continuing growth in life insurance premiums.
While life insurance is still a minor part of household assets, bank deposits
continue to be the largest component of household savings amounting to almost 64% of
household savings according to BCG report of 2004 on China. The percentage of life
insurance in the household savings has increased from 2% in the year 1996 to 4% in the
year 2002 (Figure 2.9)
Figure 2.9: Composition of household savings in China
100%
4
80%
12
28
2
4
4
60%
40%
82
64
20%
0%
1996
Bank deposits
Life insurance
2002
Bonds
Stocks and Other holdings
Source: Boston consulting Group Report 2004
51
China has started the process of licensing life insurance companies for every
province. It means that if a life insurance company is licensed for a province, it is
permitted to do business only in the territory for which license has been accorded. Life
insurance companies looked at provinces providing opportunities for growth. Shanghai
and Guangzhou are currently the two most competitive cities for foreign-invested
companies.
As and when other cities open, foreign insurers entering China need to select the
location of their new ventures carefully based on economic and industry specific factors
as well as company specific business strategies. It is clear from Table 2.14 that
Shanghai is still the first choice city for foreign entrants, although Manulife, ING, and
AXA will soon open their 2nd branches in Guangzhou, which will reinforce it as the
number two city for foreign life insurers. .
Table 2.14: Foreign joint venture life insurance companies in China
Foreign Insurer Year of set up
Chinese Partner
Industry Sector
Location
Manulife
1996
Sino-chem
Import/Export trade Shanghai
Allianz
1998
Dazhong
Non-Life Insurance Shanghai
ING Aetna
1998
China Pacific
AXA
1999
Minmetal
CMG
2000
China Life
Life Insurance
Shanghai
Prudential UK
2000
CITIC
Financial
Guangzhou
John Hancock
2001
Tian an
Sun Life
2002
Everbright
Financial
Tianjin
Generali
2002
China National Petroleum
Energy
Guangzhou
CGNU
N/A
COFCO
New York Life
N/A
Haier
Manufacturer
Shanghai
ING
N/A
Beijing Capital Group
Financial
Dalian
N/A
CNOOC
Energy
Shanghai
Aegon
Life Insurance
Shanghai
Import/Export Trade Shanghai
Non-Life Insurance Shanghai
Import/Export Trade Guangzhou
Source: Paul, 2002,
Note: N/A –Not available
52
It can be observed in Table 2.15 that even for the more developed cities in
China, there is a significant variation in economic activity and the level of insurance
competition. Most companies are expected to adopt a geographic roll-out strategy
starting in the more developed cities with higher wealth levels before expanding into less
developed areas. However, Table 2.15 shows that despite the lack of foreign
participation in life insurance industry, Beijing stands at second place in terms of
premium income during 2001.
Table 2.15: Number of registration of life insurance companies in major Chinese
cities -2001
Number of Life
City/Province
GDP
Premium Income
Insurers
Shanghai
60
12
1.7
Beijing
34
5
1.2
Guangzhou
32
7
0.7
Shenzhen
24
4
0.3
Tianjin
22
5
0.3
Source: Paul, 2002
2.19.2 DISTRIBUTION CHANNELS
Tied agency remains the dominant distribution channel for individual life
insurance business in China (Paul et al 2002). Several new entrants in Shanghai have
experienced problems in developing a successful agency force due to high turnover and
poaching of agents and the lack of well-trained, quality agents in the marketplace. Since
2000 bancassurance channel has emerged involving exclusive distribution agreements
between insurers and individual bank branches. Each branch of a particular bank is free
to tie up with a different insurance company. Nevertheless, this resulted in significant
sales growth in 2001, and for some companies bancassurance business comprises
more than 10% of their total premiums. This channel is likely to grow further, particularly
53
as new entrants such as Taiping Life aggressively expand and the market share of
agency business can be expected to decline in time as other channels including broker/
independent financial advisors (IFA) emerge.
2.20
EUROPEAN MARKET
Europe is the leading market in the world for life insurance, with market share
accounting for 40% of global business. With a total premium income of € 616bn and a
growth rate of 9.5% in 2005, life insurance remains by far the most important insurance
line of business in terms of turnover in Europe. More importantly the distribution of these
new
premiums
continues
to
show
a
predominance
of
financial
institutions
(Bancassurance, saving banks, post offices) as major distribution channels in many
European countries (CEA Report 2007).
This growth rate of 9.5% in 2005 is the highest level recorded within the last five
years but is still below the exceptional rate observed for the year 2000 at 16.9%. This
new increase in premium income after the negative market shock experienced in 2001,
confirms the recovery of the insurance sector from this financial crisis, demonstrates the
popularity of life insurance products in the opinion of consumers and proves the ability of
insurers to develop products conforming to the needs of policyholders. The recent
evolution of the life insurance market is characterised by an increase in the share of unitlink products from 22.2% to 24.2%, which is largely explained by the strong growth of the
stock market observed during the three last years.
54
2.20.1 Life insurance in Europe
The European life insurance market is dominated by the four main countries
(United Kingdom, France, Germany and Italy) which taken together represent 72% of the
European market. (Figure 2.10) The United Kingdom is the leading country with a
market share of 27.4% in 2005 and this market share level has shown a decrease of 10
points compared to the highest level observed in 2000. This leading position is closely
linked to the UK’s market size and to the pension scheme, which relies much more on
the private insurance sector than in most other countries (CEA Report, 2007)
Just behind the UK, France has consolidated its second place with a rise of 0.5
points to reach 19.8%. The growing share of the French market since 2000 reflects the
strong growth rate recorded in recent years. Stable at 12.1%, Italy takes third position
ahead of Germany (11.9%) where the growth and the penetration are below the
European average. All other markets have a market share below 5% individually. In
terms of Insurance density, UK continues to be the leader with 8.9% as against EUs
average of 4.69. Insurance density of other EU countries, other than the top 4 countries,
is lower than 4. (Table 2.16)
Table 2.16: Insurance density and insurance penetration in European market
Insurance Density (US $)
Insurance Penetration
2002
2003
2004
2005
2002
2003
2004
2005
Europe
620.4
726.9
848.1
911.8
4.83
4.64
4.68
4.69
United
Kingdom
2679.4
2617.1
3190.4
3287.1
10.19
8.62
8.92
8.9
France
1349.5
1767.9
2150.2
2474.6
5.61
6.81
6.89
7.33
German
736.7
930.4
1021.3
1042.1
3.06
3.17
5.15
5.19
Italy
904.9
1238.3
1417.2
1449.8
4.39
4.82
4.86
4.86
Source: IRDA reports
55
Figure 2.10: European markets – Share of total life premium
Source: CEA Report 2007
2.20.2 DISTRIBUTION
Figure 2.11: Channelwise distribution of life insurance in Europe
Source: CEA Report 2007
56
According to a sample of 10 countries, financial institutions (including banks, post
offices and savings banks) form the leading channel in the distribution of new individual
premiums (CEA Report 2007). The market share of this channel is above 50% in more
than half of the countries and even exceeds 80% in Portugal and Italy. On the supply
side, this dominance of the financial institutions is related to the willingness of banks to
offer a larger range of saving products, to increase their assets under management and
to diversify their income sources. This trend over the last decade has given birth to large
financial conglomerates offering insurance as well as bank products. On the consumer
side, the reflex leading them to consult the bank in relation to investing or saving money
is very strong. The difference between insurance and bank products is therefore not
always obvious to the consumer. Moreover, the wide variety of saving products offered
by financial institutions and the central location of all financial services can be seen as
an advantage and partly explains the success of this channel. On the other markets,
brokers or agents dominate the distribution of new individual contracts with market
shares amounting to up to 70% for brokers in United Kingdom or up to 75% for agents in
Slovakia.
Employees do not constitute the main selling channel on any market but continue
to be an important channel in countries like Estonia (39%) or Belgium (22%). Direct
selling which has long been seen as a potential threat to traditional channels has not
greatly changed consumer habits except slightly in the Netherlands where this channel
grew to 14%.
57
2.21
LIFE INSURANCE IN AMERICA
Most of the American families depend on life insurance to provide economic
protection for self and their dependents. According to the Federal Reserve’s analysis of
its Survey of Consumer Finances, sixty-nine percent owned some type of life insurance
in 2001. Americans purchased $3.0 trillion of new life insurance coverage in 2005, 4
percent more than in 2004. By the end of 2005, total life insurance coverage in the
United States reached $18.4 trillion, an increase of 5 percent from 2004. Three types of
life insurance policies are predominant in the market. Individual insurance is
underwritten separately for each individual who seeks insurance protection. Group
insurance is underwritten on a group as a whole, such as the employees of a company
or the members of an organization. Credit insurance guarantees payment of some debt,
such as a mortgage or other loan, in the event the insured person dies, and can be
bought on either an individual or a group basis. (ACLI, 2005)
Table 2.17: Insurance density and insurance penetration in American market
Insurance Density (US $)
North
America
United
States
Canada
Insurance Penetration (%)
2002
2003
2004
2005
2002
2003
2004
2005
1563.8
1565.7
1617.2
1686.3
4.48
4.25
4.12
4.05
1662.6
1657.5
1692.5
1753.2
4.60
4.38
4.22
4.14
657.3
722.9
926.1
1071.9
2.81
2.63
2.97
3.05
Source: Facts & Statistics of life insurance, Insurance Information Institute USA, 2006
2.21.1 INDIVIDUAL LIFE INSURANCE
Individual life policies offered in the American market are of two basic types,
which are in the nature of protection cover for a specified term and permanent cover on
one’s whole life.
Insurance density for USA stands at US $ 1753.2 and insurance
penetration is at 4.14% in the year 2005. (Table 2.17) Individual life is the most widely
used form of life insurance protection and accounts for about 54 percent of all life
58
insurance in force in the United States at year-end 2005. Total individual life insurance
protection in the United States totaled $10 trillion at the end of 2005 and has grown at an
average annual rate of 6 percent since 1995, when $6.4 trillion was in force. (Table 2.18)
The size of newly purchased individual life policies also grew in 2005. During the same
period the average, new individual life policy increased 14 percent to $158,000 while the
number of individual policies purchased fell 1 percent.
Table 2.18: Individual life insurance business in United States of America
New Business
1995
Face amount ($ Millions)
No of policies (in thousands)
Total Inforce
Face amount ($ Millions)
No of policies (in thousands)
2005
1057233
1796384
13835
11407
1995
2005
6448758
9969899
169000
166118
Source: Facts & Statistics of life insurance, Insurance Information Institute USA, 2006
Most life insurers are organized as either stock or mutual companies. Stock life
insurance companies issue stock and are owned by their stockholders (ACLI, 2005).
Mutual companies are legally owned by their policyholders and consequently do not
issue stock. At the end of 2005, 1,119 life insurance companies were in business in the
United States. (Table 2.19) The number of active companies has fallen steadily since
peaking in 1988, mostly due to mergers and consolidations. This streamlining helped to
reduce operating costs and general overhead significantly. Since 1990 the number of
agents and brokers in the life insurance industry in United States has got stabilized
(Table 2.20) Besides consolidation, another recent trend in the life insurance industry is
demutualization and the formation of mutual holding companies—a structure that allows
easier and less expensive access to capital.
59
Table 2.19: Nature and number of life insurance companies in USA
Nature of life insurance
2004
2005
companies
Stock
903
864
Mutual
139
135
Fraternal*
108
102
Other
29
18
Total
1179
1119
*Fraternal refers to companies owned by fraternal benefit societies
Source: Facts & Statistics of life insurance, Insurance Information Institute USA, 2006
2.21.2 DISTRIBUTION CHANNELS
Table 2.20:
Number of agents, brokers in United States of America
Year
1980
1990
2000
2001
2002
2003
2004
2005
Agents & Brokers
( in ‘000s)
1687.9
2125.5
2220.5
2233.7
2233.2
2266
2258.7
2255.4
Source: Facts & Statistics of life insurance, Insurance Information Institute USA, 2006
Life insurance was once sold primarily by career life agents, captive agents who
represent a single insurance company and by independent agents who represent
several insurers (III.org, 2006). Table 2.20 gives the details of Agents & Brokers
employed by the life Insurance Industry in the United States. Currently life insurance
company products are also sold by direct mail, telephone, and the Internet, directly to
the public. In addition, in the 1980s, insurers began to market annuities and term life
insurance through banks and financial advisors, professional organizations and
workplaces. Large portions of variable annuities, which are based on stock market
performance, and a small portion of fixed annuities, are sold by stockbrokers. Figure
2.12 gives the details of the percentage contribution of each of the channels of
distribution in the US market. It can be observed individual agents (Career agents,
60
Independent agents) dominate the distribution and bancassurance is yet to develop into
a significant channel for distribution of life insurance products.
Figure 2.12: Channelwise distribution of life insurance in United States of America
(2001)
32%
43%
22%
1%
2%
Career agents
Direct response
Independent Agent
Financial Institutions
Personal Producing General Agents
Source: Facts & Statistics of life insurance, Insurance Information Institute USA, 2006
2.22
LIFE INSURANCE IN BRAZIL
Table 2.21: New premium income in Brazil
Year
2002
2003
2004
2005
2006
New Premium (US
$ millions)
2385
3921
5580
7557
10565
Source: www.limra.com,
Life insurance represents a relatively small proportion of total insurance activity in
Brazil (18%) compared to developed countries such as the USA (30%) and Japan (40%)
(Interfund Research, 2004). This proportion has grown from 12% in 1993. Premiums per
capita were $12 in Brazil in 1999, compared to $450 in the USA and this comparison of
life insurance premiums per capita shows the underdevelopment of the life insurance
61
sector in Brazil. Similarly, as a percentage of the country’s economy, life insurance in
Brazil represented only 0.4% of GDP in 1999, compared to 1.5% in the US. (Interfund
Research, 2001). New life insurance premium during 2006 was at US $ 10,565 millions
(Table2.21) and it has been growing consistently.
Distribution of life insurance tends to be predominantly through brokers, although
the sale of life insurance through banks is also increasing. The top ten players in the
sector are responsible for 58% of total life insurance sales.
The main catalysts for
growth have been the fall in inflation since 1994, and the deregulation of the industry.
With the fall in inflation, financial products have become much more attractive, as the
preoccupation with inflation has also declined. Added to this, a wider distribution of
income and a previously low insurance penetration among the Brazilian population has
led to growth.
The Brazilian life sector is dominated by term (temporarily) life insurance, the
majority of which is sold through group life policies, usually to cover employees of
businesses. However, in 1998 long-term life insurance policies, including endowment
policies and some whole life policies began to appear in the market. Life insurance
industry shows potential for continued growth, mainly because of its very low penetration
within the Brazilian market place, and the very high latent demand for savings products.
2.22.1 DISTRIBUTION IN BRAZIL
Brokers remain the main distribution channels for insurance in Brazil, accounting
for some 70% of sales. The remaining 30% of sales are accounted for by the sale of
insurance through bank branches (25%), and through direct marketing methods (5%).
The involvement of brokers in a direct or indirect form is mandatory in Brazil. The figure
62
of an 'agent' (a salesman working purely on behalf of the insurance company) does not
formally exist, although brokers often have an ambiguous role - officially earning their
income independently from customers, but concentrating on (and supported by) just one
or two insurance companies. . There is also scope for a more effective use of customer
profiling and targeting, to make direct marketing a more effective means of distributing
personal insurance.
Insurers are experimenting with new methods of distribution, particularly in their
attempts to reach a wider market place (for example, among middle and lower income
customers who have not bought insurance in the past). Firms are keenly exploring both
broker and non-broker distribution channels. Insurers are selling products through
banks, supermarkets, gas stations, motor accessory shops and subway stations. They
are also looking at the use of affinity groups, direct marketing, and alliances with firms
such as credit card operators, and are beginning to explore the use of the Internet as an
interface for both the client and suppliers such as brokers.
Globally countries, which are in different stages of economic development, have
varying insurance density and insurance penetration levels. Each country has evolved
their principal distribution channel for life products. A summary of insurance climate for
select economies has been captured in Table 2.22.
63
Source: www.limra.com
64
247.9
Developed
Economy
United
Kingdom
Korea
416.5
60
Developing
Economy
India
Developed
Economy
18.8
Emerging
Economy
France
Unite d States
of America
176.2
Developed
Economy
China
256.6
39.6
Emerging
Economy
Brazil
Developed
Economy
12.5
Emerging
Economy
Country
Japan
Market size
(US $ Billion)
Status of
economic
development
3931.73
1817.23
2614.56
1255.22
18.3
3164
34
56.56
Insurance
Density ($)
9.97
4.35
7.35
7.62
2.53
8.63
1.95
0.99
Insurance
Penetration
(%)
Table 2.22: Life insurance market - Global perspective
IFAs / Brokers
Career Life
Agents
Agency
Tied AgencyWomen
Tied Agency
Financial
Institutions
(Bancassurance)
Agency
Broker
Dominant
distribution
Channel
REFERENCES:
1
ACLI, American council of Life Insurers,
2
Annual Reports of IRDA
3
BCG, “Building Professionalism -The next step for life insurance in China”,
Boston Consulting Group, 2003.
4
Beck, Thorsten and Webb, Iann 2002, “Economic, Demographic and institutional
determinants of Life Insurance Consumption across countries”, World bank and
International Insurance foundation, 2002
5
Bodla, B.S, Garg and Singh, “Insurance Fundamentals, environment and
procedures”, Deep and Deep publication, 2003.
6
CEA, “The European Life Insurance Market in 2005”, European insurance and
reinsurance federation, 2007. www.cea.assur.org.
7
Chu, Julia F, “The Makings of Imminent Insurance Markets in Asia”, Milliman
USA, April 2001.
8
Dickinson, Gerry, “Encouraging a dynamic life insurance industry: Economic
benefits and policy issues”, Center for insurance & investment studies, London,
2000. www.oecd.org.
9
Headey, Paul, Law, John and Zhang Caro, “China life insurance market:
opportunities for foreign entrants”’ Milliman Global, 2002.
10
Hong An, Chi, “Opportunities and challenges in the Korean insurance market”
Milliman Global, March 2004.
11
ICFAI, “Life Insurance Volume I & II”, The ICFAI University Press, 2002.
12
ICRA, “The Indian insurance industry- A report” May 2003
13
III, “Facts & Statistics of life insurance”, Insurance Information Institute USA,
www.III.org.
14
III, “Risk Management”, Insurance Institute of India, 1997.
15
Inter fund- research, www. Interfund-research.com, 2001.
16
Jawaharlal U, “Insurance Industry – Emerging Trends”, The ICFAI University
Press, 2004.
17
Jawaharlal U, “Insurance Industry- Volume III”, The ICFAI University Press,
2003.
18
NIA, “Life Insurance Underwriting”, National Insurance Academy, Online learning,
Pune, www.niapune.com.
19
RBI reports. www.rbi.org.in
65
20
Reiche, Edward, “The Development of Life Insurance Companies in Emerging
Asian Markets” Address in 6th Global conference of actuaries, 2004.
21
Rejda, George E, “Principles of Risk Management and Insurance", 8th Edition,
Pearson education publication, 2004
22
Ryotaro, Kaneko “Life Insurance in Japan” IIS Speech 2004.
23
Steel Roger, “Winning Strategy for Life Insurance Companies in China” Deloitte,
Touche, Tohmatsu, 2000.
24
Stephenson. Mary J, “Risk Management - Life Insurance”, 2000.
25
Sun, Hua (Peter) and Affleck Allan, “Report on the Taiwan Life Insurance Market”
Woodrow Milliman Asia, 2004.
26
Swiss Re – Sigma No 5/2006
27
Vaughan, Emmett J
& Vaughan Therese, “Fundamentals of Risk and
Insurance”, 9th edition, Wiley publication, 2003.
66