To boost foreign investments in the insurance sector, the Indian Parliament has enacted the Insurance (Amendment) Act, 2021 (“2021 Act”), and the Indian government has amended the Indian Insurance Companies (Foreign Investment) Rules, 2015 increasing the permitted foreign investment in insurance companies from 49% to 74%. As a natural corollary, the requirement of insurance companies being owned and controlled by Indian residents has been done away with.

In this ‘Fresh off the Press’, we have briefly delved into the changes enacted, and analyse how this is actually disadvantageous to one of the most interested investor buckets – the private equity investor.

LEGISLATIVE EVOLUTION

Prior to 2015, 26% foreign investment was allowed in the insurance sector (insurance companies and intermediaries alike). In 2015, the Insurance (Amendment) Act, 2015 (“2015 Act”) and the Indian Insurance Companies (Foreign Investment) Rules, 20151 (“2015 IRDAI Rules”) were enacted, permitting 49% foreign investment in both insurance companies and intermediaries. However, the 2015 Act and the 2015 IRDAI Rules also introduced the requirement that ownership and control of all insurance entities remains with Indian residents, which was not a requirement earlier.

In the budget speech for 2019-20, the Indian finance minister announced that appropriate measures would be taken to expand the limits of foreign investments in the insurance sector. While the 2015 IRDAI Rules were amended in September 2019 to remove the 49% foreign investment restriction, an amendment in the exchange control regulations was introduced in February 2020 to allow 100% foreign investment into insurance intermediaries, consequently also doing away with the requirement of ‘control’ to remain in the hands of Indian residents. However, the investment limits with respect to insurance companies remained unchanged at 49%.

In April 2021, the 2021 Act was enacted, which made appropriate amendments to the Insurance Act, 1938 (“Insurance Act”) permitting foreign investment up to 74%, subject to the conditions notified. Now, on May 19, 2021, the 2015 IRDAI Rules have also been amended by the Ministry of Finance (“2021 IRDAI Rules Amendment”) to permit 74% foreign direct investment in insurance companies.

CHANGES INTRODUCED IN 2021 ACT AND THE 2021 IRDAI RULES AMENDMENT

• Increase in foreign investment limit in insurance companies
  The foreign investment cap for insurance companies has been increased from 49% to 74% under the automatic route, subject to Insurance Regulatory and Development Authority of India (“IRDAI“) approval being taken wherever required as per the provisions of the Insurance Act. The 2021 Act incorporated the change in the Insurance Act and the 2021 IRDAI Rules Amendment has incorporated this change in the 2015 IRDAI Rules. The 74% cap, as earlier, includes direct and indirect investment, including investment by foreign portfolio investors.While this is a welcome change for many, it gives rise to a bunch of interesting scenarios. Majority of historical insurance joint ventures entered into with foreign financial and strategic players have had clauses giving the foreign partner the right to increase their shareholding if the law permits such an increase, subsequently. In 2015, when investment limits were increased from 26% to 49%, a number of insurance companies saw disagreements between the Indian and foreign partners over valuations. The same may happen again since now foreign partners of such JVs can increase their ownership from 49% to 74%. Indian promoters may now also want to be paid a control premium for exceeding control, which would only add to the complication!
• ‘Control’ test done away with
  As mentioned, the 2015 Act and the 2015 IRDAI Rules introduced the requirement for ‘ownership and control’ to rest with Indian residents. This was a major concern for foreign investors, as it limited the rights that the foreign investors could seek. While there has been no bright-line test laid down, the IRDAI issued guidelines on determining control.2 Further, this was also a concern for existing investors in insurance companies, since the governance framework required substantial changes to remove rights, despite no further foreign investment coming in.With the regulatory requirement tilting the governance framework in favor of residents, shareholders’ agreements were amended to cater for control being in the hands of residents. The removal of the ‘desi-control’ requirement is likely to again warrant a re-look at governance frameworks, where non-resident investors would want to realign the balance in their favour.
• Conditions to be complied with
  • For any foreign investment
    As was the case with the insurance intermediary relaxation in 2019, the 2021 IRDAI Rules Amendment has introduced certain conditions for insurance companies to comply with, if they have any foreign investments. However, as opposed to the conditions imposed in relation to insurance intermediaries, the conditions are lighter in case of insurance companies.
    The 2021 IRDAI Rules Amendment requires that a majority of the board and key management persons should be resident Indian citizens. In addition, one out of the chairman of the board, the managing director or the chief executive officer needs to be a resident Indian citizen3. Considering that non-resident investors can also nominate Indian citizens as directors on the board, it seems that the requirement should not pose significant challenges to comply with. In addition, the requirement of majority of key managerial personnel and the managing director / CEO / chairman of the board to be residents is also something that should not pose concerns, since the non-resident investors can appoint/nominate these members.A transition period of 1 year has been provided to insurance companies to comply with these conditions. While this should not pose a significant concern for any insurance company, ‘grandfathering’ of insurance companies having any foreign investment till such date could have been considered.
  • More than 49% foreign investment
    • Board construct
      For insurance companies with foreign investment exceeding 49%, at least 50% of its directors must be independent directors (or 1/3rd, in case chairperson of the board of directors is an independent director). While the intent of the condition seems unclear, it is likely that the Indian government is looking to impose governance mechanisms in a majority foreign owned insurance company similar to that of a listed entity.
    • Maintenance of reserves
      Further, to ensure that insurance companies have enough liquidity, the IRDAI has mandated that if dividends are paid out by the insurance companies in any financial year, and the solvency of the insurance company is below 1.2 times (the ‘control level of solvency’), it shall ensure that at least 50% of its net profits are retained as a general reserve.

DISADVANTAGE ‘PE INVESTORS’?
While the foreign investment norms have been relaxed, private equity investors (PE investors), who are extremely bullish on the sector, are now potentially at a disadvantage from a regulatory perspective. The IRDAI PE Guidelines, that were introduced in December 20174 require all PE investors (domestic or offshore) to set up an Indian special purpose vehicle (SPV) for them to invest in Indian insurance companies as promoters (i.e. in excess of 10%). This not only results in a requirement of an approval under the exchange control regulator for non-resident PE investors (since the SPV is a pure holding company) and potentially also from the RBI (since the SPV may be deemed to be a non-banking financial company), it is also inefficient from a tax perspective, since all gains from sales of shares are taxed at the SPV level, before they can be repatriated to the PE investor.

1.  Notification number G.S.R. 115(E) dated February 19, 2015
2.  IRDAI’s Guidelines on Indian owned and controlled dated October 19, 2015 available online at https://www.irdai.gov.in/ADMINCMS/cms/whatsNew Layout.aspx?page=PageNo2644&flag=1
3. A resident Indian citizen is defined as an individual who is resident in India, and is a citizen of India by virtue of the Constitution of India or the Citizenship Act, 1955.
4. IRDAI (Investment by Private Equity Funds in Indian Insurance Companies) Guidelines, 2017