<p>With the enactment of the Insurance Laws (Amendment) Act, 2015 ("Insurance Amendment Act"), there has been a perceptible increase in interest in the insurance sector. Apart from other significant changes introduced, one of the seminal changes was the change in the definition of an 'Indian insurance company' pursuant to which the cap on foreign shareholding in an Indian insurance company stands increased from 26 per cent to 49 per cent.<br><br>As of the end of July 2015, the Ministry of Commerce and Industry reported that India received $184.97 million foreign direct investment ("FDI") in the insurance sector between the months of March and May 2015. While animal spirits may have awoken and there is an immense amount of discussion around deal-making in the insurance space, there are certain significant issues which are being discussed, or will need to be discussed between foreign investors (including shareholders of existing joint ventures) and Indian counterparts, in relation to investment in such Indian insurance companies. Set out below is a brief overview of some such key issues.<br><br><strong>The 'Control' Conundrum</strong><br>Perhaps the most significant, the Insurance Amendment Act and the Indian Insurance Companies (Foreign Investment) Rules, 2015 ("Insurance FDI Rules") provide that an Indian insurance company shall be owned and controlled by resident Indians. Rule 2(c) of the Insurance FDI Rules therein, read with Section 2(7A) of the Insurance Act, 1938, provides that "'control' shall include the right to appoint a majority of directors or to control the management or policy decisions including by virtue of their shareholding or management rights or shareholders agreements or voting agreements". Further, given the provisions of Rule 9 of the Insurance FDI Rules and paragraph 6.2.18.7.2(f) of the Consolidated FDI Policy dated 12 May 2015 ("FDI Policy"), all conditions in relation the increase of FDI applicable to insurance companies shall apply 'on the same terms as above' to insurance brokers, third party administrators and other insurance intermediaries registered under the relevant regulations notified by the Insurance Regulatory and Development Authority of India ("IRDA"). Accordingly, Indian insurance intermediaries would also need to ensure that they remain Indian owned and controlled. <br><br>The existing uncertainty arises from the fact that the requirement of 'control' of an Indian insurance company vesting with Indian residents is new and didn't exist until the introduction of the Insurance Amendment Act. In the past, there have been instances where foreigners who invested in an Indian insurance company (upto 26 per cent) had a vast set of rights (some of which could imply "control" vesting with a non-resident under the Insurance Amendment Act). Further, unlike in respect of the Securities Exchange Board of India ("SEBI") and the Competition Commission of India ("CCI"), the IRDA does not have an existing body of jurisprudence in assessing 'control'. Accordingly, there has been some uncertainty as to what rights when granted to a foreign investor (whether positive rights or 'negative' rights - termed as affirmative vote matters) under existing shareholders' agreements (which may be the case for most insurance joint venture agreements) would be permissible. For example, an affirmative vote matter at the board and shareholder meetings level in the hands of a foreign investor in respect of the appointment of key managerial personnel or determination of the insurance joint venture's business plan may not be acceptable, as they may indicate foreign 'control'. While there is a line of thought which assumes that the IRDA may adopt an interpretation of control similar to other regulators (i.e. SEBI and CCI), these may provide imperfect parallels given that each regulator has defined 'control' to satisfy its respective regulatory objectives (ie. SEBI's objective of protecting minority shareholders in listed companies, and CCI's objective of merger control and preventing anti-competitive and monopolistic arrangements). However, given the aforementioned background, there is another line of thought that joint decisions between the resident and non-resident shareholders of Indian insurance joint ventures may not fall foul of applicable law.<br><br>Given that 'control' is also defined under the FDI policy, there is some apprehension as to whether the Foreign Investment Promotion Board (in stake increases beyond 26 per cent) may adopt an interpretation of 'control' different from the IRDA. However, it appears that, once FIPB and IRDA applications are filed by the foreign investor, the Indian promoter and the insurance joint venture, both regulators may enter into discussions as to whether the insurance joint venture would continue to remain Indian owned and controlled. <br><br><strong>The 'Options' in Pricing</strong><br>Once the 'control' question is put to rest, the next hypothetical 'bee in the bonnet' is the question of the legally permissible price per share which can be paid for acquisition of shares by a foreign investor. The share valuation saga began on 4 May 2010, when the Reserve bank of India ("RBI") published A.P. (DIR Series) Circular No. 49 ("RBI Circular") which, inter alia, replaced the requirement of determining fair value of shares in an FDI transaction in accordance with the valuation guidelines prescribed by the Controller of Capital Issues with the fair value determined by a SEBI registered Category-I merchant banker/ chartered accountant as per the discounted free cash flow method. Subsequently, the IRDA published a press release dated 16 June 2010 ("IRDA Press Release") which stated that the provisions of the RBI Circular were applicable to Indian companies in sectors other than the financial sector, and accordingly, the pricing guidelines under the RBI Circular would not be applicable to the insurance sector. There was a fair amount of comfort drawn from the clarification contained in the IRDA Press Release by insurance companies and investors alike that the pre-agreed pricing mechanisms built into call option clauses granted to foreign investors and incorporated in joint venture agreements/ shareholders' agreements between the Indian promoters and the foreign investors of Indian insurance joint ventures (which were incorporated into the articles of association of the joint venture) for future increases in foreign investment may not actually be impacted by the pricing guidelines prescribed under the RBI Circular.<br><br>However, following the introduction of the Insurance Amendment Act, this criteria on valuations has been tweaked and the current position is encompassed in Rule 8 of the Insurance FDI Rules, as well as paragraph 6.2.18.7.2(f) of the FDI policy, which provide that any increase in foreign investment of an Indian insurance company shall be in accordance with the pricing guidelines specified by the RBI under the Foreign Exchange Management Act, 1999 ("FEMA"). The pricing guidelines prescribed by the RBI provide, inter alia, that a transfer of, and subscription to the shares of an unlisted company from a resident person/ entity to a non-resident entity/ person shall be at a price which is greater than the fair value worked out in accordance with any internationally accepted pricing methodology calculated on an arm's length basis by a chartered accountant.<br><br>Given the above, foreign investors may not be able to increase their equity shareholding at the commercially agreed price formulae agreed to in their shareholders' agreements with the Indian promoters of their insurance joint venture. It remains to be seen whether the Central Government or the RBI provide any leeway in relation to applicability of the RBI pricing guidelines to equity stake increases. While arguments can be made by foreign investors claiming that the applicability of pricing guidelines has effectively been made retrospective (given that the relevant call options for purchase/ subscription to additional shares will actually be exercised now ie. after the clarification on the applicability of the RBI pricing guidelines to the insurance sector); the likelihood of regulators acceding to this is questionable. Accordingly, both parties would need to undertake a valuation or multiple valuations (depending on the content of their shareholders' agreement) to determine the fair value of shares in accordance with applicable law as on date.<br><br><strong>'Banking' on Exclusive Tie-ups</strong><br>Some of the existing Indian insurance joint ventures have been promoted by financial institutions such as banks. Most shareholders' agreements between such Indian banks and the foreign investors (as well as insurance joint ventures with Indian partners who are not banks) contain provisions which require the Indian banks to enter into distribution arrangements with the insurance joint venture they have invested in, thereby creating an exclusive distribution channel for the insurance products created by the Indian insurance joint venture. Given the value associated with having a reliable and broad-based distribution network, these exclusive distribution tie-ups are an essential contributor to the wealth of Indian insurance joint ventures.<br><br>One of the significant impacts of such exclusive distribution arrangements in the insurance sector was that insurance companies effectively could not use Indian banks which had investments in other insurance joint ventures as distribution channels for their products. Accordingly, the idea of an open architecture of insurance distribution was mooted, pursuant to which it was proposed that banks and non-banking financial companies would act for more than one insurance company through the bancassurance model (registering as either a bancassurance corporate agent or a bancassurance broker). Apart from two exposure drafts in relation to bancassurance (which were not eventually notified), a more recent (albeit temporary) concern was the inclusion of provisions requiring multiple insurance distribution tie-ups under the first exposure draft of the IRDA (Registration of Corporate Agents) Regulations 2015 ("Draft Regulations"). The Draft Regulations proposed certain limitations on business generated from a single insurer , which would have effectively required corporate agents (including banks registered as corporate agents) to enter into insurance distribution arrangements with more than one insurance company in each sector of the insurance industry.<br><br>However, after several industry representations, the IRDA released a revised exposure draft of the Draft Regulations on 29 May 2015, pursuant to which corporate agents were allowed to choose up to three insurers in a particular line of insurance business (ie. life, general, health) instead of a minimum of two insurers in this respect. Further, insurance business was no longer proposed to be capped as long as, at the time of the corporate agent's registration, a 'Board Approved Policy' addressing, inter alia, the manner of soliciting and servicing insurance products, and the process of adopting the open architecture policy going forward. While the most recent version of the Draft Regulations have not yet been notified, they provide some amount of relief for Indian banks which have promoted insurance companies. That being said, going forward, Indian promoters and foreign investor in insurance joint ventures would need to factor in the policy shift from exclusive distribution the open architecture - a change which may arrive gradually, but appears certain to arrive in the near future.<br><br><strong>Concluding Thoughts</strong><br>Given the aforementioned issues, foreign investors, Indian promoters and Indian insurance companies alike would need to proceed with caution, and after comprehensive discussions with legal and financial advisors, when considering equity stake increases in existing Indian joint ventures. That being said, there is information in the public domain of certain Indian insurance joint venture which have moved quickly in filing FIPB and IRDA applications, which are understood to be under process or have been approved. In any case, once there is greater clarity on the IRDA's interpretation of 'control', we may see more insurance deals being closed.<br><br><em>Disclaimer - The views of the authors are personal, and should not be considered as those of the firm.</em><br><br><em>The author are Anuj Sah, Associate Partner, Khaitan & Co. and Rohan Singh, Associate, Khaitan & Co.</em></p>
