Increasing share of non-participating
business in India – systemic risks
associated with it
Archana Anoor, Rahul Khandelwal and
Rutika Kumar
Guide: Philip Jackson
Agenda
• Introduction
• Life insurance business evolution in India – changes
in business mix
• Systemic risk
–
–
–
–
Definition & triggers
Macro-level
Insurance business (non-par, in particular)
Mitigation Measures
History of Par and Non- Par in India
12.0
7000
10 yr Gsec Yield Vs Sensex
11.0
6000
10.0
Yield
• LIC - Operating as monopoly
after nationalization in 1956
• Products sold – Mostly Par
5000
9.0
4000
8.0
3000
7.0
2000
6.0
10 Year Yield
5.0
Sensex
1000
4.0
0
2000
2001
2002
2003
From 2000 to 2004
• Privatization of the sector in 2000
• Products Sold – Similar to LIC and mostly par endowment
• Issues on Par portfolio - Sharp dip in interest rates in 2000 to 2004
• IRDA Distribution of Surplus Regulation (2002) - ‘90:10’ gate
• Alternatives – Non-linked non par (until 2003-2004 ~ 20%)
Sources: IRDA Journal, BSE Sensex website, RBI website, Research Report of Miliman
2004
Sensex
Pre 2000
10 Year Yield
2004
From 2007 to 2010
2005
16000
14000
12000
10000
8000
6000
4000
2000
0
Sensex
2006
2007
10 yr Gsec Yield Vs Sensex
12.0
25000
11.0
20000
10.0
Yield
• Private Sector - ULIPs (by 2010 NB ~ 80%) and
non-linked non par continued
• LIC – ULIPs ( ~ 60% in 2007 – 08) and Par
continued
• Stock market crashed and sharp reductions in
interest rates in 2008 – impact on par
portfolio again
• Non par guaranteed products became more
attractive
10 yr Gsec Yield Vs Sensex
12.0
11.0
10.0
9.0
8.0
7.0
6.0
5.0
4.0
9.0
15000
8.0
10000
7.0
6.0
10 Year Yield
5.0
Sensex
5000
4.0
0
2007
Sources: IRDA Journal, BSE Sensex website, RBI website, Research Report of Miliman
2008
2009
2010
Sensex
• ULIPs (non par) were introduced
• Rising level of stock market – Sensex Doubled
(6K to 12K)
• Products Sold – Par mostly by LIC, Non Par
(mostly by private players)
Yield
From 2005 to 2007
Sensex
History of Par and Non- Par in India
History of Par and Non- Par in India
From 2011 to 2012
• Flat market – both equity and bond market
• Decrease in ULIPs and increase in trad par and non par business
• Reduced distributor compensation in ULIP – Product Regulations 2010
• Negative impact on consumer demand – sharp drop in stock market in 2008
• Mis-selling issues on ULIPs emerged aggressively - 100% allocation charge product and
highest NAV products
• More guarantees are offered on non par to attract customers(G-sec linked prod)
• NB of around 80% in traditional par and non par in 2011-12
NB Premium
12.0
11.0
10.0
9.0
8.0
7.0
6.0
5.0
4.0
25000
100%
20000
80%
15000
60%
10000
5000
0
2011
2012
10 Year Yield
Sensex
Sources: IRDA Segment wise data, BSE Sensex website, RBI website
Sensex
Yield
10 yr Gsec Yield Vs Sensex
40%
20%
0%
2009-10
non par (link)
2010-11
non par (non link)
2011-12
Par
History of Par and Non- Par in India
Total value of Investments under various funds from 2011 to 2013
• For LIC
• ULIP investment reducing – aftermath of stock market shock
• Pension and General Annuity & Group Fund increasing – demand of guarantees and annuities
• Life Fund steady - attraction of par business continued
• For Private Sector
• ULIP investment reducing – aftermath of stock market shock
• Pension and General Annuity & Group Fund – annuities and group fund
• Life Fund increasing speedily - demand of guarantees under non par business
Tot Value of Investment under various fund – LIC
100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
2010 - 11
Sources: IRDA Journal
2011 - 12
2012 - 13
Tot Value of Investment under various fund – Private
100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
2010 - 11
UL fund
2011 - 12
Pension and GA & GF
2012 - 13
Life Fund
History of Par and Non- Par in India
From 2013 to Now
ULIPs and traditional non par increasing:
• Upward trend in sensex – Impacting ULIP sells (since, 2014 Jan the sensex has touched a
33% growth)
• Attraction of higher guarantees(GSVs) on non-par – making impact on sales
Par business reducing :
12.0
11.0
10.0
9.0
8.0
7.0
6.0
5.0
4.0
30000
10 yr Gsec Yield Vs Sensex
25000
20000
15000
10000
10 Year Yield
Sensex
5000
0
2012
2013
Sources: BSE Sensex website, RBI website
2013
2014
Sensex
Yield
• Enhanced Guarantees – Ensuring 0% customer IRR(@4%) – PRE raised
• Enhanced Cost – Complexity/additional governance requirement
• Downward mean reverting trend in Gsec yield - started impacting par portfolio
• Lower profitability – ’90/10 gate’
Prospective Regulation - ‘0% customer IRR on Par and
Illustrated MB of 90% of premiums paid on ULIPs @4%’
• Easier to illustrate for ULIPs - less guarantees than par
• More obvious for non par savings contracts (not a reg requirement)
• Move towards non-par is expected.
Systemic Risk
Image source: http://www.gardalundur.is/g/images/stories/domino-effect.jpg
Systemic risk
Definitions:
•
•
•
•
Contagion
Chain Reaction
Collapse or failure of a major part of financial system
Domino effect
Triggers:
• External e.g. contagion fears in non-insurance
operations
• Internal
• Covered in more detail later (sources of systemic risk)
Indicators of systemic Risk
Conclusions of Geneva association Systemic
Risk Working Group
FSB/IAIS defined criteria to assess an institution's systemic risk
• Size
• Substitutability
• Interconnectedness
• Speed of loss of transmission to other parties - slow pace of claim
settlement in insurance industry
Application of criteria to main activities of insurers & reinsurers
• Investment management
• Liability origination
• Risk transfer
• Capital Management
Conclusion : Insurers do not pass systemic relevance test
• Limited size means effect of financial markets not disruptive
• Slow speed of their impact allows insurers to absorb them e.g, raising
capital or orderly wind up
•FSB,
Features
of interconnectedness means contagion risk limited
Source:
IAIS
Do the findings apply to Indian
insurance industry?
Size: Volume of financial services provided by the individual
component of the financial system
If LIC is listed it could be the most valuable Indian company at
Rs.4.5 – 5 lakh crore (Business Standard, June 2014)
If above metrics are aggregated for all insurers the impact will
be higher
Do the findings apply to Indian insurance
industry? (contd)
Test for Substitutability
• Does the insurer have any technical specifics or play such a unique
role in a market that it would be difficult to substitute an
equivalent actor in the short-term if the institution were to
disappear?
• Is the capacity that the institution deploys to its market so large or
unique that others could not step in with capacity sufficient to
enable the market to clear?
Interconnectedness: Only if risk can be transmitted then the institution
or its activities present a risk for the system
•
•
•
•
•
Insurers as owners of financial assets
Linkage between company and financial system
Linkage between insurers and bank
Linkage between insurers and reinsurers
Insurance companies within complex financial services groups
Do the findings apply to Indian
insurance industry? (contd)
Time
• Immediate shock or a slowly ticking bomb? Pace of transmission
• Slow pace might increase substitutability for rebuilding capital e.g.
slow pace of claim settlement in insurance industry
Other factors added by IAIS
• How leveraged is an institution and its investments?
• Liquidity risk and maturity mismatches
• Complexity : Lack of transparency implied by complexity – unclear
to regulators, market participants and the company what
exposure it has
• Global activity
Sources of systemic risk –
insurance industry
Systemic risk – insurance industry
Characteristics of insurance industry
• Up-front premiums – contribute to stability, insurance
industry is self-funding
• However, upfront commission, acquisition costs with future
profits – make it more vulnerable
• Large AUMs (roughly 10% of world’s total financial assets*),
expanding industry => net buyers of assets, long term
nature, unlike other investors insurers’ assets must have
direct relevance to liabilities
• Characterisitics of non-par business:
• High guarantees (fixed, non-discretionary)
• Competitive market (so low premiums)
• Therefore, inability to adjust resiliently to shocks
* International Financial Services Research, Oct 2009
Systemic risk – insurance industry
Investment related:
•
•
•
•
•
•
•
•
•
•
Buying habits that lead to Concentration risk
Insurers primary owners of financial securities
Decide on type of securities to buy and when to sell
Favour certain type of securities
Investment strategies impacted by regulatory restrictions on
holding certain assets which best match liabilities
Leads to coordinated investment activities by insurers
Systemic risk due to coordinated activity:
Can inflate bubbles in certain securities or sectors related to those
securities
Ignite or exacerbate fire sale of assets as soon as their credit rating
goes down to avoid regulatory ramifications.
This will aggravate further downgrading of assets contributing to
their sudden illiquidity
Systemic risk – insurance industry
Investment related:
• Sale of investment oriented products guaranteeing contractuallyspecified investment returns to policyholders
• CPPI strategy
• ALM risk
• Mismatch: Long term guarantees Vs unavailability of long term
stocks
• Reinvestment risk
• Liquidity risk:
• Reduced liquidity of certain assets or liquidity crunch in
banking operations
• long term nature of assets => liquidity lock-in
• Mostly planned claims e.g. maturity but policyholders can
accelerate this through surrenders => liquidity risk
• Policyholder exercise options, change behaviour e.g. large
surrenders when market move adversely
Systemic risk – insurance industry
Investment related (continued):
• Severe economic or market downturn
• Adverse interest rate movements (low interest rates, high inflation)
– affect on guarantees inherent in non-par portfolio, exacerbated if
no hedging and priced riskily (i.e. using high yields)
• Eventually, one or a combination of above risks could affect
insurer’s financial position
Systemic risk – insurance industry
Underwriting/core insurance related:
• Claims are contingent on risk events happening a catastrophe can lead
to insurance run- pandemic, terrorist attack
• Slow pace might increase substitutability for rebuilding capital e.g. slow
pace of claim settlement in insurance industry
• no sudden run-off claims paid a slow pace, not paid immediately after a
catastrophe therefore, however:
• An adverse A/E could potentially lead to running into risk, with high
mortality risk in term, longevity risk in annuities
• Industry-wide common standards of underwriting: common
inadequacy, mis-estimations could be detrimental
• Imbalance between pricing & underwriting
Policyholder runs
• Increase in policyholder withdrawals due to:
• Worries about insurer's solvency
• Fall in markets and liquidity needs
• Policyholder buying ULIPs not aware of risks
• Regulator prescribed Guaranteed Surrender value
Systemic risk – insurance industry
Counter-party (reinsurer, in particular):
• Same reinsurers are used by multiple market players – failure of
one big reinsurer can cause systemic risk
• Withdrawal of reinsurance cover for particular events e.g. after
9/11, no terrorism cover
• Prescriptive Reinsurance guidelines:
• Maximising retention within India - concentration risk as
diversification of risk will not occur
• Reinsurers exiting market or reinsurance not available on
favourable terms?
• No reinsurance support on data, product design etc
Systemic risk – insurance industry
Other:
• Regulatory risk, sudden change in legal/regulatory
framework
• On the other hand, during the onset of a systemic risk,
regulators’ early intervention e.g. relaxing capital
requirements temporarily prevent crisis from happening
• Systemic risks associated with long term trends e.g. climate
change, longevity
• Other causes: over-valuation of assets, ill-managed rapid
growth
• Operational risks
Systemic Risk – manage/mitigate?
Systemic risk mitigation measures
Implement comprehensive, integrated and principle-based supervision
of Insurance
Strengthen liquidity risk management e.g, liquidity stress tests
Enhance regulation of financial guarantee insurance
Increased monitoring of macro/industry-level prudence with adequate
insurance representation
Industry-wide risk management practices e.g. stringent regulatory
reserving, risk based capital?
Individual insurers – (1) good underwriting is first line of defense (2)
ALM exercises coupled with resilience tests (3) ERM
Questions?
Appendix: Sources/Reference
Links
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<www.genevaassociation.org>
<www.irda.gov.in>
<www.bseindia.com>
<www.rbi.org.in>
<www.milliman.com>
<www.financialstabilityboard.org>