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Insurance Regulatory and Development Authority Lets Insurance Providers to Hedge Interest Rate Risks

Participation in interest rate derivatives would aid such companies by shielding their return from fluctuation in the interest rates and would also protect financial health.

IRDA recently gained recognition by allowing insurance companies to hedge their interest risks by participating in interest rate derivatives of a longer tenure.

According to the present norms, insurance providers are permitted to enter Forward Rate Agreements (FRAs),Interest Rate Swaps (IRS) and Exchange Traded Interest Rate Futures (IRF) with a maximum tenure of one year.

Participation in interest rate derivatives would aid such companies by shielding their return from fluctuation in the interest rates and would also protect financial health.

All insurers are welcoming this move. It is going to help insurance companies in hedging their long-term interest rate risks.

Several products of insurance companies offer guaranteed return. However, because of fluctuation in the interest rates, returns can slump. This can put pressure on the finances companies.

Companies get into these agreements to hedge the interest rate risk on investments and the forecast transactions. Hedging interest rate risk of investment in fixed income securities would include fixed income derivative positions that are designed to negate the potential losses from present fixed income investments of them

After putting conditions, the guidelines said, a participant's dealings in interest rate derivatives would not go beyond an outstanding notional principal amount equivalent to 100 per cent of the book value of the fixed income investments of the insurance company under the policyholders fund, it said.

ULIP funds in case of life insurers and the shareholders funds taken together would be excluded.

The mark-to market gain or loss arising out of the effective hedge would be solely taken care of by the respective fund only.

There won't be entry of any contracts with promoter group entities either directly or indirectly.

The guidelines are quite comprehensive and there is a good amount of checks and balances so that insurance companies do not run into the risk of overexposure of such instruments.

The guidelines stated that the board would make sure that the Rupee Interest Rate Derivatives are good enough for the portfolio handled by the insurer and the liabilities undertaken.

Requirement is felt to establish risk measurement methodologies which are consistent with the nature and scale of the derivatives activities.

The initiation of the policy is the responsibility of the investment committee with an oversight by the board of directors.

While handling such potentially complicated products the board and the senior management of insurance company should understand the nature of the risk undertaken, complexities involved, stress levels etc.

To lessen the risk, contracts have to be verified at regular intervals at least once in a year.

Written By: PolicyBazaar - Updated: 30 December 2020
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