PE investors fighting tough rules to back insurance companies, say experts

PE investors are enabling promoters or shareholders of firms in the sector to exit but face substantial regulatory compliance, tax ambiguity and delays in approvals

In the year since the sector regulator published guidelines for private equity (PE) investment in insurance companies, six major deals have been announced.

Some PE funds have invested more through seed funding in digital insurance companies; others have exited from their holdings. 

Experts say the past year has seen a spike in investment interest by PEs in the insurance space, given the background of a tight listing environment and a need for capital which banks currently cannot afford to provide.

“Whether in the case of PE or the Qualified Institutional Placement (QIP) route, the trouble is the size of their [mid and small-tier insurance companies] financial performance is such that they cannot do the Initial Public Offering (IPO, of equity) issuance at all,” says Ashvin Parekh, managing partner (MD) at Ashvin Parekh Advisory Services. “The problem is mainly on account of promoters or shareholders expecting a price which is very unrealistic, given the size of their companies. These insurers want to receive valuations or multiples equal to that of the larger, established private players, which is unrealistic.”

Narendra Ostawal, MD at Warburg Pincus, says: “The valuations for these insurance companies are still forming, unlike in the case of banks or non-banks, where these are based on longer business history. Honestly, here, rather than based on valuations, we are making long-term growth calls.”

The recent PE deals announced in the sector have been motivated by the fact that the existing promoters, such as banks or foreign insurers, want to exit. And, PE firms are best placed to swoop in. 

Indranath Bishnu, partner at legal firm Cyril Amarchand Mangaldas, says PEs are not investing solely in response to a capital requirement from insurance companies. Instead, “the interest by PE investors in the sector has primarily been pursuant to secondary transfers. This has basically opened up the opportunity for PEs to come in replacement of existing promoters”.

One of the core conditions for investing in an insurance company is that a PE fund has to fund the deal through a Special Purpose Vehicle (SPV) or a limited liability partnership (LLP) for any investment in excess of 10 per cent. Wherein the fund would automatically be classified as a promoter.

“There is a large cost of compliance in the market already, whether on data-sharing, regulatory approvals or financial structures. So, a compliance cost on getting approved and also while remaining within the parameters all the time. Compared to that, I do not think the cost of compliance of the SPV route is a deterrent,” says Joydeep K Roy, partner at consultants PricewaterhouseCoopers.

However, a foreign PE fund will require prior approval of the department of economic affairs at the Union ministry of finance for setting up the SPV. This lack of equal legal footing could place PE funds (particularly foreign ones) at a disadvantage to non-PE funds on investing in insurance companies. 

Further, the PE guidelines of the Insurance Regulatory and Development Authority of India (Irdai) mandates that at the SPV level, the PE funds classified as promoters are subject to a lock-in period of five years. And, that a PE fund may only invest in one life insurer, one general insurer and one health insurer at the same time, as a promoter.

“The regulations are not clear on whether a single PE investor would have to create separate SPVs for promoting separate insurance companies. In case Irdai is of the view that the requirement is to create multiple SPVs, it might turn out to be an administrative burden for the PE firm,” said Bishnu. 

Another major concern, say experts, is on taxation. Every time the SPV pays a dividend to the promoter PE fund, there will be a 20 per cent dividend distribution tax (DDT).

If the PE fund sells its stake upon exit, such as when the insurer is publicly listed, the sale amount will first accrue to the SPV. This amount would be considered as income generated by the SPV and, therefore, liable for the Minimum Alternate Tax (MAT).

After paying the MAT, the income remaining will be transferred back by the SPV to the PE fund -- and that transaction would be subject to DDT or a buyback tax. Therefore, a double taxation situation could arise, where the total tax burden could be close to 35 per cent. 

Further, if the exit by a PE fund is through the sale of the SPV, it is likely to be liable for capital gains tax. Therefore, the tax implications could make exits by promoter PE funds costly, especially for foreign ones.

Experts say without specific rules on taxation methodology and without knowing the exact return made by the SPV or PE fund from its investments, the question of tax liability is probably premature at this stage, though a major concern. 

“The deal opportunity from a PE perspective is non-existent in the case of large or listed insurance companies. Whereas, for PE funds, mid-tier insurance companies provide an interesting possibility -- they have growth potential, a need for capital and, in select cases, there are strong bank partnerships, which enhances our excitement,” said Ostawal. 

Sources told Business Standard there is no fixed timeline for Irdai to approve the recent large PE deals, including structure of the deal and the shareholding agreement. Depending on the shareholders’ reputation, the approvals could come faster. 

Typically, PE deals could take at least four months to get approval, another aspect of compliance costs via this investment route. 

For now, in sum, PE firms are coming to the rescue of existing shareholders or promoters of insurance companies looking to exit their holdings but the investment environment is burdened with substantial regulatory compliance, tax ambiguity and delays in approvals.