Background

Between September 2019 and January 2020, several changes were made to the existing legal framework to increase the foreign investment limit in insurance intermediaries (including insurance brokers, corporate agents and web aggregators) from 49% to 100% and the earlier requirement of insurance intermediaries being “Indian owned and controlled” (IOC) was repealed. Following this change, the insurance industry eagerly awaited similar liberalisations for insurance companies as well. This move finally happened in May 2021, when the foreign investment limit for insurance companies was increased from 49% to 74% by the Indian government, and shortly thereafter, in July 2021, the IOC requirement was repealed by the Insurance Regulatory and Development Authority of India (IRDAI).

Regulatory approvals

Foreign investments up to 74% are now allowed in insurance companies under the automatic route (ie, prior approval from the Indian Central Government is not required). However, any transfer or issuance of shares of an insurance company in excess of 1% requires prior approval of the Indian insurance regulator, the IRDAI. Other regulatory approvals could be applicable depending on the specifics of each transaction.

Safeguards and conditions

Simultaneously with this increase in foreign investment limit and removal of the IOC requirement, the Government and IRDAI also prescribed certain new conditions which require every insurance company having any foreign investment to ensure that a majority of its board of directors, a majority of its key management persons, and one among its chairperson of the board, managing director and chief executive office are “resident Indian citizens”.

To qualify as a “resident Indian citizen”, an individual must be an Indian citizen and should have resided in India for more than 182 days during the course of the preceding financial year.

For insurance companies having foreign investment in excess of 49%, two additional requirements have been introduced:

• retention of profits – at least 50% of the net profit for a financial year must be retained in general reserve of such insurance company if, for such financial year, a dividend is paid on equity shares; and at any time during the financial year, the solvency margin of the insurance company is less than 1.2 times the control level of solvency of 150%;
• independent directors – at least 50% of the board of such insurance company must consist of independent directors. If, however, the chairman of the board is an independent director, only one third of the board needs to consist of independent directors.
  Potential impact on the Indian insurance sector

While this move is still very recent, some insurance companies are already undertaking transactions that will see an increase in their foreign investment beyond 49%. The increase in the foreign investment limit has the potential to act as fuel to propel Indian insurance companies and the insurance industry as a whole, by providing access to more foreign capital. Some expected outcomes are growth and expansion, reduction of financial burden on Indian promoters, entry of new foreign insurers, increase in overall competition in the industry, reduction in costs for policyholders and introduction of innovative insurance products and technologies. With foreign shareholders having the ability to own a majority stake and control insurance companies, there will be more incentive for them to share technical know-how with the Indian insurance companies and enhance focus on product innovation.

This also opens doors for new joint ventures in the Indian insurance sector where foreign insurers that may not have entered the Indian insurance market till now due to restrictions on ownership and control can set up joint ventures with Indian investors looking to be minority non-controlling shareholders. This increases the available options for Indian promoters in the context of their role in insurance companies.

With the increase in overall competition in the insurance industry, a natural corollary would be better claims servicing, customer-focused products and a reduction in costs of insurance products. This could help in making insurance products more accessible to a wider segment of the Indian population, increase insurance penetration, and enhance the overall policyholder experience.

Influx of Private Equity Investments in the Indian Insurance Sector

India has seen a steady increase in private equity investments (led by private equity funds) in the insurance sector. Many new insurance companies are moving away from the traditional joint venture structures, where an Indian promoter – typically, a well-established corporate house – would enter into a joint venture partnership with a foreign insurer to set up an insurance company, to more diversified investment structures, usually involving several private equity investors. Similarly, there has also been a rise in private equity investments in insurance intermediaries.

There are two routes for investment by private equity funds in unlisted insurance companies:

• as an “investor”, holding up to a 10% stake. As an “investor”, the fund may invest in the insurance company either directly or indirectly through a special purpose vehicle (SPV). An SPV is an Indian company or a limited liability partnership, formed for the exclusive purpose of investment in an insurance company; or
• as a “promoter”, usually holding more than a 10% stake. A fund cannot invest as a “promoter” directly in an insurer, and such investment can only be made through an SPV.

Investment conditions

Some of the key conditions that apply to private equity investments under the PE Guidelines are:

• all private equity investors are required to satisfy the prescribed “fit and proper” criteria; and
• investors are restricted from creating any encumbrance or leveraging the investment.

Promoter category private equity investors are:

• subject to a lock-in of five years (“Lock-in”). The Lock-in also extends to the shareholders of the SPV who hold 10% or more of the capital of the SPV;
  required to undertake to subscribe to the rights issue of an insurer, to ensure that the insurer is not cash strapped;
• required to seek prior approval of the IRDAI in the case of induction of new shareholder(s) in the SPV by fresh issuance of shares beyond 25%.

Recent private equity investments

• In 2019, Warburg Pincus acquired a 26% stake in IndiaFirst Life Insurance.
• In 2019, Carlyle bought a 9% stake in SBI Life Insurance. Carlyle recently exited this investment in August 2021.
• In 2020, Warburg Pincus and Premji Invest acquired a 9.99% and 16.01% stake, respectively, in SBI General Insurance.
• Go Digit General Insurance has investors such as A91 Partners, TVS Capital and Faering Capital.
• Acko General Insurance has investors such as Amazon, Catamaran, Ventureast, SAIF Partners and Accel. Acko is also in the process of inducting new investors such as General Atlantic, Multiples, Canada Pension Fund and Lightspeed.

With the increase in foreign investment limits and the gradual shift away from traditional investment structures, private equity investment in India is expected to grow exponentially in the near future.

A New Era of Consolidation

In addition to the inflow of large PE funding, 2021 also ushered in an era of consolidation in the Indian insurance sector, with an increase in consolidations and mergers. The advent of the pandemic and its impact on the financial sector across the country saw several larger insurance companies (both life and general insurers) acquiring smaller insurance companies, in order to reach the next phase of growth.

In September 2021, the general insurance company ICICI Lombard completed its merger with Bharti AXA, resulting in the creation of India’s third-largest general insurer. In 2021, HDFC Life Insurance Company Limited commenced its acquisition of Exide Life Insurance Company Limited, and will now proceed to merge with it this year, having received the regulatory nod on 1 January 2022. Earlier in 2020, the standalone health insurer HDFC Ergo had also merged with fellow health insurer Apollo Munich Apollo Munich Health Insurance, making HDFC Ergo the second-largest private insurer in the accident and health insurance business.

Such consolidations are likely to increase insurance penetration in the country and support long-term solvency and capital infusion requirements of such insurers. Successful mergers will also help lower operating expenses and help smaller insurers achieve much needed economies of scale.

The recent shift towards consolidation in the Indian insurance sector reflects the signs of a maturing industry, which is focused on growth, stability and profitability, while also serving customer needs better.

Digitisation of the Insurance Sector in the Wake of COVID-19

While digital penetration in India has increased exponentially in the last decade, insurance penetration has been slow to follow suit. That said, in the last few years, the Indian insurance space has sought to reinvent itself like never before by adopting digital solutions. The COVID-19 pandemic brought about severe disruptions to traditional insurance procurement/servicing processes and has catalysed the digitisation of the sector.

Regulatory push

The IRDAI was quick to recognise that digitisation was quintessential to meeting the challenges to the insurance industry owing to the COVID-19 pandemic, and took measures to ensure availability of substitute modes of digital contact for policy servicing and claims settlement. Insurers were encouraged to devise appropriate insurance products protecting from risks arising out of COVID-19. The IRDAI also committed to process such product approvals on a fast-track mode. Insurers were instructed in the early stages of the pandemic itself to make special efforts to enable policyholders to pay premiums using digital payment avenues, display on their websites FAQs for COVID-19 claims, issue policy documents via email and educate their policyholders on alternative arrangements made for premium payments, and settlement of claims.

Pursuant to representations from insurers regarding the difficulties in printing, handling and dispatch of policy documents during the pandemic-induced lockdown and the desirability of adopting total digital means of doing business, the IRDAI granted an exemption to insurers from the requirement of issuing policy documents and the copy of the proposal in physical form and also dispensed with the requirement to obtain a wet signature on proposal forms. Although this exemption was made for a limited period on account of the pandemic (currently extended till 31 March 2022), it may be useful to provide a general exemption in the post-pandemic era as well.

Digilocker

In another significant push towards digitisation, the IRDAI has instructed insurance companies to issue digital policies via “Digilocker”. Digilocker is a flagship initiative under the Digital India programme of the government of India, where citizens can get access to authentic documents/certificates in digital format, in their document wallet, from the original issuers of these documents and aims at minimising the use of physical documents. Digilocker is expected to drive reduction in costs, elimination of customer complaints relating to non-delivery of policy copy, improved turnaround times, and on the whole improve policyholder experience. To promote the adoption of Digilocker, insurers have been advised to educate retail policyholders about this facility and the ways to use it.

Regulatory sandbox

Against the backdrop of the global fintech revolution, which ushered in novel and sophisticated technological innovations in the global insurance market, in July 2019, the IRDAI introduced the IRDAI (Regulatory Sandbox) Regulations, 2019 (the “Sandbox Regulations”) with a view to create a conducive regulatory environment for insurers and intermediaries to pilot innovative approaches for the development of the Indian insurance sector. Under the sandbox regime, proposals such as crowdfunding of premium, app-monitored wellness programs, insurance gift cards, need-based products, artificial intelligence-based automotive claims and collision estimation were approved by the IRDAI in three different tranches in the last three years. The Sandbox Regulations were to remain in effect for two years and were scheduled to expire in July 2021; however, the IRDAI extended it for a further two years to continue enabling sandbox environments to test innovations in the Indian insurance space.

Digitisation has been recognised as being intrinsic to the future growth of the sector. Digital-only insurers Acko General and Go Digit, established in the second half of FY 2017-18, have registered noteworthy growth over the last year. Insurers across the board, including traditional bricks and mortar insurers, have now adopted AI chatbots, auto-processing of claims, contactless on-boarding of customers, video bases motor claims settlements.

The Rise of Embedded Insurance

Background

With growing digital penetration in India, an increasing number of consumers are buying products and services online or through mobile applications. Insurers have begun to leverage this digital disruption to sell insurance coverage, by offering “embedded insurance” to consumers.

Embedded insurance primarily involves providing insurance coverage to consumers at the time they avail a service or purchase a product, such that insurance coverage is bundled within another core product or service. For example, when purchasing an electronic device, consumers are given an option to also purchase accidental damage and theft insurance, in order to secure their new purchase. Such embedded insurance is offered either on a paid basis (requiring payment of additional insurance premium while purchasing the core service/product), or on a complimentary basis (where the insurance cover is attached to each sale of the product or service).

Group policy arrangements

Underwriting and sale of all insurance products in India can only be undertaken by entities licensed by the IRDAI. Therefore, embedded insurance covers in India are primarily based on group insurance arrangements. Entities ordinarily buy a group or master policy from the insurer and thereafter enrol customers under the master policy for coverage, if opted for by the customer at the time of purchase of the core product/service. As such, solicitation, distribution and administration of group insurance policies is regulated extensively by the IRDAI. In order to constitute a valid “group” for group insurance under the IRDAI’s norms:

• such group should consist of persons assembling together with a commonality of purpose; and
• the group should not be formed with the main purpose of availing of insurance.

Bundling

As such, the extant insurance laws do not permit compulsory bundling of insurance products. In other words, embedded products cannot be structured in a manner where customers are forced to purchase insurance as a condition for availing of the core product/service.

Remuneration of stakeholders

Compensation payable to stakeholders in an embedded insurance model is also challenging as insurance laws in India prohibit inducements or the offering of rebates to persons purchasing insurance, and permit the payment of remuneration for insurance solicitation only to licensed intermediaries at prescribed rates. The IRDAI also strictly regulates the advertising of insurance products, and the extent to which it may be done by unlicensed third parties.

Potential impact on the sector

This model permits insurers to utilise pre-existing distribution networks for marketing their insurance products, at low costs. By exposing customers to insurance products as a seamless part of their daily lives, embedded insurance increases awareness about insurance in general. Over time, such awareness provides an upsell opportunity to insurers and may translate into greater traditional product purchase.

Embedded insurance can potentially increase insurance access to a wider demographic, and their data enables insurers to enhance overall product innovation. The next phase of growth for embedded insurance can be fuelled by insurtech players not only augmenting distribution, but also the policy servicing/claim settlement aspects. Depending on the levels of uptake by customers, this model will likely impact product innovation and underwriting functions in the coming years.

Surety Insurance: the New Horizon for Securing Infrastructure Projects

In light of the COVID-19 pandemic and consequent economic impact on liquidity and cash flow issues in the Indian banking sector, contractors and developers were finding it increasingly difficult to obtain bank guarantees for road/civil infrastructure projects. The Ministry of Road Transport and Highways, Government of India, had requested the IRDAI to examine the possibility of surety bonds being issued by general insurance companies, pursuant to which the IRDAI set up a Working Committee of experts in July 2020 to develop a framework for surety insurance in India.

Based on the Report of the Working Committee, on 8 September 2021, the IRDAI issued the “Exposure Draft on IRDAI (Surety Insurance Contracts) Guidelines 2021” and invited comments from stakeholders. Subsequently, on 3 January 2022, the IRDAI issued the final IRDAI (Surety Insurance Contracts) Guidelines, 2022 (“Surety Guidelines”) to cover surety contracts in insurance. These guidelines will come into effect from 1 April 2022.

Pursuant to the Surety Guidelines, such surety insurance may be offered to both government and private infrastructure projects in all modes. Such surety insurance cover can only be offered to specific projects (for up to 30% of the contract value) and cannot be clubbed for multiple projects.

Eligibility

The IRDAI has also prescribed certain eligibility criteria for underwriting surety insurance. A general insurer can commence surety insurance business if it has 1.25 times the minimum statutory solvency margin. If at any point in time the solvency of the insurer goes below such required level, the insurer has to stop underwriting the new surety insurance business until its solvency margin is restored to above the threshold limit. Additionally, the regulator has also prescribed that the underwritten premium in a financial year for any general insurers from the surety insurance business shall not exceed 10% of the total gross written premium, subject to a maximum of INR5 billion.

Restrictions

To ensure that the focus remains of the Indian infrastructure sector, the IRDAI has restricted surety contracts from being issued in respect of underlying assets/commitments located outside India. Further, there are restrictions on issuing surety insurance on behalf of the insurers’ promoters, associates and related parties.

To ensure collaboration, the IRDAI is allowing surety insurers to work alongside banks and other financial institutions to share risk-related information and technical expertise. This will enable insurers to closely monitor projects and develop their surety-related capabilities.

Surety insurance has been a long-awaited demand of the Indian infrastructure sector and will be a big push for its continued growth. Although it is still in its nascent stages, and we will need to wait to see how surety insurance products perform in the market, the issuance of a comprehensive legal framework in the form of the Surety Guidelines is a move in the right direction, and will certainly help distribute some of the financing pressure on Indian banks.

This article was originally published in Chambers & Partners on 25 January 2022 Co-written by: Shailaja Lall, Partner; Uday Opal, Principal Associate; Arush Upmanyu, Principal Associate; Christina Shaju, Associate. Click here for original article

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