Investing in India’s Insurance Sector

By Tracie Sloop Frost

The Indian Parliament recently enacted changes to the Insurance Act of 1938, which raise the foreign direct investment (FDI) cap in Indian insurance companies from 26 percent to 49 percent.  Since by law only domestic insurance companies are allowed to carry out the business of insurance, FDI through a joint venture is the typical process by which foreign companies acquire ownership of Indian insurance companies. 

The change in the FDI cap, designed to bring investment to India’s under-capitalized insurance sector, has encouraged insurance companies worldwide to consider opening or expanding operations in India.  But as recent regulatory issues and failed joint ventures suggest, companies will want to bear in mind the financial implications of entering into a joint venture. This article provides some considerations for entering the market, along with an overview of life and non-life insurance sector financial performance.

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Joint Venture Considerations

With the widening of the Indian insurance sector to foreign investors, the insurance market has become a tempting fruit to foreign companies looking to do business in India. However, given the risks of failure when entering into a joint venture in India’s insurance sector, companies should carefully consider the following challenges inherent in the market.

Foreign Ownership Restrictions

In India, the only way that a foreign insurance company can set up a business is by establishing a licensed local insurer through a joint venture with one or more local partners. The Insurance Act as amended requires that the Indian insurance company should be Indian owned and controlled at all times. The term “control” has been defined as the right to appoint a majority of the directors or to direct management and policy decisions.

Businesses considering entering the Indian market via joint venture should be mindful that these same restrictions could reduce the list of potential purchasers in the joint venture, should it decide to exit the Indian insurance market. Purchasers may not want to take a minority stake of a foreign insurer; nor will domestic companies want to enter into a joint venture with rival local insurers.

Limits on Promoting Insurance Businesses

The definition of insurance company under Indian law provides that the sole purpose of an Indian insurance company is to conduct insurance business. Therefore, insurers are only permitted to undertake activities that are incidental to or supplement the provision of insurance.

Further, under Indian law a foreign firm can have a stake in only one domestic insurer in the same space. This provision reduces the market share that a foreign firm can assume and could therefore hinder its ability to raise sufficient capital and diversify operations.

Regulatory Approvals

Prior government approval is required when a shareholder in an insurance company sells, or otherwise transfers, more than 5 percent of the total paid-in capital of the company. Regulations also require insurers to provide a statement indicating any shareholding changes over 1 percent of the insurer’s issued capital within 15 days of the end of every quarter. Additionally, insurers must carry on all core functions themselves. Only non-core activities can be outsourced.

The government has occasionally used outsourcing of external services to create a permanent establishment for a foreign insurer, resulting in taxation on the foreign insurer’s worldwide income. Most recently, Swiss Re won a case of against this practice in the Mumbai High Court in May 2015. However, the added cost of doing business from regulatory requirements may affect the commercial attractiveness of investment in a joint venture.

Price Restrictions

In India, the price of shares in a transfer from a foreign insurer to an Indian resident cannot exceed fair value, which is determined by a chartered accountant or merchant bank. This sets a ceiling on the maximum price an outgoing foreign shareholder can achieve for its shares in the joint venture, thus limiting a profit on sale. 

Regulatory Burdens

In view of the regulatory burden placed on insurance companies, it is perhaps not surprising that many foreign companies entering the Indian insurance market have faced significant difficulties in turning a profit. This is true of joint ventures in both the life insurance and non-life sectors.

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Life Insurance Market

Despite the potential for tremendous growth in the Indian life insurance sector, the life insurance market continues to show signs of financial stress, with only four of the 23 private insurers reporting cumulative profit in 2013 (the latest year that data is available). Various reasons exist for this, including:

• 60 percent of the individual and group business market is held by the government-owned Life Insurance Corporation of India; 
• The 12.36 percent service tax levied on the purchase of insurance contracts;
• Lack of effective, inexpensive, and diverse distribution strategies;
• Lack of penetration in the life insurance sector;
• Regulatory instability.

Moderate- to-heavy losses and slow premium growth have led several foreign joint ventures to exit the Indian life insurance market. In January 2015, U.K.-based life insurer Aviva appointed JP Morgan and Deutsche Bank to sell its stake in the Indian joint venture Aviva Life Insurance. When ING and New York Life exited life insurance joint ventures in India, ING sold its 26 percent stake for a loss and New York Life sold its 26 percent stake only for the estimated present value of future profits in the company. In 2012, HSBC put its life insurance business in India up for sale but was unable to sell it. 

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Non-life Insurance Market

The non-life insurance sector has also encountered substantial losses. In 2013, non-life premiums underwritten grew by 23 percent, but the segment continues to be saddled with considerable underwriting losses and pricing pressure. The non-life insurance industry consists of 25 companies – 18 of which are private insurers. However, six public sector non-life insurers hold a market share of nearly 60 percent. The reasons for the non-life industry’s financial woes are similar to the life industry, albeit with the notable inclusion of:

• Intense pricing competition;
• High expense ratios.

In 2012, more than half of the private sector non-insurance companies, including units of Canada’s Fairfax Financial and Japan’s Tokio Marine, reported losses. Owing to the difficult regulatory environment, steep underwriting losses and high claims ratios, non-life insurance sector companies have also sought to exit the Indian insurance market. Most notably, Royal Sun Alliance sold its 26 percent stake in Royal Sundaram Alliance, its joint venture in India, in 2014.

Reinsurance

One very bright spot in the FDI amendments relates to reinsurance. While the Insurance Laws Amendment Act 2015 caps FDI for life and most non-life insurance companies at 49 percent, it allows foreign re-insurers to open branch offices in India. In other words, foreign re-insurers can legally do insurance business in India without a joint Indian partner under the new rules.

A number of foreign insurance companies that operate in India through joint ventures are planning to open branches, including Swiss Re, Lloyds, Munich Re, and SCOR Global P&C. However, foreign reinsurance companies must wait for the insurance regulator to provide guidance on minimum capital requirements, profit repatriation and related issues.

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Gradual Progress

In sum, while Indian insurers’ profitability remains strained, the government seems committed to increasing companies’ access to capital, which is crucial for growth and increased market coverage. India’s determination to maintain domestic control over the insurance sector has caused foreign companies to review their presence in India – and to exit the country entirely in some cases.

However, the new rules allowing reinsurers to open branches in India are a move in the right direction. The reform push will likely continue, but progress will be gradual. During this new phase of growth in the Indian insurance sector, companies looking to enter joint ventures should carefully analyze all angles of their agreements to determine whether they can be profitable, and, if necessary, successfully exit the venture if the need arises.

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