The passage of the long overdue amendment, including the increase in permitted foreign investment from 26% to 49% sets the stage for new entrants and consolidation in the insurance industry. However, the condition requiring Indian control of insurance joint ventures will be a key consideration going forward.
India's top 5 insurance companies are expected to attract upwards of $3 billion of additional foreign investment in the immediate future following the recent increase in the ceiling on permissible foreign investment from 26% to 49%. One of these, for instance (HDFC Standard Life), was itself recently valued in a publicly announced deal at $3.5 billion – which reflects an impressive trajectory for a relative young industry (outside of state owned insurers).
India currently has 52 registered insurance companies, including 24 engaged in life insurance. It is estimated that over the next five years, the industry will grow at a CAGR of 12-15% and require $8 billion of additional capital. This changing landscape presents new opportunities for strategic and financial investments, and for consolidation in the industry, in no small part driven by the regulatory regime.
INSURANCE AMENDMENT ACT
The long overdue Insurance Laws (Amendment) Act, 2015 was enacted on 23 March, 2015, in one of the first legislative actions of India's new government led by Narendra Modi. The amendment was first presented before parliament as far back as 2008, but failed to get traction because of the legislative log-jam in the intervening years.
The amendment also underwent a few material changes since it was first introduced, such as the prescription for Indian control over insurance joint ventures. However, the head-line objective of increasing the ceiling on foreign investment from 26% to 49% has been achieved.
1. Foreign investment ceiling hiked from 26% to 49%
This ceiling applies to the "paid-up equity capital" of an insurance company. The extent of foreign investment is calculated on the same basis as before, i.e., on a 'proportionate' basis. Thus, for example, if a resident shareholder (R) holds a 75% stake in an insurance company (I), and a foreign investor (F) in turn holds 49% of R, then the extent of foreign investment in I equals 75% X 49% = 36.75.
2. However joint ventures must be Indian controlled
This is a new requirement imposed by the Amendment, while raising the ceiling on foreign ownership from 26% to 49%. Unfortunately, there is no bright-line definition of what is adequate to satisfy this requirement. As long as this is the case, the determination of whether an insurer is Indian controlled would have to be made on a case-to-case basis. It is clear from the amendment that 'control' is viewed more broadly than simply owning a majority of voting shares or appointing a majority of directors, and that rights under a shareholders agreement will be factored in.
3. Alternative types of capital instruments (such as non-voting preference shares)
Before the amendment, insurance companies were only permitted to issue equity / ordinary shares with a uniform par value. The amendment, however, permits insurance companies to issue "such other form of capital as may be specified by the regulations." Permission to issue preference shares or debentures, which do not carry voting rights, would open new avenues for an insurer to raise more foreign capital without impacting its compliance with the 49% ceiling on foreign ownership (which only applies to equity capital) or the requirement for Indian control.
4. Indian partner no longer required to divest stake exceeding 26% after 10 years
Previously, the Insurance Act required the Indian 'promoter' of an insurance company to sell down its stake in excess of 26% within 10 years of commencing business (with the objective of discouraging concentrated ownership of insurance companies). However, given the limit on foreign ownership (previously, 26%), this left the Indian promoter with little option but to attempt a listing or induct additional partners.
5. Health insurance will be regulated as a separate class of insurance
Health insurance is currently regulated as a part of the general insurance business. The amendment now proposes to regulate health insurance on a stand-alone basis. The object behind this is to give health insurance business priority through a more focused regulatory regime.
6. Foreign reinsurers permitted to operate out of wholly owned branch offices
Previously, only domestic insurance companies were permitted to sell reinsurance. India's largest state owned general insurance company (GIC) is currently the only active reinsurer. The government has now dispensed with the requirement for reinsurance business to be conducted only through a company incorporated in India.
7. More powers for insurance regulator, decisions now appealable
Under the amendment, the Insurance Regulatory and Development Authority of India has been granted greater flexibility to regulate insurance companies through its rule making powers on matters such as management fees, commissions and composition of the insurance company's investment portfolio. These were earlier hardwired into the provisions of the Insurance Act itself. Simultaneously, the appeals' process for quasi- judicial and administrative rulings of the authority has been streamlined by designating the securities appellate tribunal as the appellate forum. Earlier such appeals lay only to the central government.
Considerations for Investors
1. Previous joint ventures were based on the assumption that the ceiling on foreign investment would be increased from 26% to 49% in the near future. During this transition period, the Indian partner in the JV was expected to fund a substantial portion of the foreign partner's capital commitment, and was compensated with a 'fee' for the time value of its money. Alternatively, the foreign partner was expected to contribute a disproportionate share (in excess of its 26% shareholding) of JV's capital until the ceiling on foreign ownership was raised (at which point, the capital structure would be unwound). As it turned out, it took much longer than expected for the ceiling on foreign ownership to be raised to 49%, which placed considerable stress on the capital structure of these JVs.
2. Going forward, the capital structure of an insurance JV cannot be based on the assumption that the 49% ceiling will be raised in the foreseeable future. Thus, the Indian partner (s) must have deep enough pockets to fund up to half of the JV's future capital requirements on a sustained basis. That said, there is now potential for the foreign partner to meet funding gaps through non-voting preference shares (subject to specific rules, which are awaited). Needless to say, the economics of such preference shares would need to make sense.
3. The new requirement for insurance companies to be Indian controlled imposes constraints on governance rights, which a foreign investor would normally expect in a 50:50 joint venture. For instance, in another context in the past, the government has taken the position that extensive veto rights / reserved matters were a form of 'negative control'. Thus, foreign investors would need to prioritize key governance rights and reserved matters to get most 'bang for their buck'. The idea would be to get maximum leverage without tipping the scales for the control test.
4. Foreign investors should also look for additional leverage (and economics) by segmenting the value chain in the insurance business, and outsourcing functions to wholly owned affiliates. IRDA guidelines, which regulate the nature of activities that can be outsourced, will need to be factored in.
5. The possibility of non-voting securities, restrictions on control by the foreign JV partner and capital constraints of the Indian JV partner may open the door to private equity / financial investors.
6. Capital constraints of Indian participants, restrictions on foreign control and those looking to exit may set the stage for consolidation in the industry.
- Most Indian players looking to sell down and monetize their stake;
- HDFC Standard Life proposing to float 10% by raising capital through an IPO;
- ICICI in talks with Temasek and Carmignac Gestion to offload part of its stake in ICICI Prudential;
- Axa, Bupa, Standard, Ergo, Nippon Life, IAG looking to increase stake in their JVs;
- Reliance Capital looking for foreign partners for its insurance businesses;
- AV Birla Group enters into JV with MMI (South Africa) for health insurance;
- RSA exits India by selling its stake to JV partner Sundaram Finance;
- Lloyds, Swiss Re, Hannover Re and SCOR are exploring entry in the reinsurance market;
- Aviva and ING exit business in India, JV partners Dabur and Exide may rope in others.
* Public sources
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