Get complete information on the Investment Regulations for Life Insurers

The Insurance Regulatory and Development Authority (IRDA) Formulated Investment Regulations in August, 2000 and subsequently amended them in May 2001.

‘Unit Linked Life Insurance Business’:

Every insurer shall invest and at all times keep invested his segregated fund of unit linked life insurance business as per investment offered to and approved by the policy-holders.

Unit Linked policies may only be offered here the units are linked to categories of assets which are both marketable and easily realizable. However, the total investment in other than approved category of investments shall at no time exceed 25% of the fund.

An attempt has been made to discuss the issues arising out of the investment regulations pertaining to life business.

1. The inclusion of infrastructure appears to aim for channeling insurance funds into infrastructure projects which need long term funds in significant amounts. Further in the changed economic scenario, the funds could be invested in Corporate Sector for implementing he infrastructure projects.

2. Earlier also the mandated investments were directed towards social sector. However the definition of social sector under IRDA regulations is more rigorous and basically these investments are meant for the development of economically backward segments in both urban and rural sectors.

3. Even though the objectives are laudable, given the slow pace of progress in the implementation of infrastructure projects thereby slowing the off take of funds coupled with the rigorous definition of social sector the insurers, more so the existing players may find it difficult to deploy the funds in the social Sector on accretion basis, as per the Regulations.

4. The regulator may consider under the definition infrastructure Oil and Gas Pipelines, CNG, LNG Terminals, which also need huge sums of money. Further, it may also consider investments in funds exclusively devoted for infrastructure sectors as investments under infrastructure.

5. Many Infrastructure projects have foreign collaborations. The companies, for implementing these projects, are being incorporated as Private Limited Companies. On doing so, apparently, the foreign partners in these Companies enjoy certain tax benefits.

6. But the insurance Act, 1938 as amended, explicitly states that an insurer shall not out of his controlled fund investor keep invested any sum in the shares or debentures of a private limited company.

The act therefore effectively bars any investment in a private limited company. This provision may act as an impediment for flow of funds into private limited companies implementing infrastructure projects. This issue therefore needs to be re-examined.

7. In addition, the definition of rural and social sector is quite rigorous. It is indeed quite challenging for the insurance companies to evolve norms for granting loans in the social sector, wherein mostly the loaners are individuals with little or no security.

8. The insurance companies, as they are not equipped to identify the beneficiaries/genuine credit needs, may have to involve village level panchayats, NGOs, Co-operative Societies and other government agencies to lend for the social sector.

Even by lending through these organisations, the issue of monitoring will still be left unanswered, in view of the lack of administrative mechanisms available with insurers. The regulator may have to look into these practical aspects and review this regulation.

Alternatively, the insurance companies may be directed to lend to government rural organisations/nodal agencies either directly or by way of refinancing and such investments may be treated as investments under social sector.

9. The regulation does not specify any definite percentage of investments separately for infrastructure and social sectors. However, in a recent amendment proposed, it explicitly mentions that every insurer shall endeavor to maintain a proper balance between the investments made in infrastructure and social sectors thus inhibiting insurers from investing in one sector completely and complying with the regulation.

10. The compliance with this regulation may not be easy for existing life insurer i.e., LIC, as it has a huge controlled fund approximating to Rs. 200,000 Cr. 15% of this will amount to Rs. 30,000 Cr.

If one has to strike balance in the investments between infrastructure and social sector, the investment figures are mind boggling and to deploy that kind of money in the social sector may not be very easy.

Even on accretion basis, wherein the yearly accretions are in the range of Rs. 28,000 to 30,000 Crs, compliance with this regulation will be difficult as the numbers involved are about Rs. 4200-Rs. 4500 Cr.

If a balance has to be struck between the investments in infrastructure and social sector, at least an amount of Rs. 1000-1500 Cr. may have to be invested in the social sector. Therefore to comply with the regulation on year to year accretion basis, let along on total control fund, would be very difficult.

11. These investments, notwithstanding the issues mentioned above, have to comply with the norms as specified in Schedule-1. The recent amendments to Schedule-1 say that bonds issued for development of infrastructure and social sectors, duly guaranteed by government or otherwise rated AA by an independent rating agency, issued by others would qualify as approved investment.

12. Most of the infrastructure projects are implemented under new companies without any track record. General view among the rating agencies is that project bonds/debentures will not get a rating of more than A+ on their own accord.

As these projects involve substantial investments, the guarantees from parent companies may not be forthcoming. Therefore in practice bonds may not qualify as approved investment. It is assumed that “others” means other than Government.

13. The IRDA, under Section 27A. amended the following clause:

14. “All secured loans, secured debentures, secured bonds, other secured debt instruments, shares and preference shares and debt instruments issued by all India Financial Institutions recognised as such by RBI-investments to be made in terms of investment policy guidelines, benchmarks and exposure norms/limits approved by the Board of Directors of the Insurer”.

15. The Notes 2 to 4 under regulations 3 & 4 mention that all investment in assets/instruments which are capable of being rated as per market practice be rated and should carry a minimum rating of AA. If sufficient investments of this grade are not available, Investment Committee may approve investments in instruments rated A+.

16. Going by the workings of the clause, one may infer that all the project loans/debentures etc., which are generally secured by a first charge on the assets of the company and are not rated as per market practice may qualify as approved investments.

17. Another significant issue is point 7 in the notes which states “investments in equity shares listed on a recognised stock exchange should be made in actively traded and liquid instruments viz., its trading volume does not fall below 10,000 in any trading session during the last 12 months or trading value of which exceeds Rs. 10 lacs in any trading session during last 12 months”.

18. It is presumed that it pertains to only secondary market operations. By virtue of this note, it is assumed that the insurer is not prohibited from investing in IPOs, project equities and other privately placed equities in companies which may not be listed immediately.

In fact many infrastructure project companies seek equity investments as part of project finance and these companies generally propose to get listed only after the project is commissioned and start earning profits.

Further, many infrastructure related funds are being floated for initial project development and these funds need equity Investments.

19. The regulations mention that other approved investments shall be governed by Exposure Norms. Hence it may be inferred that Exposure Norms may not apply for Infrastructure and Social Sector Investments.

20. The regulator has included Commercial Paper with “very strong” or more rating, inter alia, in the approved investments. In view of the developing market for Securitisation, the regulator may also consider including “Pass through Certificates” issued with “very strong rating” as approved investments.

In recent times, PTCs have slowly started coming into the market and will provide a good investment opportunity for insurers as these are generally backed by cash flows and also asset cover in the case of mortgage backed securities and suitable credit enhancement facilities.

In recent times, all PTC issued were rated as “AAA (so)”. It may be noted that in the domestic market, none of the securitised deals has experienced default as of today.

21. SEB1 in its latest move has banned the carry forward trading and introduced options on individual equities w.e.f. 2nd July. The Index futures have already started trading. Options and futures, world over, are used by insurance companies as portfolio hedging instruments.

As per the reporting formats prescribed by the IRDA, it appears there is no bar on insurance companies to deal in derivative instruments. However, detailed guidelines may be necessary in view of the varied risk profile of derivatives depending upon the purpose for which they are traded in/held.

For example if an insurance company holds derivative instruments purely for hedging its portfolio, which will enable it to reduce the investment risk on the portfolio, it may be considered as an approved investment.

22. As already mentioned above, many infrastructure projects are being implemented as Private Ltd. companies. Besides, many of these projects are coming up with structured products such as Take Out Finance etc. These instruments may be considered as part of the financing instruments for the projects along with the traditional instruments.