Insurance Regulatory and Development Authority (IRDA) today allowed insurance companies to hedge their interest risks by participating in interest rate derivatives of a longer tenure.
As per existent norms, insurers are permitted to enter Forward Rate Agreements (FRAs), Interest Rate Swaps (IRS) and Exchange Traded Interest Rate Futures (IRF) with a maximum tenure of one year.
However, as per the final guidelines insurers would be able participate in interest rate derivatives over one year. However, there is no upper cap for maturities of such instruments.
Participation in interest rate derivatives would help such companies to protect their return due to fluctuation in the interest rates and protect financial health.
Commenting on the guidelines, ICICI Prudential Executive Director Sandeep Batra said "It is a welcome move. It will help insurance companies to hedge their long-term interest rate risks."
Some of the products of insurance companies provide guranteed return. However, due to fluctuation in the interest rates, returns can come down. This can put pressure on the finances companies.
As per the guidelines, the objective of any use of the listed derivatives is that they must be used for hedging purposes only to reduce the interest rate risk.
"Companies enter into these agreements to hedge the interest rate risk on investments and the forecast transactions. Hedging interest rate risk of investment in fixed income securities would cover fixed income derivative positions that are designed to offset the potential losses from existing fixed income investments of them," it said.
Putting conditions, the guidelines said, a participant's dealings in interest rate derivatives would not exceed an outstanding notional principal amount equivalent to 100 per cent of the book value of the fixed income investments of the insurance company under the policyholders fund, it said.
This would exclude ULIP funds in case of life insurers and the shareholders funds taken together, it added.
The mark-to market gain or loss arising out of the effective hedge would be borne by the respective fund only.
Exposure limits pertaining to single issuer, group and industry will be applicable for the exposure through FRA and IRS contracts, it said.
No contracts shall be entered with promoter group entities either directly or indirectly, it added.
"The guidelines are fairly comprehensive and there is a fair amount of checks and balances so that insurance companies do run into the risk of overexposures of such instruments," Batra said.