Irda may mandate ring-fencing in M&As

Insurance companies will have to set aside assets to cover the liabilities of acquired entities.

The Insurance Regulatory & Development Authority, which is finalising the mergers and acquisitions (M&A) guidelines, is expected to mandate that a company acquiring another insurance player will have to ring-fence the assets of the acquired entity to ensure that the interests of the policyholders are protected.

According to sources close to the development, in the guidelines that are expected to be released next month, an acquirer is likely to be asked to set aside the assets of the acquired entity and not trade them to avoid any asset-liability mismatch at the time of maturity of a policy.

In addition, Irda is also expected to mandate that after the acquisition, a separate actuarial assessment of both the entities be carried out annually to ensure that the liabilities are adequately backed by assets.

In case of the life insurance business, the regulator will prescribe special rules for the pension business which is a long-term liability, Irda sources say.

While companies are not looking at the acquisition route to expand their business, the rules are expected to come into play when the consolidation process started a few years down the line.

The regulator is, however, unlikely to step into valuation-related issues. It, however, intends to seek greater transparency on the exercise, an Irda official says. To strengthen corporate governance, the regulator will also ask for transparency in decisions taken by the newly-appointed board.

Valuations in the life insurance industry depends on the embedded value. This involves the calculation of the present value of surplus, as distributed to shareholders. For life insurers, business is tied to solvency and the long-term nature of the products sold.

So, the regulator wants acquirer to carefully assess the liabilities of the company to be acquired and then analyse them according to the assets backing them. A bulk of the liabilities pertain to policyholders.

For an insurer, the assets would include the investment in various securities. In addition, the capital, which is a liability as it came from promoters, provided additional comfort as the solvency margin is prescribed at 1.5 times the business underwritten.

For non-life insurers, the valuation will depend on the projection of expected future profits and calculation of present value, the sources say.

“The assumption of liabilities has to be acceptable to both parties, and the company which is going to acquire will have to examine the values in the broader context,” a senior Irda executive said.

Irda had set up a committee few months ago to work on the M&A guidelines.

“Mid- and small-sized companies would look at the acquisition route to grow their business. Also, there was no exit route for insurers. It will help the companies if the consolidation is a win-win situation,” said Reliance Life Managing Director and CEO P Nandgopal.

“About 90 per cent of the insurers will see their valuations decline after the asset and liabilities disclosures are made mandatory under the M&A guidelines. It will help in drawing a comparison between companies. The ultimate beneficiary would be the shareholders and promoters of the company,” said Bajaj Allianz Managing Director and CEO Kamesh Goyal.