The opening up of India’s public monopoly insurance sector to competition from private companies in 2000 was billed as a major financial system reform. It was clearly understood that ownership rules for insurance would be liberalised progressively apace with liberalisation in other parts of the financial services industry. Since then, a large number of insurance joint ventures between domestic and foreign partners have been formed. They have transformed the Indian insurance scene and provided a much better deal to consumers.
There is now a wider choice of products providing protection against many more types of risk. Most importantly, the insurance industry has become a key player in underpinning the long-term foundations of India’s capital markets and financial system. It is a growing source of finance for infrastructure. Insurance has also been a significant source of foreign capital inflows — directly and indirectly.
The market since 2000
Moreover, the entry of private competition has forced the former public monopoly insurers to improve their performance and efficiency. Yet, despite these benefits, the government has not yet — after 13 years — lived up to its promise of fostering the growth of the industry by increasing the Foreign direct investment (FDI) limit in insurance from 26 per cent to 49 per cent. That unjustifiable delay now compromises the financial standing of many insurance joint ventures (JV) and puts a question mark over the future of an industry that is vital to the health of the financial system.
Let’s look closely at what has happened since 2000. The insurance industry requires significant inputs of capital sustained over a long period to build a viable business and meet growing policyholder commitments. It takes eight to 10 years to reach break-even. The private industry in India has lost a combined $4 billion in the last decade. In the non-life segment, 13 private sector insurers have reported losses in 2011. Many of the smaller insurance companies have looked at options to introduce new domestic partners, but there are no buyers. Most existing foreign promoters have a long-term view. They are unfazed by medium-term losses which they regard as necessary investments to generate future returns. They are looking to increase their ownership stake while their domestic partners have neither the capital resources nor the inclination to do so. A few foreign firms have grown impatient with the slow pace of progress and exited.
Following a long period of inaction and delay, the Union Finance Minister has taken the bull by the horns. He is committed to continuing with liberalising and reviving the industry. He realises that urgently needed infrastructure will require a far greater volume of investment by insurance companies and pension funds. Yet, unanticipated complications have arisen.
The core issue of lifting the FDI cap to permit inflows of capital from foreign partners, thus allowing the insurance industry to strengthen its capital base and grow, has been sidetracked by a proposal to permit new investment to come in only through Foreign Institutional Investors (FII) rather than the FDI route. That is odd for an industry that requires a longer term investment horizon than FIIs have. India’s insurance industry needs around $12 billion in capital up to 2020. Life insurance penetration is only 4.4 per cent of the country’s Gross domestic product (GDP) in terms of total premium underwritten in a year. The sector needs huge and sustained infusion of funding to build viable businesses for the long term.
The idea of increasing the capital base of the industry through FII (instead of FDI) emanated from an understanding between the government and the Opposition, which avoided lifting the FDI cap. That opposition was bolstered by the strong position taken by the Joint Parliamentary Standing Committee on Finance on grounds that remain arguable and contentious. For a variety of reasons, the notion of allowing a capital increase only through FII would be a non-starter. FIIs have a very limited role to play in insurance companies, e.g. those listed in secondary markets, or a few profitable early entrants about to launch initial public offerings (IPO). It has no useful role to play in JVs requiring significant direct injection of capital.
The Insurance Regulatory and Development Authority (IRDA) has warned publicly against the entry of FIIs in insurance. Interestingly, the government has always been more in favour of FDI rather than FII, regarding FII as being “hot” and volatile.
Factor of destabilisation
For insurance JVs that are yet some distance away from IPOs, neither foreign nor domestic investors have any incentive to allow FII inflows that will dilute extant ownership rights and oblige operating JVs to sell shares to disinterested third parties at below par. Therefore, little new investment is likely to come in. Existing JV agreements often have clauses that do not allow other foreign investors to take up equity and dilute the rights of extant shareholders who have sustained losses for a long period of time. If the idea is to increase capital inflows, this is therefore unlikely to have much impact, except for a few insurance JVs that are at the IPO stage.
If the FII-only route becomes enshrined in the amended law, it would allow new foreign entrants to establish JVs and own 49 per cent of shares immediately using a combination of 26 per cent FDI and 23 per cent FII. In contrast, existing foreign promoters would be prevented from investing more in their own JVs if the amended Bill permitted an increase in the foreign shareholding percentage through FII only. So extant foreign promoters would be incentivised, again perversely, to abandon current ventures and start new ones. That would destabilise the entire insurance industry.
From a practical perspective, the issue of new capital needed to strengthen the industry can be resolved by allowing the market to work and permitting an increase in the total foreign investment limit to 49 per cent, regardless of whether that increase is through FDI or FII. Such a compromise would not change the government’s original stance, but would accommodate the desire to permit FII as well.
The amended Insurance Bill should keep matters simple by lifting the total foreign investment limit to 49 per cent. Shareholders should be left to determine the best way to address a company’s needs — whether through FDI or FII. It should, therefore, also allow company boards to decide whether the investment should be in the form of entirely new capital or through a change in the ownership structure of existing capital. The amended Bill should leave it to the IRDA to approve such changes.
If a domestic shareholder in a JV wants to stand diluted or sell his/her shares, why should the government wish to prevent his foreign partner from buying that stake and increase its shareholding up to a limit of 49 per cent? That is for the company rather than the government to decide.
In the end, what the amended Insurance Bill needs to ensure is that India wins — i.e. policyholders, employees, shareholders, companies, and even the government — through an approach to increasing FDI in insurance that is transparent and flexible. It is time for the argument to end and for an amended Bill that is sufficiently foresighted and flexible to stand the test of time to be passed without delay.
(Vijay Kumar Shunglu is former Comptroller and Auditor General of India and has headed several key government committees on various issues.)