CHAPTER-II

REVIEW OF LITERATURE AND RESEARCH METHODOLOGY

Review of Literature is the process of identifying previous studies and going through those
studies to ascertain the level of research already conducted relating to the field of study. It
provides an idea about the research problems, research methodology applied and attainment of
research objectives by previous researches. It also helps in identification of potential areas of
research, describing research objectives, defining research methodology and developing
research report. Research methodology is the process of conducting research for research
problem under investigation. As the title of the chapter suggests, the chapter has been divided
in to two sections. Section I provides information about the literature on life insurance industry
whereas Section II deals with methodology applied in the research.

REVIEW OF LITERATURE
The literature on Indian life insurance industry includes books, theses, dissertations, study
reports and articles published by researchers and academicians in different periodicals. The
available literature for the present study is given below:
Stowe D. John (1978) examined several hypotheses derived from a simple chance-constrained
model of life insurance company portfolio using a cross-sectional, time series panel of fifteen
annual observations for ninety two large U.S. life insurance companies. Usual yield variables
and non yield variables such as the relative amount of surplus and the cost of reserve liabilities
were significant determinants of the composition of life insurance company portfolios. It was
observed that portfolio adjustments occurred more rapidly than previously reported i n the
literature.
Buser Stephen A., Smith Michael L. (1983) applied Mean Variance Model expressing the
optimal amount of insurance in terms of two components: the expected value of the wage claim
and the risk return characteristics of the insurance contract. The model thus offered an
appealing way to formulate the life insurance problem in a portfolio context. Implications of
the model for the functioning of a life insurance market were examined along with explanation
of existing accidental death contracts. It was summarized that the accidental death contract
appeals to the risk-tolerant policy owner but

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has characteristics similar to a gambling contract because the amount of coverage does not
depend on the value of the wage claim.
Mary A. Weiss (1986) illustrated a method for measuring productivity for life insurers. New
techniques for measuring output of life insurers were developed and it was developed using
total factor productivity approach for two sample insurers i.e. stock and mutual insurer for five
year intervals. The applicability of the output and productivity measurement methodologies
developed is not limited to the specific insurers studied, but rather can be used as a guide in
measuring the productivity of any life insurer or the life insurance industry in general.
Martin F. Grace and S t e p h e n G. Timme (1992) reported estimates of overall a n d
product specific scale economies using sample of four hundred and twenty three U . S . life
insurers. The study suggested that the magnitude of scale economies and cost
complementarities may vary with the scale and mix of outputs. In contrast, previous
studies only provide a single point estimate of industry cost characteristics u s i n g the sample
mean output vector. This study, therefore, provides a more complete
representation of the industry’s cost characteristic and, in turn, new insights into decisions
related to the optimal scale and mix of outputs.
Duane B. Graddy, Ghassem Homaifar, Kenneth W. Hollman (1992)
analyzed the market response of stock returns of insurers to the formulation, debate and
enactment of the Tax Reform Act of 1986. Provisions of the Tax Reform Act showed increases
in the effective tax rates of insurers despite the proposed lowering of marginal rates. The stock
prices of insurers reacted negatively in the formulation. Debate and Committee mark up phases
of the legislative process. Significant abnormal returns were not evidenced in the enactment
phase.
Mayers David and C l i f f o r d W. Smith, Jr. (1992) found that the compensation of mutual
executives and mutual subsidiary executives is lower than that of stock executives and stock
subsidiary executives in life insurance industry, Moreover, the compensation of mutual
executives is less responsive to firm performance than that of stock executives. This evidence
is consistent with the existence of differences in corporate investment opportunity sets and
resulting differences in required managerial discretion between mutual and stock life insurance
companies.

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Akhigbe Aigbe, Stephen F.Borde, Jeff Madura (1993) measured the share price response of
insurers to increase in the dividend and matched control samples of banks and industrial firms
that are similarly assessed. It was found that the share price response for insurers is positive
and significant. The magnitude of the response for life insurers is smaller than that of other
types of insurers or industrial companies but is greater than that of banks. This result may be
due to the relatively low level of capital maintained by life insurers. A cross-sectional analysis
also suggested that the share price responses across insurers are not related to firm-specific
characteristics.

Adams Mike (1997) examined empirically the determinants of audit committee formulation
in life insurance firms. The study tested six hypotheses, namely whether the existence of audit
committees is related to organizational form, firm size, leverage, asset in place, reinsurance
and total monitoring costs using pooled 1991-1993 data from New Zealand’s life insurance
industry. Fixed effects regression was used to arrive at parametric estimates. The results
indicated that consistent with expectations, audit committees appear to be positively associated
with large entities, high leverage companies and firms with high total monitoring expenditures.
However, the variables such as organizational form, assets in place and reinsurance were not
found statistically significant. Thus, the study provides mixed empirical results.

Hirofumi Fukuyama (1997) investigates productive efficiency and productivity changes of

Japanese life insurance companies by focusing primarily on the ownership structures (mutual
and stock) and economic conditions (expansion and recession). The study indicates that
mutual and stock companies possess identical technologies despite differences in incentives
of managers and in legal form, but productive efficiency and productivity performances differ
from time to time across the two ownership types under different economic conditions.
Adams Mike, Hossain Mahmud (1998) explained differences in the level of information
which is being disclosed voluntarily by life insurance companies in their annual reports. The
study thus specified the relation between voluntary disclosure and eight explanatory variables
representing major construct of the managerial discretion hypothesis in the form of fixed
effects regression model. The data for the year 1988 to 1993 was drawn from New Zealand’s

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life insurance industry. It was found that the organizational form, firm size, product diversity
and distribution system are positively related to the level of voluntary disclosure as implied by
the managerial discretion hypothesis. Non executive directors and reinsurers are those two
independent variables which were observed to be significant in opposite direction.
Ranade Ajit and Rajeev Ahuja (1999 presented an overview of life insurance
operations in India and identified the emerging strategic issues in the light of
liberalization and the impending private sector entry into insurance. The need for
private sector entry has been justified on the basis of enhancing the efficiency of
operations, achieving a greater density and penetration of life insurance in the
country and for greater mobilization of long terms savings for long gestation
infrastructure projects. In the wake of such coming competition, the LIC, with its 40 years of
experience and wide reach, is at an advantageous position. However, unless it addresses
strategic issues such as changing demography and demand for pensions, demand for a wider
variety of products and having greater freedom in its investments.
LIC may find it difficult to adapt to liberalized scenario.
Pant Niranjan (1999) by considering the impact of liberalization and Insurance Bill 1999 on
insurance sector stated that this would result in increasing involvement of the large and
powerful insurance companies of the world in the Indian insurance industry. The effect was
uncertain as this could work as an opportunity as well as a challenge for the life insurers. So
it was stressed that it is essential to take this in an encouraging manner for turning this
involvement of private sector players into a positive factor of overall growth. It was
also mentioned that such an effort would, however, require the support of a clearer and more
cogent legislation than the Insurance Regulation and Development Bill 1999.
Rao D. Tripati (1999) developed a proper perspective of the ongoing debates on the
privatisation and globalisation of the insurance sector. A systematic study of the structure and
pattern of growth of the Indian insurance industry is essential. An analysis of
pattern of growth of life insurance industry since its nationalisation in 1956 has been
carried out. This article goes into the operating results of the Life Insurance Corporation
and their macro economic importance. The study highlighted the pattern and growth of
life insurance business in India. Specifically, it deals with the analysis of growth of new
business, business in force, income and outgo (financial outflow) Life Fund i.e.

55
institutionalisation of savings and business by different zones of LIC. Finally, these indicators
a r e compared with the related macro variables. The analysis reveals that average sum assured
per policy has declined in real terms. The increase in the rural business might involve higher
transaction costs in the absence of adequate infrastructure facilities in rural areas. But income
and outgo has shown that even with lower sum assured and increase in rural business the LIC
has succeeded in converting a growing amount of annual premium income in to life insurance
fund. The outgo as a proportion of income declined partly due to the decline in death benefits
and expense in management.
Yates Jo Anne (1999) examined the early adoption and use of computers by life insurance
companies in 1950’s using Anthony Giddens Structuration Theory as theoretical lens. It
helped to know how pre computer punched card tabulating technology was used in insurance
operations and use of computers in early computer era. Most of the times, it leads to expect
the reinforcement of existing structures. It is also helpful in understanding the new ways and
innovative uses of computer technology in insurance.
Grosen Anders, Peter Lochte Jorgensen (1999) analyzed one of the most common life
insurance products i.e. participating (or 'with profits') policy and showed that the typical
participating policy can be decomposed into a risk free bond element, a bonus option and a
surrender option. A dynamic model was constructed in which these elements can be valued
separately using contingent claims analysis. The impact of various bonus policies and various
levels of the guaranteed interest rate was analyzed numerically and it was found that values of
participating policies were highly sensitive to the bonus policy, that surrender options can be
quite valuable, and that LIC solvency can be quickly jeopardized if earning opportunities
deteriorate in a situation where bonus reserves are low and promised returns are high.
Cummins J. David, Sharon Tennyson and Mary A. Weiss (1999) examined the relationship
between mergers and acquisitions, efficiency and scale economies in the US life insurance
industry. Cost and revenue efficiency was estimated for the period of 1988-1995 using data
envelopment analysis (DEA). The Malmquist methodology is used to measure changes in
efficiency over time. It was found that acquired firms achieve greater efficiency gains than
firms that have not been involved in mergers and acquisitions. Firms operating with non
decreasing returns to scale and financially vulnerable firms are more likely to be acquisition
targets. Overall, mergers and acquisitions in the life insurance industry have had

56
a beneficial effect on efficiency.
Segal Dan (2000) estimated the acquisition and maintenance costs associated with life policies
as a function of the amount of insurance and number of policies of an insurer by estimating a
cost function. The final sample consists of 448 firms and the study period includes years from
1995 to 1998. Several statistical characteristics of the costs such as mean and median of the
sample were examined. The data indicates that there is a large variation among life insurance
companies. It was found that the costs associated with life policies of the largest insurers are
much higher than the corresponding costs of other firms. Comparing the costs between “branch
firms” and non-branch firms” it was revealed that the costs of branch firms are generally higher
than that of non branch firms.
Rao D. Tripati (2000) explained the macroeconomic implications of privatization and foreign
participation in the insurance sector. It was obtained that the Life Insurance Corporation (LIC)
of India is dominant in the overall industry in two aspects: pooling and redistributing risks
across millions of policyholders and in performance of financial intermediation. Therefore,
the issue of privatization and foreign participation must be approached cautiously with a step
by step approach and should be preceded by microeconomic institutional and legal reforms.
Sinha Tapen (2002) examined the institution of insurance in India. Over the past century,
Indian insurance industry has experienced big changes. It started as a fully private system with
no restriction on foreign participation. After the independence, the industry went to the other
extreme. It became a state owned monopoly. In 1991, when rapid economic changes took place
in many parts of the Indian economy, nothing happened to the institutional structure of
insurance: it remained a monopoly. Only in 1999, a new legislation came into effect signaling
a change in the insurance industry structure. It was examined that what might happen in the
future when the domestic private insurance companies are allowed to compete with some
foreign participation. Because of the time dependence of insurance contracts, it is highly
unlikely that these erstwhile monopolies are going to disappear.
Baranoff Etti G., Sager Thomas W, (2002) explained the impact of life risk based capital
(RBC) regulation on relation between capital and risk in the life insurance industry. To
examine this issue, simultaneous equation partial adjustment model was used. Three equations
which express the interrelations among capital and two measures of risk (product

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risk and asset risk) were used. The asset-risk measure used in this paper reflects credit or
solvency risk as in RBC. Product risk assessment for life insurance products is rationalized by
transaction cost economics contractual uncertainty. A significant finding is that for life insurers
the relation between capital and asset risk is positive. This agrees with prior studies for the
property/casualty insurance industry and some banking studies. But the relation between
capital and product risk is negative. This is consistent with the hypothesized impact of
guarantee funds in other studies. The contrast between the positive relation of capital to asset
risk and the negative relation of capital to product risk underscores the importance of
distinguishing these two components of risk.
Adams Mike and Philip Hardwick (2003) stated that the insurance industry claims tend to
constitute the major proportion of total annual outgoings across almost all product lines. The
study develops a cost function of insurance claims and applies the model to 1988-93 data from
the United Kingdom and New Zealand life insurance industry. It found a similar set of results
for the two countries. In general, the results support the hypothesis that larger life insurance
firms on average face bigger claims to premium ratios than smaller life insurance firms. The
evidence concerning the relationships between claims, the composition of output, between
claims and the degree of reinsurance is mixed but there is clear support for the view that stock
firms have a less severe claims experience than mutuals. It was concluded that the model
provides intuitive insights into the determinants of insurance claims, which could help to
stimulate and direct further research.
Hautcoer Pierre Cyrille (2004) revealed that the French life insurance industry remained
underdeveloped in comparison with other countries of similar financial development during
the period between 1870 and 1939. The study explained that the wide fluctuations in the
insurance industry are the outcomes of technical peculiarities and their interaction with
macroeconomic fluctuations. Nevertheless, these fluctuations are not sufficient to explain the
industry’s long term stagnation. Low returns to clients were mainly due to their conservative
investment strategy. It was suggested to impose regulations and barriers to access of
competitors to the market. This will lead to maintaining a hold on a small but very profitable
market.

Paul J. M. Klumpes (2004) applied performance benchmarking to measure the profit and
cost efficiency of UK life insurance products. These products are required to be

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distributed through either independent financial advisers (IFA) or appointed and/or company
representatives (AR/CR) as per polarization regulations. Relative profit and cost efficiencies
are assessed using the fourier flexible form of econometric procedure and are based on detailed
product level disclosure information. United Kingdom life insurance firms employing IFA
distribution systems are found to be more cost and profit inefficient than AR/CR firms.

Ennsfellner Karl C., Danielle Lewis, Randy L. Anderson (2004) examines the
developments in the production efficiency of the Austrian insurance market for the period
1994-1999 using firm-specific data on life/health and non-life insurers obtained from the
Austrian Insurance Regulatory Authority. The article uses a Bayesian stochastic frontier to
obtain aggregate and firm specific estimates of production efficiency. The study provides
strong evidence that the process of deregulation had positive effects on the production
efficiency of Austrian insurers. The life/health and non-life firms showed similar patterns of
development in that they were less efficient during the years 1994-1996 and significantly more
efficient in 1997-1999. If the Austrian experience is representative, similar benefits from
deregulation may be expected for the Central and Eastern European countries that prepare for
the accession to the European Union.
Tone Kaoru, Biresh K. Sahoo (2005) applies a new variant of data envelopment analysis
model to examine the performance of Life Insurance Corporation (LIC) of India for a period
of nineteen years. The findings show significant heterogeneity in the cost efficiency scores
over the observation period. A decline in performance after 1994–1995 may be due to the huge
initial fixed cost undertaken by LIC in modernizing its operations. A significant increase in
cost efficiency in 2000–2001 may prove to be a cause for optimism that LIC may now be
realizing a benefit from such modernization.
James C.J. Hao, Lin Yhi Chou (2005) estimated the translog cost function for twenty-six life
insurance companies using data for twenty three years (1977–1999). The distribution free
approach (DFA) and Battese and Coelli (DFP) model was employed to estimate inefficiency.
Then the constants or residuals were tested to see the relation of so called X efficiencies with
market share, diversified product strategy, scale efficiency and market growth ratio and in the
results efficiency was found to be related with the occurrence of market share, diversification
products strategy and scale efficiency.

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Palli Madhuka (2006) measured a life assurance security gap to examine the extent of
underinsured people. This gap is computed as the mean ratio of recommended insurance and actual
insurance to household earnings. The research provides estimates of the life insurance gap to
maintain living standards of dependents after death of the primary wage earner. It is because,
inadequate protected families put burden of their welfare on public resources. The primary drivers
of demand for risk security are age, income, affordability, wealth and desire to protect income from
inflation. Though aggregate demand is driven by these factors, various researches have shown that
there is little correlation between a specific family's need for security and its actual purchase of
insurance. According to one estimate mentioned in sigma, in the event of a spouse's death, nearly
one third of secondary earners between the ages of twenty two to thirty nine would suffer at least
a decline of forty percent in their standard of living.
Sherries Micheal (2006) explains the linkage between solvency, capital allocation and fair
rate of return in insurance. A method to allocate capital in insurance business is developed
based on an economic definition of solvency and the market value of the insurer balance sheet.
Solvency and its financial impact are determined by the value of the insolvency exchange
option. The allocation of capital is determined using a complete markets arbitrage free model
and consistency in allocated capital with the economic value of the balance sheet assets and
liabilities is observed as a result.
Yang Zijiang (2006) conducted a study in order to know how to achieve efficiency
systematically for the Canadian life and health insurance industry. For this purpose an
integrated approach of production and investment performance for the insurers was used which
provided management overall performance evaluation. A two stage data envelopment analysis
model was created to provide valuable managerial insights when assessing the dual impacts of
operating and business strategies for the industry. The results showed that the Canadian life
and health insurance industry operated fairly efficiently during the period examined (the year
1998). In addition, the scale efficiency was also found in this study.
Sinha Ram Pratap (2007) compared thirteen life insurance companies in respect of technical
efficiency for the period 2002-2003 to 2005- 2006 using the assurance region approach of
DEA. The comparison of mean technical efficiency scores reveal that mean technical
efficiency has improved in 2003-2004 relative to 2002-2003, remained on the same level in
2004-2005 and declined in 2005-2006. This is likely because of divergence in the

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performance across the life insurers. In the last two years, most of the life insurers have
exhibited increasing returns to scale. This is indicative of the wide opportunities that the
insurers have for them.
Sinha Ram Pratap (2007) estimated cost efficiency of the life insurance companies operating
in India for the period 2002-03 to 2006-07 using the new cost efficiency approach suggested
by Tone (2002) and suggested an upward trend in cost efficiency of the observed life insurers
between 2002-03 and 2004-05. However, the trend was reversed for the next two years i.e.
2005- 06 and 2006-07.This has been so because of the fact that during the initial years of
observation mean cost efficiency of the private life insurers was rising but the trend was
reversed in 2005-06 and 2006-07.

Vivian Jeng, Gene C. Lai, Michael J. Mcnamara (2007) examined the efficiency changes
of U.S. life insurers before and after demutualization in the 1980s and 1990s. Two frontier
approaches (the value-added approach and the financial intermediary approach) were used to
measure the efficiency changes. In addition, Malmquist indices were also used to investigate
the efficiency and productivity change of converted life insurers over time. The results using
the value added approach indicate that demutualized life insurers improve their efficiency
before demutualization. On the other hand, the evidence using the financial intermediary
approach shows the efficiency of the demutualized life insurers relative to mutual control
insurers deteriorates before demutualization and improves after conversion. The difference in
the results between the two approaches is due to the fact that the financial intermediary
approach considers financial conditions. The results of both approaches suggest that there is
no efficiency improvement after demutualization relative to stock control insurers. There is,
however, efficiency improvement relative to mutual control insurers when the financial
intermediary approach is used.

Desheng W, Zijiang Yan, Sandra vela, Liang (2007) created a new data envelopment
analysis model to provide valuable managerial insights when assessing the dual impacts of
operating and business strategies for Canadian life and health insurance industry. This problem
oriented new DEA model is different from classical DEA model as it can simultaneously assess
the production and investment performance of insurers. The mathematical solution is provided
for this new model and the results show that the Canadian

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L&H insurance companies operated very efficiently for the examined three year period (1996–
1998). In addition, no scale efficiency in the Canadian L&H insurance industry is found in this
study.
Sinha Tapen (2007) affirmed the journey of life insurance sector in India. The study pointed
out that it was 1956 when life insurance was nationalized and a monopoly was created. In
1992, a Government appointed committee recommended that private companies should be
allowed to operate. The private sector was admitted into the insurance business in 2000. It was
cited that the insurance market achieved nineteenth rank in 2003. Therefore, it was also
expected that this strong economic growth would make this industry one of the potentially
largest markets in the future.
Young Virgiana R (2007) developed a pricing rule for life insurance under stochastic
mortality in an incomplete market. It was assumed that life insurers are in need of compensation
for its risk in the form of a pre specified instantaneous Sharpe ratio. The results emerging from
the paper were that, as the number of contracts approaches infinity, a linear partial differential
equation is solved by price per contract. Another important result is that, even if the number of
contracts approaches infinity, the risk adjusted premium is greater than net premium only if
hazard rate is stochastic. Thus, the price reflects the fact that systematic mortality risk can not
be eliminated by selling more life insurance policies.
Sinha Ram Pratap (2007) stated that subsequent to the passage of the Insurance Regulatory
and Development Authority (IRDA) Act, 1999, the life insurance market in India underwent
major structural changes in recent years. Between March 2000 and March 2005, the number
of life insurance companies operating in India has increased from one to fifteen. As on March
31, 2005, the private sector life insurers enjoyed nearly ten percent of the premium income and
nearly twenty-five percent of the new business. In view of the changing scenario of competition
in the life insurance sector, the paper compares thirteen life insurance companies for the
financial years 2002-03, 2003-04 and 2004-05 in respect of technical efficiency and changes
in total factor productivity. For the purpose of computation of technical efficiency and total
factor productivity, the net premium income of the observed life insurance companies has been
taken as the output, and equity capital and the number of agents of insurance industries have
been taken as the inputs. The results suggest that all the life insurers exhibit positive total factor
productivity growth during the period.

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Adams Mike, Philip Hardwick, Hong Zou (2008) tested the two tax related arguments
regarding use of reinsurance for a period of ten year data from 1992 to 2001 for a sample of
United Kingdom (UK) life insurance firms. These two arguments were the income volatility
reduction and the income level enhancement arguments. It was found that UK life insurers
with low marginal tax rates tend to use more reinsurance and vice versa. Moreover, the
volatility reduction argument is not supported as tax convexity is found to have no significant
impact on the purchase of reinsurance.
Berry Stolzle Thomas R. (2008) examined liquidation strategies and asset allocation
decisions for property and casualty insurance companies for different insurance product lines.
The study proposed a cash flow based liquidation model of an insurance company and analyzed
selling strategies for a portfolio with liquid and illiquid assets. Within this framework, the
influence of different bid ask spread models on the minimum capital requirement, a solution
set consisting of an optimal initial asset allocation and an optimal liquidation strategy is also
studied. It showed that the initial asset allocation, in conjunction with the appropriate
liquidation strategy, is an important tool in minimizing the capital committed to cover claims
for a predetermined ruin probability. This interdependence is of importance to insurance
companies, stakeholders and regulators.
Zweifel Peter, Christoph Auckenthalert (2008) calls attention to a difficulty with insurer’s
investment policies that seems to have been overlooked so far. There is the distinct possibility
that insurers cannot satisfy the demands of different stakeholders in terms of expected returns
and volatility. While using the capital asset pricing model as the benchmark, the study
distinguishes two groups of stakeholders that impose additional constraints. One is "income
security" in the interest of current beneficiaries and older workers; the other is "predictability
of contributions" in the interest of contributing younger workers and sponsoring employers. It
defines the conditions for which the combination of these constraints results in a lack of
feasibility of investment policy. Minimum deviation from the capital market line is proposed
as the performance benchmark in these situations
S. Hun Seog (2008) develops an informational cascade model based on Bikhchandani,
Hirshleifer, and Welch (1992) with applications to the insurance market. The study investigates
the existence of cascades and the effects of public information on cascades. The result applies
to insurance markets to explain how catastrophic events may lead to increased

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demand, how loss shocks may lead to insurance cycles and how the heterogeneity of
policyholders affects the choice of limited auto insurance in Pennsylvania.
Lai Gene C., Michael J. McNamara, Tong Yu (2008) examines the wealth effect of
demutualization initial public offerings (IPO’s) by investigating under pricing and post
conversion long run stock performance. The results suggest that there is more "money left on
the table" for demutualized insurers than for non demutualized insurers and show that higher
under pricing for demutualized firms can be explained by greater market demand, market
sentiment and the size of the offering. The study presents evidence that the out performance in
stock returns is mainly attributable to improvement in post demutualization operating
performance and demand at the time of the IPO’s. The combined results of under pricing and
long term performance suggest that the wealth of policyholders who choose stock rather than
cash or policy credits is not harmed by demutualization.
Wen Min Ming, Anna D Martin, Gene Lai, Thomas J. O’Brien (2008) points out that due
to the highly skewed and heavy tailed distributions associated with the insurance claims
process, the study evaluate the Rubinstein-Leland (RL) model for its ability to improve the
cost of equity estimates of insurance companies because of its distribution free feature. The
implication is that if the insurer is small (assets size is less than $2,291 million), and/or its
returns are not symmetrical (the value of skewness is greater than 0.509 or less than −0.509
then it should use the RL model rather than the CAPM to estimate its cost of capital.
Thomas Gerstner, Michael Griebel, Markus Holtz, Ralf Goschnick, Marcus Haep (2008)
investigated the impact of the most important product and management parameters on the risk
exposure of the insurance company and for this purpose, the study proposed a discrete time
stochastic asset liability management (ALM) model for the simulation of simplified balance
sheets of life insurance products. The model incorporates the most important life insurance
product characteristics, the surrender of contracts, a reserve dependent bonus declaration, a
dynamic asset allocation and a two factor stochastic capital market. Furthermore, the model is
designed to have a modular organization which permits straightforward modifications and
extensions to handle specific requirements. The results showed that the model captures the
main behaviour patterns of the balance sheet development of life insurance products.

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Gatzert Nadine, Gudrun Hoermann, Hato Schmeiser (2009) attempted to quantify the
effect of altered surrender behavior, subject to the health status of an insured, in a portfolio of
life insurance contracts on the surrender profits of primary insurers. The model includes
mortality heterogeneity by applying a stochastic frailty factor to a mortality table. The study
additionally analyzed the impact of the premium payment method by comparing results for
annual and single premium payments.
Fier G. Stephen, James M Carson (2009) provided an evidence of a significant relationship
between catastrophes and life insurance demand, both for states directly affected by the event
and for neighboring states. For this purpose, U.S. state level data for the period of 1994 to 2004
was examined. It was suggested that the occurrence of a catastrophe may lead to increases in
risk perception, risk mitigation and insurance purchasing behaviour. Similarly, the study posits
that the occurrence of catastrophes also may be associated with an increased demand for
coverage against mortality risk.
Chatterjee Biswajit, Ram Pratap Sinha (2009) estimated cost efficiency of the life insurance
companies operating in India for the period 2002-03 to 2006-07 using the new cost efficiency
approach suggested by Tone (2002). The results suggest an upward trend in cost efficiency of
the observed life insurers between 2002-03 and 2004-05. However, the trend was reversed for
the next two years i.e. 2005-06 and 2006-07. This has been so because of the fact that during
the initial years of observation, mean cost efficiency of the private life insurers was rising but
the trend was reversed in 2005-06 and 2006-07.
Rao M.V.S. Srinivasa (2009) analyzed the impact of life insurance business in India and
concluded that, India’s insurance industry accounted for twelve percent of total Gross
Domestic Product (GDP) in 2000-01. It was the year in which the insurance sector was
liberalized. The percentage increased to 20.1 percent in 2005-06. The market share of the
private insurers and LIC in terms of policies underwritten was 10.92 percent and 89.08 percent
in 2005-06 as against 8.52 percent and 91.48 percent respectively in 2004-05. Total pay-out
by the life insurance industry towards commissions in 2005-06 was Rs. 8,643.29 crore as
against Rs. 7,104.46 crore in 2004-05. With a population of more than one billion, sixteen
percent of the rural population was insured at that time whereas average population insured in
India was twenty percent. Since, seventy percent of the Indian population lives in rural areas,
the potential is very attractive.

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Mcshane Michael K., Cox Larry A., Butler Richard J. (2009) delved that the regulatory
separation theory indicates that a system with multiple regulators leads to less forbearance and
limits producer gains while a model of banking regulation developed by Dell’Ariccia and
Marquez in 2006 predicts the opposite. Fragmented regulation of the US Life insurance
industry provides an especially rich environment for testing the effects of regulatory
competition. The study found positive relations between regulatory competition and
profitability measures for this industry, which is consistent with the Dell’Ariccia and Marquez
model. The results have practical implications for the debate over federal versus state
regulations of insurance and financial services in the US.
Xiaoling Hu, Cuizhen Zhang, Jin-Li Hu, Nong Zhu (2009) examined the efficiencies of
China's foreign and domestic life insurance providers. The study was conducted with a purpose
to explore the relationship between ownership structure and the efficiencies of insurers while
taking into consideration other firm attributes. The data envelopment analysis (DEA) method
was used to estimate the efficiencies of the insurers based on a panel data between 1999 and
2004. The results indicate that the average efficiency scores for all the insurers are cyclical.
Both technical and scale efficiency reached their peaks in 1999 and 2000 and gradually reduced
for the rest of the period under examination until 2004 when average efficiency were improved
again. The regression results showed that the insurers market power, the distribution channels
used and the ownership structures may be attributed to the variation in the efficiencies. Based
on the research findings and the discussions, the study also provided several recommendations
for policy makers, regulators and senior executives of insurers.
Debabrata Mitra & Amlan Ghosh (2009) stated that life insurance is of paramount
importance for protecting human lives against accidents, causalities and other types of risks.
Life insurance has been dominated by public sector in India; however, with the liberalization
of Indian economy, private sector entry in life insurance has got momentum. The public sector
insurance companies, particularly, LIC of India has emphasized on exploiting the potential of
rural India as it provides immense scope even in the post globalised era. Therefore, the paper
highlighted emerging trends and patterns in Indian insurance business during post globalised
era. It also focuses on the role of private partners in life insurance in India.

66
Mayer David, Clifford W. Smith (2010) explained that the monitoring by outside board
members and incentive compensation provisions in executive pay packages are alternative
mechanisms for controlling incentive problems between owners and managers. The control
hypothesis suggested that if incentive conflicts vary materially, those firms with more outside
directors also should implement a higher degree of pay for performance sensitivity. The
evidence of the study is consistent with this control hypothesis. It documented a relation
between board structure and the extent to which executive compensation is tied to performance
in mutual. Compensation changes are significantly more sensitive to changes in return on
assets when the fraction of outsiders on the board is high.
David L. Eckles, Martin Halek (2010) investigates incentives of insurance firm managers to
manipulate loss reserves in order to maximize their compensation. It is found that managers
who receive bonuses are likely capped and those who do not receive bonus tend to over reserve
for current year incurred losses. However, managers who receive bonuses that are likely not
capped tend to be under reserved for current year incurred losses. It is also found that managers
who exercise stock options tend to under reserve in the current period.
Jiang Cheng, Elyas Elyasian, I, Tzu-Ting Lin(2010) examined the market's reaction to New
York attorney general eliot spitzer's civil suit against mega broker Marsh for bid rigging and
inappropriate use of contingent commissions within GARCH framework. Effects on the stock
returns of insurance brokers and insurers were tested. The findings were as follows: GARCH
effects proved to be significant in modelling broker/insurer returns; the suit generated negative
effects on the brokerage industry and individual brokers. It was suggested that contagion
dominates competitive effects; spillover effects from the brokerage sector to insurance
business are significant and mostly negative, demonstrating industry integration and
information based contagion was supported, as opposed to the pure-panic contagion.
Huang Hong Chih (2010) exhibited the importance of investment and risk control for
financial institutions. Asset allocation provided a fundamental investing principle to manage
the risk and return trade off in financial markets. The article proposes a general formulation of
a first approximation of multi period asset allocation modelling for those institutions who
invest to meet the target payment structures of a long term liability. By addressing the
shortcomings of both single period models and the single point forecast of the mean variance

67
approach, this article derived explicit formulae for optimal asset allocations, taking into
account possible future realizations in a multi period discrete time model.
Wang Jennifer L., H.C. Huang, Sharon S. Yang, Jeffrey T. Tsai (2010) conducted a study
to examine the dealing of natural hedging strategy with longevity risks for life insurance
companies. The study proposed an immunization model which incorporated a stochastic
mortality dynamic to calculate the optimal life insurance annuity product mix ratio to hedge
against longevity risks. The study mode the use of the changes in future mortality using the
well known Lee Carter model and discuss the model risk issue by comparing the results
between the Lee Carter and Cairns Blake Dowd models. On the basis of the mortality
experience and insurance products in the United States, it was demonstrated that the proposed
model can lead to an optimal product mix and effectively reduce longevity risks for life
insurance companies.
Liebenberg Andre P, James M. Carson, Robert E. Hoyt (2010) stated that the previous
research has examined the demand for life insurance policy loans using aggregate policy loan
data. In contrast, the study uses a detailed household survey data set containing life insurance
and policy loan information. Four hypotheses traditionally associated with policy loan demand
were tested. The research provided the first U.S. evidence (in the post world war II period) in
support of the policy loan emergency fund hypothesis. In particular, it was found that the more
detailed emergency fund proxies used revealed a significantly positive relation between loan
demand and recent expense or income shocks.
Corsaro S., Angelis P.L. De, Perla Z. Marino, Znetti P. (2010) discussed the development
of portfolios valuation system of asset liability management for life insurance policies on
advanced architectures. The first aim of the study was to introduce a change in the stochastic
processes for the risk sources, thus providing estimates under the forward risk neutral measure
which results for gain in accuracy. The Monte Carlo method was then introduced to speed up
the simulation process. According to new rules of solvency II project, numerical simulations
must provide reliable estimates of the relevant quantities involved in the contracts. Therefore,
valuation process has to rely on accurate algorithms able to provide solutions in a suitable
turnaround time.
Sinha Ram Pratap (2010) compared fifteen life insurance companies operating in India from
2005-06 to 2008-09 using the old and new Revenue Maximizing Approach. The

68
difference between the two approaches lies in the specification of the production possibility
set. In both the approaches, only the Life Insurance Corporation of India (LIC) was found to
be efficient for the observed years followed by Sahara life very closely. However, since in the
old approach, the technically inefficient firms are penalized very harshly, the grand mean
technical efficiency score is less than fifty percent to that in the new approach.
Dutta A. and Sengupta P.P. (2010) focused on the important investment issue. They tried to
answer about whether increasing investment on IT infrastructure (which is resulting into a
technological innovation in business operation of the private companies) has a favorable
impact on efficiency or not. For the purpose, a panel data set of twelve private life insurance
companies over the financial period 2006-2009 was taken. The efficiency was evaluated by
applying Data Envelopment Analysis (DEA) and calculating the scale efficiency. The results
showed that increasing investment on IT infrastructure had a positive impact on scale and
technical efficiency change if constant and variable returns to scale assumptions were
considered.
Rao Ananth, Kashani Hossein and Marie Attiea (2010) analyzed the efficiency and
productivity issues of the insurance sector from the policymakers as well as investors view
point so as to insulate the business and financial risks of UAE corporate houses. The paper
uses two inputs of administrative & general expenses and equity & change in legal reserves
versus two outputs of rate of return on investments and liquid assets to total liability ratio to
assess the allocative efficiency of companies using DEA. The data set for nineteen insurers in
the region was considered for the study. To evaluate the performance of the insurers, the
efficiency is broken down in to technical and scale efficiency by using malmquist productivity
index. Considerable degree of managerial inefficiency among the insurers with least efficiency
in 2000 and highest efficiency in 2004 was observed as a result. Further, the insurers achieved
a mere 0.8 percent annual gain in total factor productivity over the study period.
Alamelu K. (2011) stated that the insurance sector in India was dominated by the state owned
Life Insurance Corporation (LIC) and the General Insurance Corporation (GIC) along with its
four subsidiaries. But in 1999, the Insurance Regulatory and Development Authority (IRDA)
bill opened it up to private and foreign players whose share in the insurance market has been
rising. The IRDA is the regulatory authority of the insurance sector, entrusted with

69
protecting the interests of the insurance policy holders and regulating, promoting and ensuring
orderly growth of the insurance industry in India. As financial intermediaries, life insurers tap
savings of the public in the form of premium. In order to sustain public confidence, they have
to maintain their financial credibility intact. In other words, a strong financial background
enables insurance companies to augment their business. The International Monetary Fund
(IMF) suggested a number of indicators to diagnose the health of the insurance sector. This
paper makes an attempt to analyze the financial soundness of Indian Life Insurance Companies
in terms of capital adequacy, asset quality, reinsurance, management soundness, earnings and
profitability, liquidity and solvency ratios.
Andreas Milidonis, Konstantinos Stathopoulos (2011) tried to find the relation between
executive compensation and market implied default risk for listed insurance firms from 1992
to 2007. Shareholders are expected to encourage managerial risk sharing through equity based
incentive compensation. Thus, it was found that long term incentives and other share based
plans do not affect the default risk faced by firms. However, the extensive use of stock options
leads to higher future default risk for insurance firms. It was argued that this is because option
based incentives induce managerial risk taking behaviour which seeks to maximize managerial
payoff through equity volatility. This could be detrimental to the interests of shareholders,
especially during a financial crisis.
Dutta Anirban, Sengupta Partha Pratim (2011) stated that efficiency is the key concern of
policymakers to encourage further development of the insurance industry as well as for the
managers of the insurance companies to exist profitably in the business in the long run and
used a panel dataset of fourteen life insurance companies over the period 2004–09, to evaluate
their efficiency scores by applying Data Envelopment Analysis and calculating the scale
efficiency. The results render light on policy design and implementations for future
development of the life insurance industry in India.
Neelaveni V. (2012) stated that the evaluation of financial performance of the life insurance
companies is essentially needed to select the a best life insurance policy. Therefore, five life
insurance companies are randomly selected at the time of 2002-03 and evaluated in terms of
performance. It is because, with reforms of regulations and opening up of the insurance sector
to the private management in the year 1999, tough competition can be seen in the insurance
industry. The number of general insurance and life insurance companies has been

70
increasing in the 21st century. The ultimate person is an investor or customer, who has to get
the update information, observe keenly the performance of the companies and their attractive
products.
Charumathi B. (2012) tried to model the factors determining the profitability of life insurers
operating in India taking return on asset as dependent variable. All the twenty three Indian life
insurers (including one public and twenty two private) were included in the sample for study
and the data pertaining to three financial years, viz., 2008-09, 2009-10 and 2010-11 was used.
For this purpose, firm specific characteristics such as leverage, size, premium growth, liquidity,
underwriting risk and equity capital are regressed against return on assets. This study led to the
conclusion that profitability of life insurers is positively and significantly influenced by the
size (as explained by logarithm of net premium) and liquidity. The leverage, premium growth
and logarithm of equity capital have negatively and significantly influenced the profitability of
Indian life insurers. The study did not find any evidence for the relationship between
underwriting risk and profitability.
Srivastava Arnika, Tripathi sarika, Kumar Amit (2012) explained the contribution of
insurance industry to the financial sector of an economy. It was explored that the growth of the
insurance sector in India has been phenomenal. The insurance industry has undergone a
massive change over the last few years. There are numerous private and public sector insurance
companies in India that have become synonymous with the term insurance over the years.
Offering a diversified product portfolio and excellent services, many of the insurance
companies in India have managed to make their way into almost every Indian household.
Chakraorty Kalyan, Dutta Anirban and Partha Pratim Sengupta (2012) investigate
technical efficiency and productivity growth in Indian life insurance industry in the era of
deregulation. The empirical study uses DEA method and Malmquist productivity index to
measure and decompose technical efficiency and productivity growth respectively. The results
suggest that the growth in overall productivity is mainly attributed to improvement in
efficiency. Higher pure technical efficiency and lower scale efficiency indicate the insurance
firms have generally moved away from the optimal scale over the study period. The truncated
regression exploring the main drivers of efficiency in the long run found that the claims ratio,
distribution ratio and firm-size have positively influenced technical efficiency.

71
The study also found that, the firms which had both life and non-life businesses are more
efficient than firms that has only life insurance business.
Padhi Bidyadhar (2013) focused on the role and performance of private insurance companies
for the period from 2001 to 2012. The study reflected the performance of selected private
insurance companies in the areas like number of policies floated, amount of premium collected
and the annual growth in the respective areas from 2001 to 2012. It was concluded that the
overall performances of all the private insurance companies are very satisfactory and they need
to continue this pace to penetrate their market more and more.
Sharma Vikas, Chowhan Sudhinder Singh (2013) made an attempt to analyse the
performance of public and private life insurance companies in India. The data used in the paper
covers the period from 2006-07 to 2011-12.For the analysis of data, statistical tools like
percentages, ratios, growth rates and coefficient of variation have been used. The results
showed that the LIC continues to dominate the sector. Private sector insurance companies also
tried to increase their market share. Private life insurers used the new business channels of
marketing to a great extent when compared with LIC. Investment pattern of LIC and private
insurers also showed some differences. Solvency ratio of private life insurers was much better
than LIC in spite of big losses suffered by them. Lapsation ratio of private insurers was higher
than LIC and servicing of death claims was better in case of LIC as compared to private life
insurers.
Sinha Ram Pratap (2013) estimated cost efficiency of the life insurance companies operating
in India for the period 2005-06 to 2009-10 using Farrell and Tone's measure. In both the
approaches it was found that the mean cost efficiency exhibit significant fluctuations during
the period under observation implying significant divergence from the frontier. The study also
decomposes the Farrell measure of cost efficiency into input oriented technical efficiency and
allocative efficiency. Further the cost efficiency estimates were related (through a censored
tobit model) to product and channel composition of the in-sample insurance players.
T. Hymavathi Kumari (2013) aimed at understanding the life insurance sector in India and
flagging issues relating to competition in this sector. Therefore, an attempt has been made to
study the performance of life insurance industry in India in post liberalization era. The
performance of public as well as private sector in terms of market share and growth has been

72
analyzed and it is stated that rapid rate of India’s economic growth has been one of the most
significant developments in the global economy. This growth has its roots in the introduction
of economic liberalization of the early 1990s which has allowed India to exploit its economic
potential and raise the population’s standard of living. Opening up of the financial sector is
one of the financial reforms which the government was to implement as an integral part of
structural reforms and stabilization process of the economy. Insurance has a very important
role in this process. Government allowed the entrance of private players into the industry. As
a result, many private insurers also came into existence.
Nena Sonal (2013) evaluated the performance of Life Insurance Corporation of India. The
major source of income (Premium Earned) and the significant heads of expenses (Commission
& Operating Expenses) of LIC are analyzed in order to measure the performance during the
period of study. The study period consists of five years i.e. 2005-2010. The performance
evaluation showed consistent increase in the business of LIC. During the period of the study,
no major change in the performance of the LIC is observed. So it clarifies that the performance
is unchanged and LIC has maintained the market value of their products.
Gulati Neelam (2014) analyzed the productivity in this paper. Different variables have been
used to calculate the productivity, viz- New Business Procured per Branch, New Business Per
Active Agent, Number of Policies Per Branch, Number of Policies Per Agent, Premium
Income Per Branch, Premium Income Per Agent, Ratio of Expenses to Premium Income,
Complaints per Thousand Mean Number of Policies in Force, Percentage of outstanding
Claims to total Claims Payable. The study is based on secondary data. The data has been drawn
from annual reports of LIC and IRDA and further have been tabulated and subject to statistical
calculations like t-value and CGR. It is therefore concluded that LIC has been able to earn
higher rate of return as selected variables (except expenses) have increased significantly. The
Compound Growth Rate has been found positive for income values and negative for expense
and claims payable. As a result customer centered approach is going to be the most compelling
agenda for LIC in the coming years.

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 SECTION-II
RESEARCH METHODOLOGY
Research methodology is the process of conducting research for research problem under
investigation. Research methodology is the process of identification of the research objectives
keeping in view the findings of the previous studies, collecting information and analysis of the
information for obtaining the objectives of the research. Since, Insurance sector is growing at
faster rate; it seems to be the area of interest for researcher and policyholder to know the
Operating Efficiency of Life Insurance Companies in India.

Furthermore, Wikipedia explains operational efficiency as the ratio between the input to run
a business operation and the output gained from the business. For the purpose of improving
operational efficiency, the ratio of output to input must be improved. This can be achieved by
having same output for less input, more output for same input and much more output for less
input. In addition, ehow.com defines that operational efficiency minimizes waste and
maximizes resource capabilities in order to deliver quality products and services to consumers.
It identifies wasteful processes and resources that drain the organizations profits and can also
design new work processes that improve quality and productivity. Companies are using several
techniques to measure and gauge their operational efficiency. Qualitative approaches include
benchmarking operations to industry standards and comparing and evaluating performance to
competitive companies. Quantitative analysis techniques include analyzing operations,
financial statements and the cost of goods.

Need of the Study:

In spite of India being second most populous country in the world, India’s life insurance
density is very low as compared to the developed countries and developing countries. This
shows that there is scope for life insurance sector to develop in India and hence, the need for
the study emerges.
Objectives of the Study
 To describe the developments in Indian life insurance sector.

 To present a comparative analysis of operational efficiency of Indian life insurance
companies using CARAMEL model.
 To compare the Revenue Efficiency of life insurance companies operating in India.

74
  To evaluate the Cost Efficiency of Indian life insurance industry.

 To compare the Profit Efficiency of Indian life insurance companies.

 To arrive at the logical conclusions and to provide constructive suggestions to
increase the efficiency of life insurance companies.
Scope of the Study
The study period ranges for the years starting from 2000-01 to 2011-12. Further, while
calculating efficiency scores from DEA, data from 2005-06 onwards is considered because of
non availability of consistent data for comparison in years prior to this. The Life Insurance
Corporation of India and some of the private sector life insurance companies (excluding those
which started their operations after 14th May 2002) are selected for the study. Therefore, the
profile of private sector life insurance companies is selected for the study and those which are
considered outside the scope of study are given below:
Profile of Indian Life Insurance Companies Selected for the Study

S. Regn. Date of
Name of the Company Abbreviation used
No. No. Regn.

1. 101 23-10-2000 HDFC Standard Life Insurance Company Ltd. HSLIC

2. 104 15-11-2000 Max Life Insurance Co. Ltd. MAX LIFE

3. 105 24-11-2000 ICICI Prudential Life Insurance Company Ltd. IPLIC

4. 107 10-01-2001 Kotak Mahindra Old Mutual Life Insurance Ltd. KOTAK MAHINDRA

5. 109 31-01-2001 Birla Sun Life Insurance Company Ltd. BSLIC

6. 110 12-02-2001 Tata AIA Life Insurance Co. Ltd. TATA-AIA

7. 111 30-03-2001 SBI Life Insurance Co. Ltd. SBI-LIFE

8. 114 02-08-2001 ING Vysya Life Insurance Company Pvt. Ltd. ING-VYSYA

9. 116 03-08-2001 Bajaj Allianz Life Insurance Company Ltd. BAJAJ-ALLIANZ

10. 117 06-08-2001 Met Life India Insurance Company Ltd. MET-LIFE

11. 121 03-01-2002 Reliance Life Insurance Company Ltd. RELIANCE

12. 122 14-05-2002 Aviva Life Insurance Co. India Pvt. Ltd. AVIVA

Source: Compiled from the Annual Reports of IRDA.

75
 Profile of Companies which are outside the Purview of the Study
Sr No. Regn. No. Date of Regn. Name of the Company
1. 127 06-02-2004 Sahara India Life Insurance Company Ltd.
2. 128 17-11-2005 Shriram Life Insurance Company Ltd.
3. 130 14-07-2006 Bharti AXA Life Insurance Company Ltd.
4. 133 04-09-2007 Future Generali India Life Insurance Co. Ltd.
5. 135 19-12-2007 IDBI Federal Life Insurance Co. Ltd.
6. 136 08-05-2008 Canara HSBC Oriental Bank of Commerce Life
Insurance Company Ltd.
7. 138 27-06-2008 Aegon Religare Life Insurance Company Ltd.
8. 140 27-06-2008 DLF Pramerica Life Insurance Company Ltd.
9. 142 26-12-2008 Star Union Dai-ichi Life Insurance Co. Ltd.
10. 143 05-11-2009 India First Life Insurance Company Ltd.
11. 147 10-05-2011 Edelweiss Tokio Life Insurance Company Ltd.
Source: Compiled from the Annual Reports of IRDA.

Although, the above stated companies are considered outside the purview of study, but still,
the data for these companies are combined in tables of chapter III under heading “Others”. This
is done so as to know the accurate percentage share of selected companies to total share of life
insurance industry.
Collection of the Data
The study is based on secondary data. To make the study more analytical & scientific and to
arrive at definite conclusions, the secondary data is collected from the Annual Reports, Fact
Books, Manual of the insurance and Websites of IRDA, Life Insurance Corporation of India
and private life insurance companies etc. Experts in the field were also approached for the
purpose of discussion to understand the problem in right perspective. The work of
academicians on this subject has also been consulted for the purpose of analysis. The analysis
is descriptive in nature.
Statistical Tools Applied
At the time of analyzing the data, various statistical tools such as CARAMEL Model, Mean,
Coefficient of Variation, Data Envelopment Analysis, Frequency Distribution, Compound
Annual Growth Rate and Percentages have been used in analyzing the variables.

76
CARAMEL Model: The model is used to evaluate the operational efficiency of life insurance
companies in India. The model makes use of ratio analysis. Ratio analysis is an analysis of
financial statements which is done with the help of Ratios. A Ratio expresses the relationship
that exists between two numbers taken from the financial statements. Ratio analysis is among
the best tools available with the analyst to analyze the financial performance of a company as
it allows inter-company and intra company comparison. It also provides a bird’s eye view
regarding the financial condition of the company. An overview of CARAMEL Indicators used
in chapter three of the study is presented in the table given below:

Overview of CARAMEL Indicators Used for Measuring Operational Efficiency

Type of FSI Aspects of Selected Indicators used to monitor different aspects
Financial of financial system
System
Capital Capital/Total Assets
Adequacy
Capital/Mathematical Reserves
Operating Expenses/Net Premium Underwritten
Commission/Net Premium Underwritten
Financial Earnings Other Expenses/Net Premium Underwritten
Soundness /Profitability
Expenses/Net Premium Underwritten
Shareholders Investment Income/Shareholder Investment
Policyholders Investment Income/Policyholders
Investment
Investment Income/Investment Assets
Return on Equity
(Profit after interest, tax and dividend/Share Capital)
Asset Quality Equity/Total Assets
Reinsurance Risk Retention Ratio (Net Premium/Gross Premium)
and Actuarial
Insurance Mathematical Reserves to Average of Net Premium
Issues
Sector (ANP) received in last three years.
Vulnerabilities Management Operating Expenses/Gross Premium
Soundness
Liquidity Liquid Assets/Current Liabilities
Solvency Net Assets/Net Premium Underwritten

77
 After approaching towards the results of the above mentioned ratios, rank to each parameter is
assigned on the basis of average ratio and at last, the composite ranking of CARAMEL
framework is made in order to arrive at conclusions.
Data Envelopment Analysis (DEA):
Data Envelopment Analysis (DEA) is a methodology based upon an interesting application of
linear programming. It was originally developed for performance measurement. It has been
successfully employed for assessing the relative performance of a set of firms that use a variety
of identical inputs to produce a variety of identical outputs. It is a technique based on linear
programming. It is used to measure the performance efficiency of organizational units which
are termed as (DMUs). This technique aims at measuring how efficiently a DMU uses
resources available to generate a set of outputs (Charnes et al.1978). Decision Making Units
can include manufacturing units, departments of big organizations such as universities,
schools, bank branches, hospitals, power plants, police stations, tax offices, prisons, defence
basis, a set of firms or even practising individuals such as medical practitioners The
performance of DMUs is assessed in DEA using the concept of efficiency or productivity,
which is the ratio of total outputs to total inputs. The best performing Decision Making Unit is
assigned an efficiency score of unity. The performances of other DMUs vary between zero to
one.

Here in this study, Efficiency is computed in terms of Revenue, Cost and Profit using DEA-
Solver Pro. 5.0 version of Data Envelopment Analysis and is presented in chapter four. The
chapter is divided in to three sections i.e. Revenue efficiency, Cost efficiency and Profit
efficiency of life insurance companies operating in India.
Inputs and Outputs selected for the study: Inputs and outputs selected for three different
types of efficiencies are as follows:
1. For computing Revenue efficiency, New-Revenue-V approach is used and
following data set for input/ output is used:

Inputs (I)
 Commission expenses

 Operating expenses

78
Output (O)
 Number of policies

Price (P)
 Sum assured per policy
2. Cost efficiency is calculated using New-Cost-V approach of DEA. The inputs and
output used to compute the cost efficiency score are as follows:

Inputs (I)
 Number of agents

 Number of offices

Cost (C)
 Commission expenses

 Operating expenses

Output (O)
 Sum assured per policy
3. New-Profit-V approach of DEA is applied in order to evaluate the Profit efficiency
of Indian life insurers and the following input/ output combination is used.

Inputs (I)
 Number of agents

 Number of offices

Cost (C)
 Commission expenses

 Operating expenses

Output (O)
 Number of policies

Price (P)
 Sum assured per policy

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After arriving at the efficiency scores, these scores have been distributed in four different
ranges so as to know the efficiency level of various life insurers. These ranges are up to 0.25,
0.25 to 0.50, 0.50 to 0.75 and above 0.75 and their corresponding efficiency levels Least
efficient, Low efficient, Efficient and Highly efficient. Thereafter, graph for each year is also
prepared in order to rank the insurers on the basis of their efficiency scores. After presenting
the score on yearly basis, it is compiled in a single table which consists of the score for each
year (i.e. from 2005-06 to 2011-12). Increase, decrease or no change in score in the next year
is represented by symbols such as +, - or N.C in the next step. The company having three or
more + symbols are termed as Improved performer and with - symbols as Deteriorate
performer. The company having two +, two – & two N.C. signs and with three - & three +
signs is considered to be the Consistent performer. Therefore, at last table indicating
performance of life insurers is prepared at the end of each section.

Usefulness of the Study:

Keeping in view the various issues analyzed in the study, it can be concluded that the study
provides a meaningful contribution in today’s era. The findings of the study would be
beneficial to the multiple groups of people. Firstly, the study will be helpful to the Indian life
insurance companies. With the help of the study the companies will be able to know their
ranking in the market and the ways to improve it. Secondly, it will be of immense help to the
individuals interested in investing money in these companies. Last but not the least, the study
will prove very beneficial for the students and researchers in the area of Finance, Banking and
Insurance.

Organization of the Study:

The study is organized in five chapters as follows:

Chapter I describes the profile as well as growth of Indian life insurance industry during
different phases of time.

Chapter II deals with review of earlier studies regarding efficiency of life insurers and describes
the research methodology and organization of the study.

Chapter III explains the analysis of operational efficiency of life insurance companies using
CARAMEL model.

80
Chapter IV presents the revenue, cost and profit efficiency of life insurers in India.

Chapter V provides the summary of the findings, suggestions and recommendations of the
study.

Limitations of the study:

The research work is undertaken so as to maximize objectivity and minimize the errors.
However, there are certain limitations of the study which are as follows:
 The study completely depends on the data which collected from the Annual Reports of
IRDA. Therefore, study incorporates all the limitations that are inherent in the
published data.

 The data for analysis is purely derived from annual reports. They are not adjusted for
inflation.

 Since DEA is an extreme point technique, errors in measurement can cause significant
problems. DEA efficiencies are very sensitive to even small errors; making sensitivity
analysis is an important component of post DEA procedure and this aspect has not been
carried out in this study.

 Study period is confined to financial year 2000-01 to 2011-12 only. This is due to
existence of private sector life insurance companies from 2000-01 onwards only and
data for the year 2012-13 was not available till the completion of study. Since, it is an
introduction phase of private sector life insurance companies, the results might be
affected and may not be similar in the long run.
Further Scope of the Study:
While calculating cost efficiency in the study, actual observed cost can be decomposed in to
minimum cost and loss due to input efficiency. Moreover, loss due to input efficiency can also
be expressed as input technical, price and allocative inefficiencies. Secondly, post DEA
procedure which includes sensitivity analysis can be carried out in the study. Thirdly, the study
emphasizes on efficiency of Indian life insurance companies only. Therefore, the performance
of the companies which are operating outside India can also be compared with Indian
companies.

81