Insurance industry can use derivatives to hedge equity exposures: Irdai

Regulator Irdai on Friday permitted insurers to use equity derivatives to hedge their portfolios, a move aimed at reducing risk in a volatile capital market.

Insurance Development and Regulatory Authority of India (Irdai) has issued the 'Guidelines on Hedging through Equity Derivatives' following representations from insurers.

"This move aims to facilitate insurers to hedge their existing equity exposures against volatility in equity market and ensure preservation of market value of equity investments and thereby reducing risks in equity portfolio," it said.

Under the current regulatory framework, Irdai allows insurers to deal in Rupee Interest Rate Derivatives in the form of Forward Rate Agreements (FRAs), Interest Rate Swaps and Exchange Traded Interest Rate Futures (IRFs). 

Besides Fixed Income Derivatives, insurers are also permitted to deal in Credit Default Swaps (CDS) as protection buyers.

"As there is an increasing trend in investments in equity market by insurers and owing to associated volatility in the equity prices, a need is felt to permit Hedging through Equity Derivatives. These guidelines aim to provide insurers with enhanced opportunities for risk management and portfolio diversification," the regulator said.

In line with the guidelines, insurers will be able to buy hedges in stock and index futures and options against their holding in equities subject to the exposure and position limits.

The equity derivatives shall be used only for hedging purpose.

"Any Over The Counter (OTC) exposure to equity derivatives is prohibited," Irdai said.

It further said that before taking exposure to equity derivatives, insurers are advised to put in place Board approved hedging policy; internal risk management policies and processes;information technology infrastructure; and regular and periodic audits.

A robust corporate governance mechanism should be in place wherein the Board and senior management reviews the contracts undertaken are not prejudicial to the interest of the policyholders, it added.