Mumbai: A six-member committee of India’s insurance regulator, the Insurance Regulatory and Development Authority (Irda), has recommended that insurance firms be allowed to raise capital through issuance of debt paper, said two people familiar with the move. Both of them declined to be named because a final decision has not yet been made.

If approved, the move would bring significant relief to life insurers, who are burdened by huge losses and require to raise capital.

Graphic: Ahmed Raza Khan / Mint

“Insurers, like banks, too may be allowed to raise tier I and tier II capital under the new capital structure norms," said one of the two persons.

“(A) huge amount of capital is needed in the insurance industry. Tier II bonds is a good place to begin with," said Naresh Thakkar, managing director of ratings agency Icra Ltd, pointing out that many other countries allow this in the form of subordinated debt.

Countries such as the US and Singapore allow insurers to raise money from the market by floating debt and convertible securities.

The committee was appointed last month to recommend guidelines for allowing insurers to raise money through this route. “The recommendation report is likely to be completed by July," said one of the persons.

To fund their growth requirements, life insurers periodically undertake capital infusion in the form of equity, but are not allowed to float either equity or debt instruments.

A key yardstick for assessing a life insurer’s capital needs is to evaluate its capital efficiency by comparing its gross written premium (GWP) with the capital deployed by the firm. GWP is the revenue (premiums) expected over the life of the contract. The business consumes large amounts of capital till a firm expands and it books losses only during the initial years.

To support such needs, most private insurers in India entered joint ventures with foreign firms, which were allowed to hold a 26% stake, when the sector was opened up in 1999-2000. But this meant domestic firms would have to raise thrice the capital a foreign partner brought in.

There are currently 23 insurers each in the life and non-life segments in India. According to Irda’s 2009 annual report, private sector life insurers infused equity capital of Rs5,956 crore during the fiscal ending March 2009. They have infused a total of Rs18,248 crore to date. Non-life insurers have infused Rs3,083 crore.

Last year, MetLife India Insurance Co. Ltd infused the most capital, Rs818 crore, followed by Rs750 crore by Max New York Life Insurance Co. Ltd. Tata AIG Life Insurance Co. Ltd came third with Rs649 crore.

If Irda panel’s proposal is accepted, capital infusion requirements will be lowered significantly, allowing insurance firms to expand faster without hurting profitability.

Alternatively, if the foreign direct investment (FDI) limit is increased from 26% to 49%, for which legislation is pending, the firms will be able to infuse capital with almost equal contributions from both foreign and domestic partners.

Noting that FDI limit is unlikely to be raised anytime soon, one of the persons quoted earlier said: “It is much more cost-efficient for a company to fund its growth by the money raised from public through debt papers. Since insurance is a capital-guzzling business, tier II capital could play a significant role."

The Bank for International Settlements (BIS) sets requirements on two classes of capital for banks—tier I and tier II.

Tier I capital is the book value of a bank’s stock plus retained earnings.

Tier II capital is loan-loss reserves plus subordinated debt. Total capital is the sum of both.

Subordinated debt is long-term debt that, in case of insolvency, is paid only after depositors and other creditors have been paid. Thus, it can be used like equity to offer such creditors some protection against insolvency.

Under the Reserve Bank of India’s (RBI) norms, subordinated debt paper under tier II capital must be fully paid-up, unsecured, subordinated to the claims of other creditors, free of restrictive clauses and should not be redeemable at the initiative of the holder or without RBI approval.

These securities, required to have a minimum tenure of five years, are limited to 50% of tier I capital of the bank. These instruments, together with other components of tier II capital, should not exceed 100% of tier I capital.

“To begin with, similar rules will be applicable to the tier II capital of insurance companies," said one of the persons quoted, adding that insurers may also be allowed to raise money through convertible debt and equity instruments.

Icra’s Thakkar said tier II bonds will provide protection to a large number of policies issued, a substantial number of which are long term. “The terms of issue should be largely similar to that of the tier II bonds issued by banks."

Tier II bonds issued by banks typically bear rates higher than that of government securities and are primarily bought by banks and life insurance firms. The insurers’ debt paper may offer higher rates than those issued by banks to attract more investors, according to both persons Mint spoke with for this story.

Market experts agreed with the analysis.

“The yields will be in line with the corporate bonds or slightly higher than such bonds issued by banks," said Ritesh Jain, head of fixed income, Morgan Stanley Asset Management Co. Ltd.

“At present, you get these bonds at 75-125 basis points over the sovereign and one can expect similar kind of spreads for these insurance papers," he said, adding that insurance companies themselves would have a good appetite for such bonds.

Jain also supported Irda’s proposal, saying it would allow insurance firms some leeway to access the market and meet their asset-liability match requirement.

“It’ll also create some depth in the market as there are not many options at present on the longer term and help in the development of the corporate bond market," he added.