Life is unpredictable. Whether it be protection against the risk of premature death, lost income due to disability, expenses not covered by major medical insurance or hedging any form of business risk, insurers provide the financial protection and security that people count on. Pension funds, on the other hand, operate in a different way, though their purpose is somewhat similar in securing finances.
Both insurance companies and pension funds are highly regulated, given that public funds are involved. Over 63 per cent of the total corpus of the Indian insurance sector is invested in Central and State government securities, while the remaining 37 per cent lies in instruments that meet regulatory approval.
Some of this is changing, though. A paper published by the Society of Actuaries in March 2018, explaining trends in asset allocation of major life insurers across eight Asian markets in 2011-2015, observed that there are signs of decreasing relative exposures to low-risk government bonds, and a shift to riskier asset classes to generate sufficient returns to meet policyholders’ reasonable expectations. The Pension Fund Regulatory and Development Authority is also lobbying the government to increase the equity proportion of their investment portfolios.
Of late, another investment option that perfectly meets the criteria of insurance companies and pension funds has emerged. Infrastructure Investment Trusts (InvITs) are popular investment vehicles for long-term infrastructure funding, widely prevalent across the globe with over 400 listings of similar instruments accounting for over $1 trillion of investments. In September 2014, India’s financial markets regulator notified regulations for InvITs and REITs.
Globally, InvITs are positioned as high dividend-paying investments with return expectations (11-12 per cent) slightly lower than that of a typical equity investment returns (14-16 per cent); however, returns are higher than government securities and bonds. Besides, there are no other comparable instruments that provide such stable returns over the long term, and in some cases such as power transmission assets, for as long as 30 years — matching the long-dated liabilities of insurance and pension funds.
Operating like mutual funds, they collect funds from investors and invest them in operating infrastructure projects, whose cash flows are then distributed to investors. The underlying cash flows generated by InvITs are AAA rated, 90 per cent of which needs to be distributed to unit-holders as per existing regulations. Strong corporate governance and independence from sponsors (the infrastructure developer setting up an InvIT and offering assets to the InvIT) are the pillars of such a structure.
Despite the suitability of InvITs for long-only investment, insurance and pension firms are regulatorily limited to optimise investment into them. Insurance companies cannot invest more than 5 per cent of their AUM into any one InvIT or 3 per cent of the respective fund size of the insurer, whichever is lower. Insurance firms cannot subscribe to debt securities issued by an InvIT either.
On the other hand, mutual funds are permitted to invest in up to 10 per cent of the units issued by an InvIT. Likewise, the PFRDA in 2015 allowed provident funds and national pension funds to invest up to 5 per cent in InvITs, subject to the sponsor having a minimum of AA rating.
Considering the suitability of InvITs with the investment objectives of insurance companies, it is important that insurers are encouraged to participate in InvITs.
The writer is a former Finance Secretary