Union Budget 2021: The Hon’ble Finance Minister announced an increase in the foreign investment limit for insurance companies from 49% to 74% in her budget speech on 1 February 2020.
By Anuj Shah, Harsh Khemka, Srishti Mukherjee
Union Budget 2021: The Hon’ble Finance Minister announced an increase in the foreign investment limit for insurance companies from 49% to 74% in her budget speech on 1 February 2020. This is a much-awaited development that will help the Indian insurance sector achieve tremendous growth through vast pools of capital and best in class know-how.
Until 2015, foreign investment in the insurance sector under the automatic route (ie, without Government approval) was capped at 26%. In 2015, the Government permitted Indian insurance companies to have up to 49% foreign investment, with the caveat that such companies remain ‘Indian owned and controlled’. This condition has been a deterrent for several prominent global insurers from setting up business in India.
Under the new proposal, foreign ownership and control of Indian insurers will also be permitted with some ‘safeguards’. The safeguards proposed in the budget speech appear reasonable and include requirements such as majority of the board of directors and key management persons of the insurance company comprising of Indian residents and that 50% of the board composition should comprise of independent directors. Further, to ensure that sufficient capital is retained in the books of the insurance company, foreign owned insurers will be required to hold a specified percentage of profits as ‘general reserves’.
What to watch out for
The detailed rules and regulations regarding implementation of the increased FDI limit, along with additional safeguards, will be formulated by the Ministry of Finance (MoF) and the sectoral regulator – Insurance Regulatory and Development Authority of India (IRDAI). The MoF and IRDAI will be required to play a balancing act – on the one hand, to protect the long-term interests of Indian policyholders and ensure stability in the insurance sector; and on the other, ensure that these regulations are not onerous for foreign investors so as to discourage them from expanding their presence in India.
The previous increase in FDI limits in the sector was accompanied by the ‘Indian Ownership and Control’ guidelines, as a result of which, the sector witnessed limited foreign investors increasing their stake from 26% to 49%. Similarly, the increase in foreign investment limits in insurance intermediaries from 49% to 100% last year, was coupled with stringent conditions, such as requiring IRDAI approval for repatriation of dividends and imposition of thresholds vis-à-vis transactions with related parties. Given the clear message in the budget speech that insurers will be allowed to have foreign ownership and control, we expect some of the earlier regulatory overhang that has withheld the sector from achieving its full potential, to come to an end.
Need for increased FDI
While the Indian insurance sector has been open to private players for almost two decades, it is fairly underdeveloped compared to other large economies, with low insurance penetration. The increase in FDI limits will help the sector expand and service many more Indians. Several insurers have been restricted from expanding, as cash-strapped Indian JV partners could not meet further funding obligations, and the 49% foreign investment cap prevented the foreign shareholder from infusing capital without the Indian partner participating in the capital raise.
The RBI has recently proposed to cap the investments of banks in insurance companies to 30% in order to isolate them from risks emanating from non-core businesses, including insurance. As such, this announcement is well-timed as foreign investors will be a viable substitute for insurance companies promoted by banks.
In the past decade, no new life insurance company has been set up, and only a handful of general insurance companies have been incorporated. Insurance is a capital-intensive business and requires long-term investment from promoters to ensure compliance with IRDAI’s solvency requirements (a prescribed asset-liability test). With this change, in addition to existing foreign investors increasing their stakes in their insurance JVs, several foreign insurers will be encouraged to set up shop in India as they will now get a say in the day-to-day affairs and policy decisions of the insurer.
For the insurance sector to truly achieve its potential, Indian insurers will need to rely on capital and technical know-how of foreign partners to scale-up and offer more sophisticated and innovative products. We expect that this newly found tail-wind of foreign capital and access to know-how will usher in a new era of growth in the insurance sector.
(Anuj Shah is Partner, Harsh Khemka is Senior Associate and Srishti Mukherjee is Associate at Khaitan & Co. Views expressed are the authors’ own.)