Back in February, when the government announced in the Budget that it will increase the FDI cap in Indian insurance companies from 49 percent to 74 percent, the move was met with cheer from stakeholders across the board. Industry representatives welcomed the announcement, saying that this will not only bring in funds from global investors but also help improve the Indian insurance sector, as more companies will begin to learn and adapt from global knowhow and best practices.
However, many were concerned that the actual implementation of this move on-ground may take a prolonged period of time, given that a number of separate laws and regulations needed to be amended for this increase in FDI limit to take effect, including:
Therefore, it was no surprise that global investors who were interested in a share of the Indian Insurance pie had two key questions.
However, the Indian government seems keen to roll out the red carpet for foreign investors and provide an impetus to India’s promising Insurance sector as both these questions seem to have now been answered.
Let us begin by discussing the resolution to the first question.
The Insurance Act, 1938 (Insurance Act) was amended with effect from April 1, 2021, to remove the statutory requirement that Indian insurance companies must always be “owned and controlled” by Indian residents and to empower the Indian government to impose foreign investment-linked conditions through delegated legislation.
This was followed by the publication of draft proposed amendments to the Indian Insurance Companies (Foreign Investment) Rules, 2015. The final form of amendments have now been notified, with effect from May 19, 2021. The Amendment follows the conclusion of a stakeholder consultation process, which took place from April 15-30, 2021. There are no material differences between the Amendment and the draft amendments published in April.
Coming to the second question, the conditions imposed in the Amended Foreign Investment Rules appear to be in line with the expectations of market players.
Three key changes have been laid out in the amended rules. Of these, the first will affect all Indian insurance companies that have foreign investment (regardless of the percentage) and the remaining two will affect only those Indian insurance companies that have foreign investment above 49%.
1. Residency requirement for directors and Key Management Persons (KMPs)
Indian insurance companies with foreign investment will now need to ensure that:
are “resident Indian citizens”. Indian insurance companies will have up to one year to comply with these new residency requirements for directors and KMPs.
2. Higher retention of net profits
Companies with more than 49 percent foreign investment will now need to retain at least 50 percent of their net profits as part of their general reserves if, in the relevant financial year, they have paid a dividend on their equity shares and their solvency margin was lower than 1.2 times of the control level of solvency at any time during the relevant financial year.
3. Increased number of independent directors
Companies with more than 49 percent foreign investment will now need to satisfy the following governance requirements:
(a) at least half of the board will need to comprise independent directors (if the chairperson of the board is not independent); or
(b) at least one-third of the board will need to comprise independent directors (if the board chairperson is independent).
What do these changes mean for stakeholders? Here are the key implications.
Foreign ownership and control permitted but with majority local director and KMP requirements
There were some concerns regarding the extent to which the Indian government would cut down the requirement that the “ownership and control” of an Indian insurance company must remain in the hands of Indian residents at all times. But these fears have been allayed as no ownership or control restrictions have been prescribed, limiting them to only certain citizenship and residency requirements for the board and KMPs.
Additional layer of solvency control for insurers with more than 49 percent foreign investment
An insurance company’s solvency margin is a minimum excess of an insurer’s assets over its liabilities set by the regulator. A parallel could be the capital adequacy requirements for banks.
An insurer’s solvency ratio is the size of its capital relative to all risks it has taken – often called the measure of the risk an insurer faces of claims it cannot absorb.
The proposed new requirement of retaining at least 50 percent of net profits under general reserve is linked to: (a) the solvency margin being lower than 1.2 times the control level of solvency; and (b) the payment of dividend on equity shares.
The “control level of solvency” for both life and general insurers is currently specified as a minimum solvency ratio of 150 percent. Whether 1.2 times of that ratio is an appropriate threshold will need to be assessed.
It seems unclear why purely domestic insurers should be treated differently on this front, however, and, ultimately, any controlling shareholder will want the ability to pay itself dividends. Therefore, new market entrants may factor this into valuations going forward.
Note that in relation to foreign investment in insurance intermediaries (where 100 percent foreign investment is permitted), prior permission from the regulator, the IRDAI, is required for repatriating dividends. This requirement has not been imposed in the amended rules for insurance companies, but international investors may have suggested some ability to declare dividends with IRDAI approval above these thresholds, as part of the consultation process with the government.
The Road Ahead
The Insurance Act and the Foreign Investment Rules merely specified the requirement that Indian insurance companies must be “owned and controlled” by residents. The detailed governance requirements in this regard, however, are set out under the IOC (Indian Owned and Controlled) Guidelines.
For example, the IOC Guidelines impose specific requirements that the majority of non-independent directors must be nominated by the Indian promoter and that control over significant policies must be exercised through the Indian promoter-controlled board. These are clearly inconsistent with the amended Insurance Act and the amended rules, but nevertheless, still remain in force. Therefore, the IRDAI will need to formally withdraw or rescind the IOC Guidelines together with the notification of the final amendment to the Foreign Investment Rules.
Going forward, the Foreign Exchange Management (Non-Debt Instruments) Rules, 2019 and the consolidated FDI policy published by the Department of Industrial Policy and Promotion (FDI Policy) will also need to be amended, or a clarificatory notification in the form of a press note with similar effect will need to be published, as a final step.
Given the pace of developments so far, this may well be implemented very shortly.
Recently, two US lawmakers commended India’s move to increase FDI limit in insurance, saying it will deepen bilateral trade and investment.
All in all, India’s insurance sector is primed to step into a new era of growth and transformation.
—Haigreve Khaitan is Senior Partner at Khaitan & Co, one of India’s largest and leading full-service law firms. He has advised top global businesses and business leaders on a variety of corporate matters and worked on some of the largest M&A deals in India. The views expressed in this article are personal.
(Edited by: By Ajay Vaishnav)
First Published: IST