Increase in FDI limit in insurance sector to 49% from 26% will likely provide exit  opportunities for promoters. Given the modest growth in business for life  insurance sector and weak profitability of non-life, and that insurers have  significantly high solvency margins, contribution of incremental FDI to expansion  will be limited. If all promoters decide to sell 23% stake to foreign players the  potential inflows can be around USD 3.5bn. But a realistic estimate could be much lower at USD 0.4-0.8bn.
Policy decision and claimed benefits: Government’s decision to allow 49% FDI in insurance from the current 26% is expected to facilitate infusion of fresh capital into the sector, boost expansion and support fund availability to the infrastructure sector. Government claims that sector requires USD5-6bn for its immediate growth requirement.
While the policy will need to be cleared by the Parliament (which is going to be difficult) we analyze the proposal in the context of prevailing industry conditions.
FDI can provide exit opportunity to promoters: In our view, expansion of FDI limit may not translate into large inflows immediately as the sector is going through a normalization phase. While higher FDI participation may not contribute substantially to the medium term growth, it can potentially provide exit opportunity for existing promoters and stimulate listing of companies. Our estimate indicates that if all promoters decide to sell additional 23% stake to foreign players the potential inflows can be around USD 3.5bn. However, in a more realistic scenario of only few promoters deciding to exit the inflows could be much lower at USD 0.4-0.8bn. Overall, while capitalization requirement for non-life sector can be higher than life, which in our view do not require much capital for expansion, the performance parameters of nonlife sector and lower participation of private sector in non-life (contributing only 19% of net worth in total private sector networth in life and non-life) will pose challenge to the anticipated FDI inflow.
Life insurance- High solvency margin at 3.9x provides significant headroom: Given high actual solvency margin, averaging at 3.9x for private life insurers vs required 1.5x, there is sufficient scope for business expansion even with out additional capital. The key issue for life insurers is the slow growth in business, reflected in just 3.5% CAGR during FY07-12 in individual Annualized Premium Equivalent (APE) and around 9.5% for overall APE inclusive of group premium. Redemptions in unit linked plan (ULIPS) and modest growth in overall business have resulted in several companies closing branches and release of capital charge, implying rise in ASM to 3.9x in Jun-12 vs 3.0x in Mar-10.
Normalization in life insurance, regulatory changes to stimulate growth: The long term prospects of sustained growth for life insurance business has been impacted by weak premium flows over the past two years due to 1) tighter regulatory framework which has limited distribution incentive for unit linked plans of private sector in particular, and 2) Recent decline in financial savings of the households. Efforts/factors indicating improved future flows into life insurance products include 1) quicken approvals process for new products, 2) expanding scope for banks to market multi-company products, 3) additional tax incentives and 4) lowering of bank deposit rates. But the more important factors in our view are 1) adverse track record of returns on ULIP schemes, 2) decline in house hold financial savings (assets-liabilities) by -0.5% and -9.2% during FY11 & 12 respectively, 3) sharp decline in financial assets/personal disposable income of household from 23% in FY07 to 14.4% in FY12E, 4) deceleration in disposable income growth amid high inflation and 5) rebound in financial liability/financial asset ratio to 28.3% in FY12 from 20.6% in FY10 after the sharp decline from 37% in FY07.
Overall, it will require significant effort to improve flows into life insurance given the context of further deceleration in disposable income resulting from higher taxes, lower subsidy, persistent high inflation and weak employment arising from broader growth deceleration.
