IRDAI issued Guidelines on Hedging Through Equity Derivatives (“Guidelines”) having reference number IRDAI/F&I/GDL/INV/041/02/2025 dated February 28, 2025. The key highlights of the Guidelines are as under:
- IRDAI initially permitted insurers to engage in financial derivatives in 2004, focusing on Fixed Income Derivatives, and later updated the guidelines in 2014 to include Rupee Interest Rate derivatives. In 2012, insurers were also allowed to deal in Credit Default Swaps. As insurers increasingly invested in equity markets and faced rising volatility, IRDAI recognized the need for hedging through equity derivatives. In response, new guidelines on equity derivative hedging were issued under Clause 13 of Schedule III of the IRDAI (Actuarial, Finance, and Investment Functions of Insurers) Regulations, 2024.
- Insurers are allowed to use equity derivatives for hedging their existing equity exposures. The key objectives of permitting equity derivatives for insurers are to hedge against equity market volatility, preserve the market value of equity investments, and reduce the overall risk in equity portfolios.
- Insurers are permitted to use the following exchange-traded equity derivatives to hedge their existing positions:
- Stock Futures and Index Futures: Insurers can take short positions in Stock Futures and Index Futures, but only to the extent of their existing equity holdings in the respective funds. The short futures position shall be taken within the same fund where the underlying equities are held.
- Stock Options and Index Options: Insurers can take positions as option holders (buyers) and are allowed to buy only put options on stocks and indices to hedge their existing equity holdings in the respective funds. These put options shall also be purchased within the same fund where the equities are held.
Any Over the Counter (OTC) exposure to equity derivatives is strictly prohibited.
- Equity derivatives are permitted for Unit Linked Funds (new funds only), Life Funds, Pension, Annuity and Group Funds, and Investment Assets of General or Health Insurers.
- The total equity derivative positions in a fund (including stock futures, stock options, index futures, and index options) shall not exceed the market value of the underlying equities held within the same fund on any given day. Any passive breaches of these limits shall be corrected within 15 days.
- The aggregate number of Stock Futures contracts and Stock Put Options cannot exceed the quantity of the respective underlying equities held as investment on any day.
- Additionally, the notional value of hedging through index futures and index put options combined shall not exceed 20% of the market value of the unhedged portion of the equity portfolio within the same fund on any day. Any passive breaches in these limits shall be corrected within 15 days.
- Hedges using index futures/options are deemed “highly effective” if the loss/gain ratio is within 80-125%. If outside this range, the position shall be unwound and profits/losses accounted for. Hedge effectiveness shall be tested at least quarterly. Equity derivative positions shall comply with SEBI/Stock Exchange limits, including trading member position limits.
- The notional value of equity derivatives is calculated as follows:
- For Short Stock Future and Short Index Future: (Lot Size) × (No. of Contracts) × (Price of Futures)
- For Stock Put Option and Index Put Option: (Lot Size) × (No. of Contracts) × (Strike Price)
- Equity derivatives can only be used for hedging long equity positions, with exposure not exceeding the underlying position being hedged.
- Insurers shall establish a Board-approved Hedging Policy, regularly assess hedge effectiveness, and comply with SEBI and stock exchange guidelines.
- Derivatives shall be unwound immediately if the underlying is sold, and insurers need to ensure staff training, clear management responsibilities, and risk controls.
- Before engaging in equity derivatives, insurers shall conduct a Systems Audit and inform the Authority prior to their first exposure to equity derivatives.
- The Board and senior management of the Insurer shall review the risks and complexities of equity derivative positions and report compliance to the Risk Management Committee quarterly.
- The Chief Risk Officer (CRO) shall be responsible for monitoring and reporting on equity derivative programs, ensuring compliance with guidelines, and addressing non-compliance with the Risk Management Committee.
- Insurers shall disclose in ULIP brochures their intention to trade in equity derivatives, explain associated risks and returns, highlight potential losses, and set exposure limits.
- All equity derivative contracts shall be recognized at fair value on the balance sheet, with gains or losses recorded in the Revenue Account for linked business and the Fair Value Change Account for non-linked or general/health insurance business.
- Insurers shall disclose their financial risk management objectives, hedging strategy, and accounting policies, along with a statement of exposure through equity derivatives in their financial statements.
- The statement of exposure should include the market value of equities held, notional value of equity derivative positions, and the percentage of derivative positions relative to the market value of the equity portfolio.
- Insurers shall report quarterly on their hedging positions, including the notional value of equity derivatives, scrip-wise details for stock futures and options, and the hedging position for index futures and options.
- Insurers shall also disclose the unhedged equity portfolio and the percentage of index futures/options relative to the unhedged portion, along with derivative turnover, unwinding data, and profit/loss from equity derivative transactions.
- Detailed reports shall be submitted for each fund, including market value, positions in stock futures/options, and margin maintained for equity derivatives.
- Insurers shall report quarterly on derivative turnover, unwinding of equity derivative contracts, and profit/loss from equity derivative transactions.
A copy of the Guidelines is attached for your ready reference.
Source category: IRDAI
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