On 30 December 2020, the Insurance Regulatory and Development Authority of India (IRDAI) held that the promoters of Sahara India Life Insurance Company Limited (Sahara Life), being four Sahara group companies (together holding around 98.19% of Sahara Life), are no longer 'fit and proper' and that they should divest their shareholding in Sahara Life within six months (Sahara Order). This followed IRDAI's ongoing scrutiny of Sahara Life and its promoters, which commenced in 2015, when the IRDAI identified certain financial and governance issues.
While the requirement for promoters of financial sector entities to be fit and proper is not new, its strict implementation by the IRDAI by essentially asking Sahara Life's promoters to exit, has definitely put the spotlight on its significance in financial sector entities.
In this article, we will discuss the very genesis and rationale for having 'fit and proper' requirements for promoters of insurance companies and analyze the reasoning behind the Sahara Order to understand key takeaways from an IRDAI standpoint.
Fit and Proper: The What and the Why
Since financial sector entities (including insurers) receive and deal with substantial amounts of public money and savings, there is an inherent need for a higher level of regulation and scrutiny to ensure that public interest is protected. In this context, ensuring fitness and propriety (also referred to as 'suitability' in some jurisdictions) of promoters and individuals in key managerial positions of financial sector entities is extremely critical.
At the international level, the Joint Forum on Financial Conglomerates (Joint Forum) was established by the Basel Committee on Banking Supervision, the International Organisation of Securities Commissions and the International Association of Insurance Supervisors (IAIS), comprising an equal number of senior bank, insurance and securities supervisors from several countries. After a meticulous global consultation process and conducting practical testing exercises, the Joint Forum released a detailed paper titled 'Supervision of Financial Conglomerates' (Publication), which provides international supervisory standards and guiding principles for financial sector regulators across the globe. One of the chapters in this Publication is on 'Fit and Proper Principles', which has the key objective to ensure that financial sector entities are managed in a sound and prudent manner and their shareholders are not a source of weakness to those entities. This chapter essentially provides that key managers, directors and shareholders of financial sector entities should meet the fitness, propriety or other qualification tests. Typically, fitness tests assess the competence to fulfil responsibilities through qualifications, experience and financial position, while propriety tests assess integrity and suitability through business reputation, past civil/criminal actions and sanctions by regulators.
Specifically in the context of insurance, the IAIS is an international organisation that develops principles and standards for the supervision of the insurance sector. The IAIS has released a set of core principles called the Insurance Core Principles (ICPs), which serve as a global standard for supervision of the insurance sector. ICP 5, which deals with 'Suitability of Persons', provides that significant owners, board members and key management persons (KMPs) in control functions of insurers, should meet certain suitability requirements. Board Members, senior management and KMPs should possess: (i) competence, which is demonstrated generally through professional qualifications, knowledge and experience within insurance and financial sectors; and (ii) integrity, which is demonstrated generally through character, personal behaviour and business conduct. Similarly, significant owners of insurers should possess: (i) financial soundness, which is demonstrated by sources of funding and future access to capital; and (ii) integrity, which is demonstrated in personal or corporate behaviour. ICP 5 also provides recommendations for the steps that insurance regulators may take if the above suitability requirements are not met on an ongoing basis. In case of a director or KMP who does meet the suitability requirements, a regulator could direct the insurer to appoint a different person for the position in question. In case of shareholders, the regulator could require the shareholder to sell its stake to a fit and proper person within a specified period (as was done by the IRDAI under the Sahara Order) or even suspend exercise of voting rights. ICP 5 goes to the extent of recommending that regulators could consider withdrawing or imposing conditions on the insurance registration in case of a major breach of such suitability requirements. Lastly, ICP 5 also emphasises the need for exchange of information with other regulators (in the local as well as other jurisdictions) to verify the suitability of shareholders, directors and KMPs.
The above principles prescribed under the Publication and the ICPs, form the foundation on which the IRDAI has prescribed fit and proper requirements for shareholders, directors and KMPs in several regulations that govern insurers and insurance intermediaries in India. Similarly, the Reserve Bank of India (RBI) and the Securities and Exchange Board of India (SEBI) have also prescribed fit and proper requirements in the context of various types of entities regulated by them.
Fit and Proper: Regulatory Landscape for Insurers in India
The IRDAI (Registration of Indian Insurance Companies) Regulations, 2000 (Registration Regulations), prescribe fit and proper criteria for applicants who propose to set up an insurance company and also require that any change in the information furnished, should be intimated to the IRDAI, to ensure monitoring on a continuous basis (see Section 26 of the Insurance Act, 1938). Some criteria considered by the IRDAI at this initial stage of setting up an insurer include the general track record of promoters, sources of funds to meet solvency and capital requirement, performance of promoters in their business and the past conduct and performance of directors and persons in management of the promoters and proposed insurer.
Since these prescribed fit and proper criteria need to be met on an ongoing basis, IRDAI's regulations require that anytime there is a change in shareholder, director or KMP, such change also complies with the relevant fit and proper criteria. These requirements are specified under the IRDAI (Transfer of Equity Shares of Insurance Companies) Regulations, 2015 (Transfer Regulations) and the IRDAI (Listed Indian Insurance Companies) Guidelines, 2016 (Listed Insurer Guidelines) for change in shareholders, and the IRDAI's 'Guidelines for Corporate Governance for Insurers in India' dated May 18, 2016 (CG Guidelines) for change in directors and KMPs.
The Transfer Regulations require insurers to furnish details about the proposed transferee for the IRDAI to undertake a due diligence prior to granting approval for a share transfer. In line with the Publication and the ICPs, such details include details about civil/criminal/regulatory actions, financial statements and income tax returns for past five years and a note on financial strength and sources of funds from which the investment is proposed to be made. The primary objective of the IRDAI is to assess the financial integrity, absence of convictions or civil liabilities, appropriate competence, experience, qualification and good reputation of the proposed transferee.
Similarly, the IRDAI (Investment by Private Equity Funds in Indian Insurance Companies) Guidelines, 2017 (PE Guidelines) that apply in the context of private equity fund investments in insurance companies and the Listed Insurer Guidelines that apply to listed insurance companies, prescribe fit and proper requirements for potential investors. The PE Guidelines specify more detailed and comprehensive criteria for determining fit and proper for investments exceeding 10%, as compared to investments up to 10%, which have fewer criteria. Similarly, the Listed Insurer Guidelines have also created three categories of investors based on quantum of investment: (i) 1% or more but less than 5%; (ii) 5% or more up to 10%; and (iii) more than 10%; and the criteria for determining fit and proper become more detailed and comprehensive as the quantum of investment increases. In fact, in the case of investments referred in (ii) and (iii) above, the Listed Insurer Guidelines refer to the investor as a 'major shareholder' and specify that if such major shareholder does not satisfy the fit and proper criteria within six months of the close of a financial year, then the IRDAI shall initiate appropriate action, including a direction for such shareholder to transfer its shareholding to any other fit and proper person. The Listed Insurer Guidelines also have in place provisions for continuous monitoring to ensure that major shareholders of listed insurers continue to remain fit and proper.
In the context of directors and KMPs, the CG Guidelines require every director and KMP of an insurer to meet the fit and proper criteria at the time of appointment and continuously thereafter. The insurance company is required to carry out a due diligence and obtain prescribed declarations from directors and KMPs periodically, to ensure this compliance. The information required to be submitted for such a due diligence includes relevant professional achievements, details of any proceedings, litigations or investigations and association with any entity that was penalized in the past.
Analysis of the Sahara Order in the Context of Fit and Proper Requirements
Background: Sahara Life has been under IRDAI's scrutiny since 2015, when IRDAI identified certain financial and governance issues in its Annual Report for the financial year ending 31 March 2015. The issues involved poor financial performance, its failure to comply with IRDAI regulations and despite notices from the IRDAI, its failure to take corrective actions. In light of this, in June 2016, the IRDAI held that Sahara Life acted in a manner prejudicial to the interests of policyholders and appointed an administrator to manage its affairs under Section 52A of the Insurance Act, 1938. Basis the administrator's report which cited a total failure of Sahara Life's governance system and the fact that its promoters are no more fit and proper, the IRDAI passed orders in July 2017 directing: (i) Sahara Life not to procure or collect proposal deposits or underwrite new business; and (ii) ICICI Prudential Life Insurance Company Limited to take over the life insurance portfolio of Sahara Life (after inviting proposals from several life insurers). Sahara Life filed appeals against the above IRDAI orders with the Securities Appellate Tribunal (SAT), which quashed IRDAI's order directing ICICI Prudential Life Insurance Company Limited to take over the life insurance portfolio of Sahara Life, on the ground that adequate hearing was not provided to Sahara Life. SAT held that the IRDAI should proceed from the stage of seeking a representation from Sahara Life on the report filed by the administrator as well as providing an opportunity of being heard to Sahara Life in consonance with the principles of natural justice. The IRDAI invited Sahara Life to provide its comments on the administrator's report and there was another round of correspondence, finally leading to a personal hearing in December 2019, which together formed the basis of the Sahara Order.
Summary of Charges: In the Sahara Order, the broad categories of charges levied against Sahara Life are in the context of issues surrounding: (i) finance and accounting functions, including wrongful transfer of funds to group entities; (ii) corporate governance functions, including failure to comply with the fit and proper requirements by Sahara Life's promoters and operating without a board approved business plan; and (iii) lapses in internal controls and systems.
Fit and Proper Requirement for Promoters: The IRDAI focused on the promoters of Sahara Life (Promoters), which are four Sahara group companies together holding around 98.19% of Sahara Life.
When Sahara Life was granted registration as a life insurer by the IRDAI in February 2004, one of the key basis was that Sahara India Financial Corporation Limited (SIFCL), a majority shareholder, was registered with the RBI as a Residuary Non-Banking Financial Company (RNBFC). However, in September 2015, RBI cancelled SIFCL's registration as an RNBFC on the grounds of serious financial irregularities and indiscipline, including transfer of funds to related parties and the RBI applied for liquidation of SIFCL (which proceedings have been stayed by the Supreme Court of India, in an appeal filed by SIFCL). IRDAI specifically noted that it was concerned that SIFCL, being a majority shareholder, had ceased to be a regulated entity, which was a material change from the position at the time when IRDAI had granted registration to Sahara Life. Sahara Life had also failed to bring this change to the IRDAI's notice, which was a breach of the Registration Regulations.
In the context of another Promoter, Sahara India Commercial Corporation Limited (SICCL), in October 2018, SEBI directed SICCL and its directors including Subrata Roy and O.P. Srivastava, to refund the money along with interest at 15% per annum, collected in violation of the Securities and Exchange Board of India Act, 1992 and also barred them from accessing the securities market for four years from date of completion of refunds to investors.
As such, the IRDAI appears to have relied on orders and observations made by RBI and SEBI against the Promoters, which is in line with the principles prescribed under the Publication and the ICPs, discussed above. This is an important factor to consider at the stage of inducting new shareholders, directors and KMPs.
The IRDAI also reviewed in detail the financial statements of all the Promoters and held that their financial statements do not demonstrate the financial strength or ability to support the future capital requirements of Sahara Life. SIFCL and SICCL cannot infuse capital into Sahara Life given that SIFCL has pending liquidation proceedings and SICCL has been inactive since the financial year 2016-2017. Since Sahara Care Limited (SCL), another Promoter, has accumulated losses to the tune of 25% of its paid up capital and Sahara Infrastructure and Housing Limited (SIHL), also a Promoter, has meagre revenues with larges losses in its books, these entities may also not have the ability to infuse capital in Sahara Life.
In summary, the IRDAI noted that the four most significant promoters of Sahara Life are related group companies and each of them were facing either regulatory or financial issues and their ability to fund the future capital requirements of Sahara Life was highly doubtful. Therefore, the IRDAI held that none of the Promoters met the fit and proper requirements to be promoters of an insurance company and directed the Promoters to transfer their shareholding to any other fit and proper promoters within six months, subject to the Transfer Regulations.
Interestingly, the IRDAI did not restrict its scrutiny to only the Promoters, but went one level above to scrutinize the shareholders of the Promoters as well. It held that since Subrata Roy, his wife Swapna Roy, J.B. Roy and O.P. Srivastava are substantial shareholders in all the Promoters (they together held 99.7% of SIFCL, 70% of SCL, 60.6% of SICCL and 56.8% of SIHL) they are in a position to exercise influence over their decisions relating to strategic, operating, investing and financing policies of Sahara Life and are therefore, the ultimate beneficial owners of Sahara Life. IRDAI also noted the adverse orders passed by SEBI against some of these individuals. The IRDAI indicated that being the ultimate beneficial owners of Sahara Life, they were also required to meet the fit and propter criteria. Promoters of insurance companies will need to factor in IRDAI's above approach while structuring their insurance ventures.
It will be interesting to see if Sahara Life files an appeal against the Sahara Order with the SAT and if yes, what will be the outcome of such appeal. Irrespective, the Sahara Order clearly shows that the IRDAI will take strict action against promoters of insurers who do not meet the fit and proper criteria. As such, a one-dimensional tick-box approach to compliance with the fit and proper requirements is clearly not enough, as the consequences of non-compliance could be significant. Insurers in India need to assess their compliance with the fit and proper requirements with a fine-tooth comb to make sure that they do not fall foul of the fit and proper requirements.
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