Greenvissage Explains – June, 2024

Greenvissage explains, Is Credit Default Swaps a boon for mutual fund investors?

The Securities and Exchange Board of India (SEBI) recently proposed a significant change for the mutual fund industry – allowing them to participate in the credit default swap (CDS) market. This move has the potential to improve risk management for mutual funds and offer more diversified investment options for investors. Credit Default Swaps (CDS) are a type of financial derivative that functions similarly to insurance for lenders. They are contracts between two parties, where the buyer of the CDS pays a periodic fee to the seller in exchange for protection against the risk of default by a borrower or issuer of a bond. The CDS is a financial agreement functioning like an insurance policy for bond investments. The borrower or the issuer of the bond whose default risk is being insured is called as Reference entity. The entity selling the CDS of reference entity is called seller who agrees to compensate the buyer in case the borrower defaults. The entity who purchases these CDS, often a lender or investor, is called a buyer who hedges against the risk of default on a particular loan or bond. For example, if a bank lends money to a company and wants to protect itself against the risk of that company not paying back the loan, the bank can buy a CDS from another financial institution. If the company defaults, the CDS seller compensates the bank for the losses.

SEBI’s proposal outlines a framework for mutual fund participation in the CDS market. Mutual funds can buy CDS protection for both investment-grade and below-investment-grade bonds. Mutual funds with sufficient liquidity can also sell CDS contracts, allowing them to potentially profit from market fluctuations. To prevent excessive risk, SEBI proposes a cap on a mutual fund’s total CDS holdings (bought and sold) at 10% of its Assets Under Management (AUM). Mutual funds will be required to disclose their CDS positions regularly to ensure transparency for investors. By buying CDS, mutual funds can mitigate the risk of losses if a bond issuer defaults. This allows them to invest in a wider range of bonds, including those with slightly lower credit ratings, potentially increasing returns. CDS can be used to manage a portfolio’s overall risk exposure. By strategically buying and selling CDS contracts, fund managers can fine-tune their risk profile. Increased mutual fund participation in the CDS market could lead to a wider variety of investment products with varying risk-reward profiles. By allowing mutual funds to better manage risk, SEBI’s proposal could potentially lead to more stable returns for investors.

SEBI’s proposal to allow mutual funds to participate in the CDS market has the potential to benefit both mutual funds and investors. By offering more risk management tools and potentially more diversified products, this change could lead to a more robust and attractive mutual fund industry in India. However, staying informed about CDS and associated risks remains crucial for investors before making investment decisions.

References:

Greenvissage Explains, Why did LIC never sell Health Insurance policies?

The Life Insurance Corporation of India (LIC) has recently shown interest in entering the health insurance sector. Given its stature as India’s largest financial institution and dominating the life insurance market with a 75% share, this move raises several questions. Why has LIC, a colossal entity in the insurance domain, refrained from venturing into health insurance until now? And what has changed its stance? The timing of LIC’s interest in health insurance is notable. Health insurance is becoming increasingly important in India, with a growing awareness of the financial risks associated with serious illnesses and medical emergencies. The COVID-19 pandemic has highlighted the critical need for comprehensive health coverage, leading to a surge in health insurance penetration across the country. LIC’s potential entry into health insurance could provide much-needed competition to existing players, fostering innovation and possibly leading to more affordable and comprehensive health insurance options for consumers.

Contrary to the popular belief that LIC has never engaged in health insurance, the corporation does offer products that cover medical expenses. An example is the LIC Arogya Rakshak plan, which provides a fixed benefit for specific health risks. For instance, the plan might pay out a predetermined sum of INR 2.5 lakhs for a coronary artery bypass surgery, irrespective of the actual medical costs incurred. This approach contrasts sharply with the typical indemnity-based health insurance plans, which cover the actual expenses incurred during hospitalization, up to a predefined limit. The flexibility of indemnity plans makes them more attractive as they provide comprehensive coverage for various medical expenses, including those that may arise from unforeseen complications.

The primary reason for LIC’s limited presence in the health insurance market lies in regulatory constraints. The Insurance Regulatory and Development Authority of India (IRDAI) mandates that life insurance and general insurance (which includes health insurance) require separate licenses. LIC, being licensed primarily as a life insurer, is restricted from selling indemnity-based health insurance products or introducing specialized health plans tailored for different demographics or medical conditions. Historically, LIC was once a composite insurer, offering both life and general insurance products through its subsidiary, Oriental Insurance. However, in 1972, the Indian government nationalized general insurance companies and established four specialized entities for general insurance. This bifurcation effectively restricted LIC’s operations to life insurance, leaving general insurance, including health, to other specialized entities.

Recently, there has been considerable discussion about the possibility of reintroducing composite licenses, which would allow companies to offer both life and general insurance products under a single entity. This regulatory change could enable LIC to enter the health insurance market comprehensively. Although the timeline for such regulatory amendments remains uncertain, LIC is preparing for this potential shift by setting the groundwork for rapid expansion into health insurance once the regulatory environment becomes favorable. LIC’s strategy to enter the health insurance market involves pursuing inorganic growth. Instead of building a health insurance division from scratch, LIC plans to acquire stakes in existing health insurance companies. This approach allows LIC to leverage established networks, expertise, and customer bases to swiftly establish a significant presence in the health insurance sector.

References:

Greenvissage explains, What is National Health Claim Exchange?

The recent launch of the National Health Claim Exchange (NHCX) by the National Health Authority (NHA) and the Insurance Regulatory and Development Authority of India (IRDAI) marks a significant milestone in the Indian healthcare and health insurance sectors. The National Health Claim Exchange (NHCX) is a digital platform designed to simplify and expedite the health insurance claims process in India. It aims to act as a centralized hub for all health claims, reducing the administrative burden on hospitals and ensuring a seamless, paperless, and secure environment for managing health insurance claims. The NHCX is poised to revolutionize the way health insurance claims are processed, promising a streamlined, efficient, and secure platform that benefits patients, hospitals, and insurance companies alike.

The NHCX centralizes health claims, eliminating the need for multiple portals and manual paperwork. This consolidation is expected to reduce the administrative burden on hospitals and provide a more uniform approach to managing claims. By moving to a digital platform, the NHCX ensures a paperless process, enhancing data security and reducing the risk of errors associated with manual handling of claims. The platform aims to expedite the claims process, potentially reducing waiting times for patients and minimizing out-of-pocket expenses. This efficiency can be particularly beneficial in emergency medical situations where prompt claim processing is crucial. Through the uniform presentation of data and centralized validation, the NHCX could lead to more standardized healthcare pricing, bringing greater transparency and fairness to healthcare costs. The NHCX enhances the ability to detect and prevent fraudulent claims through robust data verification mechanisms, protecting both insurers and policyholders.

India’s healthcare system faces several challenges, including high out-of-pocket expenditures, inefficiencies in claim processing, and high operational costs for hospitals. A significant portion of healthcare expenses in India are paid out-of-pocket by households, with many not covered under any insurance scheme. The NHCX’s streamlined claims process can lead to faster claim settlements, reducing financial burdens on patients and incentivizing more people to use health insurance. Different insurance companies have varying requirements and processes, leading to delays and errors in claim decisions. The NHCX aims to create a standardized system that simplifies and speeds up claims processing, providing greater transparency and efficiency. Currently, hospitals in India deal with a multitude of portals and manual processes for submitting and tracking claims. The NHCX’s centralized platform can significantly reduce these administrative burdens, freeing up resources for better patient care.

Full integration of the NHCX platform requires significant effort and training. Smaller hospitals, especially in rural areas, may lack the necessary IT infrastructure or trained staff to adopt the new system, potentially slowing down its implementation. Successful adoption of the NHCX relies on building trust among policyholders and ensuring efficient service delivery. Historical communication gaps and complexities between hospitals and insurance companies need to be addressed to foster collaboration. Handling sensitive health and financial data on a centralized platform requires robust cybersecurity measures. Ensuring data privacy and preventing breaches are critical to maintaining trust and safeguarding the platform. The introduction of the NHCX aligns with several government initiatives aimed at expanding health insurance coverage and reducing healthcare costs. Programs like the Pradhan Mantri Jan Arogya Yojana and Pradhan Mantri Jeevan Jyoti Yojana are already working towards improving insurance penetration in India. The NHCX can complement these efforts by enhancing the efficiency and effectiveness of health insurance claims processing, thereby increasing insurance adoption rates.

References:

Greenvissage explains, What are Exchange Traded Funds?

Exchange-Traded Funds (ETFs) have rapidly emerged as a compelling investment option in India, offering a unique blend of the flexibility of stocks and the diversified exposure of mutual funds. ETFs are investment funds traded on stock exchanges, much like individual stocks. Each ETF holds a diversified portfolio of assets, which can include stocks, bonds, commodities, or a mix of these. They are designed to track the performance of a specific index or asset class. The key attributes of ETFs – such as their ability to be traded throughout the trading day and their typically lower expense ratios – make them an attractive option for a wide range of investors.

There are various types of ETFs depending on the underlying assets. Equity ETFs track equity indices like the Nifty 50 or the Sensex. They provide investors with a broad exposure to the stock market, reflecting the performance of the underlying index. Debt ETFs invest in a variety of fixed-income securities such as government bonds and corporate bonds. They are suited for investors seeking stable returns with lower risk compared to equities. Gold ETFs track the price of gold and offer a convenient way for investors to invest in the precious metal without having to handle physical gold. International ETFs allow Indian investors to gain exposure to global markets by tracking indices or sectors from other countries. Sectoral ETFs focus on specific sectors like technology or pharmaceuticals, or themes such as ESG (Environmental, Social, and Governance) investing, providing targeted exposure. Hybrid ETFs combine multiple asset classes, offering a balanced approach to risk and return by investing in both equities and bonds.

The ETF market in India has grown exponentially, driven by several key factors. Growing investor awareness about the benefits of ETFs has contributed to their popularity. Educational campaigns by financial institutions and media coverage have played a significant role in this regard. The Securities and Exchange Board of India (SEBI) has fostered a conducive environment for ETFs by implementing supportive regulations and encouraging transparency. Institutional investors, including pension funds and mutual funds, have increasingly embraced ETFs for their cost-effectiveness and ease of access to diverse asset classes. The launch of a variety of ETFs, including sector-specific and international options, has provided investors with more choices to meet their investment needs.

ETFs offer instant diversification by pooling together various securities, reducing the risk associated with individual investments. With typically lower expense ratios compared to mutual funds and no load fees, ETFs are a cost-effective investment option. Being traded on stock exchanges, ETFs provide liquidity and flexibility, allowing investors to buy and sell shares throughout the trading day. ETFs disclose their holdings daily, providing investors with clear visibility into their investments. ETFs are structured to be more tax-efficient than mutual funds, as they generally incur fewer capital gains distributions.

Despite their advantages, ETFs in India face several challenges that need to be addressed. While awareness is growing, many retail investors are still unfamiliar with how ETFs work and how they can be integrated into their investment strategies. ETFs are subject to market volatility, and their performance can be impacted by fluctuations in the underlying indices or asset classes. Some niche ETFs, particularly those focusing on specific sectors or themes, may experience lower liquidity, making it challenging for investors to execute large trades without affecting the market price. ETFs aim to replicate the performance of an index, but discrepancies between the ETF’s performance and the index—known as tracking errors—can occur, impacting returns.

References: