With over fifty insurers today, aggregate premiums of approximately $82.8bn in the financial year 2019, and insurance penetration levels in 2018 of 3.70% (compared to a global average of 6.09%), India is an exciting insurance market, offering growth opportunities for international investors. However, foreign direct investment (FDI) caps and other regulatory issues have meant that international investors are required to set up local joint ventures that need to take into account a number of regulatory considerations. This article sets out the key regulatory issues in India from an international investor perspective.
Overview
The Insurance Act 1938, and the subordinate regulations, guidelines and circulars issued by the Insurance Regulatory and Development Authority of India (IRDAI), constitute the primary regulatory framework for the insurance sector in India. Key aspects of this regulatory framework are:
- Shareholder categorisation. Shareholders of Indian insurers are categorised either as ‘investors’ (those holding up to 10%, individually, and up to 25%, collectively) or as ‘promoters’ (those holding more than 10%). Being a promoter will involve acceptance of lock-up restrictions and commitments to provide additional funding (if needed).
- Registration. Registering a new insurer in India is a two-stage process that often takes a year. This involves the satisfaction of the ‘fit and proper’ test, providing a business plan for regulatory scrutiny and minimum capitalisation of approximately $13m. Life insurance, general insurance, health insurance (standalone) and reinsurance are treated as separate registration categories.
- Solvency ratio. The minimum regulatory solvency ratio is 150%, calculated with reference to the available solvency margin (ie the excess of assets over liabilities, in both policy holders’ and shareholders’ funds, as determined in accordance with the IRDAI’s regulations). Insurers may issue equity shares, preference shares or non-convertible debentures for solvency purposes.
- Changes to capital. Changes to more than 1% of an insurer’s paid-up equity capital (whether through primary issuances or secondary transfers) require the IRDAI’s prior approval.
Current foreign investment restrictions
The FDI cap for Indian insurance companies remains at 49%, which means that international investors cannot hold a controlling stake. The Indian partner’s control is further entrenched by the IRDAI’s guidelines on ‘Indian ownership and control’, which limit the foreign partner’s influence in governance and operational matters and which also regulate affirmative voting rights in favour of an international investor. There is also an overlay of general IRDAI governance guidelines that apply to all insurers.
Issues for PE investors
Investments by private equity (PE) funds (including alternative investment funds (AIFs)) in Indian insurers need to satisfy incremental ‘fit and proper’ criteria, under specific guidelines issued in December 2017.
Historically, PE funds have often invested as ‘investors’ (ie individual holdings up to 10% only). For investments as ‘promoters’ (ie individual holdings greater than 10%), on the other hand, the 2017 guidelines provide for a stricter regime, of which, the key conditions are:
- The investment must be structured through a special purpose vehicle (SPV) established in India. This structure, however, involves tax leakage and, for foreign PE funds, certain exchange control concerns as well.
- The investment must be through ‘own funds’ only (and not borrowed funds) and may not be encumbered or leveraged.
- The SPV’s shareholding in the insurer will be locked-up for five years. That lock-up will also apply to individual holdings of more than 10% in the SPV.
- Issuances of more than 25% in the SPV’s capital will require prior IRDAI approval.
- The SPV must commit to subscribe to future rights issues of the insurer.
- At least one-third of the insurer’s board must comprise independent directors. In addition, if the insurer’s chairperson is not an independent director, the insurer’s CEO/ managing director must be a professional (and not nominated by the promoter).
Insurance intermediaries
Product distribution in India takes place through brokers, agents (both individual and corporate), web aggregators and insurance marketing firms. Other key insurance intermediaries include third-party administrators and surveyors and loss assessors. Each insurance intermediary is regulated under a separate set of regulations, including codes of conduct. Minimum capital requirements vary from approximately $100,000 for direct brokers to approximately $13,000 for insurance marketing firms.
Bancassurance remains the dominant mode of insurance distribution in India, more so after the institution of the ‘open architecture’ system in 2015, which disallowed exclusive distribution arrangements between insurers and corporate agents and permitted agents to distribute the products of up to three life insurers, three general insurers and three health insurers. Distribution through web aggregators is another key growth area, as penetration levels of both insurance and the internet in India rise. Web aggregators are permitted to generate leads for insurers but cannot favour one insurer over another and are also restricted from undertaking any other business.
In September 2019, the IRDAI regulations were amended to allow FDI up to 100% in insurance intermediaries (subject to corresponding changes to Indian exchange control regulations). However, the accompanying amendments imposed various conditions, including an approval requirement for dividend repatriation, caps on related party payments and a requirement that a majority of the board and key management must be resident Indian citizens.
Conclusion – where next for international investors in India?
There has been market speculation that the FDI cap for insurance companies may be increased (possibly to 74%). This follows the Indian finance minister’s budget speech in July 2019, which mentioned the government’s willingness to consider proposals for ‘further opening up of FDI’ in the insurance sector and the increase of the FDI cap for insurance intermediaries (as summarised above). However, the ‘Indian ownership and control’ guidelines which impose a number of governance restrictions will also need to be eased, for the liberalisation to be truly effective and investors will need to carefully monitor developments in that regard. Also, new entrants will need to invest time in understanding the registration regime, find suitable local partners and put in place effective distribution arrangements, as those are key drivers for success in the Indian market.