Explained | Why government decided to call off PSU insurers’ merger

Every insurance company is required to maintain a minimum capital at all times. This is called solvency in insurance parlance. As per the Insurance Regulatory and Development Authority of India (IRDAI) rules, the solvency has to be at least 1.5X. Simplified, this means that the assets are to be 1.5 times the liabilities.

When the merger proposal was announced by former finance minister late Arun Jaitley in February 2018 in his Budget speech, the idea was that the three entities would be amalgamated and subsequently listed on the stock exchanges. This meant that an exercise to value the firms first before a merger could be initiated.

EY was appointed in December 2018 to look at the merger process and also fix the solvency levels.

Meanwhile, the solvency levels of the insurers were either too close to the minimum requirement or dropped below.

As of Q3FY20, United India Insurance’s solvency margin was at 0.94, National Insurance was 0.12 while that of Oriental Insurance was 1.54.

National Insurance, which had a wide gap between its solvency margin and the minimum solvency mandated by IRDAI, had said in its public disclosure that this is after considering full fair-value change account balance and 2.5 percent discounting on motor third party IBNR (incurred but not reported) provisions as per forbearance given by the regulator.

Government sources told Moneycontrol that it was decided that unless the solvency margin was at least 1.6 and above, it wouldn’t have made financial sense to merge the entities.

To deal with the situation, on July 8 the Union Cabinet approved a capital infusion for an overall value of Rs 12,450 crore (including Rs 2,500 crore infused in FY20) in the three insurers.

Of the total, Rs 3,475 crore will be released immediately while the balance Rs 6,475 crore will be infused later.

Low levels of profits

Due to the rising claims in segments like motor and health insurance and the multiple large and small natural catastrophes in FY19 and FY20 adding to the losses for the three state-owned general insurers.

United India had a net loss before tax of Rs 1,358.62 crore as of December 31, 2019. For Oriental Insurance, the net loss stood at Rs 388.37 crore for 9MFY20. National Insurance’s net loss stood at Rs 2150.1 crore for the period ended December 31, 2019.

A merger of three loss-making entities would have meant that the resultant valuation of the combined entity would have at least 20 percent than the perceived value of Rs 1.5 lakh crore.

A lower valuation would have meant that a proposed initial public offering (IPO) would have been delayed further.

Considering the Rs 1.5 lakh crore IPO, the government could have gained Rs 15,000 crore even if it sold only 10 percent through a disinvestment process.

Coronavirus outbreak

The final nail on the coffin was the Coronavirus outbreak that led to a nationwide lockdown. Economic uncertainty led to customers deferring the purchase of policies and premium payments while claims from health ailments were on the rise.

A merger at this juncture would have not only pulled down the valuation of the combined entity but also would have required an additional Rs 7,000 crore-8,000 crore funds to be infused over and above what the Cabinet approved.

A smaller but crucial factor was that the PSU general insurance association agents were also not in favour of the merger and the subsequent listing of the firms. An immediate impact would have been a loss of jobs across the board since a merged entity wouldn’t require multiple people pursuing the same functions.

Taking all these factors into consideration, dropping the merger proposal was the best way out for the government. Officials are of the view that once the three insurers are profitable with above than 1.5 solvency margin consecutively for four quarters, this proposal could be revisited.

What's next for these insurers?

For National Insurance and United India Insurance, the first step would be to use the capital infusion to bring up the solvency margin to 1.5. After this, the focus will be on cost cuts and improvement in the bottomline while focussing on corporate and retail customers to improve the topline.

Considering the proposed merger, IRDAI had allowed a relaxation for these companies on the solvency issue. However, now that the proposal has been called off, the regulator may also seek clarity on what steps these PSU insurers would take to improve their balance sheet and capital requirement.