Subordinated debt issuances, or hybrid bonds, have emerged as a major source of growth capital – and higher solvency ratio1 cushion – for non-life insurers. As many as seven of them raised Rs 2,181 crore in fiscal 2017, and more issuances are on the cards with non-life premium growth expected to be buoyant this fiscal.
 

In December 2015, the Insurance Regulatory and Development Authority of India (IRDA) allowed insurers to raise non-equity forms of capital such as subordinated debt or preference shares, which qualify as regulatory capital, and help improve the solvency ratio of insurers.

The first hybrid bond issuance was in July 2016, and since then seven non-life insurers have tapped the debt market with March 2017 alone seeing four of them raising Rs 1,166 crore. Crisil has rated five issuances thus far aggregating Rs 2,008 crore, which has been placed at competitive yields.
 

Says Gurpreet Chhatwal, President, Crisil Ratings: “Subordinated debt issuances have emerged as a very good alternative to equity as they enable insurers to raise capital at an optimal cost. Hybrid issuances will gain impetus given buoyant growth prospects for non-life insurers.”
 

In fiscal 2017, non-life insurers registered a premium growth of 32% driven by a four-fold rise in crop insurance premiums because of the Pradhan Mantri Fasal Bima Yojana. Though premium growth will moderate in fiscal 2018, it will still be strong at ~18-20% aided by a significant hike in motor third-party premium, price correction in the group health segment, and increased penetration in the crop insurance and retail segments.

Solvency ratios of non-life insurers are expected to improve because of a change in the way solvency margin is calculated. IRDA has recently revised the factor used to compute solvency margin for crop insurance to 0.5 from 0.7 and extended the timeframe to recognise government dues in available solvency margin to one year from six months so as to enable capital optimisation and improve insurance penetration. This will result in 10-15 basis points (bps) rise in the reported solvency ratios of non-life insurers with sizeable exposure to the crop insurance business.

Yet most insurers will need external capital to fund growth while maintaining solvency ratio because internal accruals may come up short given modest underwriting performance. Majority of the insurers are promoted by
large established companies. Growth capital, nevertheless, is expected to be funded through a combination of equity and hybrid bonds given its cost effectiveness. 
 

However, investors in hybrid bonds of insurers need to be cognisant of additional risks on account of restriction on debt servicing if the solvency ratio falls below the regulatory stipulation. Further, in case of insufficient profit or loss, approval from the regulator would be required to service these bonds. 
 

Crisil’s rating methodology entails a rigorous evaluation of the financial strength of the insurer and extent of cushion in solvency ratio over the regulatory minimum. 
 

Says Krishnan Sitaraman, Senior Director, Crisil Ratings: “For rating subordinated debt instruments, the extent of cushion in the solvency ratio that an insurer intends to maintain over and above the regulatory requirement on an ongoing basis is considered a critical factor.”

As promoters of most insurers are large established companies, their ability and commitment on infusing equity to enable insurers to maintain solvency ratio cushion are also taken into consideration when rating hybrid bonds.