Consolidation of insurance firms calls for drastic overhaul of the system
As reported by Financial Chronicle in its Monday edition, the government is considering consolidation amongst three of the four general insurance companies where it currently owns a majority stake. This move comes at the back of government intention to take these companies public. We believe that it makes imminent sense for the government to pursue this consolidation before taking them for listing on bourses. There are multiple reasons for taking this position. First, the hard reality is that despite being around for years, government-owned general insurance companies have proved to be grossly inefficient. Whether on financial or operational parameters, these entities have under-performed when it comes to utilisation of capital. In one such insurance company, the situation is such that while premium collections are rising, net profit has dipped sharply in the last two years. In another case, the company does not match the solvency criteria as laid down by insurance sector regulator.
This inefficiency becomes starker when compared to working with some private sector non-life insurance companies, which have been around for just a decade, but have gobbled market share at a much faster rate and are also far better placed when it comes to utilisation of capital employed. Little wonder that today they are making an attempt at merger so that they can improve their balance sheets. A part of why these firms remain inefficient is because they are public sector companies. By definition, they hardly seek business or do production innovation in an industry, which even the regulator accepts that solicitation plays a big role in sales.
Another reason for the low operational profitability is because these insurance companies have been fighting each other for whatever business comes to them sitting across the table – and this mind you, without the kind of balance sheet strength needed to fight a long battle in the insurance sector. With consolidation, two important things can happen. First, the operational cost of the merged entity is going to dramatically come down. At the moment, there is high amount of duplicity in the physical infrastructure between these companies. A merger will reduce this duplicity and add to net margins of the merged entity. Globally, insurance is largely sold online and that requires a strong balance sheet. It is only in India where human element dominates insurance sales. Over a period of time, that too will change and when that happens with a stronger and bigger balance sheet, state owned entities would be able to give real competition to private sector players. But the one thing, which our policy makers need to ensure, is that consolidation should not be in terms of financial merger of companies.
The government needs to go in for a complete recast, which gets in more industry professionals to the merged entity and lateral hire from other private companies. Today, the biggest reason why public sector insurance companies don’t get the best talent in the industry is because compensation levels at state-owned companies are extremely low. Unless the government does not fix these issues, there is little hope of any structural change in the way these companies work. The government would be well advised not to think too much about the modality of the consolidation because its biggest beneficiary would be government itself.