Ensuring the safety of insurance sector

The RBI recently proposed to reduce the ownership by banks over insurance companies at a maximum of 20 per cent from a present 50 per cent.

This move is to be welcomed, as the close inter-relationship of banks with the insurance sector and other financial investment companies, causes opaque monopolies that distort the market and concentrate risks dangerously for the bondholders, lenders, depositors, home borrowers, persons taking out an insurance claim and shareholders. The recent takeover of Reliance Capital by the RBI is an example of where the sector as a whole should not be heading.

Insurance and banking are at their core two very different businesses. Insurance is a ‘long term’ stand-alone business in which companies have to wait for long periods to break even and make profits. It is liquidity rich. Capital gets locked up for longer cycles than banking. Insurers do not usually raise debt to purchase financial assets to cover claims.

It is a business that is required to be responsive to its customer base. Despite the need for skilled leadership, the Boards of insurance companies tend to be populated with the nominee members of promoters, investors and owners.

Banks, in contrast, are institutionally interconnected through the interbank market and are more exposed to liquidity risk. Banks’ interest in lending and credit-creation is not conducive to the cash flow dynamics of the insurance companies.

Banks as corporate agents, obtaining commissions, are interested in selling the insurance packages to customers who are frequently unaware of the terms and conditions, leading to the closure of the policy within a short time though the premiums are not returned. The conflicts in objectives have an impact on the ability of those sitting on the Board of insurance companies to make optimal decisions about reliably selling insurance, making investments and managing cash flows.