The insurance market in India has been one of the major sectors of financial services for more than 150 years. Insurance companies are one of the most prominent players in the financial services industry. The industry consists of 53 insurance companies, of which 24 are in the life insurance business and 29 are non-life insurers. With over 500 million people in India being covered under the life insurance and general insurance schemes provided by the insurance companies, the industry is enveloped by a vast number of stakeholders. Thus, it is imperative to have a structured and a well-defined insolvency framework for insurance companies. Since a large portion of the population is covered by insurance policies on fundamental matters such as life, health, property, vehicle, accident, etc., the possibility of an insurance company turning insolvent might be worrisome. Further, with the implementation of the Insolvency and Bankruptcy Code, 2016 and its recent amendments, which have developed stricter insolvency frameworks, there have been some cases where financial service companies have been admitted into insolvency proceedings under this Code.
The insurance companies in India are primarily governed by the provisions of the Insurance Act, 1938 and the Insurance Regulatory and Development Authority of India Act, 1999 (hereinafter referred to as the IRDAI Act). These acts treat insurance companies the same as any other company formed under the Companies Act, 2013 (subject to certain conditions of qualification laid down under the Insurance Act). An insurance company needs to comply with high capital structure requirements due to its operations in the financial service industry. It needs to have:
The Insurance Act also provides that a promoter in Indian insurance company can, at no point in time, hold more than 26% shares in its paid-up equity capital. However, if such is the case, he/she shall divest the excess capital held more than the limit, over a period of 10 years.
Additionally, the Act also demands robust solvency margins from an insurance company. An insurance company shall always maintain an excess of assets over its liabilities by at least 50 crores. It is also obligated to maintain sufficient mathematical reserves to provide for liabilities arising out of contracts of insurance or policies when the insurance company is in the business of life insurance. For a company involved in the general insurance business, the excess assets over liabilities shall be the highest of the following amounts:
From the provisions discussed above, it is evident that the regulatory framework demands a considerable amount of cushion when it comes to funding and guarantee that there is no concentration of control in the insurance companies in India. Such provisions are in place to ensure that there is enough liquidity in the companies to function and sustain in the highly risky and volatile financial services market. To an extent, such a framework aims to ensure that the companies never even have to reach a stage of insolvency and liquidation. However, insurance companies have a large number of stakeholders depending on their functioning. Therefore, an insolvency framework is of paramount importance for them.
The insolvency framework of insurance companies in India is limited to the Insurance Act, 1938. If an insurance company is not able to meet its capital and solvency margins discussed in the previous section, it shall head into insolvency. The Act provides that initially, a financial plan is to be submitted by the defaulting company to the IRDAI. The plan must contain the proposed measures to be taken by the company to correct the deficiencies in meeting the capital or solvency requirements. Importantly, the plan must indicate such proposed measures that will solve the deficiencies within 3 months. If an insurance company does not adhere to the given deadline, it shall be wound up by the Court.
The winding up process of insurance companies must be carried out in accordance with the provisions of Companies Act, 2013. The general practice is to pay off all the liabilities and dispose ofall the assets of the company. Now, the position of insurance policy holders in the balance sheet of an insurance company determines how effectively they are protected under the insolvency framework. The insurance policy claims, wherein the claims have fructified, are recorded under the liability section of the balance sheet of an insurance company. However, there is no mention of policy claims when they are yet to fructify. This leads to a peculiar situation where future claims not falling under the ‘liabilities’ section of an insurance company are not settled in the winding up process. This essentially means that policy holders, who are yet to make their claims from their respective insurance companies, have no apparent protection under the scheme of insolvency under the Insurance Act, 1938.
It is important to note that apart from the insolvency provisions under the Insurance Act, there are several other protective provisions which aim to safeguard the interests of the investors, creditors and policy holders of an insurance company. One such provision is Section 52H. It provides that upon receipt of a report from the IRDAI, if the Central Government is satisfied that the insurance company is being managed in a manner detrimental to the interests of the public, shareholders or policy holders, it has the power to the acquire the undertakings of such an insurance company.
Similarly, Section 52 states that the Central Government, upon being satisfied that a life insurance company is being managed in a manner detrimental to the interests of its policyholders, may appoint an administrator to manage the affairs of the company.
Therefore, from the provisions discussed above, it is safe to conclude that the legislature has provided for a cohesive insolvency framework for the insurance companies in India. However, with the recent developments in the insolvency regime in India (such as the implementation of the Insolvency and Bankruptcy Code of 2016 and its associated rules and regulations), it is essential to understand the differences in the applicability and the effect of the two frameworks.
The Insolvency and Bankruptcy Code (hereinafter referred to as IBC) is the prevailing insolvency law binding over corporate debtors. Section 7, Section 9 and Section 10 of the IBC provides for the mechanism of corporate insolvency resolution process (CIRP) against corporate debtors. But, importantly, the definition of “corporate person” excludes financial service providers. Due to this very embargo under the Code, insurance companies, despite being corporate persons, do not fall under the purview of the Code.
However, in the wake of certain companies recently facing the problem of excessive outstanding credit, there are recent developments in the Code with regard to the inclusion of financial service providers within the purview of the Code. Section 227 of the code gives power to the Central Government to notify the financial service providers upon which the Code shall apply. Therefore, with respect to its power, the Central Government passed the Insolvency and Bankruptcy (Insolvency and Liquidation Proceedings of Financial Service Providers and Application to Adjudicating Authority) Rules 2019 (hereinafter referred to as the FSP rules).
However, the FSP rules are only applicable to the notified financial service providers in the Official Gazette by the Central Government. Currently, only non-banking finance companies (which include housing finance companies) with asset size of Rs.500 crore or more, as per last audited balance sheet, fall under the purview of the FSP rules. Therefore, essentially, insurance companies are essentially still governed by the Insurance Act in matters of insolvency and bankruptcy. Nonetheless, the Central Government has assured further inclusion of categories of FSPs under the rules. Therefore, it is highly probable that insurance companies might be brought under the purview of the FSP rules. With this, insurance companies will then be subject to the following key provisions of the rules:
In instances where an order of liquidation is to be passed by the NCLT, the appropriate regulator must be consulted. Similarly, in cases of voluntary liquidation of the FSP, it is required to obtain permission from the appropriate regulator before initiating the voluntary liquidation process. The FSP Rules also stipulate that the license or the registration of the FSP to engage in the business of providing financial services shall not be suspended or cancelled during the liquidation process, unless an opportunity of a hearing is granted to the administrator.
Therefore,with reference to the key features of the FSP, the essence of an effective insolvency framework is prevalent. The provisions under the FSP provide for safety and effective disposal of the insolvency process simultaneously. The regulator is involved in every step of the way to ensure whether the right decision is made after taking into consideration the macro effects of the insolvency. This ensures that the interests of the creditors and all the other stakeholders are equitably addressed under the regime.
While comparing the insolvency regimes under the IBC, its associated FSP rules and Insurance Act, it is interesting to note that the latter provides for a much more comprehensive and safer framework for insurance companies. During the analysis of the benefits of an insolvency regime, the provisions which deal with insolvency alone shall not be analysed in isolation. The objective of such a regime should not only be to provide a fast liquidation process and highest value for the assets sold but also to sustain a debtor and help to continue as an ongoing concern. The debtor would then be able to make continued and timely payments to the creditors.
Here, the Insurance Act provides for greater safeguards and has several provisions which aim to sustain an insurance company and prevent it from falling into insolvency. Provisions for government acquisition of life insurance companies, submission of financial plans by the insurance companies which set out a blueprint to rectify the shortfalls of the companies in adhering to the capital and solvency requirements under the Act, and appointment of administrators who have wider powers than the ones appointed under the IBC regime establish the effectivity of the Insurance Act to deal with matters of insolvency if and when they arise. Therefore, it is only fair that the insolvency of insurance companies is handled by the Insurance Act and insurance companies do not fall under the purview of IBC.
A recent development in the cases admitted under the IBC regime poses an interesting issue for insurance companies. In the case of Apeejay Trust v. Aviva Life Insurance Co. India Ltd., where the operational creditor initiated insolvency proceedings on the premise that Aviva defaulted in paying service tax and license fees dues. The NCLT ordered the initiation of insolvency proceedings against Aviva Life Insurance Co. India Ltd. on the ground that the debt owed to the creditor is “operational” in nature. The Tribunal further held that Aviva could not use section 3 of the IBC as a ‘blanket cover’ on the ground of it being a financial service provider.
The decision to order insolvency proceedings against Aviva, a life insurance company which has a solvency margin of 150%, merely because the nature of the debt was operational, is bad in law. Section 3(7) of the Code clearly exempts financial service providers from the definition of a corporate person. Further, the rationale of including an operational creditor in the insolvency proceedings against a corporate debtor is that if a corporate person has such a low rate of solvency that it is not able to meet even its day to day credit requirements, insolvency is the best option for all the stakeholders involved. Therefore, a life insurance company, with a solvency margin of 150% shall not be brought into insolvency under the IBC regime, especially when there are separate provisions under the Insurance Act governing the same. The development in the Aviva Case, has cast a shadow of mystery over an otherwise clear stance on the insolvency regime applicable to an insurance company.
During the pre-1991 era, most financial institutions were majorly state owned. Therefore the fear of failure of such institutions was minimal. However as the market became liberalized, private holdings in such institutions and privately-owned financial institutions started ramping up their presence in the Indian market. As the market evolved, the relationship amongst financial institutions became complex and inter-connected. Therefore, during the financial crisis of 2008, the financial sector was the worst hit due to the complexities and interconnectedness of the entities in the sector.
Such large-scale damage throughout the global economies led to the awareness of the importance of strong and comprehensive frameworks for the financial sector to enable it to absorb the effects of such financial crises. The G20 realised the importance of such awareness and established the Financial Stability Board (hereinafter referred to as FSB). It was established to monitor and draft recommendations about global financial systems. The FSB issued a set of rules called the “Key Attributes of Effective Resolution Regime for Financial Institutions” in 2011. The core principles were adopted by the G20 in 2014 in order to reduce taxpayer support for solvency following the global financial crisis. As a member of G20, India is committed to implement the key attributes into its domestic law. These key attributes have specified several factors to be included in such a framework, including:
India, incorporating all the above key attributes laid down by the FSB, introduced the Financial Resolution and Deposit Insurance Bill in 2017. The Bill was aimed to provide a sound resolution framework for financial institutions, including banks, insurance companies, payment systems, SIFIs, mutual and pension funds and Indian branches of foreign financial institutions, among other financial institutions. The Bill aimed to divide financial institutions on the basis of risk into categories such as low, moderate, material, imminent and critical, based on capital adequacy and other factors. These financial institutions in the material and imminent categories were requited to submit a restoration plan/resolution plan and would be subjected to subsequent periodic monitoring by the appropriate resolution authority.
However, the Bill was never passed as a legislation due to the huge public outcry regarding the Bail-in clause. The clause essentially gave powers to the appropriate authority to either cancel the debts owed to creditors or to convert such debts into instruments of ownership like equity. This provision could have been beneficial during mergers or acquisitions of such debt ridden financial, but the public feared that the clause might be invoked at the expense of the interests of deposit holders.
The key attributes, as laid down by the FSB, were readily incorporated into domestic laws, by countries like USA, UK, France, Germany, etc. as part of their G20 commitments. It is pertinent to note that such countries are developed countries and have extremely different financial sectors compared to a developing country like India. Public sector undertakings still dominate the financial sector in India. This was completely opposite to the situation in developed countries, where the private sector dominated the financial markets. Therefore, it was only fair that the bill was not passed and sent back for reconsideration.
The issue of insolvency is daunting when it comes to any financial service provider and more so, when it comes to an insurance company. This is because of the sheer volume of people covered by insurance policies and the importance of the subjects for which insurance policies are taken. Hence, a superior sense of safety is expected from the framework of the insurance companies to keep the companies solvent and provides for adequate and seamless alternatives at times of insolvency. Correspondingly, upon careful analysis of the insolvency regimes of insurance companies under the Insurance Act and other corporate debtors under the Insolvency and Bankruptcy Code of 2016, the Insurance Act provides for a safer and seamless framework which has numerous checklists and safeguards to prevent an insurance company to even get to the point of insolvency. The recent developments with respect to the FRDI bill and the inclusion of insurance companies under the purview of IBC (Aviva Life Insurance Co. Ltd. Case) are discouraging. If promoted further, will shroud the insolvency framework of insurance companies. The Insurance Act deals extensively with the insolvency of insurance companies and has established a better framework which ensures adherence and strict compliance by the insurance companies. A change in the application of the regime will only make the situation fragile for insurance companies and all of their stakeholders. Therefore, any new developments with regard to the subject must be made meticulously, keeping in mind the importance of insurance companies in determining the health of the financial sector of the country.