Usage of FRA by Indian life insurers is nothing to worry about, says Emkay

Brokerage Emkay believes that concerns arising from the recent global pension developments regarding the usage of Interest Rate Derivatives by Indian life insurance are exaggerated. A closer analysis of (Forward Rate Agreement) FRA usage by Indian life insurers implies that such insurers are totally safe and there is nothing to worry about. FRA is used by Indian life insurers to hedge the risk in only regular and limited premium-paying non-par guaranteed products, which are a component of the overall product portfolio. Recent global developments have brought attention to hedging and derivative usage by domestic life insurers. LIC, India’s public sector insurer, has not used FRA so far. For the listed private players, the notional FRA quantum outstanding is 2.12 per cent of their total investments as of FY22, according to a Times Now report. A 100 bps interest rate spike will lead to a Mark to market (MTM) notional loss of 6-10 per cent of the notional FRA for such life insurers.

Hence, the quantum of FRA and its MTM changes can be easily managed for listed private life insurers. As non-par products have begun to gain prominence in 2019, life insurers continue to offer these policies, which hold a huge potential market. According to Emkay, the only risk to the growth of non-par products could be from any legislative changes regarding taxation, the probability of which is low.

What are forward rate agreements?

FRA’s are over-the-counter contracts between parties that determine the interest rate which has to be paid on an agreed date in the future. The party who is paying the fixed rate is known as the borrower, while the party paying the variable rate is called the lender. An FRA could have a maturity of up to five years.

A borrower might enter into an FRA with the intention of locking in an interest rate if he/she believes that the rates might increase in the future. FRAs are very flexible, and the settlement dates can be tailored to the requirements of those involved in the transaction.

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