Everybody is familiar with the term insurance. It is a contract
entered between two parties where one party (insured) pays the other (insurer)
an amount (referred to as premium) to compensate itself or a third party in
case of some financial or personal loss. Thus, insurance is nothing but a way
to transfer risks from one party to another party in exchange of a small
amount. The question arises as to why a small amount is enough for the other
party when the expected payout if that risk materialises is huge? The answer is
simple. The party that insures the other collects these small amounts from
thousands or lakhs or millions of people. Accordingly, these insurers work on
probability and other complicated mathematical and statistical models to
mitigate their risk and eventually turn out to be profitable by collecting
these small amounts and paying for any claims lodged by the insured public.
However, the above risk management leaves one small loophole to be
covered. What if an earthquake or a hurricane or a tsunami strikes and causes
damage to lives and properties of thousands of people. Even a large insurance
company would have to suffer huge losses in the form of extremely high payouts.
Accordingly, these insurance companies also buy insurance protection to protect
themselves against these situations. This phenomenon of buying insurance
protection by insurance companies themselves is referred to as reinsurance. A
reinsurer may be either a specialist reinsurance company, which only undertakes
reinsurance business, or another insurance company. Some of the famous
reinsurance companies of the world are – Munich Re, Swiss Re, Berkshire
Hathaway (General Re), Hannover Re, SCOR, etc.
In India, insurance sector, moved from being an unregulated sector
to a completely regulated sector to partly deregulated sector now. India being
a developing country and one of the least penetrated insurance markets in the
world, there is tremendous scope of growth for insurance and reinsurance
business. Since the reinsurance business involves managing risks of the
entities that themselves manage risks, it involves not only immense expertise
but also huge amount of capital to run the business profitably for a
considerable amount of time. It is these risks and the expertise required that
makes it very difficult to become profitable. Presently, India has only one
specialised reinsurer – General Insurance Corporation of India (GIC Re). Besides
GIC Re, reinsurance contracts are entered by other Indian insurance companies
or foreign reinsurers.
The above facts clearly indicate that if adequate support is given
by the regulators and the Government, India can be a destination for large
reinsurance businesses. However, there are certain regulations and rules that
impede the growth of this business in India –
·
Every insurance
company has to mandatorily cede (give away) 10% of its premium to GIC Re which
then assumes 10% of the risk covered in that policy. If the insurance company
wishes to reinsure above 10% of the policy amount, it can do so but has to
preferably try to offer to Indian insurance companies and only balance left is
to be offered to foreign reinsurers. However, no specific foreign reinsurer can
reinsure risks individually in excess of 10% of the policy amount.
The above cession to reinsurers
(whether mandatory or otherwise) fetches commission to insurance companies as
they are getting business for reinsurance companies. Thus, what tends to happen
is that when 10% of the mandatory or obligatory cession to GIC Re takes place,
many loss making insurance portfolios are transferred to it which GIC Re would
never have taken up if it would not have been mandated to do so. Recently,
getting frustrated by the losses it has to bear on the obligatory business, GIC
Re is planning to remove reinsurance commission on certain portfolios being
ceded to them. Accordingly, this mandatory cession should pave way for cession
in a manner a free market economy would have.
Furthermore, the attempt by the IRDA
(Insurance Regulatory and Development Authority) regulations to retain maximum
reinsurance business in India mandates insurance companies to try to offer
these products to other Indian insurance companies first and then to foreign
reinsurers. Rather than this, attempt should be made to appropriately
capitalise Indian reinsurance sector by easing FDI limits from existing 26%.
Even though the proposed Insurance (Amendment) bill plans to increase FDI
limits to 49% only, it would be even better if this limit is increased to 74%
or 100% for specifically reinsurance service providers due to huge amount of
capital requirements for that sector. This would lead to reduced dependence of
insurance companies on the obligatory services of GIC Re and unregulated
foreign reinsurers.
·
Next absurdity
that needs to be mentioned is that no amount is to be paid by foreign
reinsurers as margins or a portion of premiums as a security to do business in
India, unlike when GIC Re goes abroad to do business in Malaysia, Singapore,
USA, etc.
Even though I am a staunch proponent
of free market, capitalism and lesser regulated businesses but these situations
should not be at the cost of security of stakeholders of the businesses.
Suppose there is a claim and the foreign reinsurer is not in a position to pay
due to some huge losses suffered recently in some other reinsurance operations,
insurers in India would have to go abroad and fight the case (which would be a
costly and time consuming affair in itself). Besides, the law mandates the
insurer to pay the amount regardless of the recovery from the reinsurer. Thus,
it would be a blow to the Indian insurer. However, if a portion of premium is
held as security with the IRDA and such premiums from different foreign
reinsurers are pooled together, they can create a sizeable reserve and can be
used during dire times by IRDA to extend help to Indian insurers.
Even though foreign reinsurers
should enjoy a rating of at least BBB (with Standard & Poor) or equivalent
rating of any other international rating agency before any business is placed
with them, it would still be a wise idea to collect some amount in the nature
of security from them as mentioned above. Furthermore, some slight regulations
on their operations with regard to Indian businesses are needed except just a
mere review of the reinsurance treaty between insurer and reinsurer by IRDA.
·
Next, I would
like to highlight is the problem of TDS (Tax Deducted at source) on payment of
reinsurance premium by insurance companies. Reinsurance premium payments are characterised
in the nature of income of the reinsurers by the tax department and thus,
liability to pay TDS by insurance companies arises on payments made to either
Indian or foreign reinsurers.
TDS and other forms of taxation lead
to lower payments being collected by the receiver, which in this case is the
reinsurer. To blossom the extremely low penetrated general insurance sector and
the reinsurance pertaining to that sector, reduced or nil taxation on
reinsurance premium is necessary so that easy pass-through of premium and easy
mitigation of insurance risks can be done.
·
Lastly, I wish
to comment on a proposed move by IRDA to cap the risks passed to reinsurance
firms. It is proposed that insurance companies whose period of operation is
upto 10 years can pass only 50% of their risks while the companies whose period
of operation is beyond 10 years can pass only 30% of their risks.
IRDA contends that if an insurer has
low retention limit, then such insurers only act as an insurance service
provider than as a risk bearing insurer. However, I feel that this is one of
the most absurd and unneeded moves proposed by IRDA especially when insurance
business has such low penetration in India. Lower amount being passed to
reinsurers means that to maintain higher amount of insurance premium
collections, larger risk bearing capacity should be there, which entails higher
capital requirements. Proposed move to induct FDI upto 49% from existing 26% may help somewhat but overall it needs
to be mentioned that IRDA should not tell the insurers as to how to manage
their risks or do their business. This move, if announced, would be nothing
more than a fracture in the leg of a young footballer learning how to play
well.
It is needed to be highlighted that
regulations should not be introduced for regulations sake but should pave the
way for growth of businesses in a manner conducive for all stakeholders. If the
authorities take a note of the above issues and corresponding suggestions into
account and of course other issues not mentioned above, India, with its
extremely intelligent workforce can make reinsurance as one of the fastest
growing businesses in the country.
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