ÌFDI HIKE IN INSURANCE

Underwriting Profits For Foreign Finance Capital

 N M Sundaram

THE issue of FDI hike is not normally part of the budgetary exercise but that did not prevent the union finance minister P Chidambaram from treading the contentious path of announcing hike in foreign equity in three crucial sectors namely insurance, civil aviation and telecommunications. The finance minister in his characteristic style slipped a fast one in the course of his budget speech. This he did knowing fully well that not only the trade unions in the three industries but also a broad spectrum of public opinion in the country are opposed to the measure. He also knew that the left political parties on whose support in parliament the government depended for its survival too have articulated their stout opposition openly. That the finance minister chose to embark on this controversial exercise smacks of arrogant nonchalance to the views of the very forces that brought him and his government to power namely the people and the very political forces that sustain his government. This is irresponsible brinkmanship that must be reigned in by those more responsible in government including the prime minister. The onus of keeping at bay the communal and anti-people forces represented by the BJP and NDA cannot be on the left parties alone. The Congress that leads the UPA and other constituent parties must bear equal responsibility.

CAUTION REQUIRED

It is not our contention that India does not require FDI at all. But it cannot be allowed indiscriminately and its entry must be strictly in the national interest and not at the whim and choice of foreign finance capital. The fact remains that 13 years of economic liberalisation did not attract FDI to the extent and in areas desired by the reform oriented governments but in trickles at the choice and direction of the foreign investors. What was allowed free entry was speculative capital by the foreign institutional investors (FIIs) and others who are seen to play ducks and drakes with the Indian economy particularly through stock market manipulations. In this background, if the foreign investors desire to plough in FDI in select sectors one must be extremely cautious and consider the desirability with utmost care and circumspection.

The national security aspect and other compulsions that kept civil aviation and telecommunications in the public sector need not be reiterated here excepting to feel shocked at the curious explanation that the finance minister gave in regard to telecommunications. He said that in this sector foreign equity already remained more than what was officially known and permitted and that he was only regularising it. If it were so, he ought to feel concerned about it because its alleged presence over and above the permitted limit is simply illegal. It is extraordinary that the finance minister instead of seeking action against this gross violation of the law is seeking to compound the crime by regularising it. In the US, foreign equity in telecommunication is only 25 per cent and in Europe between 30 to 35 per cent. The pressure for free entry into India in this field is because of the growth prospects, which is around 15 per cent as compared to around 3 per cent in those countries and the enormous degree of competition leading to monopolisation of the market by few companies.

In civil aviation too, the growth potential in the US and countries of Europe is low and the airlines companies are in serious crisis. Another aspect is that in the US and major countries of Europe open sky policy is not being followed in the domestic sector and the skies are monopolized by only domestic carriers. The condition of the aircrafts used and the shabby service provided indicates that they can do well with some more of their own investments instead of burdening themselves with the task of improving the Indian civil aviation.

We will not say anything more on these two sectors at this stage, the focus of this article being insurance.

MISLEADING THE PUBLIC

The finance minister speaking in the forum of FICCI said that foreign equity was being increased from 26 per cent to 49 per cent only in the private insurance companies and that the LIC and GIC would remain in the public sector, as if this required clarification. He also wondered what was the material difference between 26 per cent and 49 per cent when the control would remain with the Indian promoter. If there would be no difference why increase the FDI at all? People are not that naïve, as he would believe.  His purpose obviously was different. He wants to question why the trade union in insurance sector should oppose when the FDI hike was confined to the private insurance companies, which have been asking for it. And, what is the relevance and justification of the left parties’ opposition when the public sector entities were left untouched?

This is a typically clever attempt to confuse and mislead public opinion. In doing this Chidambaram is trying to be clever by half. It is therefore important to clearly understand why increase in foreign equity is objectionable and must be opposed in all its ramifications namely how it would weaken the public sector industry, impair its capacity to contribute to expanding insurance cover all round and provide strategic and vital social investments for healthy development of the Indian economy. Before going into this aspect, it is equally important to understand fully the state of insurance industry in the US and countries of Europe and the financial manipulations and misdemeanours in which most if not all of the foreign companies seeking bigger presence in the Indian insurance market are guilty of in their own countries of origin.

INSURANCE INDUSTRY IN THE US & EUROPE

It is a well known fact that the insurance companies in the US and Europe are in deep crisis – crisis brought about not only due to the enormity of claims that have arisen but also because of the declining growth experienced. In the US as well as in important countries of Europe, the insurance companies are facing negative growth rates. (Source: Sigma - Swiss Re.) So much so they have seen their profits as well as market capitalization declining. Added to this are numerous litigations and scrutiny as well as prosecution by regulatory authorities that have sapped the confidence of the insuring public and entities. These insurers are notorious for repudiating claims and forcing claimants seek remedy through compromises or through litigation. A whole lot of legal practioners thrive on this.

Let us look into some specific companies that have presence in India. In 2002, American Insurance Group (AIG) boasted of a market capitalisation of 190 billion dollar next only to the Citigroup with 220 billion dollar, among the financial behemoths. The Economist carried out an analysis through Seabury Insurance Capital.  The analysis revealed:  “if AIG were valued in line with its best competitors, its stock market capitalization would be almost 100 billion dollar lower than it is. If AIG were compared with insurers of similar size and financial strength, the disparity would be even greater: 120 billion dollar. For that to be justified, AIG's profits would have to grow almost two-thirds faster each year than similar companies, for at least the next 25 years.”  (Shine a Light: Article published in The Economist dated February 28, 2002)

DUBIOUS RECORD OF US & BRITISH COMPANIES

Fraudulent accounting: A more recent article in The Economist (May 4, 2004) entitled “AIG’s Accounting Lessons” came with a screaming headline: “The world's largest insurance company shows how to polish a profits statement.” AIG also comes under the authority of the New York Stock Exchange, on which it is listed and where, until recently, its chief executive, Hank Greenberg, was a director (a clear case of conflict of interest) It may be pointed out, the NYSE's manual for listed companies states that “changes in accounting methods to mask” unfavorable news “endangers management's reputation for integrity”.(Ibid) And, in the greedy and complex world of financial markets where profit matters most, who cares about integrity?

The Tata’s who are in collaboration with AIG in India recently announced that they would concentrate on its core field of operation, obviously steel, and divest other interests. The government’s move now is such as to give dominant space to an American company like AIG with such dubious reputation.

Falsification of documents and forged signatures: Let us now take another American company Prudential that is tied up with ICICI. Both New York Times (May 31, 2003) and Wall Street Journal (May 31, 2003) reported that securities and insurance regulators were enquiring whether Prudential Financial Services (one of America’s largest insurance companies) falsified documents, forged signatures, and asked clients to sign blank forms. The alleged goal was replacement of customers' variable annuities with new annuity contracts – transactions that usually carry large commissions for the sales force. Variable annuities are a complex combination of mutual funds and insurance. This is nothing but fraudulent sales practice. The regulators have been charging Prudential and other insurance companies for systematic sales fraud.

History of violation of regulatory law: Lurking behind these headlines is Prudential's troubled history of sales abuses for well over a decade to the extent records indicate. The Wall Street Journal report aforesaid, chronicles the instances where the company fell foul with the regulators since 1993. In 1997, Prudential agreed to pay 2.6 billion dollar to settle a class-action lawsuit attacking abusive life insurance sales practices. That settlement followed a 65 million dollar fine from state insurance regulators in 1996. Prudential subsidiaries have paid nearly 400 million dollar more in the last decade to settle allegations about the improper sale of limited partnerships and variable life insurance. In 2001, the National Association of Securities Dealers (NASD) fined Prudential Securities 20-million dollar for failing to follow internal policies relating to the sale of annuities.

The forgotten lesson of Equitable: It is important to recapitulate the near collapse of Equitable in the year 2000, a major life insurer. On a conservative estimate, the total loss to the policyholders was estimated at £3 billion. On average, policyholders lost 25 per cent of their savings, though some saw the value halved.

Standard life too in bad ways: A recent report in The Economist dated April 1, 2004, refers to the sorry plight of Standard Life of UK. The company would continue to remain weak and vulnerable unable to remain afloat without the possibility of raising money in debt or equity markets.

AMP, Royal & Sun close life business: This is not all. AMP closed its life operations for new business in June 2003; and Eagle Star, Royal & Sun Alliance and Skandia Life shut down their with-profits businesses in 2002. (AMP and Royal Sun have presence in India)

FACING SOLVENCY CRISIS

“Most European insurance companies are in dreadful shape” blares another headlines in The Economist dated February 12, 2004. The article is captioned “A Bad Business.” A recent report by Mercer Oliver Wyman, a consultancy, found that European life insurance companies are short in capital by a whopping €60 billion—and they will need to find it somehow and soon. This is despite last year's stock market rise that reduced insurers' capital shortfall by €45 billion (77 billion dollar). The shortfall in capitalization is due among others to European Union’s new regulation on solvency called ‘Solvency 2’ that will be enforced across Europe from 2005 through 2007. In the more developed countries like the UK, France, Germany etc. it will be from 2005 itself. These will force insurers to value first assets and then liabilities at market value instead of their historic cost.  (In contrast LIC has more than fully covered its liabilities.)

The following chart as published by Mercer Oliver Wyman Report shows the woeful inadequacy of capital in respect of insurers of major European countries.

The German, Swiss, French and the British insurers are the worst of the lot as compared to the Italian and Spanish companies. The reason is not far to seek. The latter invested a large part of their investments in bond and debt instruments and in property, the former in tune with the liberalisation mania sweeping financial markets were heavily loaded with equities. They also charged less premium compared to the risks undertaken and the returns promised, in seeking larger share of business in a highly competitive market unlike their Italian and Spanish counterparts. These companies like the American companies AIG, Prudential etc. heavily dabbled in derivatives too, which are highly risky propositions. (Again in contrast, LIC and public sector general insurance companies in India invested a large part of their funds in bonds and securities besides investing in socially oriented schemes; LIC’s equity portfolio is just 9 per cent of its total investments though in quantum terms it is the biggest investor in equities in India)

CONSOLIDATION IS THE RULE

Where is the competition? They again and again talk of the virtues of competition. What is happening in reality is quite the opposite. The big ones are absorbing the small companies.  The aforesaid article in The Economist says: “in future, the industry will probably be dominated by a few big firms, such as Allianz, ING, Prudential or Aegon, who can at least afford to make mistakes.”

Even these big ones are struggling to survive through mergers and acquisitions. It is known that the French giant AXA is courting the reluctant Genarali of Italy into a grand merger. Their aim is not only to get over their individual problems but also face competition better. If they combine together they might become number one in world insurance relegating the American AIG behind. (Source: The Economist – June 17, 2004)

TAX DODGERS’ HAVEN

In the second week of June this year, those assembled for the World Insurance Forum heaped praise on their host, Bermuda, for its friendliness to their industry. Why not? Bermuda has served as a haven for insurance companies in America and Europe that wanted to dodge taxes in their own countries. Lots of big insurers have headquarters or offices in this small Caribbean paradise particularly since 1985. More came after the Hurricane Andrew in 1992 and more still after September 11, attacks to take full advantage of the increasing premiums. Now Cayman Islands and other tax havens are competing. These are the Benedict Arnolds (to borrow an expression for tax evaders, from John Kerry, the Democratic presidential candidate in the US) who are supposed to fund India’s economic and social development and who are now being given more space.

RAISING FDI CAP IN INSURANCE SECTOR

Let us now examine the implications if increasing FDI cap in the insurance sector is really necessary:

Why can’t the private promoters expand their capital: The private companies in India functioning in collaboration with foreign companies simply cannot expand their business without injecting further capital. One option was for the Indian promoters to provide the required 74 per cent for capital expansion in order to attract additional capital from their foreign partners confined to 26 per cent of the total. This way though the percentage share of capital would remain 74:26 between Indian promoters and their foreign partners, the foreign equity would increase in quantum terms enabling the private companies to expand their business. This option is always open to them. But the Indian partners are unwilling or unable to foot the bill and therefore the risk of additional capital on their part. They just want to ride piggyback on their foreign partners and get the desired profits by getting increased the share of equity of the latter, without much burden on their part.

Control by foreign finance capital: This exercise of increasing foreign equity would only enable foreign companies to gain control over the Indian people’s savings without any tangible benefits for their country’s development. This would pave the way for control by foreign finance capital on the insurance industry and ultimately on the Indian economy.

Public sector would bear the brunt: At the same time the public sector would be carrying the given task of providing insurance cover and investment funds both in profitable and non-profitable areas of the economy. The private companies have been concentrating their operation only in the metropolitan and other big centres confining their attention on the richer sections and skimming creamy layers without giving so much of a second look to more needy areas of insurance cover and investment. Their presence is hardly felt in rural areas. Such a situation would lead to progressive weakening of public sector insurance and impair its capacity to serve national objectives.

The IRDA & the government turning a blind eye: Both the IRDA and the government have been turning the other side when these private companies dodge every one of their social mandates. There has been no worthwhile scrutiny of the working of the private insurance companies, the way they do business, settle claims, build up reserves and invest their funds, by the regulator. At the same time the public sector LIC and general insurance companies have been burdened with newer impositions besides having to bear the social cost of insurance and investment. The imposition of the service tax on which the private companies have little or no burden having very little by way of renewal premium or renewal commission is a case in point. Also is the imposition of the solvency margin on the public sector when the values (historical as well as market) of equity as well as investments are much higher, the claims settlement experience is excellent and the best in the world and all liabilities are more than fully secured.

No new technology or new products either: It was claimed by the Malhotra Committee which recommended opening up of insurance sector that new technology and products for which the Indian market was crying for would come with the induction of private and foreign players. What new technology and product has been introduced, may we ask? What these private companies have done is rehash of the same products periodically introduced by LIC and public sector general insurance companies. Yes, one product they have introduced, that is a hybrid mutual fund that shifts the risk from the insurer to the insured forcing LIC also to follow suit!

No investment in infrastructure and social sector: It was loudly claimed that with opening up of insurance sector to private players, investment in infrastructure and social sector would increase tremendously. The Rakesh Mohan Committee has argued that there will be explosion of infrastructure investment through this process. May we ask, what is the contribution of private insurance companies to infrastructure development let alone social development?

Why no reference to the NCMP agenda: The National Common Minimum Programme enjoins as follows in relation to insurance: “LIC and GIC will continue to be in the public sector and will continue to play their social role. In addition, the social obligations imposed by regulatory bodies on private banks and private insurance companies will be monitored and enforced strictly.” Why is it the finance minister found no time to state in his budget speech how he proposed to “monitor and enforce” social obligations of private insurance companies (and private banks) but straight away jumped to hike in foreign equity in insurance?

LIC braces itself to fulfill the promise: In the meantime LIC (public sector general insurance companies too) is bracing itself to fulfill its assigned task with a massive investment kitty of Rs 100, 000 crore in 2004-2005. A news item in The Financial Express dated July 13, 2004 proclaimed: “The entire investible resources of the life insurance behemoth will be deployed in different segments like G-Sec, infrastructure, equity, corporate bonds and social security plans.” Confirming the plans, LIC, MD R N Bhardwaj said, “We have been able to generate Rs 1,00,000 crore of investible resources for the current fiscal.”  Adding more will be possible in the future if only the government refrains from impairing this proven potential in its wild goose chase.

CARRYING BAGGAGE OF THE NDA AGENDA

The private insurance companies and their foreign partners have been lobbying for hike in foreign equity for long and had been assured this by the NDA government if they were reelected. As happens generally, they must have underwritten this assurance by appropriate political funding too. But the election results turned sore for them. So they lost no time in lobbying the new UPA government with its so called ‘dream team’ to come to their rescue. They also knew where the heart of the new finance minister lay and appealed to him when he came to Mumbai to reassure the stock markets and corporate interests that their interests were safe. The mandate of the people who voted the new government to power and the caveats of the NCMP too were promptly forgotten. The N K Singh Committee (of NDA days) recommendations for enhancing the foreign equity would always come in handy to give ‘legitimacy.’ Now the question is where is the independent application of the mind by the new government, which is a coalition dependent on the support of the left parties whose policies are to be tempered by the overriding covenants of the NCMP?

AIIEA and insurance employees cannot keep quite under the circumstances. They have protected and toiled to enable public sector insurance to grow to this extent serving the cause of the country and the people so magnificently. They shall not allow any fancy plan of the finance minister or the government to spoil this achievement.  In order to succeed in facing the new challenge they must mobilise themselves and mobilise the people in a much bigger way than they have done so far.