Reinsurance business : Hopes and Challenges : A Global perspective

Mrs. Bindoo Malviya (Sr. Lecturer) Shri Vaishnav Institute of Management, Indore (MP).

Abstract
Over the last decade, India has emerged as one of the world's fastest growing economies. Both the domestic Indian and global insurance and reinsurance industries have maintained an upward surge of all-round growth. The liberalization and globalization of financial services worldwide, has untapped potential, both in life and non-life insurance, which has made growing economies like India the center of attention. With the entry of national and international insurance companies into countries like India arising out of sudden spurt of growth and proactive proliferation of primary insurance in this part of the world, the global reinsurance markets have seen accelerated buoyancy all around. The increased activation in the systems and transaction modules of insurance and reinsurance, particularly in the last five to seven years has generated many innovative trends, opportunities and challenges to the reinsurance fraternity, specifically to Asian reinsurers, and especially General Insurance Corporation. Reinsurance is multi-billion dollar global industry that is vital to the financial stability of insurance companies. It enables them to provide insurance against risks they otherwise would not be able to accept safely. Despite of its enormous growth opportunities, it has gained very less attention in financial industry. This paper is an attempt to understand the concept of reinsurance and how it works. The paper also highlights the causes for its recent development, its importance in the era of globalization, role of IRDA and the government to give a `push' to the industry, associated barriers in this industry and opportunities for expansion.

Introduction :
Insurance is in the nature of trust It is based on the principle of spreading the risk and sharing of losses among many to reduce the financial burden of an individual. Insurance companies retain only that part of the risk assumed by them which can safely by borne by them out of their own funds and reinsure balance risk with other insurers. Reinsurance is insurance a second time or again; renewed insurance. A contract by which an insurer is insured wholly or in part against the risk he has incurred in insuring somebody else. The practice of insurers transferring portions of risk portfolios to other parties by some form of agreement in order to reduce the likelihood of having to pay a large obligation resulting from an insurance claim. Investopedia Says: This procedure is used by insurance companies to reduce the risks associated with underwritten policies by spreading risks across alternative institutions. It's like portioning out pieces of a larger potential obligation in exchange for some of the money the original insurer received to accept the obligation. The party that diversifies its insurance portfolio is known as the ceding party. The party that accepts a portion of the potential obligation in exchange for a share of the insurance premium is known as the reinsurer. Thus, reinsurance, which is the insurance of an insurer, is the ultimate spreading of the risk basket of the insurer in the international market. Hence, reinsurance support is the backbone of insurance business. Objectives of Reinsurance : Reinsurance provides a better spread of risk, allows the primary insurers to accept much larger risks beyond their own capacity, settle accumulated losses arising from catastrophic events and maintain their stability in financial results. Also known as "insurance for insurers" or "stop-loss insurance". Importance of Reinsurance :In this context, the purpose of reinsurance is to :

Protect the insurer from the results of many large losses due to calamities. Increase the underwriting capacity of the insurer by providing a forum, to which the insurer can transfer risk underwritten beyond its own capacity of retention. Enable an insurer to underwrite novel and prototype risks - especially in respect of new insurance like aerospace activity, financial market risk exposures etc. with technical and experience input from reinsurers. Enable insurers gather global and hence more reliable experience on various risks through the under-writing experience of the reinsurers operating worldwide. Enrich insurers with the research and development of the reinsurers. Thus, reinsurer is a friend, philosopher and guide to the insurer.

Working of reinsurance
The IRDA is charged with regulating and overseeing the orderly growth of insurance and reinsurance business in India. This includes: Protecting the interests of policyholders; Establishing guidelines for the operations of insurers, reinsurers, and brokers; Specifying the code of conduct, qualifications, and training for insurance intermediaries and agents; Promoting efficiency in the conduct of insurance business; Regulating the investment of funds by insurance companies; Specifying the percentage of business to be written by insurers in rural sectors; and Handling disputes between insurers and insurance intermediaries. Role IRDA and the Government Although Indias Parliament recognizes the need to create an open and free insurance market in India, the IRDA appears to be intent on maximizing retentions within the country until the market stabilizes.To further this objective, all Indian insurers must cede 20 percent of every policy written in the country to the national reinsurer, GIC, and must exhaust local capacity before looking outside the country for reinsurance coverage. Even then, there are certain limits on the amount of risk that can be ceded to any one external reinsurer. IRDA guidelines also stipulate that in addition to providing reinsurance to domestic companies, the GIC will facilitate the formation of market pools to further ensure that the bulk of insurance premium remains within India. In addition, all Indian insurers must have their reinsurance programs approved by the IRDA. In its new reinsurance capacity, the GIC accepts both the 20 percent statutory cessions on business written in the country as well as reinsurance business from other markets. It is aggressively seeking to expand beyond its domestic borders and participate in world markets. Sharing its business with the global broker community can help the GIC achieve this goal. The GICs current mission is to protect its market share and acquire new customers, and only time will tell how successful it will be in building a sound reinsurance portfolio. Global insurers and reinsurers can also apply for licenses, but they face additional requirements and restrictions . In addition, the IRDA requires that every insurer operating in India write a certain amount of business in rural areas. For a general insurer, this amount is 2 percent of total gross premium written in the first year of operation, 3 percent in the second year, and 5 percent thereafter. Furthermore, a new Indian insurance company will be permitted to invest policyholders' funds only domestically. The IRDA Act also lifts certain barriers to foreign direct investment in Indias insurance industry.Global insurers are now permitted to set up and register a domestic company in order to write business in India having a capital base of at least US$20 million, and their investment in such company is capped at 26 percent. Thus, to participate in the market, they must form a joint venture with an Indian partner that is able to invest the remaining funds. The equity investment limit is the same for global reinsurers seeking to write business in India, but they are required to put up capital of approximately US$45 million

in order to establish a domestic company. Since the IRDA first enacted these rules, 8 new global non-life and 13 new life insurance companies have entered the market. On the other hand, no global reinsurer has established a domestic company. Instead, most of the top international reinsurance companies operate from their overseas offices by sharing the reinsurance risks picked up by the GIC.

Reinsurance Sector Globally

Reinsurance is multi-billion dollar global industry that is vital to the financial stability of insurance companies. It enables them to provide insurance against risks they otherwise would not be able to accept safely. As the mechanism of insurance and reinsurance is a dynamic process, insurance markets all over the world have been undergoing contractual permutations and combinations with improvised technological innovations in the operational systems. With the entry of national and international insurance companies into countries like India arising out of sudden spurt of growth and proactive proliferation of primary insurance in this part of the world, the global reinsurance markets have seen accelerated buoyancy all around. The increased activation in the systems and transaction modules of insurance and reinsurance, particularly in the last five to seven years has generated many innovative trends, opportunities and challenges to the reinsurance fraternity, specifically to Asian reinsurers, and especially GIC. By virtue of its experience and exposure in providing reinsurance support and guidance to its non-life insurance subsidiaries for more than three decades, GIC has excellent organizational and technical skills in taking care of reinsurance arrangements for the current Indian insurance market. Looking to the proactively effective regulatory mechanism put in place in the country, the accelerated growth momentum generated in the Indian insurance market and the technical expertise of GIC as national reinsurance leader, all the market players, including the IRDA, can take full advantage of electronic communication technology to further improve existing reinsurance arrangements throughout the world. Meanwhile, GIC Re, as part of its strategy to expand its operations and to make its presence felt globally has recently upgraded its representative offices in London and Dubai into full-fledged branches and accelerated its action plan to finalize alliance with local reinsurance companies in the eastern and southern part of the African continent. GIC Re also has a representative office in Moscow, which has been playing a proactive role in coordinating the strategic reinsurance arrangements with that part of the world. GIC Re recorded an overall under-writing loss of 759.5 million rupees for the financial year 2006-07, however, it has achieved a robust growth of more than 156 per cent in its net profits of 15.31 billion rupees, compared to 5.98 billion rupees during the corresponding period in the previous year.

Global Players : Below is a list of the top reinsurance companies worldwide from 2006. 2009 Ranking 1 2 3 4 5 6 7 8 9 10 Prior Rankings (1) Organization Name Swiss Re Munich Re Berkshire Hathaway Re Group (3) Hannover Re Lloyd's of London (4) SCOR RGA Reins Co Transatlantic Partner Re London Reins Group 2008 1 2 3 4 5 6 8 9 12 7 2007 1 2 3 4 5 9 6 8 10 13 2006 2 1 3 4 5 14 9 11 12 8

Due to the ever-changing financial industry, it is difficult to say what the largest reinsurers are currently. For example, in early February 2009, shares in the world's second largest reinsurer, Swiss Re, dropped 28 per cent (the most in 19 years) after appealing to Warren Buffet's Berkshire Hathaway for more than $2.5 billion to help restore capital as a result of record losses since the financial crisis began. Overall, GIC ranks 21st among non-life reinsurers with a net worth of $1.4 billion, and according to GIC Re, it is positioned as the lead reinsurer in the Afro-Asian region and other emerging economies. Recently, for example, it acquired 15 per cent shareholding in Kenya's East Africa Re with an investment of $2 million. Vision of Reinsurer (GIC) : Hon'ble Ex-Finance Minister, Mr. Yashwant Sinha, had visualized India's potential to become the hub for reinsurance activities in the Asian continent. GIC will leverage its strengths to achieve this vision. GIC has a long-term objective of emerging as the preferred reinsurer in the Afro-Asian region. The Near and the far east Asian region, Middle East, SAARC and African and East European countries including Russia and CIS, have been identified as having growth potential. GIC would try to acquire quality inward business from these target markets with a view to earn valuable foreign exchange for the country. A premium of US$ 500 million is being targeted to be achieved within the next 2-3 years. Towards this goal, GIC would soon embark upon a very well devised marketing strategy. GIC's first representative office outside India is being set up in London very soon. It proposes to enter into strategic agreements with large insurance companies in the targeted region.

Key challenges in this industry (within and abroad)

As Indias market develops and the need for reinsurance coverage grows, the GIC will likely need to export even more of its business. In fact, if the potential of such market segments as agricultural insurance is achieved, the reinsurance requirements will be far too massive for the GIC alone to handle. In the three years since the IRDA established the 26 percent cap on foreign investment, not one global reinsurer has set up a company in India. Instead, most of the top 50 global reinsurers operate indirectly from their overseas offices by sharing the reinsurance risks assumed by the GIC. One reason for the unwillingness to invest in a domestic company is that the global reinsurers feel that rates for reinsurance products are inadequate and not at all reflective of global market conditions. Another reason is that the reinsurers must put up a huge amount of capital for only a 26 percent share in a domestic company. Recently, the Indian government has started to discuss increasing this foreign direct investment cap to 49 percent for reinsurers, which may ultimately change the face of the market. Global reinsurers have been pressuring the Indian government to completely deregulate insurance tariffs, arguing that the rates do not reflect market realities. The government appears to recognize that eliminating tariffs is critical to getting all general insurers on an equal footing, and tariffs are expected to be slowly phased out over the next few years. In the meantime, to protect themselves against assuming too much risk for too little premium, reinsurers have begun to restrict claims limits on liability covers to $150 million and to impose caps and restrictions on certain other risks assumed. As the risk management needs of Indian insurers grow, the GIC will likely become increasingly unable to handle their coverage requirements. In addition, the need for a global reinsurance brokers perspective should increase as insurers encounter new exposures.International brokers will have the experience to bring to India the products of the global marketplace as well as the technical know-how and exceptional customer service. A number of global reinsurance companies are eager to set up branch offices in India, but GIC has resisted allowing reinsurance branch offices because it fears that they will introduce even tougher competition than what India now faces. Under the present joint venture arrangement, a reinsurer can only write business up to its capital limit. However, a branch office could access the capital of its parent and thus conceivably write much more business. On the other hand, the branch office is legally liable to cover all of its claims, whereas its current liability under the joint venture structure is limited to 26 percent. The biggest challenge confronting reinsurers today is the ability to price the product properly. Reinsurance is not like the bond market, where capital is directly invested and returns are easy to determine. "It's harder to say how much capital is being employed in a given decision to provide reinsurance. Many companies are using short cut techniques to make these determinations, but they don't have truly sophisticated capital management

techniques."Many actuaries are working on capital allocation models to help establish more realistic prices but Pricing based primarily on competition has led to the cycles that plague the insurance and reinsurance industries. Inadequate pricing leads companies to insolvency when major hurricanes or other disasters hit. The pricing problem also causes investors to be wary of reinsurance stocks, making it difficult to raise capital. Reinsurance monopoly : The state-owned General Insurance Corporation (GIC), with its traditionally close ties to the primary insurers of the public sector, holds a monopoly, being the only domestic reinsurer in India. Mandatory cessions to GIC and its right of first refusal privilege prevent Indian primary insurers from diversifying their risks freely and flexibly.

Opportunities for expansion.

Nevertheless, the presence of international reinsurers in India will continue to grow. As GICs assumed reinsurance business expands, both from within and outside of the country, it will need to further reinsure this business with the major global reinsurers.Now that the GICs four subsidiaries are no longer linked to their parent, they are also free to arrange their own reinsurance and will increasingly turn to the major international companies. The same holds true for domestic private sector companies, who are quickly learning how to place their reinsurance programs. To further counter Western competition, the GIC is seeking to form an Asian trade block with such companies as China Re and Korean Re to share each others major commercial risks. The reinsurer is also offering a comprehensive range of risk management solutions to the Afro-Asian market as part of its effort to become the regions professional reinsurance solutions partner. A recent proposal has been put forward to increase foreign direct investment to 49 percent. In addition, global companies are pushing for the right to establish branch offices in India. These changes are likely to substantially increase the presence of international insurers, reinsurers, and brokers in India.The entry of a large number of Indian and foreign private companies in non-life insurance business has led to greater choice in terms of products and services. Increased consumer awareness of the benefits and importance of insurance and reinsurance has generated many more buyers; and new channels among them brokers, bancassurance, the Internet, and corporate agents have provided additional ways of getting products and services to customers. Global reinsurers stand to benefit greatly from the expansion of commercial crop coverage in India. The country is heavily reliant on agriculture, and as it becomes more market oriented, a strong agricultural insurance scheme is a necessity. In 2004, the Agriculture Insurance Corporation of India (AICI) introduced the Farm

Income Insurance Scheme (FIIS). The aim of this new insurance plan is to protect farmers income against such risks as natural perils, disease, and price fluctuations. With Indias farmers estimated at almost 100 million, the reinsurance needs would be massive if all of these farmers were covered under this national scheme. An alternative to their 26 percent share in a joint venture company

Growth opportunities today lie in the markets of Asia and Latin America. These markets are expanding at a much faster rate than U.S. and European markets, and they're beginning to deregulate. For example, the privatization of reinsurance monopoly in Brazil . "This will enable Brazilian insurers to seek quotes from competitive reinsurers worldwide and open growth opportunities for the reinsurance business in Brazil which is a major market," Hence, growth opportunities in the mature markets of Western Europe and the U.S. will be confined mainly to niche business. India would benefit from a further broad opening of the reinsurance sector to international reinsurers : Competition is necessary for the insurance industry to serve society most efficiently. Insurance in India has undergone significant change since the market was opened in 2001. However, there is still room for further liberalization. The insurance industry is integral to development and fosters economic growth by providing risk management and insurance cover for projects requiring large amounts of capital. The presence of international reinsurers will be a vital element by making additional capital available and relieving Indian insurers of partial or entire risks that are too large for their own capital base. Furthermore, an international reinsurer can develop innovative products to cover small and medium-sized risks. This will support local and foreign direct investment, and encourage the creation of new jobs. The fundamental business model for placing reinsurance risks can be moved to a web-based system.The industry and proprietary exchanges are up and running. As the business becomes more thoroughly web-enabled, he believes competition will create a more open market for reinsurance transactions The reinsurance industry also has an early-warning function by constantly monitoring the long-term evolution of risks, for example in the field of natural hazards such as tsunamis or earthquakes. "Up to now the capital markets have focused almost exclusively on high end catastrophe risks. However, as they become more comfortable with insurance, they may begin to provide other reinsurance-type arrangements such as stop-loss protection on adverse development of casualty loss reserves and risk protection for large losses. This will mean more competition for reinsurers.

Major suggestions
Lifting of Barriers to Foreign Direct Investment in Indias insurance industry and also increase the percentage limit of foreign direct investment . There has been a massive change in the knowledge level and expectations of insurance and reinsurance buyers since liberalization efforts began. This can be accounted for partly by market efforts to educate clients as well as by the entry of intermediaries with global skills and experience that are helping clients make informed purchasing decisions. Improvements in Regulatory guiding Principles : Regulation should support global capital and risk management supervision Market discipline is as important as regulation Future reinsurance capacity from capital markets Regulation must focus on risk based models and capital measurement Regulation should be limited to risk based capital adequacy, risk management and governance "The Internet, growth, and profitability are the three challenges keeping reinsurance people awake nights. The industry must face up to investor demands for higher returns, the changing needs of clients, and changes in the competitive marketplace." The Internet doesnt adds significant value to the reinsurance transaction. it makes communication faster and more efficient. However, in most cases, reinsurance is, he says, a "consultative sale, not a commodity sale." Merger and acquisition activity is creating larger insurance companies that may require less reinsurance. It will challenge the traditional reinsurance industry to use its experience and expertise in new ways. They won't be able to succeed on conventional reinsurance alone in the new marketplace. In this environment, reinsurers and brokers who specialize will be the winners. . Emphasis should be given on Positioning perspectives in a changing market, Innovative value creation as a challenge, and Shifting customer needs and expectations. To improve capital efficiency. This will involve developing and exploiting new means of spreading risk while accessing and allocating capital in more cost-effective ways. The industry must begin to achieve consistent profits at levels acceptable to the investment community, elsewhere to achieve its required rate of return." "Investors expect higher returns from reinsurance because of the increased volatility of the business compared to primary insurance," will need to focus more directly on specific classes of business rather than trying to write everything. Guarantee unrestricted free global reinsurance trade where insurers are free to select their reinsurers and reinsurers are guaranteed free exchange of settlement of balances against guaranteed free exchange of settlement of balances and financial security

To establish a permanent critical amount of market momentum to progress best practices by way of healthy competition. One of the outstanding issues to be developed is a reinsurance regulation which allows reinsurers to pursue their function as professional risk managers. Insurance to the maximum benefit if the following important criteria are met.

Conclusion
Thus, it may be concluded that reinsurance supplies the insurance industry with capital: intellectual capital, informational capital, and most importantly, financial capital. Reinsurance increases the capital efficiency of the insurance industry by promoting best practices among insurers and supplying relatively cheap, temporary capital while helping insurers reduce the volatility of their loss experience. Greater capital efficiency will be achieved through better and more efficient mechanisms for dispersing risk, both within and outside of the insurance and reinsurance industries. The reinsurance industry in the new millennium can no longer do business as usual. Major developments challenge the industry in the areas of technology, competition, pricing, growth, and the changing marketplace. The global insurance and reinsurance industry will be able to continue their superior role of risk managers for commerce and industry, eventually for the global society. In addition to finding better ways of managing risks, reinsurers must find the will and the means of improving their operational efficiency. Reducing transaction and infrastructure costs will dramatically change the cost/benefit analysis that insurers perform when making decisions about reinsurance purchases and will make them opt for more reinsurance and greater risk diversification. Better spread of risk will mean less earnings volatility, less need for capital and greater earnings for the insurance and reinsurance industries. . The Indian reinsurance market has to increase its capital base to meet the competition, their liabilities and stay financially sound. To provide for a stronger capital base of the whole global market will be a pre-requisite.

References
Insurance Principles & practice M J Mathew, RBSA Publishers Insurance M N Mishra S.Chand and Company Ltd http://www.hoovers.com/ en.wikipedia.org/wiki/ www.globalreinsurance.com www.gicofindia.in www.propertyandcasuality.com www.iupindia.org. http://www.reinsurance.org/i http://business.mapsofindia.com 2004 by the Insurance Information Institute in Reinsurance: Fundamentals and New Challenges.