Insurance Reforms: A Bridge Too FAR ?

The NDA government in a hurry to pass long pending Insurance Laws (Amendment) Bill, seems to have thrown the champagne with the cork. There is a pressing need for clarity as indicated by this article...

The Insurance Laws (Amendment) Act, 2015 ("Act") was passed by Parliament on 12 March 2015 and was made effective from 26 December 2014. This marked the end of a 7-year-long wait for increase of threshold for total foreign investment in an Indian insurance company from 26% to an explicitly composite limit of 49%. The Narendra Modi government introduced this big ticket reform based on the 41st Report of Standing Committee on Finance (2011-2012) ("Report") which advocated the need for increasing foreign capital in the insurance sector based on the future outlook of Indian economy.

The Report pegged total capital requirement of insurance sector at INR 60,000 crore (approx. USD 10 billion) over the next five years, 49% of which was predicted to arrive as foreign equity investment. The Report stated that such proposed increase in foreign investment would lead to an increase in the insurance penetration from 3% to 6% by providing greater access to domestic and foreign pools of long-term capital for the Indian insurance sector thereby resulting in financial stability and industry consolidation. Despite stiff political opposition, the Narendra Modi government stood by its commitment to give effect to this reform.

However, in spite of all the hype and expectations, only a fraction of the foreign investment has trickled into the insurance sector. While several foreign investors remain keen to participate in the Indian insurance sector, a plethora of insurance rules/regulations tempered with commercially unreasonable conditions and multiple governing agencies have created regulatory hassles for foreign investors.

This article seeks to analyse the key legal issues which have created uncertainty and lack of clarity in the regulatory framework governing the Indian insurance sector.

'CONTROL' ISSUE:

Section (7A (b)) of the Act defines "Indian insurance company" to mean any insurer, being a company limited by shares in which aggregate holdings of equity shares by foreign investors, including portfolio investors, does not exceed 49% of paid-up capital of such Indian insurance company, which is Indian owned and controlled. The ownership test will continue to be met automatically as shareholding of 'non-residents' is capped at 49%.

However, the newly prescribed requirement of control vesting with Indian residents under the Act has taken the foreign investor community by surprise as such a requirement was non-existent under the earlier regime. The term "control" has been defined to 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.

In practical terms, this means that investors, who were exercising some form of control under the earlier regime while holding up to 26%, will need to surrender that control in favour of the Indian partner.

This appears to be in stark contrast to the overall objective of liberalising the regulatory regime. It is likely that any foreign investor who invests a large chunk of money to own up to 49% of an insurance company will want to exercise some form of 'control' over its investee company.

Since foreign investments in excess of 26% require the approval of IRDA1 and FIPB2, prior to such increase the proposal will need to be submitted to the IRDA and FIPB for approval. How IRDA and FIPB interpret control remains to seen. In the past, various regulators such as SEBI3 and CCI4 have taken diverse views in interpreting what constitutes control.

One hopes that IRDA clarifies its position on what constitutes control and takes a liberal interpretation (especially because such restriction was absent in the earlier regime). In our view, a pragmatic approach would be that foreign investors should continue to have the basic minority protection rights which are desirable for an investor to protect its investments such as veto rights.

Computation Conundrum:

The method of computing foreign shareholding in an Indian insurance company is fraught with lack of clarity. The computation is determined by FDI5 Policy, Investment Rules and applicable IRDA regulations.

a) Overall Foreign Investment Limit: The overall equity investment limit in an Indian insurance company is 49%, out of which 26% has been permitted under automatic route (that is without governmental approval) and the remainder 23% is subject to approval route (i.e. with government approval).

b) Calculating Foreign Shareholding: Calculation of foreign investment in an insurance company is governed by IRDA (Registration of Indian Insurance Companies) Regulations, 2000 ("Regulation"). Regulation 11 provides the manner of calculation of 26% equity capital held by a foreign company as the aggregate of quantum of paid-up equity share capital by (i) foreign company either by itself or through its subsidiary companies or nominees in the applicant company; (ii) other foreign investors, non-resident Indians, overseas corporate bodies and multinational agencies in the applicant company and the quantum represented by that proportion of the paid-up equity share capital to the total issued equity capital of an Indian promoter company. There existed ambiguity in this mechanism of calculation. However, IRDA has interpreted it to mean that if a foreign entity holding shares in an Indian insurance company also holds shares in the Indian promoter of that insurance company, then the total shareholding of that foreign entity in the Indian insurance company, along with its direct shareholding in the Indian insurance company, the indirect shareholding through the Indian promoter shall also be taken into account.

This prevailing ambiguity is sought to be rectified by way the proposed amendment to the Regulations. The proposed amendment to Regulation 11 (1), lays down the manner of calculation of direct and indirect foreign investment by foreign investors. It provides that the summation of the direct and indirect holding of equity capital by a foreign investor shall be arrived at, by accounting for the following:

1. quantum of paid up equity share capital held by foreign investors including foreign venture capital investors, in applicant company; and

2. proportion of paid up equity share capital held or controlled by such foreign investors in Indian promoters or Indian Investors as mentioned in sub-clauses (i) of this sub regulation.

In our view, the proposed amendment observes status quo as the nature of computation would remain the same.

Indian Owned and Controlled Company Requirement of the Indian Promoter:

To add to the complications, the Ministry of Finance on 19 February 2015 published the Indian Insurance Companies (Foreign Investment) Rules, 2015 ("Investment Rules") which prescribed an additional condition of Indian ownership and control of the Indian parent company seeking to investment in the Indian insurance company ("IOCC requirement")6. Such a peculiar criterion has been introduced for the first time by the Indian regulators. This condition has come as a spanner in the plans of several Indian insurance companies whose Indian partner has significant holding from foreign investors to be able to permit increase of foreign investment percentage.

The mandatory IOCC requirement prescribed in Investment Rule 4 is problematic for practical application of Regulation 11 which prohibits foreign investment in Indian promoter/investor beyond 49 % in order to ensure that 51 % of shareholding of such investor vests with a resident Indian citizen. Hypothetically, where a FPI holds 30 % shares of Indian promoter/investor, which in-turn holds 74 % of the insurance company would leave such FPI with the option of directly investing not more than 26 % into the Indian insurance company.

The computation is as follows:

• [(26 % FDI by FPI) + (74 % Investment by Indian Investor7)] = 100 % Share Capital of Indian Insurance Company. Any indirect investment by this FPI at the level of the Indian promoter would trigger the FIPB approval requirement.
• [(26 % held by FPI) + ({30 % of 74 %} Indirect investment by same FPI in the Indian Investor) = 48.22 % Total Foreign Investment by such FPI into Indian insurance company.

The computation of foreign shareholding at the level of Indian promoter/investor throws up new challenges for foreign investor looking to structure deals to avail advantage of new FDI policy.

Conclusion:

The liberalisation of the Indian insurance sector was projected as a low-hanging fruit for the Narendra Modi government and had the ability to attract billions of dollars in FDI into India. These reforms had captured the attention of innumerable foreign investors. In a hurry to pass the long-pending Insurance Laws (Amendment) Bill, the NDA government seems to have thrown the champagne with the cork. The requirements imposed and the lack of clarity on the aforementioned issues has left the investors baffled. There exists a pressing need for clarity in sector regulation, which is a sine qua non of investor confidence. However, there is still time to bring about the much required clarity and remove the various impractical bottlenecks. The regulators should act swiftly to remedy this situation by providing clarity on the issues highlighted in this article.

1. Insurance and Regulatory Development Authority.
2. Foreign Investment Promotion Board.
3. Securities and Exchange Board of India.
4. Competition Commission of India. Foreign Direct Investment.
5. Foreign Direct Investment.
6. Investment Rule 4.
7. 51% of such Indian Investor should be held by resident Indian entities.

Disclaimer - The views of the authors are personal, and should not be considered as those of the firm.