>LIFE INSURANCE: IRDA’s final guidelines: Near-term pain, long-term gain

Continuing its focus on bringing uniformity in product features and improving disclosures, the Insurance Regulatory and Development Authority (IRDA), today, came out with final guidelines on ULIPs, encompassing the entire spectrum of product features and charge structure. These guidelines will be applicable from September 2010 (against the earlier deadline of July 2010).

KEY CHANGES
• Lock-in period and premium payment term raised to five years. Further, life/health cover is made compulsory for all products (excluding pensions and annuities), strengthening long-term protection feature of the instrument.

• All pension products to guarantee return of 4.5% to protect the lifetime savings from adverse fluctuations at the time of maturity.

• So far, capping of charges applied only on door-to-door basis at 3% for 10- year policy and 2.25% for 15-year policy; this is now fixed at 4% in the sixth year, dropping to limits prescribed earlier as the policy tends to maturity. Distribution charges to be spread evenly over the lock-in period to eliminate front loading.

• With the perspective of ensuring that only acquisition expenses are recovered in the event of discontinuance of the policy, surrender charges have been capped. Surrender charge will be much lower than the current levels.

OUR VIEW
• Directionally, IRDA has attempted to make ULIP a long-term protection contract covering risks related to mortality, longevity and health, and at the same time offering a fair deal to the policyholder, doing away with the excesses in the system.

• Clarity on charge structure facilitates pricing and setting up reasonable longterm assumptions.

• In line with expectations, capping of charges will impact margins adversely. However, capping of surrender charges is a bigger blow compared with capping the difference between gross and net yield, as it would not only restrict the ability to generate revenue, but also raise the persistency risk borne by the insurers.

• With limited product differentiation, having low and variable cost business model will be critical. This, in turn, will lead to cost cutting across the sector, impacting distributor commissions adversely.

• Stringent capping of charges will make products cheaper and more attractive, a big positive for volumes in the long run.

• However, in the near future, some negative impact on volumes is possible as:
a) insurers will not be able to cater to market for short duration products and
b) lowering of distributor commissions will make selling ULIPs uneconomical for marginal distributors

• Insurers will try to push as many ULIPs as possible before new norms set in.

• With all pension plans carrying guarantees, there will be a shift towards fixed income securities in life insurers’ AUM.

To read the full report: LIFE INSURANCE

>BANKING: Base rate set to roll (EDELWEISS)

Today, State Bank of India (SBI) announced its base rate at 7.5%, in line with its guidance of below 8%. Banks in India will move to a new lending rate regime of base rate from July 1, 2010. The new regime will replace the common Benchmark Prime Lending Rate (BPLR) that largely proved ineffective, given wide disparities between banks and proliferation of sub-PLR lending. Following SBI’s announcement, other PSU banks (BoB, PNB etc) have also announced base rate of 8%. Over the next few days, we believe other PSU banks will mirror SBI and fix base rate at ~7.5-8.5% depending on their cost of deposits and proportion of CASA. Private sector banks, on the other hand, are expected to announce rates closer to 6.5-7.0%, marginally higher than the earlier expectation of 6.0-6.5%, given the recent rise in short-term rates.

■ Our view

• We see the following impact of a new base rate regime: Marginal swing in market share in favour of private banks Having set a rate lower than PSU banks, we expect private banks to witness shift in business from top-rated corporates specifically for short-term needs. However, limits on borrower-wise exposure could restrict the swing in favour of private sector banks.

• Partial increase in disintermediation: Disintermediation is set to increase as the top rated corporates are likely to opt more for commercial papers (CP). However, we expect limited migration as CP rates over the past one month have picked up by 150-200bps gyrating to the liquidity tightness and are currently hovering at ~6.5-7.0%- paring down the differential significantly. Also, given that the CP market is not very deep (limited appetite below P1/P2+ rated corporate), we believe the midsize corporates will continue to depend on the banking system.

• Cost of funds may rise for large corporates: Though there is no prudential limit set by RBI for banks’ investment in CPs, banks are expected to set internal limit on exposure via CP. Hence, we believe large corporates will not be able to fully meet their short-term needs via the CP route. Therefore, there could be marginal rise in cost of funds.

■ Structurally, we see new base rate regime as positive for banking industry

• Volatility in margins to reduce: In the current cycle, we saw banks sharply increasing and reducing their lending rates. Impact of margins was strongly positive in the initial phase, while it was negative in the downcycle. Moral suasion was leading to strong volatility in NIMs, especially for PSU banks. This move could reduce artificial changes to yields. However, effective yields could still be managed given that other components like tenor premium and credit risk premium are within banks’ control.

To read the full report: BANKING

>SHALE GAS: Small footprint …big impression!

1. What is shale gas?
2. Shale gas in the US: Long forays g g ys in a short time
3. Shale gas reserves in other parts of the world
4. Major Implications
5. Foray of RIL in this space: Opportunities and implications
6. Annexure

1.a. What is shale gas?
■ Shale are fine-grained sedimentary rocks comprising of mud (mix of clay mineral flakes) and small fragments of other minerals

■ Shale gas is produced from shale formations, which act as both reservoir as well as source rocks.

■ Shale tends to have lower recovery than conventional plays e.g., shale plays in Marcellus are estimated to yield only 3-12% of total organic carbon.

■ Every shale is different so each shale has its own learning curve in terms of extraction technology and corresponding operational and break-even costs.

■ Shale gas production was considered uneconomic earlier because of low permeability and gas content.

■ Emergence of a new drilling technology in the 1990s and higher natural gas prices made shale gas viable

To read the full report: SHALE GAS

>Prospects for Global Defence Export Industry in Indian Defence Market (DELOITTE)

Over the past decade, the Indian Ministry of Defence has put into motion plans for an unprecedented modernisation program of its defence capabilities.

Following the Kargil conflict in 1999, India was confronted with the recognition that much of its
Soviet-era equipment was outdated and obsolescent compared with its regional rivals. India faces the theoretical prospect of a war on two fronts, one with a major power rival (China) and the other with a powerfully-armed middle power that poses potential threats to its homeland security (Pakistan). Both China and Pakistan have significantly expanded their military capabilities in the past decade.

In this context, India has embarked on a major defence acquisition program, aimed at increasing the size, capability and self-reliance of its Defence Armed Forces.

The scale of the planned investments reflects both its need to make up for lost time as well as its expanding economic power. India has seen its economic capacity to fund its capability modernisation expand almost exponentially over the past two decades. During this time India has been increasingly moving towards a more open-market economy, reducing historic controls
on foreign trade and investment and privatising a range of government-owned companies across a range of sectors, from airports to electricity generation to telecommunication firms. This has catalysed India to be one of the fastest growing emerging markets, with its GDP growing by seven per cent each year on an average since 1995. India’s ‘economic miracle’ has been
underpinned by a significant expansion in its advanced manufacturing, engineering and
ICT industries and is forecast to continue. The IMF in 2009 projected India’s GDP would grow in real terms by more than 7.5 per cent on an average from 2010 to 2014. India’s economy
is projected to be 60 per cent of the size of the United States economy by 2025 and second only to China by 2050.

Its acquisition plans include a substantial procurement program for the Army, Navy and Air Force. Realising that the Revolution in Military Affairs (RMA) effectively passed India by in the 1990s, the government is seeking to develop a flexible, mobile and networked defence
force with substantial power projection capabilities.

Many of the assets India is acquiring are at the leading edge of technology, including 180 Sukhoi Su-30MKI aircrafts, Scorpène class submarines, advanced Russian T-90 main battle tanks and state-of-the art information and communication systems. More than USD 42 billion in total defence expenditure is targeted by 2015, of which approximately USD 19.20 billion would be
expected to be spent on capital equipment for the Defence Armed Forces.


Key findings: acquisition plans by each domain
India’s budgeted acquisition plans are expected to see an overall expansion of capital expenditure from approximately USD 19.20 billion by 2015 (Table 1). The Defence Service’s capital expenditure budget is expected to achieve a compound annual growth rate (CAGR) of 10 per cent from 2011 to 2015.

This represents a marginal slow down in budgeted expenditure from the past decade (CAGR of budgeted expenditure of 13.8 per cent from 2003-2010).

Taking account of inflation, however, tempers the estimate of the overall opportunity; when accounting for India’s inflation rate, the real growth in Defence Service capital expenditure is expected to be marginal over the next two years before increasing to a real growth rate of about 5.3 per cent from 2012 to 2015.

Navy and Coast Guard acquisitions
The Indian Government has publicly recognised that India’s expanding maritime responsibilities and interests necessitate enhancement in naval and coast guard force levels. By 2022, the Indian Navy has plans to have a 160-plus ships Navy, including three aircraft carriers, 60 major combatants (including submarines), and close to 400 aircrafts of different types. The Indian Coast Guard is all set to double its force levels and manpower in the next few years and triple it in the next decade in order to protect the country’s maritime zones and assets.

To read the full report: INDIAN DEFENCE MARKET