Diwali holds a special place in the Indian calendar. Not only is it the Festival of Lights and the beginning of the Hindu financial year, but this year's celebration was also notable in insurance circles. The Insurance Regulatory and Development Authority (IRDA) of India had previously declared that it would issue the first insurance licence by Diwali - and it finally did.

This marked - at long last - the implementation of a Bill that was first proposed many years ago. It has been a year since the IRDA Act was passed and insurance was opened to private participation and overseas equity, but procedural delays had created a big bottleneck. Another stumbling block was the miserly 26% cap on overseas equity in Indian insurance ventures. India's reform story is replete with examples of joint ventures that turned sour because local partners had no money or expertise to bring to the table. The insurance sector has found itself at risk of being the backdrop to a repeat of the same story, unless the foreign equity is raised to 51% as demanded by multinational insurance companies keen to tap the massive growth potential of the Indian insurance market.

Insurance deregulation in India has had a chequered past, and the liberalisation of the Indian insurance sector has been the subject of much heated debate for some years. The 1998 winter session of India's Parliament witnessed lawmakers grappling with the issue of whether to allow private and foreign companies into India's Rs400bn (£7.5bn) insurance sector. After several unsuccessful attempts, the Insurance Regulatory and Development Authority (IRDA) Bill finally was passed in December 1999, opening up the insurance sector to private Indian and foreign entrants and putting an end to the monopoly position enjoyed by the state-owned Life Insurance Corporation and the General Insurance Corporation since 1956 and 1973 respectively. It also gave statutory powers to the IRDA.

Growth in the insurance sector was expected to accelerate rapidly with an influx of new entrants following the new legislation. However, the rate of growth has been nowhere near the potential, and many multinational insurance companies, initially eager to enter into joint ventures with domestic companies, seem to have become a lot more circumspect.

The initial euphoria for joint ventures was before the IRDA had come out with its guidelines. Once they were out, and allowed only 26% equity participation for the foreign players in the market, international insurers realised that the deregulation was not going to be as big as they had envisaged. Many decided to close shop, although most did not.

Once the guidelines were out for all to read, the foreign insurers also realised that the investment criterion was inhibiting profit growth. The returns did not justify the investments, by their understanding. In addition, with the majority stake being with the domestic partner, foreign insurers would not have say in the management of the company and important decisions could be considered without them. Pay packages, technology transfer, products and their pricing when offered by the foreign insurers would not mean that they would run the show. As a result, domestic insurers realised that they had the upper hand in the day-to-day workings of the company and asked for a bigger slice of the pie. However, the proximate, and ultimately more important causes lie in the political, economic and social environment of today's India.

In the wake of India's nuclear tests in 1998, foreign capital fled the country while the Hindu-nationalist Bharatiya Janata Party (BJP) government faced a political crisis, resulting in the president disbanding Parliament in April 1999 and forcing the country into national elections in the autumn of last year, the third set of elections since 1996. Prior to the election, the fractured government prevented the establishment of a stable government, slowing much-needed reform and pushing the Bombay Stock Exchange and the value of the Indian rupee down. Although the election of the BJP candidate, Atal Behari Vajpayee, led to the cementing of power in the hands of the BJP and the possibility that open market reform efforts would accelerate while the government's high fiscal deficit would be reigned in, movement in these areas has generally been disappointing to date.

Pressures to cut India's high fiscal deficit are forcing some movement towards free market reforms. Although the federal deficit, which reached 5.6% of GDP last year, is viewed as too high and far above the target of 4%, the combined state and federal deficit of 8.5% of GDP is of serious concern. Although the recently announced national budget does offer some incentives to foreign investors, it is generally viewed as being weak both on efforts to pass bold reforms and on efforts to significantly cut the deficit. Rather than cutting spending, the government hopes to reduce the deficit through tax increases. The impact of this will only be marginal, reducing the deficit to a still too high 5.1% of GDP.

Although it is clear that the government will have to make fiscal reform a top priority in the near future, additional military spending related to the country's tensions with Pakistan in Kashmir is worsening the fiscal situation. In addition, the volatility of the situation in Kashmir also raises the possibility of outright war with Pakistan, a prospect which kindles Armageddon-type fears because both countries have a tendency to wave the nuclear weapons flag. This has been a further damper on the fervour with which multinational insurers initially greeted the deregulation of this sector.

Another concern is that free market reforms also appear to be focusing on the country's hi-tech industries. Although reform of this sector is welcome since it prods the economy towards additional market-opening measures and assists in raising GDP, it does not address India's need for improved infrastructure in areas such as banking, power, telecommunications and transportation. This is further likely to make the task of expanding insurance penetration a tough one.

In addition, the insurance employees' union is offering stiff resistance to any private entry. This is in contrast to bank and telecom unions which were less upset about private entry in their respective sectors. So what are the unions' objections to private entry in insurance? While there are several points raised by the unions, three objections seem to be the most important:

  • that there is no major untapped potential in insurance business in India;

  • that there would be massive retrenchment and job losses due to computerisation and modernisation; and

  • that private and foreign firms would indulge in reckless profiteering and skim the “urban cream” market, ignoring rural areas.

    Considering that only about 35 million out of a potential of 250 million people are covered by life insurance and there is complete absence of personal insurance products such as pensions and health insurance, the “no untapped potential” argument cannot be accepted. It is, however, true that tapping the vast rural and mostly agricultural sector for insurance will require a radically different and innovative marketing approach.

    The fear of job losses is also unfounded, judging from the experience of insurance liberalisation in South Korea, the Philippines and other countries. If anything, employment and job creation (through a system of agents) rose several times over in recently deregulated markets. And, finally, the fear of skimming urban markets is best tackled by regulatory requirements as in airlines and telecom liberalisation.

    The real motive behind the unions' protests is that the dismantling of government monopoly would provide a challenge to the labour aristocracy. In the absence of competition, customers simply do not have any options. Through private entry, the state monopoly corporations would be forced to continuously upgrade service quality, product variety, premium rates and grievance redressal mechanisms to keep up with the competition. In fact, the recent spate of advertising campaigns - and several new insurance products - show that both major state companies are already on their toes. With deep pockets, massive investible funds, and a wide and well-established network, they do not have to worry about surviving. The unionised employees, however, have to shape up and increase productivity if these companies are to compete with the new entrants.

    Moreover, a coalition government in Delhi cannot be seen to be insensitive to the demands of these unions, which are supported by its allies and opponents on the both the Left and the Right of the political spectrum. India has seen several successive governments in the last decade, and most of these have been changing coalitions of the same set of parties in different permutations and combinations. The political foes of today could very well be the potential allies of tomorrow in a polity that has become increasingly divorced from ideology and more wedded to short-term expediency. In such a situation, the government cannot afford to annoy any major political party-backed union. Indeed, the government is loath to alienate even the smallest minority voices against reform, because the smallest margin can make the difference - as recent events in Florida have proved.

    The market for insurance in India is woefully undeveloped. The reach, and thus penetration, of the institutions is weak. Moreover, the extended joint family system has long acted as an informal insurance mechanism, with family members coming to the rescue. Of the one billion people in India, only about 35 million are covered by insurance. The country's life insurance premium total, as a percentage of GDP, is just 1.4%, compared to 11.6% in South Korea. When it comes to non-life insurance, the Indian scenario is even weaker.

    Having said that, two relatively modern trends in the Indian social context affect life insurance business significantly. One is the break-up of the joint family system, which worked like an insurance arrangement. With more and more nuclear families becoming the rule, there is greater demand for insurance as social security. The second trend, also connected with the first, is that the elderly are increasingly having to fend for themselves. In 1990, India had about 54 million people above the age of 60. This number is expected to rise to 71 million by this year, and to almost 10% of the total population by 2010. Thus future senior citizens look to plan for their own old age, rather than be a burden on their children. There is greater awareness of planning for old age, and the need for pensions and annuities. These two trends portend a large and growing market for life insurance in India.

    Other factors which are catalysing these developments include the increase in the size of India's middle class, rising per capita incomes and rising literacy. With an estimated size of 250 million, the middle class is at least four times as large as the current coverage.

    Nevertheless, low disposable income is limiting insurance penetration. Most Indians are busy meeting bare necessities, let alone thinking ahead. Indeed, voluntary protection coverage-seeking behaviour is rare even in the middle class, and the apathy of the state-run system is partly to blame. However, a projected 7% growth rate of the economy which translates into higher savings, and a proliferation of savings instruments, an economically liberalised atmosphere, and greater consumer awareness and level of education about insurance, should go some way to redressing this situation. Conservative estimates put the size of the Indian market at £25bn by 2010.

    Three private insurance companies - Reliance General Insurance Co, HDFC Standard Life Insurance Co and Royal Sundaram Alliance Insurance Co - have been the first off the block, but they will by no means be the last. Three others - Max New York Life Insurance Co, ICICI Prudential Life Insurance Co and IFFCO Tokio General Insurance Insurance Co - have been given in-principle clearance.

    India stands at threshold of an exciting win-win policy, if it plays its cards right. For the companies, many of which have been marking time during the past few years, it means they can at last commence business in what is widely regarded as a market with great potential. Global insurance majors have long been salivating at the prospect of tapping into a huge and growing middle class, the vast majority of whom do not have any insurance cover at the moment.

    For consumers, it means more choices, lower premium payments and better service. It means all the benefits that competition can bring and which have been denied to consumers so far. For the economy at large, there is good news in store too as the savings mobilised by insurance companies are invested in long-gestation projects. Clearly this is one case where all are winners.

    However, the country is now at a juncture where developments could go either way. If the politicians can provide political stability through consensus and/or coalition in domestic policy, and peace with the neighbours through diplomacy, if the economic planners can provide economic stability by controlling the fiscal deficit and controlling special interest groups, if economic growth is spread across the economy, raising disposable incomes and expanding the middle class, if society can get over its innate mistrust of non-familial social security mechanisms, and if the companies themselves are innovative enough to suit their products to the prevailing social and economic reality, then India stands at the brink of one of the largest expansions of the market for insurance ever seen. If not, then it will be an unparalleled opportunity lost.

    Roli Asthana is a lecturer in development studies at the London School of Economics.