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But where's the growth?

The life insurance sector begins the task of wiping out losses that piled up over almost 10 years. But the focus on profits comes at a cost.

twitter-logo Anand Adhikari        Print Edition: July 11, 2010

A colony of penguins living on an iceberg in Antarctica wakes up one not-so-fine morning to a potential catastrophe. A particularly observant penguin chick called Fred notices that the iceberg is melting and might break into pieces. Fred decides to approach the 10-member leadership council, which runs the affairs of the colony, and which is headed by Louis.

Fred meets Alice, one of the members of the leadership council, who, he feels, is less likely to dismiss his melting theory. Alice becomes Fred's voice in the leadership council, which, after much hesitation, decides to visit the melting point. Fred and Alice manage to create a sense of urgency in the leadership council. A team is created to search for another iceberg, and the colony shifts to a new home on a different iceberg just in the nick of time.

This simple fable is based on the work of Harvard Business School's John Kotter, which resulted in him co-authoring a book (with Holger Rathgeber) titled Our Iceberg is Melting. The parable was used to good effect in April this year by V. Vaidyanathan, Managing Director and CEO, ICICI Prudential Life Insurance Co, when he held an "interactive CEO forum" in Mumbai.

Vaidyanathan's objective in discussing the tale with some 150 senior managers was to make them aware of the need for change and heroic action amidst a challenging environment. The message he was sending to key personnel at the life insurance subsidiary of ICICI Bank was clear: It was time for a strategic shift. The focus of the company had to shift from growth at any cost to profitable growth and rightselling (as opposed to indiscriminate selling). "If we ignore the danger (of growing without making profits), it's like ignoring the imminent breaking of the iceberg," he warned.

The warning signs courtesy profitless growth have been flashing not just at ICICI Prudential, a 74:26 joint venture between the second-largest Indian bank and Britain's Prudential, but at every player in the 10-year-old private sector life insurance industry. Companies grew at heady levels that ranged between 60 and 100 per cent in the 2002-2008 period. But that growth has been coming at a cost: Huge accumulated losses, with no clear sight of breakeven. Over the past couple of years, the breakneck pace of growth in new business premium has slowed down dramatically.

And during this period, growth took a backseat with the focus shifting to the bottom line. ICICI Prudential, for instance, recorded its maiden profit, of Rs 257 crore, in its 10th year. Bajaj Allianz Life Insurance Co. showed the highest profit amongst private sector life insurers, of Rs 542 crore. Kotak Mahindra Old Mutual Life recorded an over three-fold jump in profits. And Birla Sun Life Insurance succeeded in pruning its losses to Rs 435 crore from Rs 702 crore a year ago.

But if the private sector life insurance sector is showing signs of a turnaround, there's little evidence of celebration. For two reasons: One, over the past two years growth in new business premium has been sacrificed at the altar of profits. In 2008-09, new business premium of the private sector grew in single digits, at just 6 per cent; last year, it was better at 13 per cent, but still lower than the nominal GDP growth rate (GDP plus inflation) of 15 per cent. The new-found profits also bring little cheer because they are a drop in the ocean of losses some of these companies have piled up over the past decade. At ICICI Prudential, the accumulated losses stand at Rs 3,518 crore, and at Birla Sun Life, they are at Rs 2,027 crore.

Clearly, the private sector life insurance sector is at a crossroads. After years of boundless growth and mounting losses, it's time to consolidate. But then, the dangers of moving to the other extreme can't be ignored— focussing on profits and ignoring the task of insuring more of the population. "If we are growing below the nominal GDP rate, we are actually reducing penetration," Kamesh Goyal, CEO, Bajaj Allianz Life, points out. Insurance penetration, measured by premium income to GDP, is still low at 4.1 per cent versus 12.6 per cent in the United Kingdom or 7.5 per cent in Japan.

For an industry that runs the risk of bleeding itself into a blackout, profits are an imperative. What's more, with foreign direct investment (FDI) in insurance capped at 26 per cent, players have little choice but to fund growth by generating cash. "Profits are important as life insurance is a tough business," shrugs Goyal.

The New Normal
At an insurance conference in Mumbai in May, G. Murlidhar, Chief Operating Officer, Kotak Mahindra Old Mutual Life, pulled out a 47-slide presentation on the "New Normal" for the industry. Therein may lie the middle path: Of moderate growth, operational efficiencies and a focus on profitability. "The focus is on efficiency," beams Mayank Bathwal, CFO, Birla Sun Life Insurance, "and we will make profits soon."

Not too many will disagree. To cut costs, Kotak Mahindra Old Mutual Life shifted headquarters from the more expensive Lower Parel commercial district in central Mumbai to suburban Sion in 2007. But a more significant shift in strategy was to aggressively exploit the banking channel (known as bancassurance) rather than sell through agents, whose commissions work out to be more expensive. "We realised that bancassurance is the more efficient channel," says Murlidhar. A tie-up with parent Kotak Mahindra Bank has resulted in bancassurance making for over a fourth of the life insurance arm's new business.

Other expenses are also being reined in. At Kotak, in order to reduce postage costs, routine communications to policyholders are clubbed together in a single post. That's just one of the initiatives that has helped cut fixed expenses by Rs 56 crore from a year ago. ICICI Prudential's Vaidyanathan keeps a close watch on the use of power, and even tea and coffee dispensers at his branches.

They are connected by sensors that transmit data to a remote server. Consumption levels are monitored with respect to the preset values and an alarm in the form of an SMS—to the company's IT department—is raised if any of the parameters exceed it. Such measures helped ICICI Prudential cut expenses by Rs 380 crore last year.

The big question, however, is: For how long can insurers rely on costcutting measures to boost the bottom line? Not for long, agree analysts. For a fresh burst of growth, what's needed is capital. That can come through two sources in the medium term: A relaxation in the FDI cap, from 26 per cent to 49 per cent; and an initial public offering (IPO). Indeed, most of the insurers command mouth-watering valuations.

The research wing of ICICI Securities has pegged the "embedded" value—essentially, a more conservative method of valuing an insurance company— of ICICI Pru at Rs 9,095 crore; and of Bajaj Allianz at Rs 5,930 crore. Is the time right for a public issue of shares? Perhaps not, given the uncertainty surrounding new regulations on unit-linked insurance plans (ULIPs), which are expected to hit volumes and margins. "Companies may put their listing plans on hold," believes Murlidhar of Kotak Old Mutual Life.

That could well prove a setback, as a burst of fresh capital will go a long way in allowing insurance companies to drive forward into the untapped rural areas. But if the FDI cap stays and market conditions aren't conducive for raising capital—will investors buy into loss-making insurers— the stage could well be set for a bout of consolidation. As capital requirements increase, the willingness of shareholders (read foreign partners) to stay in the game could reduce.

Currently, there are all of two dozen players in the private life insurance space, and those who can't wipe the red ink off their balance sheets may well become candidates for acquisition. There are already 3-4 life players courting banks to join them as equity partners. "The shoe has started to pinch. I think consolidation is bound to happen," believes Bajaj Allianz's Goyal.

Goyal, who is also Country Manager of Allianz India, sums it up best. "Life insurance is no longer a sunrise industry. The euphoria of the pre-2008 days is now over," he quips. The iceberg may not have begun to melt yet, but it's increasingly getting warmer in the Indian life insurance industry.

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