The finance ministry’s proposal to allow insurance companies to invest in AA-rated securities will broaden the investment options for insurance companies, but it’s also likely to expose their policyholders to higher risk.
Currently, insurance companies only invest in AAA-rated securities that restrict their choice to government bonds and debt instruments of top government owned companies and a handful of the country’s biggest private sector firms. The AA-rated universe is many times bigger and all kinds of companies are its members. This diversity, however, can cause policyholders to sweat as the balance sheet of a typical
AA-rated company is more leveraged and it has lower earnings cushion to service debt than its AAA-rated peers.
Ratings agencies and insurance companies, however, say that the new norms will help insurers to provide better returns to policyholders without sacrificing safety. “AA-rated securities give 50-100 basis points higher returns yield than AAA-rated paper and there’s no great difference in their risk profile,” says Kartik Srinivasan, co-head Financial Sector Ratings at ICRA. Sam Ghosh of Reliance Capital agrees with this view.
Others point out its indirect benefit to India Inc. “It will help broaden and deepen the bond markets and from our perspective, ''IND AA'' rated universe of issuers represents a very high degree of safety,'' says Tarun Bansal, senior director and Head BRM, India Ratings & Research (formerly Fitch Ratings India).
But there are many others who advise caution. “Policy holders would definitely be subjected to some risk in case companies do migrate to AA-rated papers in a big way,” says Madan Sabnavis, chief economist, Care Ratings. His fears may not be unfounded. As the table suggests, a typical AA-rated company is four times more leveraged than AAA ones and their interest coverage ratio is much lower. The operating profit for a typical AA- rated company is just 14 times its interest burden against 40x for AAA-rated companies. These companies also have lower elbow room to encash their market capitalisation to retire debt in times of stress.
Not surprisingly, the proposal is deemed risky by analysts. “If you compare their balance sheets, AA- rated companies are always riskier than AAA-rated ones. The latter provide much better downside protection in bad times than the former,” says Dhananjay Sinha, co-head institutional research Emkay Global Financial Services.
Rating agencies, however, say that the risk is manageable. “There’s no threat to the quality of assets if the insurance companies invest in AA-rated paper judiciously and after studying the market and the company,” says Sabnavis.
Experts say leaving the choice of assets to insurance companies is also fraught with danger given the number and diversity of the AA-club in India. While the AAA club has just 35 members, nearly 200 companies or nearly 10 per cent of the corporate universe enjoy AA credit rating. And it includes companies whose balance sheet and valuation is as good as that of a top rated company but also those with highly leveraged balance sheets and poor valuations.
In contrast it takes lot of hard work and years of industry-beating performance for a company to get and retain AAA credit rating. Not surprisingly, this privilege is currently available to only 35 non-bank and non-government companies. Many industries such as telecom, hotels, construction, textile, retail, hotels and paper have no representation in the coveted club.
