Key elements of amendment
Conditions for insurance companies receiving foreign investment
On 1 February 2021 Union Finance Minister Nirmala Sitharaman began implementing the increase of the foreign investment limit for insurance companies in India from 49% to 74%, as well as enabling foreign ownership and control in Indian insurance companies. The change comes in the wake of 2020's amendment to the Consolidated Foreign Direct Investment Policy of 2020 (FDI Policy), which increased the foreign investment limit to enable foreign ownership and control in insurance intermediaries.
The government first decided to open the insurance sector to foreign players in 2000 and permitted a 26% FDI investment. As the economy and the sector matured, there was a need to raise this cap. In 2015, the government increased the FDI limit to 49% and in 2016, all investments in Indian insurance companies up to 49% became exempt from government approval under the Automatic Route.(1) Since most of the players in the insurance sector were joint ventures between overseas insurers and Indian partners, there was a great degree of reluctance among the foreign partners to raise their shareholding to the increased limit. Their reluctance was due to the fact that the limit increase would not give them any corresponding increase in operational or management control, which had to remain with the Indian partners. Moreover, the existing joint venture agreements set out mechanisms where the foreign partners had to acquire the increased stake from the Indian partners through purchasing shares. In such cases, the foreign investor could not infuse further capital in the Indian insurance company, despite the insurance companies needing capital for operations, technological development and product innovation.
Following the amendment to the Insurance Act, 1938, effective from 1 April 2021, the definition of an Indian insurance company was modified to increase the permissible foreign shareholding to 74%. On 15 June 2021, the Department for Promotion of Industry and Internal Trade (DPIIT) subsequently released press note no. 2 of 2021 which amended the FDI policy to allow equity investments by foreign persons in Indian insurance companies up to 74% of the share capital under the Automatic Route. However, such investments continue to be subject to approval or verification by the Insurance Regulatory and Development Authority of India (IRDAI).
The press note inter alia highlights the requirement to obtain necessary licences and approvals from the IRDAI in order to undertake the insurance business, and elaborates on the obligation to comply with the applicable pricing guidelines on FDI increases in an Indian insurance company. The provisions of the press note are effective from the date of notification of corresponding revisions to the Foreign Exchange Management (Non-Debt Instruments) Rules, 2019 (the NDI Rules).
Conditions for insurance companies receiving foreign investment
On 19 May 2021, the Indian Insurance Companies (Foreign Investment) Rules, 2015 (Insurance Rules), were aligned on with the changes in the Insurance Act and set out the conditions and safeguards of foreign investment. After the implementation of Indian Insurance Companies (Foreign Investment) Amendment Rules, 2021 (the Amended Insurance Rules), the government included certain mandatory conditions for insurance companies receiving foreign investment to protect the interests of the policyholders as well as to obtain political consensus on the amendment.
These conditions were mindful of the sensitivity of the insurance sector, with the life-insurance sector alone estimated to be holding 35% of the population's total savings.(2) The key conditions introduced by the Amended Insurance Rules are set out below:
Total foreign investment
The permissible total foreign investment by foreign investors, ie, 74%, comprises foreign direct investment as well as indirect foreign investment. Calculating such investment remains the same as set out in the Insurance Regulatory and Development Authority (Registration of Indian Insurance Companies) Regulations, 2000 (the Registration Regulations).
For computation of the permissible equity capital held by one or more foreign entities, the paid-up equity shares of the target Indian insurance company held by foreign investors are to be added-up with the proportion of paid-up equity share capital held or share-capital controlled by such foreign investor, either itself or through its subsidiaries in:
- the Indian promoter of the target; or
- other Indian investors of the target.
However, this stipulation does not apply to Indian promoters or investors which are banking companies or public financial institutions.
Residency and citizenship qualification
The Amended Insurance Rules stipulate that the majority of directors and key-management persons and at least one person among the chairperson of board of directors, managing director or chief-executive officer (collectively referred to as senior management) are required to be resident Indian citizens. This requirement is applicable to all insurance companies with foreign investments, irrespective of the quantum. The Amended Insurance Rules also enumerate a time-period of one year from the date of implementation of these rules, for the applicable companies to comply with this qualification for senior management.
The Indian residency and citizenship requirement for the senior management may be viewed as a potential obstacle for foreign investors looking to invest and appoint qualified persons from the global insurance industry as part of the senior management.
Since this is an additional compliance for the company, foreign investors and insurance companies looking to enter the Indian market are required to take note that despite potentially having ownership and control, they will have to continue to rely on Indian citizens who are residents in India to man key management roles in the insurance company and its board of directors.
Retention of profits
All Indian insurance companies with foreign investment exceeding 49% are required to retain at least 50% of net profits in general reserve, if:
- the solvency margin is lower than 1.2 times of the control level of solvency; and
- dividend is paid on equity shares in the particular financial year.
With the funds allocated for general reserve purposes, other expenditures including capital expenditures, which were previously planned to be taken from generated profits, may now be restricted to an extent.
The IRDAI mandates a control level of solvency of 150% for all the insurers.(3) Now, for the insurance companies with foreign investment, an additional requirement to meet 1.2 times of the control level of solvency, ie, a 30% higher solvency margin must be maintained.
Notably, the IRDAI has retained a Solvency I or a factor-based solvency approach rather than switching to Solvency II or a risk-based approach. In a risk-based approach, the regulator evaluates the solvency levels for each insurer based on its risk profile. The IRDAI had formulated multiple committees since 2011 for implementation of a risk-based approach, however, the same has not yet been implemented.(4)
All Indian insurance companies with foreign investment exceeding 49% are required to meet either of the two requirements if:
- the chairperson of the board is not an independent director, at least half of the board of directors is to be composed of independent directors; or
- if the chairperson of the board of directors is an independent director, at least one third of the board of directors is to be composed of independent directors.
The Insurance Regulatory and Development Authority of India (IRDAI) recently passed an amendment to the IRDAI (Indian Insurance Companies) (Amendment) Regulations, 2021, effective from 8 July 2021. The July amendment seeks to align the provisions of the Registration Regulations, IRDAI (Transfer of Equity Shares of Insurance Companies) Regulations, 2015, and certain other regulations, with the Amended Insurance Rules. The amendment has introduced the requirement for an insurance company with foreign investment that is seeking registration to have either the managing director, chief executive officer or the whole-time director, along with the promoter of the company, to submit an affidavit to the IRDAI certifying compliance with the residency and citizenship qualification, in addition to the application for a grant of registration certificate. A similar affidavit is also needed to certify compliance with the requirement to retain profits, if the foreign investment of the company seeking registration is more than 49%. The amendment has also introduced a requirement for existing insurers to submit an undertaking along with relevant attachments, confirming their compliance with the residency and citizenship qualification and signed by the chief executive officer and chief compliance officer. This undertaking is required to be submitted to the IRDAI within 45 days of the board meeting on which such compliance is confirmed.
With the increased FDI limits in place, we expect to see increased activity in the sector. The policy change expands opportunities for Indian partners to exit or decrease their stakes in the insurance sector. A higher FDI limit will also help insurance companies access to foreign capital to meet their growth requirements since insurance is a capital-intensive business.
Industry insiders also point that foreign ownership and control will incentivise the foreign partner to bring its expertise, innovation, best practices and technical know-how to the Indian insurance sector as well as improve insurance penetration. Enhanced customer service experience, improvised claims settlement and adherence with global norms are likely be observed as by-products of such greater market participation by global players. With respect to insurance penetration, India, as a country with a mere 3.76%(5) penetration, falls way below the global average of 7.23%.(6) Increased insurance penetration would pave way towards enhanced competition and thereby, lead companies to reveal more attractive insurance products and improve the claim settlement ratio.
To continue aligning the concept of foreign ownership and control with the increased limits for foreign investment in the insurance sphere, a similar amendment in the NDI Rules, notified under the Foreign Exchange Management Act, 1999, will be required. Given the pace at which the government is implementing the FDI limit amendment, such a notification is likely to be issued soon.
It is expected that a number of IRDAI regulations will also be revised, including the IRDAI (Assets, Liabilities and Solvency Margin of General Insurance Business) Regulations, 2016; IRDAI (Assets, Liabilities and Solvency Margin of Life Insurance Business) Regulations, 2016; Guidelines on Indian Owned and Controlled Insurance Companies (dated 19 October 2015); Guidelines for Corporate Governance for Insurers in India (dated 18 May 2016); and other operating regulations, to align them with the policy changes brought in by the amendment and the Amended Insurance Rules.
After the implementation of these regulations as well as the regulations issued last year allowing 100% foreign investment in insurance intermediaries, a surge in foreign investments is anticipated, as well as an increase in M&A activities in the insurance sector. This is also expected to advance the emerging insurtech sector.
For further information on this topic please contact Gaurav Dayal or Kartik Chatrath at Lakshmikumaran & Sridharan by telephone (+91 (11) 4129 9800) or email ([email protected] or [email protected]). The Lakshmikumaran & Sridharan website can be accessed at www.lakshmisri.com.
(1) Paragraph 2.1.4 of the FDI Policy reads as follows: "Automatic Route: The entry route through which investment by a person resident outside India does not require the prior approval of the Reserve Bank of India or the Central Government".
(2) Further information is available here.
(3) IRDAI (Assets, Liabilities, and Solvency Margin of Life Insurance Business) Regulations, 2016 and IRDA (Assets, Liabilities, and Solvency Margin of General Insurance Business) Regulations, 2016.
(6) Further information is available here.