Alternative Approaches to Insurance and Risk Management
The article compares insurance companies' two models/structures across a range of parameters. The two models/structures are Joint-stock Company and Mutual Organisation. While a joint-stock company assumes an insured's risk for an underlying premium, the mutual organisation chooses to retain the risk within the joint pool contributed by its members who are themselves the insured parties. The primary difference in the approach is that the former works on the principle of risk transfer, while the latter is based on the premise of risk retention among insured members. With low insurance penetration and density, how can India rapidly scale the insurance services for its vast uninsured population? The challenges are both on the demand as well as supply side. Like many other developed and developing economies, can India leverage the potential of both these models to rapidly increase the penetration as well as the density of insurance in the country? Is its single-pronged strategy sufficient, or does it need a multi-pronged approach? This article attempts to understand each model's pros and cons and whether they have a role to play in the underpenetrated insurance market in India.
Introduction
In the past two decades, India has witnessed an increase in the penetration as well as density of insurance, in both the life and non-life categories. According to the Insurance Regulatory and Development Authority of India (IRDAI), the combined penetration of insurance increased to 3.76%of the Gross Domestic Product in 2019 from 2.71% in 2001 (IRDAI 2021). The penetration of life insurance stood at 2.82%, whereas it was 0.94% for the non-life segment. The density of the insurance also increased from $11.5 in 2001 to $78 in 2019 ($58 for the life insurance segment and $20 for the non-life insurance). However, India’s insurance penetration and density lag behind its peers and global average by a substantial margin. As of 2019, the global insurance penetration stood at 7.23%, almost twice that of India, while the density was $ 818 or over ten times.
A study by reinsurer Swiss Re estimates the protection gap in India for health insurance alone to be approximately $369 billion as of 2017 (Swiss Re Institute 2018). The IRDAI estimates the protection gap in India to be approximately rupees three trillion ($ 400 billion).[1] According to G Srinivasan, Director of the National Insurance Academy (NIA) and former CMD of the New India Assurance (FE Bureau 2021), the protection gap in India is 90%, and there is an urgent need to plug the increasing uninsured economic losses and loss of lives.
Measuring Protection Gap/Underinsurance
Protection gaps differ widely in size, nature, and dynamics, depending on the line of business and the general maturity of the insurance market (The Geneva Association 2018). There is no one-size-fits-all; hence, we have different perspectives and definitions for the same. Below are some of the definitions:
- The most appropriate definition of insurance protection gaps is the difference between the amount of insurance that is economically beneficial and the amount of coverage purchased (Schanz and Wang 2014).
- The health protection gap is defined as the sum of financial stress arising from unforeseen, direct, and out-of-pocket medical expenses and that unaffordable portion the households avoid (Swiss Re 2012).
With the insurance protection gap amongst the highest in the Asia-Pacific region, Indians are vulnerable to health and economic shocks. The Geneva Association (2018) lists the following challenges for the insurance sector on the demand and supply sides.
| Demand-side Challenges | Supply-side Challenges |
|
|
Source: Understanding and Addressing Global Insurance Protection Gaps, The Geneva Association, 2018.
In the face of these challenges, coupled with the country's own issues of distribution and reach and the inability of insurance companies to rapidly scale operations due to capital adequacy requirements, how can India rapidly increase the penetration and density of insurance? Are there alternative approaches and lessons to be learnt from the experiences of other countries? Are there lessons for the IRDAI from its senior-most peer and the banking sector regulator—the Reserve Bank of India (RBI)? Can the IRDAI take a leaf or two out of the RBI's playbook of differentiated banking licenses to increase the penetration and access to banking services? Like the RBI, can the IRDAI use both the iron fist and the light touch in governing/regulating the differentiated insurance entities? The table below compares two of the most widely used insurance/risk management models globally on a range of parameters to identify their inherent strengths and challenges.
Comparison of Joint-stock Company versus Mutual Organisation
| Sr. No. | Parameter | Joint-stock Company | Mutual Organisation |
| 1 | Ownership | Owned by shareholders of the company who may or may not be policyholders | Owned by the members/policyholders |
| 2 |
Management of the organisation |
Appointed by shareholders of the company | Appointed by the policyholders of the organisation |
| 3 | Investments/capital allocation | The initial capital required for the business is made available by shareholders and/or the borrowings by the organisation. | The initial capital required for the business is met through the premiums/contribution of policyholders. In some instances, financial aid from a donor can also help meet the initial business cost. |
| 4 | Surplus/profit | In case of profits, the company can either retain the funds for its business activities/expansion and/or distribute as dividends to its shareholders. | In case of surplus, the organisation retains the amount to create buffer capital to meet emergencies and/or use the capital to offer additional services. The organisation can also choose to reduce subsequent premiums. |
| 5 | Deficiency/loss | In case of deficiency or a loss, the shareholders contribute additional funds to meet the capital requirement of the business. There is no direct impact on the policyholders. | In case of deficiency, the organisation can decide to reduce the quantum of sum assured and/or draw from the reserves to honour the payments to its members. |
| 6 | Financial stability | The organisations are governed by the regulatory policies of a country/region and hence comply with the minimum capital adequacy requirements and other financial considerations. | In regions where they are regulated, financial stability is defined by the regulatory requirement. In places where they are self-regulated, a contingency/emergency fund is created to meet the requirement. In addition, the size of the mutual organisation can impact its financial position. For example, if it is too small, then it is vulnerable. |
| 7 | Incentive design for management team | Since the stock company is for-profit, financial performance is an important parameter in the design of the incentive structure. The incentive is often linked to the financial health of the organisation. | If non-policyholders/external teams manage the mutual, then the honorarium is generally fee-based, which can be fixed or a percentage of the premium can be collected. The financial performance of the mutual may not impact the incentive structure. |
| 8 | Claim settlement | The claim settlement process depends on whether the policy is cashless or on a reimbursement basis. If it is cashless, the processing is faster to meet the requirement, but reimbursements may take longer depending on why the claim was raised to various heads of expenses within the claim. | Depending on its size and financial capacity, a mutual organisation may offer claim settlement through cashless or reimbursements. However, mutual organisations in India often prefer to work on a reimbursement basis to avoid moral hazards. The reimbursements for pre-approved conditions are prompt, ranging from 24 to 72 hours, unless in exceptional cases. |
| 9 | Conflict of interest | The organisation's financial performance depends on the lower number of claims; hence, there is a conflict of interest in denying the claim. This also explains the exclusionary nature of the policies. | Since policyholders are the owners and the objective is to serve the members and not make a profit, there is no direct conflict of interest. |
| 10 | Restrictions on the age of policyholders | Generally, insurance policy is not sold to toddlers and senior citizens, especially those above 75 years. In case the policy is offered, the premium is steep. | There are no such restrictions on the age of a policyholder for becoming a member of the organisation. |
| 11 | Designed on inclusion or exclusion | A joint-stock company is for-profit, and there is often an incentive to deny a claim. Hence, the design is always exclusionary in nature so as to avoid/reduce the risks arising out of likely or higher claims. Polices are often not sold to people based on age or pre-existing conditions to reduce the financial strain on the business. | The primary aim of a mutual is to serve the members/policyholders; hence, the policies are inclusive to support the members financially in their times of need. Restrictions on the basis of age or pre-existing medical conditions are often limited. |
| 12 | Transfer/retention of risk | Once an individual/group buys an insurance policy, the risk is transferred to the insurance company. | The policyholders, who are also the owners, retain the risk. The risk is shared among the members/policyholders. |
| 13 | Diversification | The policyholders can be from diverse backgrounds and belonging to different geographies as well as varied professions and lifestyles. Hence, the risk of concentration in the portfolio is lower. | Most mutual organisations start with a set of people belonging to the same region/profession, so the portfolio carries a concentration risk. The occurrence of an event specific to the community/region or profession can cause a financial setback to a mutual organisation. |
| 14 | Frauds | The prevalence of fraud in a stock company is high. Frauds happen both at the policyholder as well as the service provider/hospital levels to extract higher sums. | Since the policyholders are often known to each other, the chances of fraud go down substantially as the members risk being eliminated from the group. |
| 15 | Policy design | While the need and requirement for a policy originates from the people, the policy design is generally top to bottom. In addition, the standardisation of policy for economies of scale eliminates/reduces the flexibility to modify it to suit the requirements of different people. | As mutual organisations are incorporated to meet the specific needs and requirements of the people of a particular region or profession, the design of the policy is always from bottom to top. Though there is policy standardisation here as well, the structure of the organisation provides flexibility in designing the policy to meet the needs of the policyholders. |
| 16 | Voting rights | Voting rights are directly proportional to the shareholding in the company; one vote for each share held. | Each member has only one vote. |
| 17 | Scalability | A joint-stock company can easily be scaled across geographies, which in fact helps it to redistribute its risk and avoid concentration. The core values remain intact. | As mutual organisations are designed to serve the specific needs of communities, the concept of mutuality diminishes as the organisation scales its operations (be it geographically or otherwise in the case of profession-specific mutual organisations). It tends to lose the essence of its very origin. |
Source: Authors’ own.
Observations
While both forms of institutions aim to manage/reduce the prevalent risks, the two adopt different approaches. A joint-stock company is for-profit and hence there is a high possibility of a conflict of interest between the shareholders and the insured, whereas a mutual organisation is generally not-for-profit; hence, the friction is relatively lesser. The scalability of operations is easier for a joint-stock company as compared to a mutual organisation. Further, a mutual organisation may run the risk of concentration due to its focus on a particular region/profession/gender; this may not be the case for a joint-stock company whose operations and customers are not limited by geography/profession/gender. The presence of moral hazard is a major impediment to the growth and development of insurance. Moreover, moral hazard is present at either end of the spectrum—customers and the organisation and hence the trust deficit in conventional insurance is extremely high. In fact, according to the World Health Organization, mutual insurance firms can help build trust and encourage familiarity with the concept of insurance (WHO 2020).
Mutual Insurance Organisations in India
Mutual insurance organisations have existed in India for over a century now. The first mutual in India—the Bombay Mutual Life Assurance Society Limited was established 152 years ago in 1871. Recent studies have shown the presence of mutual organisations across the length and breadth of the country, offering services in life and non-life segment as well as for livestock (ICMIF 2017). An IRDAI working group constituted to study the potential for standalone microinsurance companies (IRDAI 2020) and the NIA report (2020) have acknowledged the presence along with the role played by mutual organisations in providing insurance services. The latest edition of the Inclusive Finance India Report (Vishwanathan 2021) also recommends using mutual and cooperative insurance services to increase the access and coverage of insurance in the country.
Conclusions
The protection gap in India is extremely high, and urgent steps are needed to reduce it. The thrust on the insurance solutions being offered by joint-stock companies to increase the penetration and density has its limitations, at least in terms of the pace of the coverage, which is of the essence. Hence, the IRDAI should explore the possibilities of encouraging differentiated and people-led insurance solutions to fill this gap. While there remain questions on the efficiency and efficacy of these models, the regulator can learn from the best practices adopted by its peers in both developed and emerging economies for mutual insurance to function. Closer home, there are lessons to be drawn from the RBI on the use of differentiated banking services to achieve its goal of financial inclusion. Each form of an insurance organisation, with its pros and cons, has a critical role to play in reducing the protection gaps and contributing towards the country's economic development. Furthermore, all can flourish together and complement each other rather than competing.
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