Insurance and pensions

Detail

1. Why insurance exists: pooling risk

• Insurance is a contract. You pay a small fixed sum, the premium, and the insurer promises to pay you if a stated loss happens.
• Risk pooling: many people pay small premiums into one pool, and the few who actually suffer a loss are paid from it.

• Worked example: 10,000 households each face a 1% yearly chance of a fire loss of Rs 5 lakh.

  • Expected claims = 10,000 × 1% × Rs 5 lakh = Rs 5 crore.
  • Pure premium per household = Rs 5 crore ÷ 10,000 = Rs 5,000. The insurer adds costs and profit on top of this.
  • Each household swaps an uncertain loss of Rs 5 lakh for a certain cost of about Rs 5,000.

• Two branches:

• Life insurance pays on death (term cover) or on survival to a set date (endowment or pension products).

• Non-life (general) insurance covers health, motor, fire, marine, crop and other property and liability losses.

• Two problems that affect insurance (the concepts are defined in banking-regulation-npas):

• Adverse selection (a problem before the contract): people with high risk are more likely to buy cover. For example, sick people rush to buy health cover. Premiums then rise and healthy people drop out. Insurers respond with waiting periods and medical checks.
• Moral hazard (a problem after the contract): people who are insured take less care. For example, a fully insured car owner parks carelessly. Insurers respond with deductibles (the first part of the loss is paid by you) and co-payment.

2. History of the sector

• 1956: LIC. The Life Insurance Corporation was set up by nationalising 245 insurers (companies and provident societies) under the LIC Act 1956.
• 1972: GIC. The General Insurance Corporation was set up for general insurance after that business was nationalised.
• 1994: Malhotra Committee. Its report recommended opening the sector to private companies and creating an independent regulator.
• 1999: IRDA Act. It set up the IRDA (now IRDAI, the Insurance Regulatory and Development Authority of India) and allowed private companies to enter.
• FDI cap in insurance (the highest share of an Indian insurer that foreigners may own):
• 26% (1999/2000) → 49% (2015) → 74% (2021) → 100% (2025).

• The 100% limit comes from the Sabka Bima Sabki Raksha (Amendment of Insurance Laws) Act 2025, which Parliament passed on 17 December 2025.

• What the 2025 Act does:

• It amends three laws: the Insurance Act 1938, the LIC Act 1956 and the IRDA Act 1999 [2].
• FDI is raised from 74% to 100% of paid-up equity capital [2][3]. The Centre notified 5 February 2026 as the date the Act came into force [2].
• The Net Owned Fund (NOF) that a foreign reinsurer must hold is cut from Rs 5,000 crore to Rs 1,000 crore. NOF is the reinsurer's own capital after losses are deducted. A lower NOF makes it easier for foreign reinsurers to open branches in India [3].
• A share transfer now needs IRDAI approval only above 5% of paid-up capital, up from 1% [3].
• IRDAI gets more powers. It can approve mergers and schemes between insurers and non-insurance companies. It can supersede (replace) an insurer's board if the insurer is harming policyholders. It can regulate the pay of intermediaries and inspect them [3].
• "Insurance intermediaries" now also include managing general agents and insurance repositories [3].

• The Act creates a new Policyholders' Education and Protection Fund. It is funded by government grants, penalties and other sources [3].

• Composite insurance licence means one company may sell both life and non-life insurance.

• The PRS summary of the 2025 Act lists no composite-licence provision [3]. Treat the old rule (separate life and non-life companies) as still in force (verify current).

3. Measuring the reach of insurance

• Insurance penetration = (total premium ÷ GDP) × 100.
• Insurance density = total premium ÷ population. It is the premium paid per person, usually given in US dollars.
• Latest data (FY 2024-25):
• Penetration was 3.7%: life 2.7%, non-life 1.0% [4].
• Density was USD 97.0 [4].

• The global average penetration is about 7% (NCERT scaffold: ~3.7% vs ~7%) [4].

• Worked example (density): premium of Rs 11.93 lakh crore ÷ about 145 crore people ≈ Rs 8,200 per person. At about Rs 85 to the dollar, that is roughly USD 97.

• Size of the sector (FY 2024-25):
• India is the 10th-largest insurance market by premium, with a 1.8% global share (Swiss Re data) [4].
• Insurers issued 41.84 crore policies and collected Rs 11.93 lakh crore in premiums [4].
• They paid claims of Rs 8.36 lakh crore [4].

• Assets under management (the money insurers invest on behalf of policyholders) were Rs 74.44 lakh crore on 31 March 2025 [4].

• Why this matters beyond protection: life insurers and pension funds hold money for decades. That makes them large long-term buyers of government securities and infrastructure bonds.

• IRDAI's goal: "Insurance for All by 2047". The main tools are:
• Bima Sugam: a one-stop digital marketplace for buying policies, servicing them and settling claims.
• Bima Vistaar: a low-cost bundled product combining life, health, accident and property cover.

4. How insurance is sold and how risk is shared

• Bancassurance means banks sell an insurer's products to their own customers. The bank acts as a corporate agent and earns commission.
• Advantage: it reaches customers through the bank's large branch network at low cost.

• Concern: mis-selling. For example, a bank may push a policy on someone applying for a loan, as an unstated condition for getting the loan.

• Reinsurance is insurance for insurers. An insurer passes part of its risk to a reinsurer, so that one huge loss cannot sink it.

• Example: an insurer covers a Rs 1,000 crore factory and cedes (passes on) 70% to a reinsurer. After a total loss, the insurer pays Rs 300 crore itself and the reinsurer pays Rs 700 crore.
• GIC Re is the national reinsurer. Indian insurers must give it a fixed share of their business. This is called obligatory cession.

• Foreign reinsurers work in India through branches, including in GIFT IFSC. The lower NOF under the 2025 Act helps them enter [3].

• Microinsurance is low-premium, low-cover insurance for poor households. It is governed by IRDAI regulations of 2005, revised in 2015.

• PMJJBY (Pradhan Mantri Jeevan Jyoti Bima Yojana, 2015) gives life cover.
• PMSBY (Pradhan Mantri Suraksha Bima Yojana, 2015) gives accident cover.

5. New risk-transfer tools

• Indemnity insurance vs parametric insurance:

	Indemnity insurance	Parametric insurance
What triggers payment	The actual loss	A measurable index, such as rainfall, wind speed or earthquake magnitude, crossing a set threshold
Loss assessment	Needed (a surveyor checks the loss)	Not needed
Speed of payment	Slow	Fast
Main risk	Disputes and delay	Basis risk: the trigger may not match your real loss

• Parametric example: a policy pays Rs 50 crore if a cyclone's wind speed goes above 180 km/h. The money comes within days, with no damage survey.
• Some states have bought parametric disaster cover, for example Nagaland (verify current).

• Crop insurance schemes are covered in financial-inclusion-rural-credit.

• Catastrophe (cat) bonds are insurance-linked bonds.

• Investors earn a high coupon (interest).
• If a specified disaster happens, they lose part or all of their principal (the money they lent), and that money pays for the disaster.
• In this way, disaster risk moves from governments and insurers to capital markets.

• The World Bank has issued cat bonds for Mexico, the Philippines and Chile. India is exploring one (verify current).

• Surety bonds are guarantees backed by an insurer that a contractor will complete the contract.

• They replace bank guarantees in infrastructure contracts. That frees up the contractor's bank credit lines for working capital.
• Timeline: announced in Budget 2022-23; IRDAI guidelines in 2022; first surety bond issued in December 2022.

6. Pension design: defined benefit vs defined contribution

	Defined benefit pension (OPS)	Defined contribution pension (NPS)
Benefit	50% of last pay, indexed to DA	Depends on contributions and returns
Funding	Unfunded, pay-as-you-go from the budget	Funded, market-linked
Who bears the risk	Government (fiscal)	Employee

• Defined benefit (DB): the pension amount is promised in advance.
• Defined contribution (DC): only the contributions are fixed. The final pension depends on how the invested money grows.
• Pay-as-you-go: today's taxes pay today's pensioners. No fund is built up.
• Indexed to DA: the pension rises with Dearness Allowance, which is linked to inflation.

7. National Pension System (NPS)

• Coverage:
• Central government recruits joining from 1 January 2004 (armed forces are excluded).
• States opted in.

• Open to all citizens from 2009.

• Accounts:

• Tier I is the locked-in pension account.

• Tier II is a voluntary account from which money can be withdrawn.

• Regulator: PFRDA (Pension Fund Regulatory and Development Authority), under the PFRDA Act 2013.

• Exit rule (scaffold): up to 60% can be taken as a tax-free lump sum, and at least 40% must buy an annuity.
• The 2025 amendments give non-government subscribers more flexible exit and withdrawal rules (verify current).

• Worked example (60:40 rule): a corpus of Rs 50 lakh gives up to Rs 30 lakh as a lump sum. At least Rs 20 lakh goes into an annuity. At an annuity rate of 6% a year, that is about Rs 1.2 lakh a year, or Rs 10,000 a month.

• Annuity is a regular income, usually for life, bought from an insurer with a lump sum.

• It covers longevity risk, the risk of living longer than your savings last.

8. Unified Pension Scheme (UPS)

• Timeline:
• Cabinet approved it on 24 August 2024 [5].
• It was notified on 24 January 2025 as an option within NPS [6].
• It has operated since 1 April 2025 [6].

• It covers about 23 lakh central government employees [5].

• Legal and regulatory base:

• PFRDA regulations put UPS into operation [7].
• The CCS (Implementation of UPS under NPS) Rules, 2025 were notified [8].

• The tax benefits available under NPS also apply to UPS [9].

• Features:

• Assured pension: 50% of the average basic pay of the last 12 months, after 25 years' service. For shorter service, the pension is proportionate, down to a minimum of 10 years [5].
• Minimum pension: Rs 10,000 a month after 10 years' service [5].
• Family pension: 60% of the employee's assured pension [5].

• Lump sum at retirement: one-tenth of monthly emoluments (pay + DA) for each completed six months of service.

• Worked example: an employee's average basic pay over the last 12 months is Rs 80,000.

• After 25 years' service: pension = 50% × 80,000 = Rs 40,000 a month.
• After 20 years' service: pension = 40,000 × 20/25 = Rs 32,000 a month.

• Lump sum after 25 years: there are 50 completed half-years, so 50 × 1/10 = 5 months' emoluments. If emoluments are Rs 1 lakh a month, the lump sum is Rs 5 lakh.

• How UPS differs from both designs:

• Like the OPS, it assures a pension.
• Like the NPS, it stays contributory and funded, because the employee also contributes.

9. OPS revival and fiscal risk

• Some states moved back to the Old Pension Scheme (OPS).
• Why they did it: it saves money now.
• The state stops paying its NPS contribution (the employer's share).

• Its current spending falls.

• Why the RBI warned it is fiscally unsustainable:

• It creates large unfunded future liabilities, because pensions will have to be paid from future budgets.
• Those liabilities grow with longer lives and DA increases.
• The burden shifts onto future taxpayers.

10. Other schemes and the coverage gap

• Atal Pension Yojana (2015): a guaranteed pension of Rs 1,000-5,000 a month for unorganised workers.
• NPS Vatsalya (2024): an NPS account opened for minors by their parents.
• EPFO and EPS-95 are covered in employment-informal-sector.
• Coverage gap:
• India's population is ageing.
• Most informal workers have no pension.

Prelims Hooks

• Insurance penetration = premium ÷ GDP × 100 (3.7% in FY 2024-25). Density = premium per person (USD 97 in FY 2024-25). Do not confuse the two [4].
• In FY 2024-25, life insurance penetration (2.7%) was far higher than non-life penetration (1.0%) [4].
• The Sabka Bima Sabki Raksha Act 2025 amends the Insurance Act 1938, LIC Act 1956 and IRDA Act 1999. It allows 100% FDI and cuts foreign reinsurers' NOF from Rs 5,000 crore to Rs 1,000 crore [2][3].
• FDI cap sequence: 26% → 49% (2015) → 74% (2021) → 100% (2025).
• Malhotra Committee (1994) → IRDA Act 1999. LIC was created in 1956 from 245 insurers. GIC was created in 1972.
• Parametric insurance pays when an index crosses a trigger, with no loss assessment. Indemnity insurance pays the actual assessed loss.
• Surety bonds replace bank guarantees in infrastructure contracts. They were announced in Budget 2022-23 and first issued in December 2022.
• UPS: 50% of the average basic pay of the last 12 months (not the last pay drawn) after 25 years; minimum Rs 10,000; family pension 60%; in effect from 1 April 2025 [5][6].
• NPS is regulated by PFRDA (PFRDA Act 2013), not IRDAI. Annuities are sold by insurers, which IRDAI regulates.
• Obligatory cession means Indian insurers must pass a fixed share of their business to GIC Re.

Mains Points

• Low penetration is a protection gap.
• At 3.7% against a ~7% global average (FY 2024-25), one disaster or illness can push a household into poverty [4].

• 100% FDI, a lower NOF for reinsurers, Bima Sugam and Bima Vistaar aim to bring in capital, competition and reach. But IRDAI must still control mis-selling, for example through bancassurance [2][3].

• Disaster risk finance.

• India pays for most disasters after they happen, from the budget.

• Parametric cover, cat bonds and a larger reinsurance market (GIFT IFSC) would move part of this risk to markets before disasters strike and give faster payouts (GS-III: disaster management).

• OPS vs NPS vs UPS is a fiscal trade-off.

• OPS gives employees certainty but leaves unfunded liabilities for future budgets.
• NPS protects the budget but puts market risk on employees.
• UPS is a middle path: an assured pension inside a funded, contributory system [5].

• The RBI's warning on OPS links this debate to state fiscal health and intergenerational equity (fairness between today's and tomorrow's taxpayers).

• Ageing and informality.

• Most informal workers have no pension, so APY, NPS for all citizens and NPS Vatsalya matter for old-age security.
• Long-term pension and insurance funds also finance infrastructure and deepen the bond market.