This action might not be possible to undo. Are you sure you want to continue?
CHAPTER 1 INTRODUCTION TO REINSURANCE
The term µReinsurance, also termed as insurance of insurance¶. Means that an insurer who has assumed a large risk may arrange with another insurer to insure a proportion of the insured risk. In other words, in the event of loss, if it would be beyond the capacity of the insurer than this reinsurance process is restored to. In reinsurance, therefore, one insurer insures the risk which has been undertaken by another insurer. The original insurer who transfers a part of the insurance contract is called the reinsured and the second insurer is called the reinsurer. Of course the reinsurance has to pay reinsurance premium for risk shifted. For example, a man wishing to insure his premium for 10 lakhs goes to an insurance company, which will accept the risk if it is satisfied as to the condition of the property. But if it its own limit is probably Rs 5 lakhs, it will arrange with another company to reinsure or to take up so much of the risk as exceeds its limits, i.e. Rs 5 lakhs, so that if the house is burnt down the original insurer would pay the owner Rs 10 lakhs. But they would be recouped 5 lakhs, by the reinsurance offices. To be effective, the reinsurance policy must be formulated after carefully considering all aspects of the situation to which it is to be applied.
MEANING:Reinsurance is a means by which an insurance company can protect itself against the risk of losses with other insurance companies. Individuals and corporations obtain insurance policies to provide protection for various risks (hurricanes, earthquakes, lawsuits, collisions, sickness and death, etc.). Reinsurers, in turn, provide insurance to insurance companies. It is a financial management tool. It is always behind the high quality insurance program or a complex commercial risk of any good insurer. Reinsurance industries are maintaining upward surge all round growth, both in the domestic and global fronts in the last few years. The untapped, both in life and non ± life insurance, particularly in growing economies like India and china, is the center of attraction to leading players in insurance and reinsurance, thanks to globalizations and liberalizations of financial services particularly in last decades. It is a tool of risk management, mutually support and supplement each other in providing risk mitigation to the individuals and organizations at micro level and to the country. Reinsurance is instrument of risk transfer and risk financing. Reinsurance can be described as contract made between an insurance company (insurer) and a third party (reinsurer) where in the later will protect the former by paying losses sustained by it under the original contract of insurance, unlike primary insurance, the reinsurance mainly deals with catastrophic risk which are not only highly unpredictable but have the potential capacity to cause huge devastation thereby threatening the solvency of the insurance company.
DEFINITION:Reinsurance is a transaction in which one insurer agrees, for a premium, to indemnify another insurer against all are part of the loss that insurer may sustain under its policy or policy or policies of insurance. The company purchasing reinsurance is known as the ceding insurer: the company selling reinsurance is known as the assuming insurer, or, more simply, the reinsurer. Reinsurer can also be described as the ³insurance of insurance companies´ Reinsurance provides reimbursement to the ceding insurer for lasses covered by the reinsurance agreement. It enhances the fundamental objectives of insurance to spread the risk so that no single entity finds itself saddled with a final burden beyond its ability to pay. Reinsurance can be acquired directly from a reinsurance intermediary.
OBJECTIVES OF REINSURANCE:Insurer purchases reinsurance for essentially four reasons: 1) To limit liabilities on specific risks 2)To stabilize loss expanses 3)To protect against catastrophes; and 4)To increase capacity. Different types of reinsurance contract are available in the market commensurate with the ceding company¶s goals. 1. Limiting liability: By providing a mechanism in which companies limit loss exposure to levels commensurate with net asset, reinsurance companies allows insurance companies to offer coverage limits considerably higher then they could otherwise provide. This function of reinsurance is crucial because they allow all companies, large and small, to offer coverage limits to meet their policyholders¶ needs. In this manner, reinsurance provides an avenue for small-to-medium size companies to compete with industry giants. In calculating an appropriate level of reinsurance, a company takes in to account the amount of its available surplus and determines its retention based on the amt of loss it cam absorb financially. Surplus, sometime referred to as policyholders surplus, in the amount by which the asset of an insurance exceeds its liabilities A company¶s retention may range from a few lakhs rupees o thousand of crores. The reinsurer indemnifies the loss exposure above the retention, up to the policy limits of the reinsurance contract. Reinsurance helps to stabilize loss experience on individual risks, as well as an accumulated loss under many policies occurring during a specified period. 2. Stabilization: Insurance often seeks to reduce the wide swing in profit and loss margins inherent to the insurance business. These fluctuations result, in part, from the unique nature of insurance, which involves pricing a product whose actual cost will not be known until sometime in the future. Though reinsurance, insurance
can reduce these fluctuations in loss experience, thus stabilizing the company overall operating result. 3. Catastrophe protection: Reinsurance provides protection against catastrophe loss in much the same way it helps stabilize an insurer¶s loss experience. Insurer uses reinsurance to protect against catastrophes in two ways. The first is to protect against catastrophic loss resulting from a single event, such as the total fire loss of large manufacturing plant. However, an insurer also seeks reinsurance to protect against the aggregation of many smaller claims, which could result from a single event affecting many policyholders simultaneously, such as an earthquake as a major hurricane. Financially, the insurer is able to pay losses individually, but when the losses are aggregated, the total may be more than the insurer wishes to retain. Though the careful use of reinsurance, the descriptive effect catastrophes have on an insurer¶s loss experience can be reduced dramatically. The decision a company makes when purchasing catastrophe coverage are unique to each individual company and vary widely depending on the type and size of the company purchasing the reinsurance and the risk to be reinsured. 4. Increased capacity: Capacity measures the rupee amount of risk an insurer can assume based on its surplus and the nature of the business written. When an insurance company issues a policy, the expenses associated with issuing that policy-taxes, agents commissions, administrative expenses-are changed immediately against the company¶s income, resulting in a decrease in surplus, while the premium collected must be set aside in an unearned premium reserved to be recognized as income over a period of time. While this accounting procedure allows for strong solvency regulation, it ultimately leads to decreased capacity because the more business an insurance company writes, the more expenses that must be paid from surplus, thus reducing the company¶s ability to write additional business
FUNCTIONS OF REINSURANCE:There are many reasons why an insurance company would choose to reinsure as part of its responsibility to manage a portfolio of risks for the benefit of its policyholders and investors (1)RISK TRANSFER The main use of any insurer that might practice reinsurance is to allow the company to assume greater individual risks than its size would otherwise allow, and to protect a company against losses. Reinsurance allows an insurance company to offer higher limits of protection to a policyholder than its own assets would allow. For example, if the principal insurance company can write only $10 million in limits on any given policy, it can reinsure (or cede) the amount of the limits in excess of $10 million. Reinsurance¶s highly refined uses in recent years include applications where reinsurance was used as part of a carefully planned hedge strategy. (2) INCOME SMOOTHING Reinsurance can help to make an insurance company¶s results more predictable by absorbing larger losses and reducing the amount of capital needed to provide coverage. (3) SURPLUS RELIEF An insurance company's writings are limited by its balance sheet (this test is known as the solvency margin). When that limit is reached, an insurer can either stop writing new business, increase its capital or buy "surplus relief" reinsurance. The latter is usually done on a quota share basis and is an efficient way of not having to turn clients away or raise additional capital. (4)ARBITRAGE The insurance company may be motivated by arbitrage in purchasing reinsurance coverage at a lower rate than what they charge the insured for the underlying risk.
[Type text] Page 6
(5) REINSURER¶S EXPERTISE The insurance company may want to avail of the expertise of a reinsurer in regard to a specific (specialized) risk or want to avail of their rating ability in odd risks. (6) CREATING A MANAGEABLE AND PROFITABLE PORTFOLIO OF INSURED RISKS By choosing a particular type of reinsurance method, the insurance company may be able to create a more balanced and homogenous portfolio of insured risks. This would lend greater predictability to the portfolio results on net basis ie after reinsurance an would be reflected in income smoothing. While income smoothing is one of the objectives of reinsurance arrangements, the mechanism is by way of balancing the portfolio. (7) MANAGING THE COST OF CAPITAL FOR AN INSURANCE COMPANY By getting a suitable reinsurance, the insurance company may be able to substitute "capital needed" as per the requirements of the regulator for premium written. It could happen that the writing of insurance business requires x amount of capital with y% of cost of capital and reinsurance cost is less than x*y%. Thus more unpredictable or less frequent the likelihood of an insured loss, more profitable it can be for an insurance company to seek reinsurance.
ORIGIN AND DEVELOPMENT OF REINSURANCE:In the years 1871 to 1873, no less than twelve independent reinsurance institutions were founded in Germany, of which very few survive today. The pressure of competition led to unwholesome practices, and soon many of these newly formed companies found themselves in dire straits. In branches of insurance, other than fire insurance, we find no definite tendency in the '70's toward the establishment of separate reinsurance facilities in Germany. Ernst Albert Masius, in his "Rundschau" in 1846, deplored the lack of reinsurance facilities in hail insurance. Even at the present time, this branch of the business lacks adequate reinsurance service. Fundamentals in the most widely accepted sense, reinsurance is understood to be that practice where an original insurer, for a definite premium, contracts with another insurer (or insurers) to carry a part or the whole of a risk assumed by the original insurer. By insurers we mean all persons, partnerships, corporations, associations, and societies, associations operating as Lloyd's, inter-insurers or individual underwriters authorized by law to make contracts of insurance. We may define insurance as an agreement by which one party, for a consideration, promises to pay money or its equivalent, or to do an act valuable to the insured, upon the happening of a certain event or upon the destruction, loss or injury of something in which the other party has an interest. The insurance business is the business of making and administering contracts of insurance. Insurance contracts are of two types those which engage merely to pay a sum of money on the happening of an event, or merely to begin a series of payments on or after the happening of a certain event, are contracts of investment. Contracts of insurance which engage to pay money or its equivalent, or the doing of acts valuable to the insured, upon destruction, loss or injury involving things, are contracts of indemnity. And so, reinsurance may be second insurance of (a)Contracts of investment and/or (b) Contracts of indemnity. There may exist, therefore, two types of insurance business, depending upon which of these two organic contracts the business engages to administer.
THE FIRST INDEPENDENT REINSURANCE COMPANY ;In 1846, the first independent reinsurance company was founded in Germany, the Cologne Reinsurance Company. This was the idea of Mevissen. He held that an independent reinsurance company would be no competitor of the direct-writing companies and that it was certain to be welcomed by and to receive a good volume of business from those companies. Mevissen's idea of 1846 did not mature, however. For various reasons the company did not begin business until 1852, and then only with the assistance of considerable French capital. This marked the establishment of reinsurance as a specific, independent branch of the business. Out of small beginnings, this company began to prosper and its example began to attract other enterprising persons. During the first three years of its business life the Cologne Reinsurance Company extended its operations in Germany, Austria, Switzerland, Belgium, Holland and France, and then tried to arrange treaty contracts with English companies. It seems that domestic English reinsurance business, at that time, was quite unprofitable to the reinsures and the Manager of the Cologne was obliged to keep out Of the English market. On June 24, 1853, a fire treaty was concluded between the Aachen and Munchener Fire Insurance Company and its subsidiary, the Aachener Reinsurance Company. This was an early example of a true "first surplus" treaty under which the reinsurer was allotted one-tenth of every surplus risk, with certain modifications in respect to various classes of risk enumerated in the contract. It is interesting to note that the Aachen - Munchener Company had an earlier arrangement with L' Urbaine, Paris.
FIRST RECORDED REINSURANCE CONTRACT:The first reinsurance contract on record relates to the year 1370, when an underwriter named Guilano Grillo contracted with Goffredo Benaira and Martino Saceo to reinsure a ship on part of the voyage from Genoa to the harbor of Bruges. As early as the twelfth century, marine insurance began to be transacted through the so-called "Chambers or Exchanges of Insurance," which had for their object, first, the promotion of the marine insurance business on a solid basis and, second, the settling of disputes arising among merchants and others concerned in bottomry and respondentia contracts. In later years, these Chambers or Exchanges of Insurance became corporate bodiesand instead of remaining confined to the original function of regulating and registering insurance made by others, actually undertook an insurance business themselves. With the establishment and functioning of Lloyd's in 1710, there was a marked decline in the transaction of insurance business through these Chambers or Exchanges. There is a suggestion of reinsurance practice in the "Antwerp Customs" of 1609. Some mention of reinsurance practice is to be found also in the "Guidon de la Mer," a code of sea laws in use in France from a very early date. These marine regulations were consolidated and published at Bordeaux in 1647 and at Rouen in 1671. The author of the consolidations was said to have been Cleirac. With the shift of centers of commerce from the south, southwest and west of Europe to the north, England's foreign trade grew. Marine insurance followed in its wake. Some underwriters found they could affect reinsurance with others. Underwriters were accustomed to assign parts of risks to others at lower rates, and these reinsures had hopes of finding other persons who would take parts of these risks at still lower rates. This traffic in premium differences was so greatly abused that in 1746 it was forbidden. (19 Geo. II, c 37, Section 4). Under this statute, reinsurance was permitted only if the party whose risk was reinsured was insolvent, bankrupt or in debt and if the transaction was expressed in the policy to be a reinsurance. The statute was more or less of a dead letter and was repealed by 27 and 28 Vict.c 56, Section I on July 25, 1864
WHAT TO REINSURE? The question of what to reinsure has to be considered from both the insurer's and reinsurer's perspectives. Reinsurance replaces the risk of an uncertain large payout, with a certain low payout. The insurer must decide how much of that certain payout to accept in return for avoiding the risk of large payouts. That is, the decision to reinsure is a question of how much risk to cede/retain based on financial management of the trade-off between reinsurance cost and the risk of pay out fluctuations. In deciding how much cover to offer, the reinsurer faces the same issues that determine whether an insurer's risk is reinsurable as the insurer faced in the original contract with the individual. Quite simply, if a risk is insurable it is reinsurable. Decision making process arises because, in practice, decisions on insurability are made for non-underwriting reasons ² for example, market building and political reasons. Therefore, the reinsurer needs access to the data on which the original insurances decisions was made. If that data is not available, the reinsurance market can fail to offer reinsurance, not because they risk is intrinsically not reinsurable but because the default decision is to not reinsure. This default is to err on the side of caution. WHY IS OBLIGATORY REINSURANCE NEEDED? It is not for nothing that the laws of the land prescribe a minimal portion of the insurance business to be compulsorily reinsured with another insurer / reinsurer. The insurance business is inherently and intrinsically risky as the losses are of a probabilistic nature, and when they take place, they do so with a randomly varying frequency. This is more so, in the case of new or small insurers, or where existing insurance companies underwrite new classes of business. In such cases, a certain portion of their insurance risk cover must, in their own interest, be reinsured to ensure that the risks are spread. In India, at least till the market attains maturity, it is essential for compulsory / obligatory cessions to remain in the statute book (or alternatively in subordinate legislations likes insurances regulations). In medium size and mega value risks, it is inevitable that certain cessions are placed on an optional (what we in insurance business parlance refer to as
[Type text] Page 11
facultative) basis. Facultative reinsurance arrangements always carry a lower rate of reinsurance commission. For example, in the fire businesses an insurer gets 30 per cent reinsurance commission through obligatory cessions, whereas on highvalue risks the optional portion fetches anywhere between 17 per cent and 25 per cent depending on market conditions. Thus, the insurer stands to gain substantially on direct cessions. Obligatory cessions apply to all policies across the board. Motor insurance, particularly, in India is a bleeding portfolio. An insurer, therefore, has the advantage of minimizing his losses in motor insurance by at least 20 per cent, thanks to the obligatory cessions. For the national reinsurer, the loss in the motor portfolio due to the obligatory cessions is so high, that it often wipes out the profit earned in other classes of business. As mentioned earlier, in the Indian market, which has a combination of new, small and existing insurers underwriting new businesses, the 20 per cent obligatory cessions has always been a matter of comfort. It is a source of reassurance to the insured as well. Therefore, obligatory cessions create an automatic Obligatory cessions ensure that a minimum of 20 per cent (subject to certain quantum restrictions in fire and engineering) premiums are retained within India provided, of course, the reinsurer again does not cede them on proportionate basis. In case of perils like earthquake and terrorism, among others, foreign reinsurers are usually unwilling to provide full cover. This has paved way for market pools to provide the capacity / cover. Market pools are also a form of obligatory cession, normally managed by the national reinsurer. However, it must be conceded that this concept of obligatory cession should be progressively phased out as the market grows and gets integrated with world markets. The concept of obligatory cession may seem restrictive to insurers, who feel that they should be given the freedom to choose their own reinsurer. Even so, regulators must ensure that even if risks were to be reinsured abroad in the absence of obligatory cessions, the premium loss on account of such cessions should be replaced by corresponding 'inward acceptances'. Through this, they achieve:
[Type text] Page 12
good spread of risks geographically and class-wise foreign exchange cost is restored insurers also learn and get experience in the foreign reinsurance business pacify to the extent of the amount ceded, so that the direct insurers do not become vulnerable to the vagaries and whims of the foreign reinsurance market and brokers.
WAYS TO REINSURE There are three basic ways in which MIU can be reinsured: - Pooled reinsurance ² MIUs join together in a relationship that links them only through the pool. There is typically some form of standardization across the pool to ensure transparency and avoid one scheme profiting at the expense of another. The more heterogeneous the MIUs the better the pool advantage, and the more regionally dispersed, the lesser risk of fluctuation due to epidemic or natural disaster. Pooling enables better use of reserves. -Reciprocity also enables a better use of reserves, but in this case the MIUs are known to one another and probably have other ties and commonalities. - Subsidies from government or donors ² this may sustain the MIU, but may also send inappropriate signals to the key players. The lessons from previous insurance experience indicates that subsidies can worsen or alleviate market failure depending on where into the system they are paid, that there may not be a perfect method to subsidies, and no matter how well run an MIU subsidy may be essential in the long run due to the gap.
TYPES OF REINSURANCE (1) PROPORTIONAL Proportional reinsurance (the types of which are quota share &surpl us reinsurance) involves one or more reinsurers taking a stated percent share of each policy that an insurer produces ("writes"). This means that the reinsurer will receive that stated percentage of each dollar of premiums and will pay that percentage of each dollar of losses. In addition, the reinsurer will allow a "ceding commission" to the insurer to compensate the insurer for the costs of writing and administering the business (agents' commissions, modeling, paperwork, etc.). The insurer may seek such coverage for several reasons. First, the insurer may not have sufficient capital to prudently retain all of the exposure that it is capable of producing. For example, it may only be able to offer $1 million in coverage, but by purchasing proportional reinsurance it might double or triple that limit. Premiums and losses are then shared on a pro rata basis. For example, an insurance company might purchase a 50% quota share treaty; in this case they would share half of all premium and losses with the reinsurer. In a 75% quota share, they would share (cede) 3/4 of all premiums and losses. The other form of proportional reinsurance is surplus share or surplus of line treaty. In this case, a retained ³line´ is defined as the ceding company's retention - say $100,000. In a 9 line surplus treaty the reinsurer would then accept up to $900,000 (9 lines). So if the insurance company issues a policy for $100,000, they would keep all of the premiums and losses from that policy. If they issue a $200,000 policy, they would give (cede) half of the premiums and losses to the reinsurer (1 line each). The maximum underwriting capacity of the cedant would be $ 1,000,000 in this example. Surplus treaties are also known as variable quota shares. (2) NON-PROPORTIONAL Non-proportional reinsurance only responds if the loss suffered by the insurer exceeds a certain amount, which is called the "retention" or "priority." An example of this form of reinsurance is where the insurer is prepared to accept a loss of $1 million for any loss which may occur and they purchase a layer of reinsurance of $4 million in excess of $1 million. If a loss of $3 million occurs, the insurer pays the $3 million to the insured, and then recovers $2 million from its reinsurer(s). In this example, the reinsured will retain any loss exceeding $5
[Type text] Page 14
million unless they have purchased a further excess layer (second layer) of say $10 million excess ofs$5smillion. The main forms of non-proportional reinsurance are excess of loss and stop loss. Excess of loss reinsurance can have three forms - "Per Risk XL" (Working XL), "Per Occurrence or Per Even XL" (Catastrophe or Cat XL), and "Aggregate XL". In per risk, the cedant¶s insurance policy limits are greater than the reinsurance retention. For example, an insurance company might insure commercial property risks with policy limits up to $10 million, and then buy per risk reinsurance of $5 million in excess of $5 million. In this case a loss of $6 million on that policy will result in the recovery of $1 million from the reinsurer. In catastrophe excess of loss, the pedant¶s per risk retention is usually less than the cat reinsurance retention (this is not important as these contracts usually contain a 2 risk warranty i.e. they are designed to protect the reinsured against catastrophic events that involve more than 1 policy). For example, an insurance company issues homeowner's policies with limits of up to $500,000 and then buys catastrophe reinsurance of $22,000,000 in excess of $3,000,000. In that case, the insurance company would only recover from reinsurers in the event of multiple policy losses in one event (i.e., hurricane, earthquake, flood, etc.). Aggregate XL afford a frequency protection to the reinsured. For instance if the company retains $1 million net any one vessel, the cover $10 million in the aggregate excess $5 million in the aggregate would equate to 10 total losses in excess of 5 total losses (or more partial losses). Aggregate covers can also be linked to the cedant's gross premium income during a 12 month period, with limit and deductible expressed as percentages and amounts. Such covers are then known as "Stop Loss" or annual aggregate XL. (3) RISK ATTACHING BASIS A basis under which reinsurance is provided for claims arising from policies commencing during the period to which the reinsurance relates. The insurer knows there is coverage for the whole policy period when written. All claims from cedant underlying policies incepting during the period of the reinsurance contract are covered even if they occur after the expiration date of the reinsurance contract. Any claims from cedant underlying policies incepting outside the period of the reinsurance contract are not covered even if they occur during the period of the reinsurance contract.
(4) LOSS OCCURING BASIS A Reinsurance treaty from under which all claims occurring during the period of the contract , irrespective of when the underlying policies incepted, are covered. Any claims occurring after the contract expiration date are not covered. As opposed to claims-made policy. Insurance coverage is provided for losses occurring in the defined period. (5) CLAIMS MADE ± BASIS A policy which covers all claims reported to an insurer within the policy period Irrespective of when they occurred.
REINSURANCE INDUSTRY As one of the business market research paper has put it ³Reinsurance is an international , multi billion dollar industry that is vital to the financial stability of all types of insurance companies.´ It is a method of ceding part of the financial risk the direct insurers assume by accepting risk from risk owners, particularly mega risk, mainly against the earthquakes, tsunami, terrisom, etc. However, in terms of magnitude / size, reinsurance is highly complex global business and for example, it accounts for more than 9% of the total premiums generated from property. The whole mechanism of insurance and reinsurance being a dynamic process. The electronic media and internet technology have substantially added to the efficiency and simplification of mechanism of reinsurance operations. The increased use of information and internet technology by the insurance companies have made collecting, compiling, and data warehousing of updated technical data on millions of mega risk faster and also revolutionized the procedural input on underwritings, accounting and claims processing and settlement by both primary insurance and reinsurance. The new type of electronic system specific transactional methodology since put in place has cut short the embarrassing delays in reinsurance acceptance, cessions and adjustment or settlement among the participating companies. Looking to the latest trend and overwhelming success rate of multi benefit life insurance products like ULIPs and pension plans, which combine risk cover with investment components.
GENERAL INSURANCE COMPANY (GIC) :GIC, the sole reinsurance company of our country, by virtue of its experience and exposure in providing reinsurance support and guidance to its erstwhile non life insurance subsidiaries for more than three dacades, has excellent organizational and technical skills in taking care of reinsurance arrangements for the present insurance market of India ± life and non ± life and has since adequately established itself as the national reinsurance leader. Mean while, GIC reinsurance as part its strategy to expand its operation and to make its present felt globally has recently upgraded its representative offices in London and Dubai. Incidentally, the sole national reinsurer of india also has another representative office in Moscow. GIC has developed necessary skills and has qualified manpower to take care of growing needs of the expanding Indian industry. For the financial year 2006-07, through GIC reinsurance recorded an overall underwriting loss of Rs. 75.95 cr ,it has achieved a robust growth of more than 156% in its net profit at Rs. 1531 cr ,as against rs.598 cr during the corresponding period period in the previous year. GIC ranks 2st among non life insurers with a net worth of $1.4 bn. As per GIC reinsurance chairman,it is positioned as the lead reinsurer in the Afro-Asian region and other emerging economies. during 200607, the premium income for GIC Re went up from Rs. 200 toRs.270 cr. It is learnt that its international reinsurance business amounted to 22% of its total turnover for the year. 3rd Asian Reinsurers¶ Summit was organised by GIC of India, in February 2003 at Mumbai. Eleven reinsurers from Japan, China, Hong Kong, Singapore, Taiwan, Korea, Indonesia, Malaysia, Singapore, Philippines and India participated in the summit with the aim of reinforcing of strengths for mutual development, undertaking joint research, data sharing & information management and furthering business co-operation
CHALLENGES FOR REINSURANCE MARKET :Prior to nationalization in 1973, the reinsurance market in India had a much diluted presence in the industry. The foreign companies operating in India were managing their risk portfolio with their parent companies overseas. To safeguard the identified and limited risk of insurance companies, local companies created India Insurance Pool. The developments after nationalizations insurance industry created a new body with the merger of India Reinsurance and Indian Guarantee for its reinsurance business to support the technology and engineering mega projects. Some of the major issues in accounting have been undertaken considering the recent developments in the business. The return from foreign companies are to be incorporated when received upto 31st march and returns from indian companies and state insurance funds received as of different dates are accepted upto the date of finalization of accounts. Arising out of the occurrence of disastrous like terrorist attack on world trade center etc. which brought about unprecedented loss of life and property and thereby unbearable liability and operational crisis onto the reinsurance industry world over. There is a wide difference between the rates required by the international reinsurers and those charged by the domestic insurers leading to the price affordability as an issue. Where there are tariffs, like a case of India, the customers cushioned from the rate of increase in the international market. Such impositions are required to be self ± absorbed. The Indian market is in absence of the competitive environment of the international reinsurers at the local level, and has depended mainly on the domestic market understanding and basing probability of business ceded rather than on underwriting and risk information criteria. A regular interaction for regional co-operation has to be developed to set up a framework of the areas of co-operation and the mechanism, with this India has to compete with the global reinsurance giants. However, the tightening of reinsurance premium in India has been attributed to the low volumes. As market become global, country regulators face challenges in policy formulation for creating a market that develops and keeps confidence of the industry and for keeping international trade regulation intact.
[Type text] Page 19
WHAT INDIA NEED TO DO? The opening up of the market as a whole and insurance sector in specific has created a potential for the Indian companies also to pool up bigger fund to support the capital intensive sectors. The market has to ensure that the domestic companies increase their own capacities and introduce more strict guidelines as first ± hand risk carriers. Insurance companies have to establish the business relations with their reinsurer to prevent them from worldwide reinsurance cycle that affects on capacity and stability. Worldwide the reinsurers are becoming strict on technical results of the insurance, therefore a disciplinary watch is required on insurance business as it is the base of reinsurance. The above problems or difficulties are not very new for a sector that is the transition. Since, some of the products are losing the importance (like proportional treaty), it is necessary to have sufficient premium income to maintain the balance and to bear unexpected losses. To have the best rates and terms from reinsures, the risk profile and exposure to catastrophe risk information transfer to reinsurer should be comprehensive and reliable. Due to the market opening through the WTO operation, there is net outflow expected in the premium from the developing countries as they have a low capitalization in most of the insurance companies. This could lead to weaken the objective of the serious efforts for the regional cooperation developments amongst the nations. The efforts towards developing a synergetic approach to model a successful cooperation will require to work on many areas simultaneously rather than organizing efforts only for one direction and loosing others, they are as follow:
Pooling of financial resources Creating Investment opportunities Pooling of technical resources Joint ventures, alliance and partnership
Research and developments Pooling of information Developing standard accounting system for business
GLOBAL POSITION :Arising out of the occurrence of disastrous like Hurricance,terrorist attack on world trade center etc. which brought about unprecendented loss of life and property and thereby unbearable liability and operational crisis onto the reinsurance industry world over. The huge amount of losses incurred, in the aforesaid events, forced the reisurers to hike the rates substantially and also change the terms and conditions of reinsurance arrangements. The law and regulations governing reinsurance operation in some of the advance and developing countries have seen few changes, making them more stringent in reinsurance acceptance and compulsory cessions to the local reinsurance companies.
REINSURANCE UNDERWRITING Reinsurance underwriting is the process of building up a portfolio of assumed risks; ii involves selecting the accounts and defining the conditions/rates at which the accounts are to be accepted for assumption of risk. It is one of the most vital functions of the management and the ultimate results of the company depend upon the efficacy. Several arguments have been put forth as to whether underwriting is an art or a science in fact it several traits of both ± one has to consider the previous results, make quantitative/qualitative analysis of the results of the previous years. At the same time it involves a g deal of the underwriter's intuitive judgment and often his gut-feeling. In the long run it is the correct and positive dynamics of underwriting that decide the success of a reinsurance company, just as much as that of an insurance company. Underwriting being a function of such vital importance holds the key to the success of an organization. History is witness that very rarely has a reinsurance company got into difficulties due to a poor investment decision but a major underwriting loss can critically impair the company and throw it out of business.
FACTORS THAT AFFECT REINSURANCE BUSINESS For underwriting to be effective in the long run, a clear understanding of the reinsurance contract is absolutely essential for both the parties. The cedent company needs this understanding to plan its risk-retention, types of reinsurance required etc. For the reinsurer, it is necessary to plan for his portfolio, with an eye on the possible accumulations of losses, underwriting a single large risk etc. After identifying the type of contracts that a reinsurance company has to underwrite during a period, it has to identify the various sources of business that it wanes to get involved in. The different sources of reinsurance business are: Domestic direct underwriting companies Foreign direct underwriting companies Other reinsurance companies Reinsurance brokers Domestic business has various advantages like low acquisition costs, easy manageability etc and further it is free from ether complications like adverse fluctuation of foreign exchange, economic instability of the country etc. It suffers from the drawbacks of low volume and spread of business, which is essential to build up a stable and profitable portfolio. Further, the expertise and experience of the reinsures that are spread across the globe are also denied in case of domestic business. Or the other hand, overseas business has the advantages of wide geographical spread but the cost of maintenance may be higher. Further, other complications like difference in language, legal systems, market practices and exchange control regulations may surface hence, a healthy balance of domestic and overseas business will enable the reinsurer to develop a strong, stable and profitable portfolio. Retrocession treaties among various reinsures could be a source of underwriting international business with a balanced geographical spread. But the company should closely watch for higher costs of acquisition and low profitability. One possible solution to overcome these difficulties is to develop business through intermediaries or brokers, subject to cost of brokerage, delays in remittances and underwriting being in control. Another aspect which has to be considered in finalizing a reinsurance contract is the class and spread of risks. The reinsurance company will have to make a selection of risks depending on the size and intensity. A single aviation portfolio may consist of a very small number of large risks, whereas there can be several small household burglary
[Type text] Page 24
accounts with limited risk exposure. Similarly, even within a class, mere can be variation in risk exposure, like fire policy for residential dwellings as against that of a large industrial undertaking or industrial complexes. Hence a proper balance will have to be struck between various classes; and within a class, between various risks. CLASSES OF BUSINESS POLICY It is of paramount importance for an underwriter to know at the outset as to what classes of risks are to be covered viz. Property, Casualty, etc. It must be ensured that the particular class is a genuine insurance risk which can be defined and quantified properly so that premium considerations do not lead to avoidable conflicts. Further, within the class, method of reinsurance whether proportional/non-proportional, facultative/treaty etc., lias to be selected, depending on the reinsurer choice as well as suitability. DESIGNING A REINSURANCE PROGRAM Having decided a particular class and amount of business to be involved in, a company must decide some form of reinsurance which it requires. Basically the facultative form is more cumbersome, time- consuming and also more expensive. As such it is always wiser to consider a suitable combination of treaties. The ultimate choice as regards a particular treaty or a combination of treaties would depend upon whether the portfolio is exposed to large individual losses or accumulation of losses from sporadic, isolated events. Apart from the above, other considerations that have a bearing on a company's choice of portfolio are: Administrative costs and ease of operations. Effect on company's net retained premium income Whether it wishes to have reciprocal arrangements with other insurers. In case of large risks on classes of business such as Fire, Engineering, Marine hull, etc., a surplus treaty would be the best option for the cedent company as it would enable retention of a large part of premium income. However, because of the special skills involved, a company might be inclined towards reinsuring the business on a risk excess of loss. Further, the administrative hassles of maintaining a squibs treaty are more as compared to those of quota share or
[Type text] Page 25
excess of icss. It would also enable the company to attain a higher rate of commission on a quota share treaty. The excess of loss treaty is also very beneficial in that it is very simple to operate. The company after deciding on the amount of excess of loss cover protection need not go for any reinsurance on individual risks. If the company is in the habit of issuing policies for unlimited liability (motor third party), the final layer of excess of loss cover should also be for an unlimited amount. An insurance company which is also involved in inward reinsurance can increase its capacity to accept large reinsurance risks. However, in order to keep a check on its net retention, retrocession facility should be made use of. Depending on its net retention ability, the company can retrocede the surplus amounts to retrocession Aires, for which it may make use of the quota-share retrocession policy. For the protection of its net retained part an excess loss cover would be useful. Need for reinsurance is paramount because a company has to target the maximum amount of business in order to ensure growth and achievement of its goals. However, while assuming high amounts of risks it is possible for the growth to sustain large losses which may have an impact on the capital reserves. To avoid this, an insurance company has to necessarily go for reinsurance. Several obligatory treaties can help achieve this requirement by providing automatic cover with minimum exclusion. Ii is particularly useful for a new insurance company with a low retention capacity. While arranging for reinsurance, a company must concentrate on good security of the reinsurer. Good security amounts to power of withstanding any large risk and not the offer of large commissions and lower premium rates. Similarly, the reinsurer also judges whether the cedent company is worth entering into a contract with. Mutually, the two should decide upon the level of reinsurance arrangements and the rates at which it is to be finalized.
RECIPROCAL BUSINESS A company may seek reciprocal arrangement with another reinsurer in order to have a spread of its business and also to maintain a large volume of premium income, without affecting its solvency strengths. However a totally reciprocal arrangement (100%) is not possible and the reinsurance companies should aim at a mutually agreeable balance. For entering into reciprocal business, a company should look for the following points. Companies with whom reciprocal business is being planned should be fundamentally strong, should possess good business ethics, and should have a good history of treaties. Besides, a thorough knowledge of the conditions of the country in which a party in is operating, is absolutely essential. The treaties proposed to be exchanged should be reasonably balanced with an acceptable ratio of Host of other services apart from providing reinsurance coverage
This action might not be possible to undo. Are you sure you want to continue?