Indonesia Insurance Law Unlikely to Discourage Future M&A Activity

Indonesia's new comprehensive insurance law, that took effect 23 October, adds some restrictions to foreign investment in the sector, but is unlikely to discourage future M&A activity involving international insurers, says Fitch Ratings.

The agency maintains that foreign-investor interest in Indonesia's insurance sector will remain high because of its low market penetration rate, the country's large population, and the expected growth of its middle class.

The new law provides greater clarity on regulations and the government's policy focus with regards to the industry, replacing the much broader and more general terms written into the previous insurance law passed in 1992.

With the prospect of a new law having lingered over the sector for over a year, its passage clears up uncertainty over the strategic direction of regulation and gives insurance companies comprehensive guidelines on key issues related to foreignownership, policyholder protections, and takaful (Islamic insurance) products.

Notably, the 80% cap on foreign investments in Indonesian insurers remains in place, despite earlier speculation that this might be reduced.

The 80% cap is higher than that in several of the large peer nations in south/south-east Asia, and is a key factor encouraging foreign interest in the sector. By comparison, Malaysia has a limit of 70%, while the cap is 49% for Thailand and India.

Maintaining the 80% limit provides the clearest indication yet that the government remains open to foreign investment in the insurance sector. As such, Fitch maintains that international interest in Indonesian insurance will remain strong, with M&A activity expected to continue in the short to medium term.

In addition to the potentially large scale of the market owing to the country's large population, the relatively low insurance penetration rate of only 2.1% of GDP, and an average annual economic growth rate of 5.6% (forecast for 2014-2017), should contribute to steady growth for the sector over the long term.

It is important to note that the law has tightened up the requirements for the 20% Indonesian shareholding, closing some loopholes which had enabled higher foreign stakes.

Language allowing for "Indonesian legal entities" to qualify as Indonesian shareholders, even if the entity was wholly owned by foreign citizens, has been removed from the new legislation. This would affect joint ventures fully controlled by foreign investors that are operating in Indonesia.

Foreign firms operating under such parameters will have five years to ensure their holdings meet the 80% limit.

Furthermore, the risks of further tightening of foreign ownership limits remain. Government regulations to implement the law, which must be released over the coming two and a half years, could yet effectively reduce the foreign investor cap.

There are no signs yet that the government intends to do this, and the likelihood of such action in the short term is low.

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