Indonesia's minimum equity requirements for insurers could open doors for M&A

New minimum equity requirements could spur dealmaking in the Indonesian insurance industry.

The Indonesian Financial Services Authority (OJK) is significantly raising minimum equity requirements over two phases ending in 2028, with differing minimums depending on the insurer. Compliance with the first phase was scheduled for completion on Dec. 31, 2023, while the second must be completed by Dec. 31, 2028.

The regulatory change came following multiple cases of insurers failing to pay maturing policies, according to a note from law firm Ali Budiardjo Nugroho Reksodiputro (ABNR), which said that equity can include paid-up capital, together with other elements such as retained earnings and receivables.

Some form of M&A activity is a path insurance companies can take should they face difficulty in meeting the new equity requirements, ABNR partner Ayik Candrawulan Gunadi said.

Consolidation options

The OJK said capital capacity limitations could disrupt the insurance sector's resilience and stability, which may consequently hinder the industry's development.

The country's general insurance association, the Asosiasi Asuransi Umum Indonesia (AAUI), supports the OJK's move, executive director Bern Dwyanto told S&P Global Market Intelligence via email, although it suggested it would have been better to set the minimum equity requirements two financial years after the implementation of IFRS 17, which takes effect Jan. 1, 2025.

Bern said that 13 of the AAUI's members, made up of 71 insurers and seven reinsurers, had equity of below 150 billion Indonesian rupiah, meaning that consolidation could occur within the industry.

Several forms of consolidation are open to insurers, including a merger or an acquisition, Ayik said. Another option was the formation of an "Insurance Company Group" (KUPA), Ayik told Market Intelligence.

Under a KUPA structure, an insurer is not dissolved and is allowed to maintain its existing business entity, wherein a financially stronger affiliate becomes a holding company while the insurer becomes a subsidiary, Ayik said. Insurers with a significant range of affiliations might form a KUPA, Ayik added.

M&A activity could gain traction within the fragmented market as smaller insurers unable to meet the requirements within the given time frame may have to tap into alternative measures to continue operations, said Billy Teh, an analyst at S&P Global Ratings in Singapore. Market consolidation would help to ensure the survival of stronger players, leading to better financial stability within the industry and restoration of consumer confidence in the insurance sector, Teh added.

"As of end-2022, about one-third of the 130 insurers operating in Indonesia are below the planned first stage minimum equity requirements," Teh said. "Considering the substantial increase in planned requirement levels through 2028, the ability of industry participants to effectively manage this transition will be tested."

Capital injections from parent companies, some of which are foreign-owned, or debt issuances are also options to meet the requirement, which Teh expects will enhance insurers' capital strength and their ability to withstand stress.

Indonesian Government Regulation 14/2018 on foreign ownership in insurance companies set the maximum threshold for foreign equity ownership of an Indonesian insurance company at 80% but exempted insurance companies with existing foreign ownership levels that exceed 80%, according to the US State Department. Subsequently, the government issued Government Regulation 3/2020 to strengthen the grandfathering provisions of Regulation 14 by allowing foreign investors to inject capital and maintain their existing capital share, repealing the obligation under Regulation 14 for a local shareholder to make a corresponding 20% capital injection in the event of a capital increase.

Further discussion

Bern highlighted the need for further discussion on product mix when it comes to equity and capital requirements.

"Simple products mean products that have low risk, because there are some companies that have low equity but are healthy and play in complex products," Bern wrote. "On the other hand, there are also companies that have large equity but most of their portfolio is in simple products, so this will definitely be more competitive."

The minimum amount of capital and the risk inherent in the insurance company are not directly proportional, Bern said.

The OJK hosting public discussions on the equity requirement and issuing a circular letter providing guidance for the regulation would be helpful, Ayik said.

Ayik noted that as of 2023, there were more than 140 entities operating in the insurance industry, with the majority silent over the equity requirement.

A number of Indonesian insurers contacted by Market Intelligence did not respond to requests for comment.

As of March 20, $1 was equivalent to 15,740 Indonesian rupiah.