Creating a Stronger Regulatory Framework for the Insurance Sector Research Paper June 2013
A New Act drafted for the Insurance Sector Insurance Density and Penetration low; but growth in premium high In order to assess the potential and performance of the insurance sector, two parameters- namely insurance density and insurance penetration, were evaluated and compared with neighbouring countries. For FY 2010/11, while India’s penetration stood at 5.1%, Nepal and Sri Lanka recorded a lower rate of 1.3% and 1.2% respectively. In terms of insurance density, Nepal was lagging behind with a density of only USD 7.6 as compared to figures as high as USD 29.4 and USD 64.4 for Sri Lanka and India. Nonetheless, the premium in Nepal grew at a rate of 14.8%, as compared to a growth rate of 4.8% and 2.7% for Asia and the World. This corroborates the fact that the insurance sector is at a nascent stage which leaves scope for expansion in the years ahead.
The insurance sector has undergone significant changes in the past decade, but the regulations in place have not kept up with the dynamicity of the industry. The Insurance Act, 1992 has seen two amendments since its inception; one in January, 1996 and the other in January, 2002. After almost a decade, the Act is being revised by the Insurance Board (IB). The drafting of a new act can be regarded as a positive step overall as it provides better grounds for tighter regulation of the insurance industry. All procedures regarding approval, licensing, renewal, valuation have listed down clearly. After the commencement of the new Act, the IB will be converted into the Insurance Authority of Nepal (IAN). Furthermore, the powers of the IAN will be enhanced in better decision Nepal Insurance Board making, monitoring and correcting of fraudulent activities. However, certain amendments relate to capital requirement and licensing in the new draft Act raised contentions amongst the private sector and thus, they sought to review the draft Act. This issue was also raised in the Financial, Monetary and Insurance Affairs Working Group of the Nepal Business Forum on 6 June 2011.
Timely Revision of Act for Growing Insurance Sector The economic liberalization policy through the restoration of democracy initiated in the early 1990s paved way for the growth and opening up of the financial sector. One of the developments was the enactment of the Insurance Act, 1992 to govern the insurance sector. Realizing the importance of the insurance sector in the financial economy, the IB drafted a new Act to better regulate the sector and prepare the sector for future growth. Since its inception in 1992, only two amendments have been made, with the last amendment in January 2002. Lack of timely revision of the Act and inadequate power given to the IB, coupled with the need to address the change and growth in the insurance sector with better governance and accountability, has led to the formation of a new draft Insurance Act.
Role of the Nepal Business Forum Despite the timeliness and the need for a new Insurance Act, the insurance companies were particularly concerned over few changes in the Act that needed careful review and as a result of which the Financial, Monetary and Insurance Affairs Working Group of the Nepal Business Forum have suggested a review of the draft Insurance Act. As per the decision of the Working Group meeting, a working committee was also formed by the Ministry of Finance in order to assess the issues raised by the private sector comprising of representatives from MoF, NRB, Nepal Insurance Association and IB. Though the draft Act was welcomed, based on the significance of changes as well as resistance received from the private sector in relation to the Act, the following major issues were key areas of concern: Increment in paid up capital requirement of life insurance companies to NPR 2 billion from the existing requirement of NPR 500 million; and of non-life insurance companies to NPR 1 billion from the existing NPR 250 million is too high. The time limit to meet the proposed requirement is five years from the date of enactment of the proposed draft Act, which is perceived as too less. Restricting insurance companies from doing business with companies where financial interest exists (Corporate Governance guidelines). Requirement of renewal of registration every year is viewed as a hassle. Others include the provision of allowing new insurance companies, to only issue shares to the public after five years is viewed as restrictive and bringing in Rastriya Beema Sansthan (RBS) under the purview of the Insurance Authority of Nepal (IAN).
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Creating a Stronger Regulatory Framework for the Insurance Sector
Snapshot of the Insurance Industry over the Past Five Years 1
Fire Insurance
Particulars Premium Collection Life Non Life Total Premium Investment Life Non Life
(Amount in NPR Millions)
FY 07-08
FY 08-09
FY 09-10
FY 10-11
FY 11-12*
CAGR
5,490 3,852 9,342
6,636 4,420 11,056
8,766 6,497 15,263
10,450 7,171 17,621
13,361 8,100 21,461
24.9% 20.4% 23.1%
20,350 4,183
26,516 5,008
36,467 6,806
42,751 7,473
52,381 8,605
26.7% 19.8%
Total Investment2
24,533
31,524
43,273
50,224
60,987
25.6%
Contribution to GDP Net Profit Life Non Life Total
5.7 289.7 295.4
266.8 469.4 736.2
195.5 565.9 761.4
223.6 656.5 880.1
595.1 894.9 1490
219.6%3 32.6%
Premium Collections and Net Profit of Life and Non Life Insurance Companies 1.15% 1.12% 1.28% 1.28% 1.33% 3.7% over past Five Years
Source: Insurance Board, *as per projected data of Insurance Board
Life Insurance
Growth in the sector: The insurance sector has witnessed tremendous growth since the opening of the financial sector to insurance business. Currently, there are 9 life and 17 non life insurance companies operating in Nepal.4
Aviation Insurance
Source: Insurance Board
Insurance Industries in Nepal Life Insurance Companies Rastriya Beema Sansthan, National Life Ins., Life Insurance Corporation Nepal Ltd., American Life Ins., Asian Life Ins., Gurans Life Ins., Surya Life Ins., Prime Life Ins.. Non-Life Insurance Companies Nepal Insurance Co., The Oriental Ins., National Ins. Co., Himalayan General Ins., Co., United Ins., Premier Ins., Everest Ins., Neco Ins., Sagarmatha Ins., Aliance Ins., NB Ins., Prudential Ins., Shikhar Ins., Lumbini General Ins., NLG
Total and Average Figures for the Insurance Industry as on FY 2011/12
Amount in NPR Millions
Particulars No. of Institutions
Life 9
Non Life 17
Insurance Premium
13,361
8,100
Avg. Premium
1,484
476
Investment
52,381
8,605
Avg. Investment
1,484
506
Paid-up Capital
2,331
1,617
Avg. Capital
291
107
Net Profit
595
894
Avg. Profit
66
52
Source: Insurance Board 1. The figures for Rastriya Beema Sansthan have been projected by the IB, since only the financials until FY 2002/03 have been audited and approved by the Annual General Meeting (AGM).
2. Refer to investment in various investment instruments allowed by IB as per Investment directive 3. The CAGR for profits of life insurance companies is very high as they are only allowed to show profits every three years. Also, the life insurance sector is only a few years old, which has led to increased growth through new entrants as well. 4.Rastriya Beema Sansthan, a government owned company, operates both life and non life insurance business. Therefore for the purpose of our calculation, its life and non life business is taken as two separate businesses.
Research Paper
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Apart from the growth in numbers, the insurance sector has seen double digit growths in premium collection, investments made and profits and this growth is expected to continue in future as the industry is at a nascent stage, leav-
ing scope for expansion. Over the past five years, the cumulated average growth rate of premium collection stood at 23% while the same figure for investments grew at 26%. The average contribution of this sector towards the GDP stands at 1.2% for the past five
years. While the industry has been growing in number and volume of business, the Act has not changed in order to incorporate the dynamicity of the insurance market.
Premium Collections and Net Profit of Life and Non Life Insurance Companies over past Five Years Non-life Insurance Companies
Life Insurance Companies
Amt in NPR Millions
Amt in NPR Millions
 Limited authority to the IB: The Act limits the powers of the IB thereby restricting the IB from tightly regulating the sector. Despite the IB being a autonomous body under the current Act, it still needs permission from the Ministry of Finance (MoF) to frame necessary bylaws.  Clarity in the processes and provisions: The processes in place have not been clearly listed down and the provisions for capital requirement and solvency margins have not been altered with the increase in the size of the industry.
The draft Act has attempted to incorporate all the aforementioned shortcomings of the current Act. The Act was prepared in consultation with various stakeholders of the industry as per the Insurance Core Principles (ICPs) fixed by the International Association of Insurance Supervisors (IAIS)5 after consultation with various stakeholder groups such as insurance
companies, Securities Exchange Board of Nepal (SEBON), Ministry of Finance (MoF), Nepal Rastra Bank (NRB), Ministry of Law and Justice (MoLJ), general public, experts and consultants. The IB also issued public notice in the national newspaper to provide any feedback or comment on the proposed draft Act which was made available on their website for over a month.
The changes were welcomed by all stakeholders of the industry given its timeliness and essential alterations. The Act was forwarded to the MoF in June, 2010. It was then sent to the MoLJ for review, after which it was forwarded to the Cabinet in October, 2011. The Act is currently pending at the Cabinet.
5. Established in 1994, the International Association of Insurance Supervisors (IAIS) represents insurance regulators and supervisors from more than 200 jurisdictions. c/o Bank for International Settlements (BIS), Basel, Switzerland
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Creating a Stronger Regulatory Framework for the Insurance Sector
Dissecting the Draft Insurance Act Upon closer analysis of the draft Act and interactions with concerned stakeholders, the research highlights the five contentious issues stated above, and the significant changes proposed to facilitate and improve the regulation of the sector. Proposed Capital requirement not Justified by Size of Market; Share Issuance also Late While insurance companies also agree to the fact that an upward revision in the capital requirement is necessary, they are questioning the amount of increase and the time frame within which such requirements need to be fulfilled. Therefore, in order to aptly assess the ability of the insurance sector to absorb the proposed capital requirement, the current state of the market and growth opportunities were analyzed along with the following key considerations.
panies, the financial resources of promoters are already tied up. Further, on the basis of projected profitability of insurance companies and commercial banks for the next six years, the average return on capital of life insurance companies stands at 15%, for non-life insurance companies at 19.9%, and for commercial banks at 52.4%. This leads to a higher opportunity cost of investment in insurance companies for promoters as they have better options in BFIs.
es to issue public shares only after a period of years does act as an entry barrier, but it also restricts companies from raising necessary capital in the early years. Further, a period of five years might affect the charm of a public issue, as investors are more willing to invest in new companies in anticipation of buying shares at face value and realizing quick returns.
mium worth NPR 1.4 billion and NPR 476 million respectively. Since the profitability and volume of business does not justify the capital increment when comparing it with commercial banks, question of overcapitalization may arise.
Disallowing Captive Insurance In the international scenario, captive insurance companies are established with the specific objective of insuring risks emanating only from their parent group or groups. Only remaining peak risks that are not self-insured by these nonfinancial companies are transferred to insurance companies.6 Since the captive sector only serves the interest of their parent group, conflict of interest does not arise. However, insurance companies in Nepal are set up as normal non life insurance companies but inadvertently get involved in captive business as well, which leads to conflict of interest. A few cases of biasness to promoters and promoter groups have also risen due to such business practices. The main reason behind implementation of the aforementioned regulation is to avoid any conflict of interest and provide fair services to all clients, and also to promote a competitive environment, as insurance companies will then acquire businesses based on competence and not connections.
A strong argument for an increment in share capital is to increase the risk taking capacity of insurance companies in order to limit the amount of reinsurance business going out of the country. Currently, 17% of life insurance premiums and 48% of non life premium collections are sent out on reinsurance. Increasing the share capital will definitely help insurance industries absorb greater risk; however, due to the size of the industry, it does not seem likely that the entire amount of risk taken by insurance industries can be borne by them. Moreover, international practices suggest that a certain portion of the risk is always offloaded to reinsurers. The issue of allowing new insurance compani
License Registration to be Renewed Every Year The Insurance Core Principles and Methodology (ICPM) published by the International Association of Insurance Supervisors7 requires insurer to be licensed before it can operate within a jurisdiction. The ICPM however is silent about the yearly renewal of registration, only stating that “as necessary, after an insurer has been licensed, the supervisory authority evaluates and monitors the degree to which the insurer satisfies the relevant licensing principles and requirements of the jurisdiction.” Most countries require insurers to renew their license through its regulator annually. Ex
While the average profitability of commercial banks stands at more than 7 times the profitability of life insurance companies and 9 times more than that of non life insurance In the current scenario, there exists an companies, the capital requirements are the average capital deficit of NPR 1.7 billion same for life insurance companies and half the amount for non life Capital Requirement and latest insurance premium collec- insurance companies. tion for the Insurance Sector in South Asian Countries Comparing the volume of business as well shows a Life Non-Life vast difference; banks on Country Capital Yearly Capital Yearly an average collect deposPremium Premium its worth NPR 26.7 bilNepal 500.0 13,361 250.0 8,100.0 lion, while life and non (existing) life insurance collect preNepal (proposed)
2000.0
16,547
1000.0
9,480.0
India
1600.0
4,644,099
1600.0
678,072.0
Srilanka
342.9
24,126
342.9
29,716.0
Bangladesh Pakistan
820.8
63,940
1641.7
18,106.0
448.5
60,997
269.1
44,851.0
Source: Respective Insurance Authorities*projected figure based on 7year CAGR
and NPR 893 million for life and non life companies to meet the new requirement. Meeting this deficit through plowing back of profits does not seem to be a feasible option given the deficit amount. Even if the entire profit is plowed back as bonus shares, insurance companies will take approximately 7 to 8 years to reach the capital requirement, which is beyond the stipulated time period. On the other hand, injection of capital through promoters can help meet the deficit. However, due to common promoters between BFIs and insurance com-
6. “Global Insurance Market Report”, 2012 Edition, International Association of Insurance Supervisors 7. The IAIS represents insurance regulators and supervisors of more than 200 jurisdictions in nearly 140 countries. Its objectives are to promote effective and globally consistent supervision of the insurance industry in order to develop and maintain fair, safe and stable insurance markets for the benefit and protection of shareholder; and to contribute to global financial stability.
Research Paper amples of such countries are India and Sri Lanka. It seems relevant and justifiable to have an annual registration requirement as it works as an additional check and balance system in place. While the current Act also requires renewal of registration every year, the draft Act specifies additional grounds on which registration renewal can be rejected. The additional provisions will ensure that only those companies which are functioning appropriately get their renewal approved. Draft Act empowers IAN; Implements Stricter Regulations While the current Act restricts the power of the IB, conversion into the IAN coupled with clarity in the functions, duties and powers of the IAN will help strengthen the governing body. As per the draft Act, insurance companies, insurance agents, brokers, surveyors and third party facilitators fall under the purview of IAN. The IAN can direct insurance companies to change or dissolve management, merge with other companies and can also suspend or cancel license subject to certain conditions. Procedures regarding approval, licensing, renewal, valuation, and processes to value claims, have been listed down step by step. Actions against
Stakeholders of the insurance sector including the IB feel that historically they have not been taken as a priority sector by the government. The insurance sector was also excluded from the comprehensive financial sector reform program from 2004 to 2009. The industry as well as the regulators have not developed at par with the banking sector. As a result, the general public is not educated on the importance of insurance. Lack of awareness programs has led to the penetration of life insurance policies being minimal. Despite the double digit growth over the years, the potential of the insurance industry has not been reached. Mentioned under the functions of the board, the draft Act explicitly states that the IAN must conduct study, research, orientation and awareness or let others conduct such activities in order to increase the market share of the insurance business. Such a provision if implemented will take a positive step towards generating awareness about the sector.
Page 5 unscrupulous activities have been mentioned explicitly and penalties have also been increased. The IAN will not need permission from the MoF for major decisions after the draft Act comes into effect. These changes will ensure that the insurance sector is better regulated and tightly monitored. Dissolution of RBS Act with the effect of the new Act Since the Rastriya Beema Sansthan is governed by the RBS Act, it has created compliance issues due to contradiction with the existing Insurance Act. RBS has not audited and approved its financial statements through an Annual General Meeting for the past 9 fiscal years which is against the Insurance Act, Company Act and SEBON directives. It is the largest player in the industry and since it is not fully regulated, it may create anomalies in the insurance sector. Once the draft Act comes into effect, with the dissolution of the RBS Act, it can be expected that the operations of RBS can be better regulated leading to a fair playing ground to all insurance companies.
Additional Powers of the IAN as per Draft Insurance Act Insurance companies, insurance agents, brokers, surveyors and third party facilitators fall under the purview of IAN. The IAN can therefore monitor, regulate and supervise the above mentioned. To protect the insured, the IAN can direct insurance companies to change the management and direct any other individual or company to look after management, subject to certain conditions. It can dissolve management as well, if deemed necessary. It can direct insurance companies to merge with other companies when liabilities exceed their assets. The Act has also clearly outlined the conditions where IAN can suspend or even cancel the license of insurance companies.
Draft Act Essential, but with Proposed Changes Analyzing the existing scenario, changes proposed by the draft Act and future growth prospective of the insurance industry, the draft act to be introduced by the IB is timely and has incorporated important aspects to ensure the sector is regulated, supervised and monitored prudently. Moreover, the draft act intends to promote preventive measures rather than corrective measures in the future. Important issues of disallowing captive business, renewing registration license every year and bringing RBS under the purview of the IAN are necessary steps to tightly monitor the industry. However, there are few issues in the draft act as outlined in the report which need to be worked upon before the final act rolls out to ensure successful implementation of the act and obtain adequate support from all the major stakeholders of the industry. The following options can be considered to ensure the proposed regulations are justified by the market. The upward revision of the capital requirement needs to be backed by a scientific study which takes into consideration the growth potential and market adequacy of the insurance sector. Such a study will ensure that insurance companies are not overcapitalized. However, in order to ensure compliance of the upward revision, a year wise capital increment plan must be implemented so that insurance companies will compulsorily have to increase their capital base every year for the number of years until the capital requirement is met. This will ensure that the insurance companies cannot wait till the deadline and say they couldn’t comply. The restriction of new insurance companies issuing public shares only after five years can be changed to two years to align this practice with the banking sector. This will give them the opportunity to raise capital easily if required, and to build their resources early on. This will also help increase transparency of insurance companies. Additionally, the aforementioned changes in the regulatory framework should also be complimented with the strengthening of the IAN. The institutional, financial and technical capacity of the IAN must be brought up to the standards that will allow it to regulate and monitor the insurance sector efficiently. Lastly, insurance companies need to place emphasis on the underwriting income rather than investment income given the downward trend in interest rates. Only then will the profitability of insurance companies be guaranteed.
ABOUT NEPAL BUSINESS FORUM
NBF Nepal Business Forum provides a platform for public-private dialogue which is aimed at accelerating and facilitating the reform process by providing the government and the private sector with a structured, transparent and result-oriented mechanism through which they can deliberate on investment climate issues, and jointly agree on reforms. NBF was created by an Executive Order of the Gov-
-ernment of Nepal in May 2010. The South Asia Enterprise Development Facility supported the Government to design NBF based on recommendations and lessons learned from earlier IFC involved publicprivate dialogue initiatives in a number of other countries. The institutional framework of NBF consists of three committees and eight sectoral Working Groups, supported by a Secretariat. At the apex is the High Level Business Forum chaired by the
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This research note was commissioned by the Nepal Business Forum and undertaken by beed management pvt. ltd. (beed), as part of a series of papers to provide independent analysis and background information on selected issues raised by the working groups of the Nepal Business Forum. The views expressed are those of beed, and do not necessarily represent the views of the Nepal Business Forum.
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