Investing abroad will help Indian insurers cut risk

India’s insurance regulations are meant to protect consumers, but they have become a straitjacket that adds to the cost of insurance products and potentially makes them more risky than necessary.

India is one of the most heavily regulated insurance markets in the world. Unlike most of their international peers, insurers here are not allowed to use third-party asset managers, and are barred from investing in a large variety of instruments and asset classes—including all overseas investments—that could help to manage risk and boost returns.

Bringing in international portfolio diversification would protect Indian insurers against pro-cyclicality and generate greater returns. Many large international insurance companies already have a presence in India through local partnerships—and the government may raise the ownership cap for foreign investors in the insurance industry to 49% from the present 26%. However, the current regulatory system bars them from using their expertise to manage the portfolios of Indian firms, be it onshore or offshore.

Given the limited scope of currently available investments, Indian insurance companies are forced to rely on domestic fixed income assets and equity products, limiting their abilities to mitigate risks and achieve higher returns.

Fixed income and equity investments work better when markets are rising and interest rates are high. But when there is a downturn and interest rates are low, today’s regulatory environment places severe restrictions on the insurance companies’ ability to optimize the service and protection they provide for their customers.

India has a lot of room for growth in the insurance industry. At $52, India’s insurance density (insurance premiums per head) is just 40% of the level in emerging markets as a whole, according to a Swiss Re report. Insurance premium income, which was worth Rs.66.4 billion in the financial year 2012-13, is estimated (by India Brand Equity Foundation) to grow at more than 30% a year between now and 2020, and pension funds alone are projected to have $1 trillion to invest by 2025.

But these numbers are a threat as well as an opportunity. The vastly increased funds being managed by the industry may well outstrip the capacity of the domestic market to absorb new investments. India needs to allow international portfolio diversification and let the best of global talent manage such sums.

By restricting insurance investment to the domestic market, the regulations are increasing investors’ exposure to cyclical downturns. It would be terrible if a farmer who is claiming on a policy due to a poor monsoon finds that the insurer has difficulty in paying because the very same monsoon has depressed the value of assets across the board, including the investment insurance policy which the insurance company had bought to cover the claims.

Diversifying a portion of the asset base beyond India’s borders would allow insurers a degree of insulation against the volatility of domestic markets. The current restrictions on diversification mean that prudent Indian insurers have to carry extra reserves, and pass on the added cost of doing so to the policyholder.

The requirement for in-house management for all funds raises the entry barriers for new companies and reduces competition. Much of today’s insurance market is driven by push factors, including tax incentives and rules compelling certain sectors to buy policies, according to a report by Confederation of Indian Industry and EY. Increased competition, new products and lower premiums would bring in more customers.

This is not a call for immediate wholesale de-regulation; any regulatory change must be handled carefully to avoid overloading the system. Policymakers need to make sure liberalization isn’t mistaken as a green light for gambling; they must set sensible rules for outsourcing fund management. And regulators would have to establish strong and consistent oversight to ensure the rules are followed, even when the funds are invested in international markets.