Insurance, Pensions and Non-Banking Financial Companies

Why non-bank finance matters

Banks dominate Indian finance, but a mature financial system also needs other channels:

• insurance to pool risk;
• pension funds to provide old-age security and patient long-term capital;
• NBFCs to reach segments that banks underserve.

The Financial Stability and Development Council (FSDC), set up in 2010 and chaired by the Finance Minister, coordinates the regulators: RBI, SEBI, IRDAI, PFRDA and IFSCA.

Insurance sector

History:

• Life insurance was nationalised in 1956, when LIC was formed.
• General insurance was nationalised in 1972 (GIC and four subsidiaries).
• The Malhotra Committee (1994) recommended opening the sector.
• The IRDA Act 1999 created the Insurance Regulatory and Development Authority of India (IRDAI) and allowed private entry. Its headquarters are in Hyderabad.

FDI limit:

• 26% (2000);
• 49% (2015);
• 74% (2021);
• the 2025–26 Budget proposed 100% for companies that invest all their premium in India. Check the status of the amending legislation.

Penetration and density:

• India's insurance penetration is about 3.7% of GDP (2023–24), mostly life insurance.
• Density, the premium per capita, is about $95.
• Both are well below global averages. Protection gaps are large for health, crop and catastrophe risk.

Public schemes:

• Ayushman Bharat PM-JAY (2018): ₹5 lakh per family a year for secondary and tertiary care, covering about 12 crore families. It was extended in 2024 to all senior citizens aged 70 and above, irrespective of income.
• PMFBY (crop insurance, 2016).
• PMJJBY and PMSBY (2015).

Reforms:

• the Bima Sugam marketplace;
• composite licences, which were proposed but are not yet allowed;
• the "Insurance for All by 2047" vision;
• risk-based capital;
• LIC's IPO in May 2022, India's largest IPO up to that time.

Pension sector

Background: India's old-age security is weak. Only about 10–12% of the workforce has formal pension cover, and India's population is ageing: those aged 60+ are projected to be about 20% of the population by 2050.

Pension systems:

• Employees' Provident Fund Organisation (EPFO): for organised-sector workers. It runs EPF (defined contribution) and the Employees' Pension Scheme 1995.
• Old Pension Scheme (OPS): defined benefit for government employees. It paid 50% of last pay and was unfunded, so its fiscal cost was rising.
• National Pension System (NPS): mandatory for central government employees joining from 1 January 2004, except the armed forces. It is defined contribution and market-linked. It was opened to all citizens in 2009, with a voluntary NPS Vatsalya for minors (2024).
• Pension Fund Regulatory and Development Authority (PFRDA): statutory under the PFRDA Act 2013. It regulates NPS and the Atal Pension Yojana.
• Unified Pension Scheme (UPS): approved in August 2024 and effective from 1 April 2025 as an option within NPS for central employees. It assures 50% of the average basic pay of the last 12 months after 25 years of service, a minimum of ₹10,000 a month, and a family pension.
• Atal Pension Yojana (2015) and PM Shram Yogi Maan-Dhan (2019): for unorganised workers.

The OPS debate: some states (Rajasthan, Chhattisgarh, Himachal Pradesh, Punjab and others) announced a return to the OPS in 2022–23. The RBI and economists warned that this would be a fiscal burden on future generations. UPS is the Centre's middle path.

Non-Banking Financial Companies (NBFCs)

Definition: companies registered under the Companies Act whose principal business is lending, investment or asset finance, regulated by the RBI under Chapter III-B of the RBI Act.

How they differ from banks:

• They cannot accept demand deposits.
• They are not part of the payment and settlement system, so they cannot issue cheques drawn on themselves.
• Their deposits have no DICGC insurance.

Types: housing finance companies (regulated by the RBI since 2019, previously by the NHB), microfinance institutions, gold loan companies, infrastructure finance companies, core investment companies and others.

Scale-Based Regulation (2021, effective October 2022): four layers, a Base Layer, Middle Layer, Upper Layer and Top Layer. Regulation gets stricter at each layer, and Upper Layer NBFCs face bank-like norms and mandatory listing.

Crises:

• IL&FS defaulted in September 2018, a systemic infrastructure lender with large asset–liability mismatches.
• DHFL (2019) was the first financial services firm resolved under the IBC, through a special window for financial service providers notified in November 2019.

These crises led to tighter liquidity norms: a liquidity coverage ratio for large NBFCs.

Role: NBFCs lend to MSMEs, vehicle buyers, gold-loan borrowers and microfinance clients. NBFC credit is about a quarter of bank credit. Co-lending with banks lets them combine banks' cheap funds with NBFCs' reach.

Common prelims traps

• IRDAI is headquartered in Hyderabad; PFRDA in New Delhi.
• NPS was mandatory from 1 January 2004 for new central government employees.
• NBFCs cannot accept demand deposits, and their deposits are not insured.
• Housing finance companies have been regulated by the RBI since 2019.
• The FSDC is chaired by the Finance Minister, not the RBI Governor.

Quick self-test

1. *What is the difference between defined benefit and defined contribution pensions?* Defined benefit promises a payout; defined contribution depends on contributions and returns.
2. *Which NBFC layer faces mandatory listing?* The Upper Layer.
3. *Which committee recommended opening up the insurance sector?* The Malhotra Committee, 1994.

Practice: Mains question

*"An ageing India needs a sustainable pension architecture." Discuss in the light of the debate between the Old Pension Scheme, NPS and the Unified Pension Scheme. (250 words)*

Analysis: closing protection gaps

India's low insurance penetration has several causes:

• low awareness and trust;
• mis-selling;
• complex products;
• distribution costs in rural areas;
• the dominance of savings-linked life policies over pure protection (term insurance).

The "missing middle" in health: about 30% of the population (roughly 40 crore people) lacks health insurance. They are too well-off for PM-JAY but cannot afford private cover (NITI Aayog, 2021). Out-of-pocket health expenditure, though falling, still pushes millions into poverty each year.

Catastrophe risk: India suffers heavy losses from floods and cyclones but has little catastrophe insurance. Parametric insurance, which pays out automatically when a trigger such as rainfall or wind speed is crossed, is being piloted. Nagaland bought a parametric disaster policy in 2024.

Pensions: the challenge is to extend coverage to informal workers and gig and platform workers. The Code on Social Security 2020 recognises gig workers. The 2025–26 Budget announced registration on e-Shram and PM-JAY coverage for about one crore platform workers.

NBFCs: the task is to keep their reach while preventing systemic risk, through scale-based regulation, better asset–liability matching and close RBI supervision of the largest players.

Way forward

• Allow composite insurance licences and differentiated insurers (micro and specialty insurers) to lower costs.
• Use the Bima Sugam marketplace and digital claims to build trust.
• Auto-enrol informal workers in pensions with matching contributions.
• Strengthen coordination in the FSDC on cross-sector risks.