New Delhi: India’s insurance regulator will soon fix an explicit cap on investment by insurance firms in initial public offerings, or IPOs, and increase their investment limit in mortgage-backed securities, or MBS, in an effort to moderate their risk exposure.
The move is expected to reduce exposure of insurance companies to equity investments, while increasing it in debt, which, the regulator believes, will reduce risk even while raising returns.
An MBS is an asset-backed security whose cash flows are backed by the principal and interest payments of a set of mortgage loans.
The investment of insurance firms in IPOs will be capped at either 10% of their subscribed capital or 10% of their fund value, whichever is lower, said officials at the Insurance Regulatory and Development Authority, or Irda, who did not wish to be identified.
The fund value is essentially the corpus associated with a particular insurance scheme.
According to existing guidelines on investments by insurance firms, the governing boards of these companies can empower their respective investment committees to invest in IPOs that meet certain conditions. However, there is no cap on the investment. The proposed cap is part of changes in investment norms that Irda is expected to notify this month.
Insurance firms will have to rebalance their portfolio by the end of September to meet the new investment norms. To ensure that these regulations are strictly followed, Irda plans to increase the reporting frequency of companies from 45 days to 21 days. This will mean that the companies have to provide an update of their investments to the regulator once in three weeks.
“Reporting frequency has been increased to ensure that companies immediately rebalance their portfolio and reclassify it, if ratings (of their investments) go down,” said an official at Irda, who did not wish to be identified.
“Given the sharp rise in the stock market most of the insurance companies were putting most of their fund value in the primary markets,” said a senior official of Irda, who, too, didn’t want to be identified. “To ensure that the entire portfolio doesn’t get diluted, the regulator has decided to put a ceiling on IPO investments and introduce other instruments for investments by the insurance companies,” he added.
Since January, 23 companies have completed their initial share sales. Of this, 15 stocks have listed at a premium over the issue price and eight below.
Insurance companies admit that the new regulations will encourage them to be more circumspect.
“It’s certainly a welcome step to avoid concentration of risk and (to ensure) diversification of investment portfolio for reducing risk of policyholders,” said Sunil Kakkar, director and chief financial officer of Max New York Life Insurance Co. Ltd.
Irda also plans to increase insurers’ headroom to invest in MBS by reclassifying them. MBS will be classified as “approved securities” in future as against the current classification of “other than approved securities”.
Investments in MBS will help insurers increase yield without sacrificing quality, said Puneet Nanda, executive vice-president and chief investment officer at ICICI Prudential Life Insurance Co. Ltd.
Irda will allow insurers to invest in MBS which get the highest possible credit rating (AAA).
Secondary market trading in MBS tends to be low when compared to bonds of similar rating, said Nanda. Consequently, the yields on MBS tend to be higher which suits insurers who can afford to wait, he added. Low trading activity, or illiquidity, decreases the price of debt securities such as bonds and increases their yield.
Last year, Parliament cleared legislation meant to boost trading in instruments such as MBS. The Lok Sabha approved the Securities Contracts (Regulation) Amendment Bill, 2006, a year ago. “It (legislative approval) is a very major step,” S. Sridhar, chairman and managing director of National Housing Bank, India’s mortgages regulator, had said then.
Other than MBS, the proposed norms permit investments in money market (or debt) instruments such as rated certificates of deposit, rated commercial papers, treasury bills and collateralized borrowing and lending obligations in the approved instruments category.
Irda will synchronize the definition of infrastructure investments with that of central bank, the Reserve Bank of India, opening the door to insurers to invest in bonds floated by developers of special economic zones. “The motive for expanding the portfolio is to put a curb on wrong marketing practices, too,” said the official.
Under the new investment norms, the regulator has decided to divide shareholders fund between funds required to maintain solvency margin and a surplus.
Insurance companies are required to maintain funds which will be sufficient to meet their liabilities (insurance policy claims) and this is called the solvency margin. The new norms will apply only to these funds. Surplus funds do not need to adhere to any investment norms.