Subhash C Khuntia
The Insurance Regulatory and Development Authority of India (Irdai) has asked insurance firms to make “prudent” decisions when it comes to investing in companies downgraded by credit rating agencies.
Subhash C Khuntia, chairman of Irdai, said that in the case of a downgrade of a company’s rating, it is for insurance companies to take action and decide what to do and how to retrieve the maximum value from their investment. “Normally, when there is a downgrade, insurers should withdraw their investment and place it somewhere else,” Khuntia said on Tuesday, speaking to reporters on the sidelines of the CII Insurance & Pension Summit in Mumbai.
Asked about LIC’s 25.34 per cent shareholding in Infrastructure Leasing & Financial Services (IL&FS), which is facing a liquidity crisis, Khuntia said, “They (LIC) will have to take a call on what to do with their investment, and I’m sure they will take a prudent decision.”
He added that disinvestment by LIC could not be done overnight, and that there would have to be a timely strategy in place. Over the past few months, rating agencies have downgraded the debt instruments of IL&FS, its subsidiaries, and the special purpose vehicles housed under those subsidiaries, with some of them being assigned the ‘default’ rating. Recently, rating agency ICRA downgraded the debt instruments of IL&FS from ‘AA+’ to ‘BB’. On Monday, CARE Ratings downgraded the non-convertible debenture (NCD) instruments of IL&FS Financial Services (IFIN) to ‘BB’ from ‘AA+’. These rating downgrades, analysts said, had been issued because of “significant deterioration in the liquidity profile of the company on impending debt servicing obligations in the near future.”
Investors such as mutual funds and life insurance companies purchase ‘investment-grade’ bonds, provided they have a minimum rating of ‘BBB’. The solvency situation of IL&FS will have an impact on insurance companies, which have invested both in the company’s debt instruments as well as equity. Analysts are predicting further downgrades to IL&FS’ other subsidiaries — IL&FS Transportation, IL&FS Tamil Nadu Power, IL&FS Energy Development, IL&FS Security Services, and IF&FS Financial Services — which will negatively impact the insurer’s investment holdings. Khuntia said that from a regulatory point of view, “we have started the process of moving to a risk-based capital system. It will, of course, take a little time, but it will be done in a couple of years”.
Last year, Irdai appointed a 10-member steering committee to suggest guidelines to implement a risk-based capital regime by March 2021. The rationale behind the insurance industry’s decision to move from the present ‘solvency-principle’ capital regime to a ‘risk-based’ capital regime is, the present rules do not help assess whether the capital position of an insurer is adequate enough, given the risks in the business.
Asked if the regulator would permit companies, on the lines of banks, to raise more than 25 per cent of their net worth from Tier-2 bonds, Khuntia said, “That request has been made today in our discussions, but my belief is that this will be possible when the industry moves to a risk-based capital regime.” Khuntia said that under the new system, companies that managed their risk well would be better off, while additional capital didn't have to remain idle. The regulatory head also stated that Irdai would start work on a risk-based supervision framework for the insurance sector. "Those who are at greater risk will require more intensive work, while those who do not display these kinds of risky behaviour need a light touch as far as supervision is concerned," Khuntia said.