When Australian insurer QBE tied up with the Rajan Raheja Group in 2007 to start an insurance venture, it bargained hard to gain an upper hand even though Indian law at the time barred foreign players from taking a stake of more than 26 per cent in a local insurance company. The 125-year-old QBE settled for a minority stake in Raheja QBE General Insurance Company but with a condition that it would raise its holding up to 50 per cent when India increases the foreign direct investment limit in the insurance sector. QBE also retained the right to appoint an equal number of board members and, in consultation with the Rahejas, the managing director of the venture as well as other top executives through the MD. In effect, QBE ran the company where the Rahejas owned the majority stake.
The arrangement has worked well so far and the general insurance company has achieved break-even. But this happy arrangement may have to be changed now. Why? In December, the government increased the FDI cap in the insurance sector to 49 per cent. Insurers had been waiting for this easing for almost a decade, but they are not celebrating just yet because the FDI cap hike came via an ordinance that would need parliamentary approval within six months, or by June this year. What has baffled insurance companies further is a rider in the ordinance which says that management control in local insurance joint ventures will remain with the Indian partner. On February 19, the government issued detailed rules for FDI in insurance specifying that Indian ownership means more than 50 per cent of the equity capital of an insurer owned by resident Indian citizens. "There could be legal complications in every joint venture post the ordinance because of shareholder agreements giving equal or higher rights to foreign partners," says the CEO of an insurance company who does not wish to be named.
India allowed private players in the insurance sector in 2000 after the enactment of the Insurance Regulatory and Development Authority (Irda) Act, 1999. The law allowed foreign companies to hold up to 26 per cent in local insurers. As the industry expanded - the country now has about four dozen insurers - demands for increasing the FDI cap grew louder. In 2008, the Congress party-led United Progress Alliance government introduced a Bill in Parliament to increase the cap to 49 per cent but the amendment could not be passed due to opposition from many political parties. The BJP-led government, formed in May last year after the party's resounding victory in Lok Sabha elections, finally increased the FDI cap but only through an ordinance as it lacks enough numbers in the Rajya Sabha. The Lok Sabha passed the Insurance Bill on March 4.
(*Update: The Rajya Sabhja passed the Insurance Bill)
Industry executives say the ordinance opens a Pandora's box in the 15-year-old private insurance industry. The ordinance defines the word 'control' as the right to appoint a majority of the directors or to control management or policy decisions including through shareholder agreements or voting rights. But this is not clear enough, say industry executives. Moreover, like QBE, many foreign partners have management control with powers to decide about the business and key appointments by virtue of rights defined in their joint venture agreements.
"People are expecting more clarification (from the government and regulators)," says Amitabh Chaudhry, MD and CEO of HDFC Life, a joint venture between mortgage lender Housing Development Finance Corporation and Standard Life Plc of the UK. Deepak Mittal, MD and CEO of Edelweiss Tokio Life Insurance Company, concurs. "There are issues like how the control will be specified, the body which will check such issues, and also operationalisation of the ordinance," says Mittal.
Haigreve Khaitan, Managing Partner at law firm Khaitan & Company, says it remains to be seen how Irda would interpret "control". "Any foreign investor investing 49 per cent is likely to expect some say in the affairs of the company. Also, the insurance sector is not as sensitive a sector as defence or telecom and there is a case for Irda to be liberal in interpreting what constitutes control," he says.
"It wouldn't matter if foreign partners control the management. A majority of board members would represent the Indian partners"
Partner, Financial Services, KPMGThe FDI relaxation will also lead to a situation where some foreign players will end up owning a higher stake in their local ventures. For example, Star Union Dai-ichi Life Insurance Company is a joint venture of three companies - state-run Bank of India has the majority 51 per cent stake, Japan's Dai-Ichi 26 per cent and state-run Union Bank of India 23 per cent. The partners had agreed at the time of signing the JV in 2008 to give majority ownership to Dai-Ichi whenever India eases its FDI regime. The equity arrangement agreed post FDI relaxation would give 44 per cent to Dai-Ichi, 30 per cent to Bank of India and 26 per cent to Union Bank of India, effectively giving control to the foreign partner. Similarly, in PNB Met Life Insurance Company, the US-based Met Life has 26 per cent stake and state-run Punjab National Bank has 30 per cent with other Indian partners holding the balance. The JV agreement provides for Met Life to own 51 per cent or lower based on the FDI regime. Met Life now can increase its stake to 49 per cent while PNB, currently the biggest stakeholder, holding much less.
A similar situation could arise when insurers list their shares on stock exchanges. Indian law requires 25 per cent of a listed company to be owned by public. So if an insurer launches an initial public offering but the foreign partner keeps its stake intact, then the Indian company would end up with a smaller holding in the joint venture. Two big private insurers - HDFC Life and ICICI Prudential - meet the 10-year criterion of Irda for listing. HDFC Life has indicated its preference for an IPO while ICICI Prudential doesn't have any immediate plan. "Standard Life has publically talked about increasing their stake but what that number would be is something that needs to be determined," says Chaudhry. HDFC and Standard Life's JV agreement talks about an equal stake of 45 per cent post the FDI relaxation. If the insurer opts for an IPO, it is not clear whether HDFC or Standard Life or both would dilute their stake.
"Insurance is not as sensitive a sector as defence or telecom and there is a case for IRDA to be liberal in interpreting what constitutes control"
Managing Partner, Khaitan & CompanyAnother area of concern is that foreign players would have to seek permission of the Foreign Investment Promotion Board (FIPB) to increase their stake beyond 26 per cent. So far, FIPB had no role to play in the insurance sector as 26 per cent FDI was allowed through the automatic route. Industry executives feel that the FIPB could restrict management rights and board representation of foreign players. There could be a possibility of the FIPB denying majority stake to foreign players if the holding of the Indian partner is comparatively lower. There could be problems even when the FIPB allows foreign players to increase their stakes with riders. "If Dai-Ichi or Met Life get a higher stake or majority stake without any rights to control the venture, why will they honour the pre-decided valuation commitments?" asks an industry executive.
Many say the FIPB will now have the final word on JV agreements. Until now, the shareholder agreements were approved by the sector regulator Irda. Shareholder agreements of many companies may need to be revised but that could discourage foreign investors. A case in point is Universal Sompo. The company is a joint venture among Japan's Sompo and four Indian partners - Allahabad Bank, Karnataka Bank, Indian Overseas Bank, and consumer goods maker Dabur. The five partners had previously agreed that Sompo would have the right to execute a fresh shareholders agreement post the FDI relaxation to 49 per cent that will reflect its revised rights based on its new holding. Another example is that of Tata AIA Life Insurance. AIA, the foreign partner, had guarded itself against "discriminatory" changes in law by inserting a clause in the shareholder agreement that says it will be entitled to transfer all its shares to a third party if a change in law materially and adversely affects its rights. Many are reading the rider of Indian control as discriminatory in nature.
So, what's the way out of this logjam? Shashwat Sharma, Partner, Financial Services, KPMG India, offers an interpretation of the rider on management control. He says it wouldn't matter if the foreign partner controls the management. "A majority of board members would represent the Indian partners. The management and CEO would be accountable to the board," he says.
Some industry executives even question the necessity of the ordinance at a time the insurance industry is not facing any capital shortage thanks to the economic slowdown in recent years. "We will need capital if growth revives in a big way," says Tarun Chugh, MD and CEO of PNB Met Life. For now, however, insurers are sitting on the fence and hoping that parliament would modify the restrictive riders before giving its assent.
CRUX OF THE MATTER
The rider on Indian partners retaining management control will affect many local insurance joint ventures -
Star Union Dai-Ichi Insurance
State-owned Bank of India currently owns the maximum 51 per cent stake, but the JV agreement allows Japanese major Dai-ichi to own 44 per cent with BoI holding 30 per cent and Union Bank of India with 26 per cent.
PNB Met Life Insurance Company
State-run Punjab National Bank is the biggest shareholder with more than 30 per cent stake, but the JV agreement allows US major Met Life to hike its stake to 49 per cent, thereby emerging as a majority shareholder.
HDFC Life Insurance Company
Housing major HDFC currently holds a majority stake, but the JV pact gives UK-based Standard Life the right to hold an equal 45 per cent stake after the FDI relaxation.
Raheja QBE General Insurance Company
Rajan Raheja-owned Prism holds 74 per cent in the JV, but the agreement allows QBE to hike its stake to up to 50 per cent if the law permits. QBE already has the right to nominate the MD & CEO, who in turn has the right to appoint the CFO and Actuary.
Universal Sompo General Insurance Company
State-owned Allahabad Bank owns the majority 30 per cent with Japan's Sompo holding 26 per cent. The remaining stake is with Indian Overseas Bank, Karnataka Bank and Dabur. The agreement allows Sompo to go up to 49 per cent, which would make it the majority owner.
*This story appeared in Business Today March 29, 2015 issue, which hit the stands before the passage of the Insurance Bill by Rajya Sabha on March 12, 2015.