The next steps for India's FDI insurance hike

For more than six decades the Indian insurance sector was under the monopoly of a few nationalised insurance companies.  These companies were seen as lumbering, inefficient entities that were unable to satisfy consumer demands, and provide varied insurance products at lower costs. 

The sector in India was liberalised in 2000, when private players and foreign direct investment (FDI) were allowed to take up to a 26% stake in Indian private insurance companies. These companies were set up as joint ventures (JVs) between large foreign insurers and Indian business groups.

More than a decade since the opening up of the sector, the government has announced its second round of liberalisation, which should give a boost to insurance.

Describing the sector as “investment starved” and recognising that “several segments of the sector need expansion”, the new Indian government in its maiden budget this year proposed to raise the FDI cap in the Indian insurance sector (which includes life and non-life insurance as well as insurance intermediaries) from 26% to 49%. 

The increase comes with two conditions:

• The insurance company will remain under full Indian management and control
• Prior government approval will be required to increase the foreign shareholding to 49%. 

The increase in the FDI cap is subject to the passage of the long-pending insurance amendment bill, which has been tabled before Parliament in India. The government also proposes to leverage the bancassurance model to increase the outreach of the insurance sector in India.

Give and take

The FDI announcement to increase the FDI cap is a positive step, especially for new foreign insurers that propose to set up shop in India under the JV route, as well as for existing foreign insurers who are keen to increase their FDI in their Indian JVs. 

However, the announcement has created some ambiguities:

• What would constitute Indian control and management?
• How would operational control arrangements continue to work under the new regime?
• What would be the impact on valuation of investments and so on? 

Foreign insurers have already infused substantial capital into their Indian insurance JVs and have retained optionality clauses in their agreements with their Indian counterparts that allow them to increase their stake at a nominal value once the FDI cap is increased.

These JV agreements have been previously vetted by the insurance regulator and the Indian government, so there are concerns that under the new regime the government will take a fresh look at what constitutes Indian management and control. It may ask for amendments in the shareholder arrangements between the foreign insurers and their Indian JV partners. 

The government has indicated that it will put in place procedures for granting approvals for increases in FDI and will release guidelines to clear any confusion as regards existing JV agreements. But it has not given any indication when these procedures and guidelines will appear.

Development incentives

Participation by foreign players in the insurance sector does not only attract foreign capital, it also means that sophisticated insurance products would become available to consumers in India. 

The growing Indian insurance sector means there is ample potential to develop a market for high-end and complex insurance products to cater to urban India. 

The growth of the insurance sector can be furthered if a more flexible regime is implemented, such as granting differentiated insurance licences to certain insurance companies, based on their focus areas and product offerings.

One area that has not yet been addressed by the Indian government is granting additional tax incentives to the insurance sector, which would go a long way to allaying the concerns of the industry. 

In India, insurance companies take a little over a decade to break even. If they were allowed to carry forward their tax losses for set-off purposes for a longer period than the eight years under current Indian tax law, this would ensure optimum use of tax losses.

The government has attempted to augment the insurance sector and has tried to lift investor sentiment.  However, for a sector with immense growth potential, it deserves more than just a policy-level announcement to increase the FDI cap. 

Foreign insurers seem keen to increase their stake in their Indian JVs, but this is only likely to come to fruition once the government clarifies its position on Indian control and management.

Russell Gaitonde is a partner with India-based tax and regulatory consultancy firm BMR Advisors (russell.gaitonde@bmradvisors.com). The views expressed here are personal; he was assisted by BMR associate director Sudeep Sirkar.