Policy paralysis: A setback for insurance sector M&A?

India’s insurance industry has been keenly awaiting the passage of the Insurance Laws (Amendment) Bill, 2008, for over six years. Despite changes in the political scenario, on each occasion that the bill has been presented for discussion in the parliament, it has faced strong opposition and criticism, particularly with regard to the proposal to increase the limits on foreign direct investment (FDI).

The bill was expected to be discussed by the parliament in December, although news reports suggested that there could be further delays. The only silver lining in the clouds is that after the change of guard at the centre, the Indian economy has shown signs of revival.

Time for reforms

For a sector riddled with increasing costs, constant regulatory changes and rampant exits of key promoters, it is urgent that meaningful reforms are introduced to bring back investor confidence and revive the sector’s low morale.

If the bill is enacted, it will provide a more conducive business environment and will act as a catalyst in accelerating merger and acquisition activity and unlocking the enormous potential for investment in this sector. There is no doubt that the sector has vast growth opportunities and investors are waiting to infuse much required capital.

Key hurdles

The biggest hurdle to the entry of new foreign players is constant regulatory and economic challenges, which brings a sense of insecurity and ultimately impedes M&A in the sector. Most of the regulatory changes were introduced with a view to streamline the industry and ensure that customer protection is not compromised. However, because they were brought in almost overnight, with no clear warning to the insurers, the companies had no time to realign their operations in tune with the regulatory changes. The industry seems to be saying that there should be some predictability and foresight in the way reforms are undertaken, rather than as a knee-jerk reaction to certain developments.

Another critical factor which is negatively affecting M&A transactions in this sector is that insurance is a highly capital intensive business and the expected return on investment is fast diminishing, due to unpredictability in long-term policies and strategies. Due to expansion plans, initial business losses and maintenance of solvency ratios as prescribed by the Insurance Regulatory and Development Authority (IRDA), the joint venture partners are required to infuse capital in insurance companies at regular intervals. Most Indian promoters, being large conglomerates, are exiting the sector and deploying their funds in other booming sectors such as e-commerce.

The sector has witnessed some M&A activity in the past two years, but it is not commensurate with the M&A activity that India has witnessed in other sectors. One reason for sluggish growth in M&A activity is that the joint venture partners, especially foreign partners, have adopted a wait-and-watch approach and are keenly awaiting the final decision on the proposed increase in FDI limits. Other reasons include high company valuations and disagreements between the joint venture partners. Despite these issues, the market sentiment is positive and the sector is hoping that the general slowdown is simply a pause and in the coming months M&A opportunities will increase.

One of the prime concerns that may arise in relation to the acquisition of an insurance company is valuation of the target insurance company and therefore thorough understanding of issues such as future income stream and liabilities, litigation costs, regulatory reserves, investments, distribution arrangements, technology, and regulatory requirements and restrictions is required.

Ripe for growth

The overall market appears ripe for M&A activity in the years to come and an improved economy and regulatory environment will certainly create a favourable platform which could result in an increase in M&A activity in this sector, particularly for market players and investors that have an aggressive strategy of building through acquisition.

It is time that Indian insurers gear up to accept the role that M&A can play in their overall growth strategy. They should initiate the process of strengthening their capabilities, by conducting strategy planning and proactively targeting potential entities which can be acquired or merged with.

Given that the IRDA has already put in place the regulatory framework, the stakeholders should now develop effective strategies for learning about the requirements and restrictions, assessing capabilities and organizational readiness and formulating appropriate plans for various scenarios in relation to M&A activities.

Similarly, in the case of insurance intermediaries, market players are keenly awaiting the report of the IRDA committee which has examined raising FDI limits for insurance intermediaries. If the IRDA permits this, intermediaries will also see a rise in M&A activity.

Shailaja Lall is a partner and Ashish Teni is a senior associate at Amarchand & Mangaldas & Suresh A Shroff & Co. The views expressed in this article are those of the authors and do not reflect the position of the firm.