Insurance companies are increasingly shifting their interest-rate hedging activities to bond forwards linked to state development loans (SDLs), as reported by Business Standard. This strategic move is driven by higher returns and ample supply in the bond forward market. The shift represents a significant change in how insurers manage their interest-rate risk exposure, with companies moving away from traditional instruments toward these alternative structures.
The Reserve Bank of India's (RBI's) bond forward framework has been instrumental in prompting this shift away from traditional instruments. According to market participants cited in Business Standard, the new regulatory framework has created favorable conditions for insurers to explore alternative hedging strategies. The RBI issued final directions on forward contracts in government securities in February 2025, with the framework coming into effect on May 2, 2025. This comprehensive framework enables long-term investors, including insurance companies, for more efficient management of interest rate risk and cash flows.
Arun Srinivasan, chief - fixed income at ICICI Prudential Life Insurance, confirmed the industry's strategic pivot in a recent statement. As reported by Business Standard, he stated that "post the introduction of bond forward guidelines by RBI, we have started participating in bond forwards with underlying state government and government securities. Given the relatively higher returns and adequate supply in SDLs compared to government securities, most of our incremental bond forward activity has shifted towards SDLs." The company has completely moved away from bond FRAs, with Srinivasan noting that "bond forwards are a much simpler product from an execution and settlement standpoint."
The higher yields and ample supply in the bond forward market are attracting insurance companies to SDL-linked instruments. Market participants have been pushing for bond forwards as an important risk-management tool for insurers, with the framework enabling forward contracts in government securities including Central government bonds and SDLs at pre-agreed prices for future settlement. The Insurance Regulatory and Development Authority of India (Irdai) in March 2025 permitted insurers to undertake bond forward transactions for hedging interest rate risk, though insurers can only take long positions and are required to report such transactions quarterly.
The bond forward market, estimated at ₹4 trillion to ₹4.5 trillion, remains dominated by foreign banks, which account for nearly 85-90% of activity. Market participants suggest that broader participation from private and public sector banks could increase if the market migrates to a centralised clearing and settlement framework. The shift from FRAs to bond forwards is expected to continue as the latter involve physical delivery of underlying securities at maturity, unlike FRAs which are cash-settled, making them more suitable for long-term investors like insurance companies.
