Indian government does not address captive insurance opportunity
For the third consecutive year, the Union Budget of India 2024 does not include captive insurance. Charul Sharma and Andrew Christie of EY take a look at recent developments.
The Union Budget 2024 of India was expected to pave the way for the captive insurance industry in the country. However, the budget release did not include any mention of captive insurance. For the insurance sector, the Insurance Regulatory and Development Authority of India (IRDAI) has set a goal of achieving “Insurance for All by 2047”.
As part of this vision, IRDAI was expected to propose amendments to the Insurance Act of 1938 during the parliamentary session. One significant proposed amendment included the issuance of captive insurance licences. However, similar to the previous two attempts in the last two budget sessions, there was nothing about captive insurance in the budget that was introduced.
For the captive insurance industry to thrive in India, it is essential to review and amend the provisions of the Insurance Act of 1938, which remains the primary legislation governing insurance in the country.
The current minimum capital requirement for establishing a general (non-life) insurance company in India is ~$12 million (INR 100 crore). This poses a significant challenge for most businesses, especially small- and mid-market companies interested in forming captives, as raising such a high amount of capital is difficult or even impossible for them. This entry barrier limits the number of businesses that can afford to set up their own insurance company.
Captives primarily insure the risks of their parent organisations and, therefore, generally may require less capital than commercial insurance companies, which cover purely third-party risks. Compared to other established captive domiciles worldwide, India’s minimum capital requirement is higher. Additionally, this capital may be “trapped” in the captive, resulting in a low rate of return, thus further lowering the feasibility of such option.
To enhance the competitiveness of the captive insurance industry in India, the mandatory $12 million capital requirement should be revised to allow the regulator to set minimum capital levels on a case-by-case basis with certain overall guardrails in place. This adjustment aims to broaden opportunities within the industry and lay the groundwork for long-term growth. It will enable large corporate entities in India to establish captives and open the market to small- and medium-sized enterprises, which have shown the highest growth rates in developed captive markets.
Restrictions
An additional hurdle for the industry is the restriction under the Insurance Act of 1938 which stipulates that an insurance company can operate in only one segment of insurance. This means an insurer can choose to be a life insurance company, a general insurer, a health insurer, or a reinsurer, but not more than one simultaneously.
While it is true that life and P&C combinations in a singular captive are not common, generally, captives can be direct and reinsurance writers in one, as well as include health risks (for example) in the same captive. When a business establishes a captive insurance company, it typically does so to cover all its insurance needs, unless it finds certain segments not feasible for inclusion in the captive arrangement. Businesses may seek to include employee benefits, general liability, and property insurance, all within one captive. Captives also function as reinsurers reinsuring the risk of its parent and sister companies. Unless this restriction is amended, it could impede the industry development.
A further challenge is the prohibition of fronting in reinsurance contracts in India. Fronting insurance, defined as the use of a licensed, admitted insurer to issue an insurance policy on behalf of a self-insured organisation or captive insurer without the intention of retaining any risk, is currently illegal as per IRDAI regulations.
In many jurisdictions, captives rely on fronting to meet regulatory standards and lender/third-party requirements. The current regulations encourage traditional insurers to retain as much risk as possible and cede as little as possible, a stance that may need revision to incentivise captives in India.
“A robust captive insurance framework would enhance India’s appeal as a destination for foreign direct investment.”
Benefits of the captive insurance market to India
IRDAI should consider adopting best practices from established captive domiciles, such as Vermont, Cayman, Bermuda or certain EU domiciles. This will allow India to be seen as being competitive with other countries that have captive laws.
Given the operational nuances of captive insurers compared to traditional insurers, creating a separate legislation focused on captive insurance is crucial for industry functionality. This legislation should create guidelines on minimum capital requirements, investment restrictions, loan-back policies, dividend distribution, fronting and more.
Establishing low-tax jurisdictions, such as GIFT City in Gujarat, can foster industry growth and attract businesses to set up captive insurance companies. GIFT City—Gujarat International Finance Tec-City—is India’s inaugural international financial services centre (IFSC). While it does mention captive insurance as a potential offshore insurance business area, it highlights the need for amendments to the Insurance Act of 1938 to facilitate the successful development of this sector.
Captive insurers in GIFT City can benefit from a 100 percent income tax exemption for 10 consecutive years. Services rendered to units within the IFSC are subject to a zero rate for Good and Services Tax (GST), meaning no GST is charged on these services. Additionally, transactions conducted within the IFSC may be exempt from several other taxes, including Security Transaction Tax, Commodity Transaction Tax, and Dividend Distribution Tax.
Captives have the potential to enhance the resilience of India’s financial sector and promote a culture of strategic risk management not only among large corporations but also within small- and medium-sized enterprises. Enhanced risk awareness and proactive management practices within captives can lead to more resilient and informed decision-making, benefiting the broader financial sector.
Captives allow for bespoke insurance solutions tailored to the specific needs of the owner organisation. This customisation ensures that unique risks are covered more efficiently, facilitating improved risk management and reduced financial volatility.
A robust captive insurance framework would enhance India’s appeal as a destination for foreign direct investment. Multinational corporations and global investors seeking effective risk financing solutions are likely to establish captives in jurisdictions with supportive regulatory environments.
Captives enable Indian businesses to retain premiums that would otherwise go to external insurers. Assuming favourable underwriting results, earned underwriting income can be reinvested into the parent company’s core operations, infrastructure development, or strategic initiatives. Further, commercial insurance premiums include profit loadings and high administrative charges. Writing a portion of business in a captive instead of a commercial insurer saves on these expenses included within the commercial premium.
Furthermore, captives would enable Indian businesses to leverage advanced data analytics and risk modelling techniques to better understand and manage their risks. By analysing historical claims data and emerging trends, captives can proactively adjust insurance strategies and optimise risk retention levels. This analytical capability enhances decision-making processes and operational efficiencies.
The establishment and operation of captive insurance entities will require a skilled workforce proficient in insurance underwriting, risk management, claims-handling, actuarial science, and compliance with regulatory frameworks. This will create demand for insurance professionals with specialised knowledge and expertise and thus create jobs for the economy. Further, India already has established captive insurance professionals who support US and European captive professional service firms (typically in a financial statement preparation capacity). This provides a readily available talent base to build upon, were the legislation passed.
Conclusion
This is the third time that the budget did not mention the captive insurance industry. For the industry to thrive in India, amendments to the Insurance Act of 1938 are required. These amendments should include lowering the minimum capital requirement of $12 million needed to form an insurance company, introducing the concept of composite insurers (which would allow general insurers to offer life and health insurance, and vice versa), and addressing issues, such as fronting arrangements and permitting insurers to act as both insurers and reinsurers.
To effectively advance its captive insurance sector, India should consider adopting best-in-class captive legislation from established jurisdictions such as Bermuda, the Cayman Islands, Vermont, or certain EU jurisdictions which feature well-defined and supportive captive regulatory frameworks. Captives have a different risk profile to commercial insurers and the respective regulations should reflect and respect these differences. Enactment of a separate act dedicated to the unique needs of captive insurance markets and structures would help the industry in India to flourish.
Captive insurers enhance a country’s financial sector resilience by promoting a culture of risk management within organisations. They enable businesses to develop tailored insurance solutions for unique or challenging risks, resulting in improved risk financing, which can lower the total cost of risk to the organisation.
A strong captive insurance sector can attract foreign investment, foster growth in the financial services industry, and create job opportunities in related fields such as insurance, risk management, and financial services.
The views expressed are those of the authors and do not necessarily reflect the views of Ernst & Young LLP or any other member firm of the global EY organisation.
Charul Sharma is a senior in the EY Financial Services Organisation Insurance Sector and is part of the Americas Captive Insurance Services practice. She can be contacted at: charul.sharma1@ey.com
Andrew Christie is a senior manager in the Americas Captive Insurance Services practice and a member of EY’s Global Captive Network. He can be contacted at: andrew.christie@ey.com
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