Business

Foreign Direct Investment in insurance

The political fraternity has set up a clear road map for liberalisation of the insurance industry and the present move to raise the FDI limit is just one of the steps.

THE PROPOSAL to raise the level of foreign direct investment in the insurance sector from 26 per cent to 49 per cent has, as expected, caused some concern among trade unions.

However, with near unanimity among major political parties on the issue, the proposal is likely to be incorporated in the Insurance Act shortly. Is it such a major issue to worry about? If not, what is the real issue at stake?

In this context, it may be interesting to look at the report of the Malhotra Committee. The main recommendations of the committee were:

The private sector should be allowed to enter the insurance business.

The promoters' holding in a private insurance company should not exceed 40 per cent of the total. However, if promoters wish to start with a higher holding, they may be permitted to do so provided their holding is brought down to 40 per cent within a specified period through a public offering.

If and when entry of foreign insurance companies is permitted, it should be done on a selective basis. They should be required to float an Indian company for the purpose, preferably in joint venture with an Indian partner.

It can be seen that, contrary to popular belief, the Malhotra committee neither recommended nor opposed the entry of foreign insurers. The intention behind the words "if and when" was to allow purely Indian companies some time to establish themselves before permitting foreign insurers to enter the market.

No serious bid

The Government accepted all the recommendations of the committee. But, as per Sec.2 (7A), incorporated in 1999 in the Insurance Act, 1938, "a foreign company's stake in the equity of an Indian insurance company shall not exceed 26 per cent, whether held by itself or through its subsidiary companies or nominees.''

This means that four foreign companies can together exercise 100 per cent control over an Indian life insurance company. Though four foreign insurance companies will never like to come together, one insurance company and three non-insurance companies can easily combine and enter the Indian market.

This was reinforced by Press Note 10 dated October 19, 2000 of the Department of Industrial Policy and Promotion, permitting the automatic approval route in the insurance sector if the foreign equity participation is up to 26 per cent. That is, for a group of foreign companies to hold more than 26 per cent stake, prior approval is required. Which may be a mere formality.

The important point that comes out from Sec. 2(7a) of the Insurance Act and the press note is that, unlike in the case of the telecom sector, the Government did not want to place any cap on FDI in the insurance sector. No political party raised its voice against this decision during the last four years while the trade unions did not fully comprehend the implications of these provisions.

A restriction has however been placed by a subordinate legislation, the IRDA Regulations 2000, in respect of registration of Indian insurance companies. This places a cap of 26 per cent on the aggregate foreign investment. This restriction is however temporary in nature and the Government can, at any time, direct the IRDA to amend this regulation in step with Sec. 2(7A).

The impression that this is a temporary restriction is reinforced by Sec. 6AA of the Insurance Act which states, "If the promoters hold more than 26 per cent of equity capital, the excess portion has to be divested in a phased manner AFTER a period of ten years from the date of commencement of operations.''

The section is quite vague about the period within which the divestment has to be completed. It has also been specifically stated that this section will not apply to promoters, being a foreign company.

It can be seen from the foregoing that the political fraternity has set up a clear road map for liberalisation of the insurance industry and the present move to raise the FDI limit to 49 per cent is just one of the steps in the road map.

The Indian partners, in most of the new insurance companies, have already passed on total operational control to their foreign partners in anticipation of the FDI limit being raised to 74 per cent. The Finance Minister has only proposed to place a partial seal of approval on what is already a fait accompli.

The foreign insurers cannot be prevented from tightening their hold over the Indian insurance industry by just pegging the FDI limit at 26 per cent. They can take over control, whatever be the FDI limit. They can be contained only if we understand their strengths and weaknesses. Their strength is their bottomless pockets. They can invest any amount of money. Their weakness is lack of patience. They can start a life insurance company, but would prefer to expand and consolidate through a series of acquisitions. They have neither the patience nor the expertise to build an organisation, brick by brick, over a period, as the LIC has done. How Coca Cola expanded its operations in India may be fresh in public memory. Block the acquisition route, they will cease to be a force to reckon with.

Promoters handicapped

This can be done by making conditions more favourable for fully Indian owned companies to enter the insurance sector and barring FDI in such companies.

The present minimum capital requirement for an insurance company is the highest in the world and the solvency margin requirements, the most stringent. They have been so designed as to keep an Indian entrepreneur from entering the insurance sector on his own. The capital actually required and a comparison of the solvency margin requirements with those prevailing in developed countries will be dealt with in a separate article.

What is needed is to lift these artificial restrictions on the entry of fully Indian owned companies. The trade unions should work towards lifting these restrictions rather than wasting their time in chasing the illusion of limited FDI, which is not the real issue at stake.

Enabling fully Indian owned companies to enter the insurance arena will lead to development of healthy industry standards and generation of better job opportunities.

R. Ramakrishnan (Actuary)

(Actuary)

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