Report on Public Issues by Insurance Companies SEBI Committee on Disclosures and Accounting Standards (SCODA)

Transcription

1 Report on Public Issues by Insurance Companies SEBI Committee on Disclosures and Accounting Standards (SCODA) Page 1

2 Table of contents Section No Section Page Number 1 Background 3 2 Constitution of the Sub-group 3 3 Scope of the Sub-group 4 4 Recommendations of Sub-group 4 5 Other issues raised by IRDA 10 List of Annexure Annexure Number Details of Annexure Page No. Annexure I Industry specific risk factors for insurance sector 13 Annexure II Overview of Insurance Industry 21 Annexure III Comparison table on disclosures made in offer documents of life insurance companies in other jurisdictions 23 Annexure IV Glossary of terms used in Insurance Industry 29 Page 2

3 Public Issues by Insurance Companies 1. Background: 1.1. There have recently been media reports that insurance companies in India are planning to raise money from the capital market through initial public offers. Till now, no company from the insurance sector has accessed the capital markets in India. Since the nature of business and risks involved in insurance sector are of a different kind, it was felt that there is a need to review whether the present disclosure requirements in offer documents as well as those on a continuous basis are suitable and sufficient for the insurance companies In this context, SEBI has been in receipt of suggestions/ observations from merchant bankers and international consultants on additional insurance sector-specific disclosures. SEBI has also received suggestions/comments from IRDA on the disclosures in offer documents by insurance companies. The areas of disclosures as identified taking into account the practices followed in other jurisdictions and suggestions/ comments of the merchant bankers and IRDA were discussed in the SEBI Committee on Disclosures and Accounting Standards (SCODA) in its meeting held on August 24, SCODA during its deliberations suggested that the suitability/sufficiency of the existing provisions of SEBI (ICDR) Regulations to insurance companies may be examined. 2. Constitution of the Sub-group: Page In order to examine the extant regulatory requirements vis a vis the disclosure requirements for insurance companies, SCODA decided to constitute a sub-group comprising following members: Sl Name Designation Organization 1. Ms. Dipti Neelakantan MD & Group COO JM Financials Ltd 2. Shri Prithvi Haldea CMD Prime Database Ltd 3. *Shri R K Sharma Deputy Director Insurance Regulatory and Development Authority

4 Sl Name Designation Organization (IRDA) 4. Dr. S. Subramanian Head, IBD Enam Securities Ltd 5. Shri Shrawan Jalan Director Ernst & Young 6. *Shri Sunil Kadam General Manager Securities and Exchange Board of India (SEBI) * Shri R K Sharma, Deputy Director, IRDA and Shri Sunil Kadam, General Manager, SEBI replaced Ms Mamta Suri, Joint Director, IRDA and Shri Parag Basu, General Manager, SEBI, respectively due to internal changes in their respective organizations. 2.2 The group places on record its appreciation for the valuable contribution made by Ms Lakha Nair, Enam securities Ltd, Shri Sanjay Purao, Deputy General Manager, SEBI and Shri E Balasubramanian, Assistant General Manager, SEBI in preparation of this report. 3. Scope of the Sub-group: The following scope of work was identified by the sub-group: i. Provisions of SEBI (ICDR) Regulations vis a vis insurance companies ii. iii. Disclosures by insurance companies Continuous disclosure requirements for insurance companies 4. Recommendations of Sub-group 4.1. Amendment to SEBI(ICDR) Regulations The provisions of SEBI (ICDR) Regulations have been examined primarily with regard to its suitability and sufficiency with respect to disclosures by insurance companies. The provisions of SEBI (ICDR) were discussed. The sub-group agreed that the provisions of SEBI (ICDR) Regulations shall be applicable to insurance companies. The sub-group after deliberations gave their comments on certain provision of the SEBI (ICDR) Regulations along with the recommendations. The recommendations of the sub-group are as follows: Page 4

5 a) Monitoring Agency: Regulation 16(1) of SEBI (ICDR) Regulations provides that if the issue size exceeds Rs. 500 crore, the use of issue proceeds has to be monitored by a public financial institution or a scheduled commercial bank. The Regulation also states that the said provision is not applicable in case of issues made by a bank or a financial institution. Sub-group noted that the said dispensation was given as banks generally raise funds to meet the capital adequacy norms set out and monitored by RBI, the sectoral regulator. Sub-group further noted that in case of insurance companies too, the funds would be raised primarily to maintain/enhance solvency requirement, as stipulated by IRDA. Further, IRDA stipulates periodic reporting of solvency ratios and has also specified investment regulations for investing the funds raised for meeting the solvency margin. In view of the above, the sub-group recommends that insurance companies may be exempted from the provision of Regulation 16 of SEBI (ICDR) Regulations in line with exemption given to banks and financial institutions. b) Disclaimer clause: In the case of banks, section XI (K) of part A of Schedule VII of SEBI (ICDR) Regulations provide for disclosure of a disclaimer clause of RBI. Similarly, a disclaimer clause of IRDA may be provided for in the offer documents of insurance companies. 4.2.Disclosures by Insurance Companies: Industry- specific Risk Factors for Insurance Companies: The insurance industry is different from other industries and has risks which are unique to it. In order to get an understanding of risks specific to the insurance industry, offer documents of certain insurance companies which came out with issue of capital in other jurisdictions were studied. Based on the risk factors disclosed in such offer documents, following are the minimum broad industry specific risk areas that needs to be disclosed: i. Claims arising out of catastrophic losses (natural and man-made), which could materially and adversely impact the profitability or cash flow of the insurance companies. Page 5

6 ii. Concentrated surrenders which may materially affect cash flows, results of operations and financial condition. iii. Differences in future actual claims resulting from the assumptions used in pricing and establishing reserves for insurance and annuity products which may materially affect earnings. iv. Risk with reference to concentration by region/type of policies of the insurance company. v. The assumptions based on which the embedded value is calculated and disclosed may vary significantly from time to time / among industry players. vi. Deviations in mortality/morbidity rates from those predicted in determining reserve amounts. vii. Deviations in persistency/lapse rates from those predicted in determining reserve amounts viii. Inability to attract and retain productive agents in a growing competitive business environment. ix. Fluctuations in reserves due to guaranteed benefits x. Inability to obtain reinsurance on a timely basis or at all, which results in bearing increased risks or reduce the level of our underwriting commitments. xi. Default by one or more of our reinsurers which could materially affect the financial condition and results of operations. xii. Regulatory restrictions on investments by insurance companies xiii. Exposure to recovery related risks including for foreclosure of the mortgages xiv. Inability to accurately predict benefits, claims and other costs or to manage such costs through loss limitation methods, which could have a material adverse effect on the operations and financial condition The sub-group recommends that the aforementioned list may act as guidance for companies while disclosing the risk factors in the offer documents. The sub-group also compiled detailed risk factors for insurance companies which are placed at Annexure I. Page 6

7 The sub-group recommends that: a. The detailed risk factors as identified by sub-group may be placed on the website of IRDA which may act as guidance to insurance companies coming out with IPO. b. SEBI may prescribe the disclosure of aforementioned list of risk factors in the offer documents of insurance companies through circular or standard observations Disclosure on Overview of the Insurance Industry: The SEBI (ICDR) Regulation does not prescribe the format or the contents of industry overview which need to be disclosed in the offer documents for any industry. However, considering the fact that no insurance company in India has come out with an issue so far, it is felt necessary that the investors get a broad overview of the insurance industry. In view of this, broad parameters under which the disclosure on insurance industry overview may be made have been listed and placed in Annexure II. The sub-group recommends that this list may be placed in the website of IRDA, which may act as guidance for insurance companies coming out with issues Disclosure of Financial Information: It is observed that the components of financial statements of insurance companies are significantly different from other companies. An insurance company prepares two types of income accounts i.e. policy holder s account (Revenue account) and shareholder s account (profit and loss account). IRDA has prescribed the formats in which the financials of the insurance companies need to be submitted to them on a periodic basis. On the other hand, provisions regarding disclosure of financial information in SEBI (ICDR) Regulations are general and are applicable to all companies. The subgroup noted that banking companies follow format of financial statements prescribed under Banking Regulation Act, 1949 and similarly insurance companies may follow formats specified by IRDA. Page 7

8 Sub-group recommended that the financial disclosure for insurance companies may be as per the format specified by IRDA Specific Disclosures which are followed in other Jurisdictions: The sub-group carried out an analysis of the specific disclosures which are followed in other jurisdictions. A detailed comparative chart along with the comments of the IRDA on each disclosure item in case of life insurance companies is attached as Annexure III. It is observed that the extant disclosure norms prescribed by IRDA are by and large at par with the international practice in vogue in various jurisdictions. Sub-group recommends that following additional disclosures applicable in other jurisdictions shall be included in the offer documents of life insurance companies i. Gross premium- along with Geographic segmentation ii. Cross selling iii. Distribution network iv. Persistency v. Operating expense ratio vi. Investment yield vii. Embedded value Report comprising of: New Business Value Value of in force business Embedded value viii. Investment of above 5% of total Funds in each sector through equity & bonds ix. Reinsurance x. Interest rate sensitivity xi. Liability for future policy benefits and policy holders account balances. xii. NBAP xiii. Manner of arriving at unrealized gain/losses under IFRS or Indian equivalent Page 8

9 As regards the disclosure on NBAP (New Business Achieved Profit) IRDA has reservations on mandating the said disclosure for insurance companies due to lack of uniformity/standardization of approach adopted for calculation, as of now. Considering the nascent stage of the insurance industry in India and lack of understanding of this business by investors in general, the sub-group felt that there is a need for an expert opinion on both the Embedded Value (EV) and New Business Value (NBV) which together reflect the fair value of the business of an insurance company. Accordingly, sub-group recommends that report of an independent actuary on the EV and NBV of the insurance company should be made a part of the offer document. The contents and format of the EV/NBV reports and criteria for actuaries who are authorized to prepare such report may be prescribed by IRDA. The sub-group recommends that SEBI may mandate the disclosure of aforementioned list of disclosure items in the offer documents of insurance companies through circular or standard observations Glossary of terms used in the Insurance Industry: In order to familiarize the investors with terms used in insurance industry and to standardize the definition and understanding of such terms, the sub-group felt that a Glossary of the terms used in Insurance industry may be prepared. IRDA provided a Glossary of the terms used in Insurance industry which is placed in Annexure IV. This glossary of terms may act as guidance for insurance companies coming out with issues. The sub group recommends that the glossary may be placed on the website of IRDA Continuous Disclosure Requirements for Insurance Companies: The continuous disclosure requirements i.e the disclosure/reporting requirements of companies after its shares are listed at the stock exchanges are prescribed through the listing agreement. The provisions of the listing agreement have been examined in light of continuous disclosure requirements of the insurance Page 9

10 companies. It may be noted that clause 41 of the listing agreement prescribes the format in which the listed companies are required to disclose the financial information on a quarterly basis to the stock exchanges. Further, a separate format of financial and a format of limited review report has been provided for banks under the clause 41 of the listing agreement. On the same lines, a separate format of financial information and a format of limited review report were recommended for the insurance companies. SCODA suggested the sub-group to re-work on the formats specified in Clause 41 of the Listing Agreement and retain only critical portions, as the same needs to be published in the newspapers. Further, SCODA suggested that the sub-group should classify those disclosures which need to be filed with the exchanges and those which need to be published. 5. Other issues raised by IRDA: 5.1. Advertisements regarding public issues: IRDA requires that all advertisements issued by insurance companies be filed with IRDA for vetting at least 30 days before publishing the same. Sub-group noted that issue advertisements are typically made post the filing of the red herring prospectus which leaves a very short time between the date of filing of RHP and issue opening date. Sub-group recommended that the issue advertisements made by insurance companies being statutory advertisements, may be as per the provisions of SEBI (ICDR) Regulations only Objects of issue: The IRDA representative suggested that insurance companies should be allowed to raise money only for the following objects: a. To augment the solvency requirement b. For general corporate purposes c. For any other purpose which has a specific approval of IRDA The sub-group noted that SEBI (ICDR) Regulations does not have any specific restriction on nature of objects for which a company can raise money from the public. Hence, the sub-group recommends that SEBI (ICDR) Regulations need not Page 10

11 be amended in this regard. However, IRDA may, if it considers necessary issue guidelines to the insurance companies in this regard Issuance of partly-paid shares: The IRDA representative stated that partly-paid shares should not be allowed as it may inflate the capital. Sub-group noted that the Companies Act, 1956 permits issuance of partly paid up shares by companies. Hence, placing such restriction through subordinate legislation may not be appropriate and may not also be legally tenable. Therefore sub-group recommended that restrictions, if considered necessary, can be put by IRDA under its regulatory powers Definition of Promoters: IRDA stated that as per the existing provisions, all the shareholders of insurance companies are treated as promoters and employees who have been issued shares under ESOP scheme are excluded. Further, any transfer of shares of more than one percent by the pre-ipo shareholders requires prior approval of IRDA. Therefore, IRDA suggested that the definition of Promoter under SEBI (ICDR) Regulations may be amended as follows: Promoters mean the shareholders of the company at the date of filing of the application for IPO with IRDA/ SEBI. However, employees / officers who have been issued shares under ESOP scheme should be excluded The sub-group recommends that the existing definition of promoters as per the SEBI (ICDR) Regulations should be applicable to the insurance companies as well and that IRDA may issue separate guidelines to insurance companies in relation to pre-ipo transfer of shares, if so considered necessary. However, disclosure regarding any such restriction shall be made in the offer document Relaxation from eligibility criteria: The IRDA representative was of the view that insurance companies may find it difficult to comply with the eligibility requirement (i.e. profitability criteria), since gestation period of life insurance business is comparatively longer and it takes around 6 to 7 years for a life insurer to achieve break even. IRDA representative enquired whether such companies can still raise capital through fixed price issue. Page 11

12 The sub-group felt that there is no need to provide specific relaxation from the eligibility conditions to insurance companies since the companies which do not comply with the profitability criteria can still raise the capital through book building process Key Management Personnel : The IRDA representative suggested the inclusion of the following officers in an insurance company in the definition of key management personnel : Chief Executive, Chief Marketing Officer, Appointed Actuary, Chief Investment Officer, Chief of Internal Audit and Chief Finance Officer. In this context, sub-group noted that the key management personnel generally means and includes only employees in management. The sub-group suggested that the provisions of extant SEBI (ICDR) Regulations may apply as it is and that IRDA, if it so considers necessary, may issue guidelines to the insurance companies specifying the inclusion of additional persons as key management personnel Disclosure with regard to uniform financial denomination: The IRDA Accounting Regulations require that figures in all financial statements should be in thousands. It was brought to the notice of IRDA representative that SEBI (ICDR) Regulations do not specify any particular denomination in which the financial information shall be disclosed. The clause VIII (G) of Part A of Schedule VIII of SEBI (ICDR) Regulations requires the issuer to use one standard financial unit in the offer document. The sub-group noted that insurance companies can easily comply with the requirement of IRDA on denomination without any conflict with the provisions of SEBI (ICDR) Regulations and hence suggested no change. ***** Page 12

13 Annexure I: INDUSTRY SPECIFIC RISK FACTORS FOR INSURANCE SECTOR (LIFE and NON- LIFE) General No insurance company is yet listed in the Indian capital market. Insurance sector has a unique operation and it presents various types of unique risks. Investors should read the section on Insurance Industry to acquaint themselves with the key features of this sector. In addition, investors should consider the risks associated with the industry in which the Company operates as well as those relating specifically to it. Interest Rate Risk Changes in interest rates may materially and adversely affect our profitability. The profitability of some of the products and investment returns of insurance companies are highly sensitive to interest rate fluctuations, and changes in interest rates could adversely affect our investment returns and results of operations. In periods of rising interest rates, while the increased investment yield will increase the returns on newly added assets in our investment portfolios, surrenders and withdrawals of existing insurance policies may also increase as policyholders seek to buy products with perceived higher returns. These surrenders and withdrawals may result in cash payments requiring the sale of invested assets at a time when the prices of those assets are adversely affected by the increase in market interest rates, potentially resulting in realized investment losses. These cash payments to policyholders would result in a decrease in total invested assets and a potential decrease in net income. Moreover, a rise in interest rates would adversely affect our shareholders equity in the immediate fiscal year due to a decrease in the fair value of our fixed income investments. Conversely, a decline in interest rates could result in reduced investment returns on our newly added assets and have an adverse impact on our profitability. During periods of declining interest rates, our average investment yield will decline as our maturing investments, as well as bonds that are redeemed or prepaid to take advantage of the lower interest rate environment, are replaced with new investments carrying lower yields, which would adversely affect our profitability. In addition, the liabilities associated with our life insurance policies tend to have a longer duration than our investment assets, which may result in the re-investment returns of our maturing investments being lower than the average guaranteed pricing rate for our insurance policies in a declining interest rate environment. Maturity Risk Due to the limited availability of long-term fixed income securities in the Indian capital market and the legal and regulatory restrictions on the types of investments we may make, we are unable to match closely the duration of our assets and liabilities, which increases our exposure to interest rate risk. Restrictions under the IRDA regulations on the asset classes in which we may invest, as well as the limited availability in the Indian market of long duration investment assets capable of matching the duration of our liabilities, can result in the duration of our assets being shorter than that of our liabilities, in particular, our liabilities in life insurance operations. If we are unable to match closely the duration of our assets and liabilities, we will continue to be exposed to risks related to interest rate changes, which would materially and adversely affect our results of operations and financial condition. Liquidity Risk Differences in future actual claims results from the assumptions used in pricing and establishing reserves for our insurance and annuity products may materially and adversely affect our earnings. Our earnings depend significantly upon the extent to which our actual claims results are consistent with the assumptions used in setting the prices for our products and establishing the liabilities in our financial statements for our obligations for future policy benefits and claims. Our assumptions include those for investment returns, mortality, morbidity, expenses and persistency, as well as macro-economic factors such as inflation. To the extent that trends in actual claims results are less favorable than our underlying assumptions used in establishing these liabilities, and these trends are expected to continue in the future, we could be required to increase our liabilities. Any such increase could have a material adverse effect on our profitability and, if significant, our financial condition. Any material impairment in our solvency level could change our customers' or our business associates' perception of our financial health, which in turn could adversely affect our sales, earnings and operations. Page 13

14 Concentrated surrenders may materially and adversely affect our cash flows, results of operations and financial condition. Under normal circumstances, it is generally possible for insurance companies to estimate the overall amount of surrenders in a given period. However, the occurrence of emergency events that have significant impact, such as sharp declines in customer income due to a severe deterioration in economic conditions, radical changes in relevant government policies, loss of customer confidence in the insurance industry due to the weakening of the financial strength of one or more insurance companies, or the severe weakening of our financial strength, may trigger massive surrenders of insurance policies. If this were to occur, we would have to dispose of our investment assets, possibly at unfavorable prices, in order to make the significant amount of surrender payments. This could materially and adversely affect our cash flows, results of operations and financial condition. Investments Risk We may incur significant losses on our investments, which may cause our investment income to decrease, and could have a material adverse effect on our financial condition and results of operations. We primarily invest in fixed income products such as term deposits, government bonds, subordinated bonds issued by financial institutions, corporate bonds and equity. Our investment returns, and thus our profitability, may be adversely affected from time to time by conditions affecting our specific investments and, more generally, by market fluctuations as well as general economic, market and political conditions. In particular, our ability to make a profit on our insurance products depends in part on the returns on investments supporting our obligations under these products, and the value of specific investments may fluctuate substantially. Future movements in market interest rates, unfavorable conditions in the Indian capital market or other factors may cause our investment income to decrease significantly, and could have a material adverse effect on our financial condition and results of operations. Catastrophic Losses Risk Catastrophic losses could materially reduce our profitability or cash flow. Our insurance operations expose us to claims arising out of catastrophes. Earthquakes, typhoons, floods, wind, fires, explosions, industrial accidents, epidemics, terrorist attacks, and other events may cause catastrophes, and the occurrence and severity of catastrophes are inherently unpredictable. It is possible that both the frequency and severity of natural disasters may increase in the future. We establish reserves only after an assessment of potential losses relating to catastrophes that have taken place. However, we cannot assure you that such reserves will be sufficient to pay for all related claims. Although we carry some reinsurance to reduce our catastrophe loss exposures, due to limitations in the underwriting capacity and terms and conditions of the reinsurance market as well as difficulties in assessing our exposures to catastrophes, this reinsurance may not be sufficient to protect us adequately against losses. As a result, one or more catastrophic events could materially reduce our profits and cash flows and harm our financial condition. Reinsurance Risk If we are not able to obtain reinsurance on a timely basis or at all, we may be required to bear increased risks or reduce the level of our underwriting commitments. Our ability to obtain reinsurance on a timely basis and at a reasonable cost is subject to a number of factors, including prevailing market conditions that are beyond our control. The availability and cost of reinsurance may affect the volume of our business as well as our profitability. In particular, we may be unable to maintain our current reinsurance coverage or to obtain other reinsurance coverage in adequate amounts and at favorable rates. If we are unable to renew our expiring coverage or to obtain new reinsurance coverage, either our net risk exposure would increase or, if we are unwilling to bear an increase in net risk exposures, our overall underwriting capacity and the amount of risk we are able to underwrite would decrease. To the extent we are not able to obtain reinsurance on a timely basis and at a reasonable cost, or at all, our business, financial condition and results of operations would be materially and adversely affected. A default by one or more of our reinsurers could materially and adversely affect our financial condition and results of operations. Like other major insurance companies in the world, we transfer some of the risk we assume under the insurance policies we underwrite to reinsurance companies in exchange for a portion of the premiums we receive in connection with the underwriting of these policies. Although reinsurance makes the reinsurer liable to us for the risk transferred, it does not discharge our liability to our policyholders. As a result, we are exposed to credit risk with respect to reinsurers in all lines of our insurance business. In particular, a default by one or more of our reinsurers under our existing reinsurance arrangements would increase our financial losses arising out of a risk we have insured, which would reduce our profitability and may adversely affect our liquidity position. In the event of a Page 14

15 catastrophic loss that affects a significant number of Indian insurers, the reinsurers may not b able to pay us on a timely basis, or at all. Embedded Value Risk The embedded value information we present in this prospectus is based on several assumptions and may vary significantly as those assumptions are changed. In order to provide investors with an additional tool to understand our economic value and business results, we have disclosed information regarding our embedded value, as discussed in the section entitled, "Embedded Value". These measures are based on a discounted cash flow valuation determined using commonly applied actuarial methodologies. Standards with respect to the calculation of embedded value are still evolving, however, and there is no single adopted standard for the form, determination or presentation of the embedded value of an insurance company. Moreover, because of the technical complexity involved in embedded value calculations and the fact that embedded value estimates vary materially as key assumptions are changed, you should read the discussion under the section entitled "Embedded Value". You should use special care when interpreting embedded value results and should not place undue reliance on them. Regulatory Risks Regulations may restrict our ability to operate. The insurance industry is subject to extensive regulation by IRDA. IRDA has broad administrative powers to regulate many aspects of the insurance business, which include premium rates, marketing practices, advertising, policy forms and capital adequacy. IRDA is concerned primarily with the protection of policyholders rather than shareholders. Insurance laws and regulations impose restrictions on the amount and type of investments, prescribe solvency standards that must be met and maintained and require the maintenance of reserves. Premium rate regulation is common across all of our lines of business and may make it difficult for us to increase premiums to adequately reflect the cost of providing insurance coverage to our policyholders. In our underwriting, we rely heavily upon information gathered from third parties such as credit report agencies and other data aggregators. The use of this information is also highly regulated and any changes to the current regulatory structure could materially affect how we underwrite and price premiums. Our business is highly regulated and we may be materially and adversely affected by future regulatory changes. Our life insurance and general insurance businesses are regulated primarily by IRDA and we are subject to laws regulating all aspects of our insurance business. In addition, our securities business is regulated by SEBI. Compliance with applicable laws, rules and regulations may restrict our business activities. Furthermore, these laws, rules and regulations may change from time to time and we cannot assure you that future legislative or regulatory changes, including deregulation, would not have a material adverse effect on our business, financial condition and results of operations. We cannot predict at this time the effect of potential regulatory changes on our business and profitability. Moreover, failure to comply with any of the numerous laws, rules and regulations to which we are subject could result in fines, suspension or, in extreme cases, business license revocation, which could materially and adversely affect us. In particular, future laws, rules and regulations, or the interpretation of existing or future laws, rules and regulations, may have a material adverse affect on our business, financial condition and results of operations. The Indian insurance regulatory regime is undergoing significant change as it moves toward a more transparent regulatory process. Some of these changes may result in additional costs or restrictions on our activities. In particular, some of the changes may require us to take additional steps to comply with new rules and regulations on a timely basis. We cannot assure you that we will be able to achieve full compliance with any such new rules and regulations within any prescribed timeframe, and any such compliance may result in our incurring increased compliance and other costs. Moreover, because the terms of our products are subject to regulations, changes in regulations may affect our profitability on the policies and contracts we issue. Regulatory investigations and the resulting sanctions or penalties may adversely affect our reputation, business, results of operations and financial condition. We may also be subject to regulatory actions from time to time. A substantial legal liability or a significant regulatory action could have an adverse effect on us or cause us reputational harm, which in turn could harm our business prospects. We are subject to periodic examinations by IRDA, which may impose sanctions, fines and other penalties on us. If IRDA, in connection with their future audits or examinations, requires us to take corrective measures or impose administrative penalties on us or if as a result we Page 15

16 become the target of negative publicity, our corporate image and reputation and the credibility of our management may be materially and adversely affected. New accounting pronouncements may significantly affect our financial statements for the current and future years, and may materially and adversely affect our reported net profits and shareholders equity, among other things. Solvency Risks Our ability to comply with minimum solvency requirements stipulated by IRDA is affected by a number of factors, and our compliance may force us to raise additional capital, which could be dilutive to you, or could reduce our growth. We are required by IRDA regulations to maintain our solvency at a level in excess of minimum solvency levels. Our minimum solvency is affected primarily by the policy reserves we are required to maintain which, in turn, are affected by the volume of insurance policies we sell and by regulations on the determination of statutory reserves. Our solvency is also affected by a number of other factors, including the profit margin of our products, returns on our investments, underwriting and acquisition costs, and policyholder and shareholder dividends. If we continue to grow rapidly in the future, or if the required solvency level is increased in the future, we may need to raise additional capital to meet our solvency requirement, which would be dilutive to you. If we are not able to raise additional capital, we may be forced to reduce the growth of our business. Insurance Risk Impact of Lapse Rates, Expense Level, mortality / Morbidity Rates Legal Risk We may suffer losses from unfavorable outcomes from litigation and other legal proceedings. Legal actions are inherent in our businesses and operations. We are subject to litigation and other legal proceedings as part of the claims process, the outcomes of which are uncertain. We maintain reserves for these legal proceedings as part of our reserves. We also maintain separate reserves for legal proceedings that are not related to the claims process. In the event of an unfavorable outcome in one or more legal matters, our ultimate liability may be in excess of amounts we have currently reserved for and such additional amounts may be material to our results of operations and financial condition. As industry practices and legal, judicial, social and other conditions change, unexpected and unintended issues related to claims and coverage may emerge. These issues may adversely affect our financial condition and results of operations by either extending coverage beyond our underwriting intent or by increasing the number and size of claims. In some instances, these changes may not become apparent until some time after we have issued insurance contracts that are affected by the changes. Risk Management Risk Our risk management and internal reporting systems, policies and procedures may leave us exposed to unidentified or unanticipated risks, which could materially and adversely affect our businesses or result in losses. Our policies and procedures to identify, monitor and manage risks may not be fully effective. Many of our methods of managing risk and exposures are based upon our use of observed historical market behavior or statistics based on historical models. As a result, these methods may not predict future exposures, which could be significantly greater than what the historical measures indicate. Other risk management methods depend upon the evaluation of information regarding markets, customers or other matters that is publicly available or otherwise accessible to us, which may not always be accurate, complete, up-to-date or properly evaluated. In addition, a significant portion of business information needs to be centralized from our many branch offices. Management of operational, legal and regulatory risks requires, among other things, policies and procedures to record properly and verify a large number of transactions and events, and these policies and procedures may not be fully effective. Failure or the ineffectiveness of these systems could materially and adversely affect our business or result in losses. Page 16

17 We are likely to offer a broader and more diverse range of insurance and investment products in the future as the insurance market in India continues to develop. At the same time, we anticipate that the relaxing of regulatory restraints will result in our being able to invest in a significantly broader range of asset classes. The combination of these factors will require us to continue to enhance our risk management capabilities and is likely to increase the importance of our risk management policies and procedures to our results of operations and financial condition. If we fail to adapt our risk management policies and procedures to our changing business, our business, results of operations and financial condition could be materially and adversely affected. Catastrophes could materially reduce our earnings and cash flow. We may experience failures in our information technology system, which could materially and adversely affect our business, results of operations and financial condition. We depend heavily on our information technology system to record and process our operational and financial data and to provide reliable services. We may be subject to severe failures in our information technology system arising from natural disasters or failures of public infrastructure, our information technology infrastructure or our applications software systems that are wholly or partially beyond our control. Although we back up our business data daily and have an emergency disaster recovery center located at a site different from our production data center, any material disruption to the operation of our information technology system could have a material adverse effect on our business. Our failure to address these problems could result in our inability to perform, or prolonged delays in performing, critical business operational functions, the loss of key business data, or our failure to comply with regulatory requirements, which could materially and adversely affect our business operations, customer service and risk management, among others. This could in turn materially and adversely affect our business, results of operations and financial condition Competition Risk Competition in the Indian insurance industry is increasing and our business and prospects will be harmed if we are not able to compete effectively as well as have a material adverse effect on our financial condition and results of operations by, among other things: reducing our market share in our principal lines of business; decreasing our margins and spreads; reducing the growth of our customer base; increasing our policy acquisition costs; increasing our operating expenses, such as sales and marketing expenses; and increased turnover of management and sales personnel. Some of our competitors may have advantages over us in one or more areas, such as financial strength, management capabilities, resources, operating experience, market share, distribution channels and capabilities in pricing, underwriting and claims settlement. In addition, we face potential competition from commercial banks, some of which invest in, or form alliances with, existing insurance companies to offer insurance products and services that compete against those offered by us. These commercial banks may also establish subsidiaries of their own to engage in insurance business directly. Such potential competitors may further increase the competitive pressures we experience. Competition from foreign-invested life insurance companies is likely to increase in the future, as restrictions on their operations in India are relaxed. Moreover, foreign-invested life insurance companies may have access to greater financial, technological or other resources than we do. We are likely to face increasing competition from companies offering products that compete with our own. In addition to competition from insurance companies, we face competition from other companies that may offer products that compete with our own, including real estate companies, mutual fund companies and other financial services providers. Market Growth Risk The rate of growth of the Indian insurance market may not be as high or as sustainable as we anticipate. The rate of growth of the Indian insurance market may not be as high or as sustainable as we anticipate. This may be the case even though we expect the insurance market in India to expand and the penetration rate to rise with the growth of the Indian economy and household wealth, continued social welfare reform, demographic changes and the opening of the Indian insurance market to foreign participants. The impact on the Indian insurance industry of certain trends and events, such as the pace of economic growth in India and the ongoing reform of the social welfare system is unpredictable and consequently, the growth and development of the Indian insurance market is subject to a number of uncertainties that are beyond our control. Page 17

18 An economic slowdown in the country, such as the one experienced following the recent global financial crisis, may reduce the demand for our products and services and have a material adverse effect on our results of operations, financial condition and profitability. In an economic downturn characterized by higher unemployment, lower family income, lower corporate earnings, lower business investment and lower consumer spending, the demand for our insurance products and services could be adversely affected. In addition, we may experience an elevated incidence of claims and lapses or surrenders of policies. Our policyholders may also choose to defer paying insurance premiums or stop paying insurance premiums altogether.if the Indian economy continues to experience a slower growth or a significant downturn, our results of operations and financial condition would be materially and adversely affected. Agents Risk All of our insurance agents are required to obtain a qualification certificate from IRDA; any changes in the regulatory policies with regard to the agents may materially and adversely affect our business. Moreover, our growth is dependent on our ability to attract and retain productive agents. A substantial portion of our business is conducted through agents. Competition for agents from insurance companies and other business institutions may force us to increase the compensation of our agents and sales representatives, which would increase operating costs and reduce our profitability. If we are unable to develop other distribution channels for our products, our growth may be materially and adversely affected. Banks and post offices are rapidly emerging as some of the fastest growing distribution channels in India. We do not have exclusive arrangements with any of the banks and post offices through which we sell insurance and annuity products, and thus our sales may be materially and adversely affected if one or more banks or post offices choose to favor our competitors' products over our own. Agent misconduct is difficult to detect and deter and could harm our reputation or lead to regulatory sanctions or litigation costs. Agent misconduct could result in violations of law by us, regulatory sanctions, litigation or serious reputational or financial harm. Misconduct could include engaging in misrepresentation or fraudulent activities when marketing or selling insurance policies or annuity contracts to customers; hiding unauthorized or unsuccessful activities, resulting in unknown and unmanaged risks or losses; or otherwise not complying with laws or our control policies or procedures. We cannot always deter agent misconduct, and the precautions we take to prevent and detect these activities may not be effective in all cases. We cannot assure you that agent misconduct will not lead to a material adverse effect on our business, results of operations or financial condition. Other Risks We depend on select actuarial personnel and could be materially and adversely affected by the loss of their services. A perceived reduction in our financial strength could increase policy surrenders and withdrawals and damage our relationship with our creditors, our counterparties and the distributors of our products. Prospective investors should acquaint themselves with the Financial Statements, drawn specifically for the insurance companies. Contingent liabilities could adversely affect the financial condition and results of operations of the insurance company. Investment in the relatives/associates of the Promoters/ Directors of the Insurance Company can be detrimental to the interests of our company. Risk with reference to concentration by region/type of policies of the Insurance Company Insurance Companies are subject to restrictions on payments of dividends We will incur increased costs as a result of being a listed company. The insurance industry is cyclical, which may impact our results. The insurance industry is cyclical. Although no two cycles are the same, insurance industry cycles have typically lasted for periods ranging from two to six years. The segments of the insurance markets in which we operate tend not to be correlated to each other, with each segment having its own cyclicality. Periods of intense price competition due to excessive underwriting capacity, periods when shortages of underwriting capacity permit more favorable rate levels, consequent fluctuations in underwriting results and the occurrence of other losses characterize the conditions in these markets. Historically, Page 18

19 insurers have experienced significant fluctuations in operating results due to volatile and sometimes unpredictable developments, many of which are beyond the direct control of the insurer, including competition, frequency of occurrence or severity of catastrophic events, levels of capacity, general economic conditions and other factors. This may cause a decline in revenue at times in the cycle if we choose not to reduce our product prices in order to maintain our market position, because of the adverse effect on profitability of such a price reduction. We can be expected therefore to experience the effects of such cyclicality and changes in customer expectations of appropriate premium levels, the frequency or severity of claims or other loss events or other factors affecting the insurance industry that generally could have a material adverse effect on our results of operations and financial condition. The insurance and related businesses in which we operate may be subject to periodic negative publicity, which may negatively impact our financial results. The nature of the market for the insurance and related products and services we provide is that we interface with and distribute our products and services ultimately to individual consumers. There may be a perception that these purchasers may be unsophisticated and in need of consumer protection. Accordingly, from time to time, consumer advocate groups or the media may focus attention on our products and services, thereby subjecting our industries to periodic negative publicity. We may also be negatively impacted if another company in one of our industries engages in practices resulting in increased public attention to our businesses. Negative publicity may result in increased regulation and legislative scrutiny of industry practices as well as increased litigation, which may further increase our costs of doing business and adversely affect our profitability by impeding our ability to market our products and services, requiring us to change our products or services or increasing the regulatory burdens under which we operate. The impact of investigations of possible anti-competitive practices by the company cannot be predicted and may have a material adverse impact on our results of operations, financial condition and financial strength ratings. We may be exposed to environmental liability from our commercial mortgage loan and real estate investments. As a commercial mortgage lender, we customarily conduct environmental assessments prior to making commercial mortgage loans secured by real estate and before taking title through foreclosure to real estate collateralizing delinquent commercial mortgage loans held by us. Based on our environmental assessments, we believe that any compliance costs associated with environmental laws and regulations or any remediation of affected properties would not have a material adverse effect on our results of operations or financial condition. However, we cannot provide assurance that material compliance costs will not be incurred by us. The effects of emerging claims and coverage issues on our business are uncertain. As industry practices and legal, judicial, social and other conditions change, unexpected and unintended issues related to claims and coverage may emerge. These issues may adversely affect our business by either extending coverage beyond our underwriting intent or by increasing the number or size of claims. In some instances, these changes may not become apparent until some time after we have issued insurance or reinsurance contracts that are affected by the changes. As a result, the full extent of liability under our insurance and reinsurance contracts may not be known for many years after a contract is issued. Recent example of emerging claims and coverage issues include: larger settlements and jury awards in cases involving professionals and corporate directors and officers covered by professional liability and directors and officers liability insurance and a growing trend of plaintiffs targeting property and casualty insurers in class action litigation related to claims handling, insurance sales practices and other practices related to the conduct of our business. We may be unable to accurately predict benefits, claims and other costs or to manage such costs through our loss limitation methods, which could have a material adverse effect on our results of operations and financial condition. Our profitability depends in large part on accurately predicting benefits, claims and other costs, including medical and dental costs, and predictions regarding the frequency and magnitude of claims on our disability and property coverage. It also depends on our ability to manage future benefit and other costs through product design, underwriting criteria, utilization review or claims management and, in health and dental insurance, negotiation of favorable provider contracts. Utilization review is a review process designed to control and limit medical expenses, which includes, among other things, requiring certification for admission to a health care facility and cost-effective ways of handling patients with catastrophic illnesses. Claims management entails the use of a variety of means to mitigate the extent of losses incurred by insureds and the corresponding benefit cost, which includes efforts to improve the quality of medical care provided to insureds and to assist them with vocational services. The aging of Page 19

20 the population and other demographic characteristics and advances in medical technology continue to contribute to rising health care costs. Our ability to predict and manage costs and claims, as well as our business, results of operations and financial condition may be adversely affected by: changes in health and dental care practices; inflation; new technologies; the cost of prescription drugs; clusters of high cost cases; changes in the regulatory environment; economic factors; the occurrence of catastrophes; and numerous other factors affecting the cost of health and dental care and the frequency and severity of claims in all our business segments. The judicial and regulatory environments, changes in the composition of the kinds of work available in the economy, market conditions and numerous other factors may also materially adversely affect our ability to manage claim costs. As a result of one or more of these factors or other factors, claims could substantially exceed our expectations, which could have a material adverse effect on our results of operations and financial condition. As industry practices and legal, judicial, social and other environmental conditions change, unexpected and unintended issues relating to claims and coverage may emerge. These issues could materially adversely affect our results of operations and financial condition by either extending coverage beyond our underwriting intent or by increasing the number or size of claims or both. We may be limited in our ability to respond to such changes, by insurance regulations, existing contract terms, contract filing requirements, market conditions or other factors. Page 20