Irda allows insurers to deal in derivatives

The regulator said that participants can undertake different types of plain vanilla FRAs/IRS

The Insurance Regulatory and Development Authority (Irda) has allowed insurers to deal in rupee interest rate derivatives, including forward rate agreements (FRAs), interest rate swaps (IRS) and exchange traded interest rate futures (IRF).

Sandeep Batra, executive director, ICICI Prudential Life Insurance, said the guidelines on dealing in interest rate derivatives were a welcome step, as these would enable life insurers to hedge the interest rate risks on the future premiums to be collected by them.

“Earlier, the risk was borne by insurers. We believe this could also popularise regular premium traditional products with in-built guarantees,” he added.

The regulator said participants could undertake different types of plain vanilla FRAs/IRS. IRS having explicit/implicit option features are prohibited.

The permitted purpose of dealing in interest rate derivatives include reinvestment of maturity proceeds of existing fixed income investments, investment of interest income receivable and expected policy premium income receivable on insurance contracts, which are already underwritten in life and pension and annuity business in case of life insurers and general insurance business in case of general insurers.

Irda said the overriding principle of any use of the derivatives was that they must be used for hedging purposes only to reduce the interest rate risk in the company. The counter parties necessarily have to be commercial banks and primary dealers (PDs), as permitted by RBI for FRAs and IRS.

With respect to exposure limits,  a participant’s dealing in interest rate derivatives under these guidelines shall in aggregate not exceed an outstanding notional principal amount equivalent to 100 per cent of the book value of the fixed income investments of the participant under policyholders fund (excluding ULIP funds in case of life insurers) and shareholders funds taken together.

Company boards have been advised to ensure that the rupee interest rate derivatives are suitable for the portfolio handled by the insurer and the liabilities undertaken by the insurer.