In a welcome and a much-awaited move, the proposal to increase the permissible limit for foreign direct investment (‘FDI’) in Indian insurance companies from 49% to 74% was announced on February 1, 2021, as a part of the speech on the budget for the FY 2021-22, presented by the Hon’ble Finance Minister of India. As a part of the proposal, Indian insurance companies would be allowed to have foreign ownership and control, with certain ‘safeguards’. Additionally, as per the proposal, a majority of directors on the board, and key management persons of insurance companies, would be required to be resident Indians, with at least 50% of directors being independent directors, and a specified percentage of profits being retained as general reserves of the insurance company.
Pursuant to this announcement, the Insurance (Amendment) Bill, 2021 (‘Insurance Amendment Bill’), seeking to amend the Insurance Act, 1938, was introduced in the Rajya Sabha (the upper house of the Indian Parliament), on March 15, 2021. The Insurance Amendment Bill was passed by the Rajya Sabha on March 18, 2021, and by the Lok Sabha (the lower house of the Indian Parliament) on March 22, 2021. The Insurance Amendment Bill was subsequently published in the official gazette on March 25, 2021, and the Ministry of Finance has appointed April 1, 2021 as the date on which it will come into force.
Before embarking on an analysis of the actual contents of the Insurance Amendment Bill, it is pertinent to note that the demand for increase in FDI limits in the insurance sector has been in the offing for a while now. The Hon’ble Finance Minister had hinted in her budget speech for the financial year 2019-20 that the Government will be examining suggestions for opening up of FDI in the insurance sector, after appropriate consultations. Around December 2019, the Insurance Regulatory and Development Authority of India (‘IRDAI) had recommended that the FDI ceiling for the insurance sector be revised to 74%, after consultation with multiple stakeholders (including approximately 60 insurance companies).
The key amendments to the Insurance Act, brought in by virtue of the Insurance Amendment Bill, are as follows:
Prior to the Insurance Amendment Bill, by virtue of sub-clause (b) of Section 2(7A) of the Insurance Act, an Indian insurance company was defined, inter alia, as an insurer in which the aggregate holdings of equity shares by foreign investors, including portfolio investors, do not exceed 49% of the paid up equity capital of such insurer. Further, an Indian insurance company was required to be ‘Indian owned and controlled’, in the prescribed manner. The Insurance Amendment Bill has substituted sub-clause (b) of Section 2(7A) of the Insurance Act, so as to raise the threshold of permissible foreign investment to 74% of the paid-up equity capital of the Indian insurance company. Such foreign investment in an Indian insurance company has been made subject to such conditions and manner as may be prescribed by the Central Government.
For ease of understanding, this change may be read together with the Insurance Amendment Bill seeking to substitute sub-clause (aaa) of Section 114(2) of the Insurance Act. Section 114(2) of the Insurance Act provides for the powers of the Central Government to make rules to carry out the provisions of the Insurance Act in respect of certain matters. Prior to the Insurance Amendment Bill, sub-clause (aaa) of Section 114(2) of the Insurance Act provided the Central Government the power to make rules prescribing the manner of ownership and control of Indian insurance companies under sub-clause (b) of Section 2(7A) of the Insurance Act. The Insurance Amendment Bill has substituted sub-clause (aaa) of Section 114(2) of the Insurance Act, so as to empower the Central Government to make rules in relation to the conditions and manner of foreign investment under sub-clause (b) of Section 2(7A). Given that the Insurance Amendment Bill is now in force, the Central Government is expected to publish such rules in the near future.
Reading these two amendments together, it emerges that while the threshold of permissible foreign investment in an Indian insurance company has been raised to 74% of its paid-up equity capital, such foreign investment is subject to conditions and manner as may be prescribed by the Central Government.
Section 27 of the Insurance Act requires every insurer to invest, and keep a certain percentage of its assets invested, in accordance with Section 27 and as specified by the relevant regulations. Sub-section (7) of Section 27, inter alia, provides that the assets which are to held invested under Section 27 by an insurer incorporated or domiciled outside India, are to be held in India, in trust (for the discharge of liabilities as provided in Section 27(1)) and vested with trustees who must be residents of India and approved by the IRDAI. Section 27(7) also imposes certain conditions relating to the instrument of such a trust.
Prior to the Insurance Amendment Bill, the explanation to Section 27(7) specified that Section 27(7) was also to apply to an insurer incorporated in India in which either one-third portion of the share capital was owned by members domiciled elsewhere than in India, or one-third of whose governing body consisted of such members. The Insurance Amendment Bill seeks to omit this explanation.
While the enactment of the Insurance Amendment Bill has formally set the ball rolling on increasing the permissible limits of FDI in an Indian insurance company, it is crucial to remember that as per the budget speech made by the Hon’ble Finance Minister, the proposed foreign ownership and control in Indian insurance companies will be accompanied by certain ‘safeguards’. For example, it has been proposed in the budget speech that a majority of the directors and key managerial personnel of an Indian insurance company is to be resident Indians, and at least 50% of the board of directors of an Indian insurance company is to consist of independent directors. It has also been proposed that a specified percentage of profits of the Indian insurance company is to be retained as general reserves.
To account for the above mentioned ‘safeguards’ in the budget speech, as well as the enhancement of the permissible FDI limits, extant foreign investment and insurance regulatory regimes will have to be appropriately modified, if not overhauled. We hope that the Government and the IRDAI, while rolling out the slew of amendments necessary, honours the time-tested principle of ensuring that economic rights, ownership and voting interest are commensurate in body corporates.
Under the Foreign Exchange Management (Non-Debt Instrument) Rules, 2019 (‘FEM (NDI) Rules’),the sectoral cap for foreign investment in an insurance company is currently provided as 49%, along with conditions to ensure that ownership and control remains at all times with resident Indian entities. To that extent, pursuant to the enactment of the Insurance Amendment Bill, such a sectoral cap as well as attached conditions under the FEM (NDI) Rules will need to be amended. While the budget speech did not specifically address the issue, it is highly likely that the FDI above 49% would be under the automatic route. Requirements similar to the FEM (NDI) Rules may be found in the Indian Insurance Companies (Foreign Investment) Rules, 2015 (‘Foreign Investment Rules’), and to that extent, pursuant to the enactment of the Insurance Amendment Bill, the Foreign Investment Rules will need to be amended or entirely replaced by the rules which the Central Government is likely to introduce pursuant to the Insurance Amendment Bill (which affords the Central Government rule making powers over conditions and manner of foreign investment).
It remains to be seen as to how the Government and specifically the IRDAI amend the regulatory framework premised on ‘Indian Promoter’ and ‘Foreign Investor’, as provided in IRDAI (Registration of Indian Insurance Companies) Regulations, 2000 and the IRDAI (Transfer of Equity Shares of Insurance Companies) Regulations, 2015, and what would be the restrictions on foreign body corporates who may promote insurance companies.
Further, given that the primary justification behind the hike in FDI limit is the infusion of additional capital in Indian insurance companies, we are hopeful that the IRDAI will liberalise the IRDAI (Investment by Private Equity Funds in Indian Insurance Companies) Guidelines, 2017 (‘PE Guidelines’) issued on December 5, 2017, which regulates investments by private equity funds into insurance companies.
The IRDAI Guidelines on Indian Owned and Controlled dated October 19, 2015 (‘IOC Guidelines’) caps total foreign holding in an Indian insurance company to 49% while also stipulating numerous provisions which mandate control in the hand of Indian shareholders. Para 4 of the IOC Guidelines, inter alia, vests the Indian promoter/investors with the right to nominate:
Similarly, the IOC Guidelines state that quorum is understood to mean and include presence of majority of the Indian directors. Currently, para 3.2 of the IRDAI (Corporate Governance Guidelines for Insurers in India), dated May 18, 2016 (‘Corporate Governance Guidelines’), inter alia, provides that agreements between the promoters/ shareholders and/or the articles of association of the insurance companies demonstrate that the ownership as well as control does not lie with foreign entities, but ultimately rests with resident Indian citizens at all times. We hope that the Government, apart from addressing the obvious limits on FDI ceiling and ownership, takes a pragmatic approach and acts on the principle of control being commensurate with ownership, thereby relaxing the aforesaid stipulations.
The structure proposed by the Hon’ble Finance Minister (a majority of directors and key management persons of insurance companies to be resident Indians, with at least 50% of directors being independent directors), is over and above the requirement under para 5.1 of the Corporate Governance Guidelines, wherein the board is, inter alia, required to typically have a minimum of 3 independent directors. The Corporate Governance Guidelines will need to be amended, as the aforesaid requirement is an additional requirement being introduced only for foreign-owned insurance companies. It remains to be seen whether the appropriate amendments would require directors/KMPs to be resident in India or would require them to be resident Indian citizens.
The Hon’ble Finance Minister’s proposal for keeping a specified percentage of profits as general reserves appears to emanate from the need to maintain appropriate capital adequacy and liquidity for the Indian insurance company to meet its liabilities, as well as to prohibit excessive repatriation of dividends by foreign investors. Having said that, reserves held by insurance companies are already required to be maintained in accordance with the Insurance Act and the IRDAI (Investment) Regulations, 2016, on the principle of furthering the interest of policyholders and the Government. While the impact of such a restriction can only be meaningfully discerned upon the receipt of details of the percentage of profits to be retained, prima facie, requiring foreign-controlled Indian insurers to maintain an additional level of reserves would definitely handicap foreign-owned insurers.
A very significant determinant of whether the hike in the permissible FDI limits in Indian insurance companies will indeed achieve the desired benefits for the insurance sector in general, including for insurance companies, investors and customers, will be the ‘safeguards’ which are proposed to be brought in. It is not clear whether the above restrictions are the only ‘safeguards’ to be proposed, or whether any additional restrictions will also be imposed as a part of such ‘safeguards’. The Government should be mindful of imposing additional restrictions such as regulatory approvals for dividend pay-outs, as the same may be excessively onerous for foreign-owned insurers.
Without a doubt, the upward revision in the FDI cap from 49% to 74% will provide a much-needed impetus to the insurance industry, which is capital-intensive and requires sustained infusion of capital, while allaying concerns of international insurers, especially those who were reluctant to invest in Indian insurance companies because of being unable to exercise ‘control’ over the company (due to the 49% shareholding cap). By way of these reforms, foreign investors will appreciate the establishment of a more equitable level-playing field between foreign and Indian investors, given that a higher shareholding will enable foreign investors to derive proportionate economic benefits and negotiate for stronger management rights and control over significant policy decisions, subject of-course to the ‘safeguards’.
The FDI reforms will facilitate capital raising by Insurtech startups along with new insurance companies, and the enhanced and regular flow of capital will allow new-age Indian entities to spend on research and development, thus creating innovative products which deepen insurance penetration and digital presence along with affordable pricing.
Apart from entry of global insurance players, we believe that extant joint venture agreements between foreign investors and their Indian counterparts governing Indian insurance companies will be renegotiated, as foreign investors are likely to increase their ownership stake (including by relying on clauses which allow such scale-up, subject to applicable law) and/or higher control, as far as possible, in light of the ‘safeguards’.
The liberalisation of the permissible threshold for FDI in Indian insurance companies is a step in the right direction. It presents a multitude of opportunities for existing as well as fresh foreign investors. Investors are recommended to stay positive and keep a close eye on the details of the regulatory framework as brought out by the Government and the regulator, in relation to the proposed amendments.
At the same time, the Government and the IRDAI, while drafting the appropriate legislative framework pursuant to the liberalised FDI thresholds, would do well to remember that the entry of global players in the Indian market is critical for the wellbeing of the insurance industry as it will bring in the much-needed capital for the insurance industry. The Government should be mindful that the safeguards proposed (or any additional safeguards) adhere to the principle of control commensurate with ownership, and are not so excessive/onerous that they end up discouraging foreign investment into the Indian insurance industry. In addition to this, easing of FDI limits will help insurers attract much needed capital to deepen insurance penetration, while also leading to job creation in the insurance sector. To that extent, an investor-friendly approach, while at the same time allaying domestic sensitivities pertaining to the insurance sector, should be the preferred outlook of the Government and the regulator.
This article was originally published in Law Street India on 08 April 2021 Co-written by: Alina Arora, Partner; Parth Gokhale, Principal Associate. Click here for original article
Contributed by: Alina Arora, Partner; Parth Gokhale, Principal Associate
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