FDI Limit Hiked to 74%: An Impetus for the Insurance Sector

[Ekta Janghu is an Associate at Wadia Ghandy & Co., Mumbai and Riya Gupta is an Associate at Algo Legal, Mumbai]

On February 1, 2021, the Finance Minister announced a host of reforms vide its first paperless budget. Amongst these, was the proposal to increase the threshold for foreign investment in the Indian insurance sector to 74% from the erstwhile threshold of 49%. The announcement was made in light of abysmally low penetration and density in the long ailing insurance sector. As per the Insurance Regulatory and Development Authority of India (“IRDAI”) Handbook 2018-19, despite the presence of 60 insurance companies (of which 24 are life insurers and 36 are non-life insurers), the insurance penetration was 2.74% for life and 0.97% for non-life insurance, much lower in comparison to the numbers in developed countries such as the United Kingdom, Singapore, France, and Japan. This indicates that the large section of the Indian population is under-served and that there is a massive bandwidth for growth in the insurance sector.

This post unravels the evolution of the foreign investment regime in the Indian insurance sector and further analyses  implications of the recently proposed hike in the threshold of foreign direct investment to 74%.

Early liberalization

Prior to 2000, the Indian insurance sector was regulated by state-owned autonomous entities such as Life Insurance Corporation and General Insurance Corporation. Subsequently, the Malhotra Committee’s recommendations in 1993 paved the way for a paradigm shift in the Indian insurance sector from being a state monopoly and restricted market to a privatized sector. Basis the Committee’s recommendations, the IRDAI was constituted under the Insurance Regulatory and Development Act, 1999 as a statutory regulator to regulate and develop the insurance sector in India and promote competition to enhance customer satisfaction. Later in August 2000, the insurance sector was opened up for private and foreign players, and foreign investors were allowed ownership up to 26% in the Indian insurance companies.

2015 Amendment: Hike in foreign investment limit to 49%

Subsequently, in 2015, the insurance sector was further liberalized to increase the foreign investment limit from 26% to 49% vide the Insurance Laws (Amendment) Act, 2015 (“2015 Amendment”) to the Indian Insurance Act, 1938 (the “Act”). After the 2015 Amendment, Section 2(7A) of the Act defined an ‘Indian insurance company.’ inter alia as:

“any insurer, being a company, which is limited by shares and in which the aggregate holdings of equity shares by foreign investors, including portfolio investors, do not exceed forty-nine percent of the paid-up equity capital of such Indian insurance company, which is Indian owned and controlled.”

Initially, the Indian Insurance Companies (Foreign Investment) Rules 2015 (“2015 rules”) prescribed that foreign direct investment up to 26% only was allowed under automatic route and any foreign direct investment proposals which take the total foreign investment above 26% and up to 49% shall require the approval from Foreign Investment Promotion Board. Later the 2015 rules were amended in 2016 vide Indian Insurance Companies (Foreign Investment) Amendment Rules, 2016 to provide for the entire 49% of foreign investment in the insurance sector to be allowed under automatic route subject to verification by the IRDAI.

The explanation to the definition of ‘Indian insurance company’ provides that the term ‘control’ would include the right to appoint a majority of the directors or to control the management or policy decisions, including by virtue of their shareholding or management rights or shareholders agreements or voting agreements. The 2015 rules further defined the term ‘Indian ownership’ as resident Indian citizens or Indian companies (owned and controlled by resident Indians) holding beneficial ownership of more than 50% of the equity share capital in an Indian insurance company.

To avoid subjectivity and provide further clarity on the interpretation of the term ‘Indian owned and controlled,IRDAI vide its notification dated October 19, 2015, issued guidelines (“Guidelines”). As per the Guidelines, ‘control’ can be exercised through one or more of the following, (a) virtue of shareholding; (b) management rights; (c) shareholders agreement; (d) voting agreement; or (e) any other manner as per the applicable laws. Further, the Indian insurance company is required to ensure that:

(a) The majority of the directors (excluding independent directors) are elected by Indian promoter(s) or investor(s) on its board;

(b) The appointment of key managerial personnel should be through the board of directors or by the Indian promoter(s) and/or Indian investor(s);

(c) Control over “significant policies” have to be exercised by the appropriately constituted board of directors;

(d) It was also clarified that notwithstanding the presence of a foreign investor’s nominee, the valid quorum for a board meeting shall be constituted with the presence of a majority of Indian directors. This suggested that the right of the nominee of a foreign investor to be present for the purposes of a valid quorum is merely protective in nature and would not constitute ‘control’ under the Act. 

While an increase in the foreign investment cap from 26% to 49% was perceived as a fundamental shift, in reality, most of the foreign investors acquired a stake in Indian insurance companies through the purchase of shares from Indian investor(s) rather than directly investing in Indian insurance companies through the subscription of shares. Hence, the majority of the foreign capital infusion could not reach the Indian insurance companies and be utilized by such insurers towards its operations, new avenues, technological development, and innovation in products catering to varied sections of the Indian population. Further, despite investing 49% in the Indian insurance company, the foreign investor(s) are not permitted to acquire management and control rights at par with Indian investor(s), but are subjected to the same restrictions, including in connection with the transfer of shares (also transmission and fresh issuance) under the Act and regulations thereunder. This created disparity amongst the Indian investor(s) and foreign investor(s), thereby dissuading the foreign investor(s) relatively from investing in Indian insurance companies. In conclusion, such factors acted as a stumbling block for the growth and development of the insurance sector.

Budget 2021: Proposal to hike foreign investment limit to 74%

Against this backdrop, the Finance Minister in the Union Budget 2021-22 announced the increase in foreign direct investment threshold in Indian insurance companies to 74% and allowed foreign ownership and control with permitted safeguards. The proposal is a welcome step and a breather for the insurance sector. The ‘safeguards’ as announced are relatively rational and include requirements, such as the majority of directors on the board of insurers and key managerial persons to be resident Indians and that a minimum of 50% of directors should be independent directors. Further, insurance companies will be required to keep a certain percentage of their profits as a general reserve, which will ensure capital adequacy and liquidity to meet known and unknown liabilities in difficult situations, thereby strengthening policyholders’ confidence.

It is expected that the higher FDI threshold limit will establish a more equitable level playing field between foreign and Indian investor(s). This will likely lead to foreign investors negotiating for equal or similar management rights and control over significant policy decisions, which is not permissible under the current scenario. This in turn, will increase foreign capital inflow, insurance penetration, solvency ratio, territorial expansion, and bring foreign expertise, managerial skills, innovation, and technical know-how to the Indian insurance sector.

Further, this move can prove favorable to Indian insurers in light of RBI’s recent proposal, hinting at its intention to cap banks’ investment limit in non-core business activities, including the insurance sector to 30%. While the move would protect banks from risk arising out of non-banking business activities, it is likely to have a direct impact on the Indian insurance companies in which banks shareholding exceeds 30% and which have bank as its promoters. Some of these, as of December 31, 2020, includes ICICI Bank (holding 51.88% stake in ICICI Lombard General Insurance Company), State Bank of India (holding 70% stake in SBI General Insurance Company), Kotak Mahindra Bank and its nominees (holding 100% stake in Kotak Mahindra General Insurance Company), Canara Bank (holding 51% stake in Canara HSBC OBC Life Insurance Company).

Lastly, since several economies have adopted risk-sensitive approach for capital requirement, the proposed move will provide much needed impetus in the direction of setting up a risk-based capital regime, thereby incentivizing insurers to formulate and implement better risk management policies.

To conclude, while the budget has laid down the broader policy changes, comprehensive rules and regulations for the implementation of government decisions are yet to be ironed out. It remains to be seen how the Ministry of Finance, in consultation with IRDAI, will formulate ‘safeguards’ around foreign ownership and control vis-a-vis protecting the interests of policyholders. Further, clarity on whether FDI above 49% would be under automatic or government route is also anticipated. Overall, the budget proposal is a step in the right direction and signals a positive shift towards international investment in the Indian insurance sector. 

Ekta Janghu & Riya Gupta

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