New IRDA norms likely to help insurance companies hedge risks better

MUMBAI: Insurance companies have been given the tools to better manage their books and offer a more stable return to policyholders. The regulator has allowed insurers to hedge their liabilities or premium inflow against interest-rate fluctuations for a longer tenure by striking oneto-one derivatives deals with other financial institutions. The Insurance Regulatory and Development Authority (IRDA) had until now allowed insurers to hedge using over-the-counter (OTC) derivatives such as interest-rate swaps and forward-rate agreements (FRAs) up to one year. Under the new norms, the regulator has not placed any limit on the tenure that can be hedged.

With this insurers will be in a position to cover risks arising out of softening interest rates. “The overriding principle of any use of the above listed derivatives is that they must be used for hedging purposes only to reduce the interest rate risk in the company,” IRDA said. “The company must be able to demonstrate that this principle is adhered to,” it added. IRDA bans interest-rate swaps having explicit or implicit option features.

The move to liberalise hedging may not directly benefit customers but it will allow insurance companies to guarantee regular premium products, according to Sandeep Batra, executive director of ICICI Prudential Life Insurance. “The move will help insurers to better manage their asset-liability mismatches,” he said. IRDA has said that exposure limits pertaining to single issuer, group and industry will be applicable for the exposure through FRA and interest-rate swap IRS contracts.

It has prohibited insurance companies from entering into contracts with promoter group entities either directly or indirectly. “This is a watershed development as the derivatives will now be approached from the liability side of the balance sheet of insurance companies. The insurer can now effectively hedge the interest rate risk for long contracts.

The long derivatives will allow us to capture and effectively extend the benefit of the current high interest rates to customers through simpler traditional products,” said Saibal Ghosh, chief investment officer, Aegon Religare Life Insurance.

Insurers, which are long-term investors with holdings of 10- and 20-year bonds in their portfolio, will grab the opportunity as it will enable them to hedge risks over a period when interest rates move in cycles. They did not do so until now since they were permitted to do it only for a year.