The new proposal emerging from a political deal (reported by FE) for increasing foreign equity in Indian private insurance JVs—by allowing FIIs to invest 23% with new equity instead of simply raising the FDI cap to 49%—should be viewed with deep concern for several reasons.
To begin with, it compromises the economic interests of all foreign insurers that have entered the Indian insurance industry; especially those who did so after 2004. Their joint-ventures have yet to reach break-even and generate positive cash surpluses and accumulate reserves sufficient to meet future long-term policy payout obligations.
It also risks introducing new third parties (i.e. FIIs) with no experience of the insurance industry as major shareholders in insurance JVs at the wrong time and at the wrong value. FIIs stand to make windfall gains in a short period of time when IPOs are launched. Yet they will have taken none of risks, nor borne the heavy costs that foreign insurers have borne for the last 6-7 years, in the face of regulatory U-turns, a sharp economic downturn, and acute policy uncertainty. All have affected the insurance industry adversely in terms of risks, revenues and profits. That introduces an element of unfairness and discrimination against the interests of long-term players with commitment to India.
The proposal favours insurers that already have related FIIs in India—through their in-house asset management operations—versus those that do not. The former can align interests through sweet-heart deals with affiliated FIIs while the latter cannot.
The proposal will create major valuation problems at entry for FIIs and for foreign insurers with a 26% equity stake in the majority of JVs that are still loss-making. It will create complications that will overtax the MoF and IRDA (and possibly the Indian courts) with undue administrative burdens.
If FIIs now entered into the shareholding of Indian insurance JVs at book value then in most JVs (especially the 17 late entrants in life insurance, 15 in general insurance and 4 in health insurance) they would be buying shares at 25-40% of par to reflect the sustained losses that long-term foreign shareholders have taken. These losses have been exacerbated by JV agreements that require foreign insurers to provide guaranteed returns of 12-24% to their domestic partners on the domestic share of the equity in these JVs. If FIIs entered into the share-holdings of the handful of pre-2003 JVs that are now in profit, they would paying 2.5 to 3 times book value at a minimum.
The tiering problem (that has arisen inadvertently) of there now being two classes of private insurance JVs in India (i.e. early entrants that are profitable versus late entrants who will not be profitable for some time) introduces a major element of unfairness into the system by introducing the forced entry of FIIs into insurance JV shareholdings well before IPOs can be contemplated.
This proposal will defeat the stated intent of MoF/GoI to increase confidence on the part of the foreign investment community by rewarding (speculative?) FIIs and discriminating against serious long-term FDI investors like insurance companies and pension funds. It will have the opposite effect from that intended by damaging rather than enhancing India’s image in the foreign investment community. It will create the opportunity for unfair (possibly illegitimate) windfall gains for round-tripped domestic capital via the FII route into domestic JVs that are close to launching IPOs.
The JV agreements that foreign insurers have with their domestic partners (all approved by IRDA), reflect clearly the intent of every foreign partner to hold 49% of the equity in the JV as soon as the rules so allow. Foreign insurers expected the FDI cap to be lifted within 5-6 years of entry. They felt encouraged when the cap was abolished for investment banks and asset management companies (integrally associated with the insurance business) within five years of their entry.
So, if asset management companies, investment banks and foreign commercial banks can be 100% foreign owned in India, why should only the insurance segment of the financial services industry be subject to unjustifiable discriminatory treatment in terms of FDI limits? Is the intent to protect the LIC and other public insurers? Is that good for the Indian consumer of insurance? If not what will be achieved?
What is to be gained by encouraging FII investment and discouraging FDI investment in a long-term industry with a 30-40 year business horizon like insurance, when every Indian government has wanted to achieve precisely the opposite? Are we now saying we now prefer FII to FDI after complaining that FII investment is hot and volatile while FDI is cold and permanent? If so why?
The FDI cap for insurance companies in India is the lowest in the world. Most Asian countries have caps of 51% (e.g. China) with Indonesia and Malaysia having higher caps and many permitting 100% FDI. What is so different about India that justifies a 26% for over 12 years after the insurance industry was opened up to the obvious and visible benefit of all Indians?
There are a number of other substantive reasons that militate strongly against this proposal. It seems to be driven by hasty political deal-making impulses without sufficient regard for unintended implications and consequences.
For these reasons MoF/GoI should stick to the original plan of increasing FDI in insurance from 26% to 49%. They should not, at this late hour—simply for political expedience which is not even necessary—complicate matters or muddy the waters by increasing foreign shareholding in insurance JVs via the FII route through a proposal that will do far more harm than good.
The author is chairman, Oxford International Associates Ltd