financial re insurance cila india

8/8/2019 Financial Re Insurance CILA India

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Financial Reinsurance ____________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________

Srinivasa Rao FIAI, FIA

Head of Corporate Actuarial Services

RGA Services India Pvt. Ltd.

27 August 2009

Mumbai

www.rgare.com



2

Over view

Financial Reinsurance & why it is always atopic

Capital Substitution via Reinsurance

O

r i

gin

alt

erms

reinsu

ran

ce & Def i

cit

account

f inancing

Introducing Financial Reinsurance in India

New Issues Due to Financial Reinsurance

Solutions to Some of those New Issues

Conclusion



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What is Financial Reinsurance?

³Fin Re´ is a common label for reinsurance whosepr imary motivation is to act as a capital substitute andwhere r isk transfer is a secondary dr iver.

A Fin re is only a concept and not an identifiable subset

B No country has found a good definition of fin re

C Let¶s therefore not try to define it today



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Why is Fin Re a Constant Topic?

This is a permanent topic globally, not just in India.

The basic reason is that insurance company owner s

don¶t want to endlessly contr ibute new capital.

A Insurers need capital to grow

B Capital has become more scarce & expensive

C Owners therefore look for alternatives to own capital



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Legitimate Capital Substitute

A prerequisite for any f in re discussion is acceptance that reinsurance can be alegitimate substitute for shareholder s¶ equity.

A Details of implementation can be debated

B Philosophical issues can be debated

C Make issues explicit, don¶t reject the label



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Yes, Fin Re Transfers Risk

Fin re transfer s the level of r isk implicitlycovered by the existing reserve or capitalrequirements. If that r isk mater ializes, thereinsurer pays.

A Criticism of low risk transfer may arise, though

B ³Fault´ is in existing requirements, not in fin re

C Focus should be correct accounting



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There has been bad reinsurance

Several high profile cases in last 10 years

These were not fin re, they were simply bad contracts

They had common characteristics:

Lack of disclosure to auditor s & regulator s

Non-Life reinsurance

Incorrectly accounted

³Finite reinsurance´ with explicit reinsurance limits

India can learn from these lessons



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Capital Substitution Effect

A f inancial reinsurance contract reduces an insurer ¶s need for capital via one or more of these three routes.

A Reduction in solvency margin requirement

B Reduction in reserves

C Payment of a lump sum consideration



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Insurer·s Needs f or Capital

Which of the sources of capital requirements could

be managed down in order to improve ROC?

A Infrastructure Investments

B Commissions, Sales Expenses, Staff, Operations

C Solvency Requirements



Original Terms Reinsurance

All elements of original insurance contract are

shared

Proportion of the risk is reinsured

Reinsurance premium is in the same proportionof the office premium

Reinsurer pays Reinsurance commission

Meet the initial commission

Meet the initial expenses

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Original Terms Reinsurance

Reinsurer pays share of commissions

Possibly even higher than propor tionate

Insurer needs less own capital

Reinsurer also bears lapse risk

This could be a major r isk bor ne be insurer



Deficit account financing

Reinsurer provides cash advance to financeNew Business

Cash advanced reflects the PV of surplus

expected to emerge from the reinsured block

Capital portion and Interest (agreed at outset ±could be variable) are first charge on the

emerging surplus

Deficit account is created by the insurer

Cash Advanced is debited

Reinsurance premium is credited

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Deficit Account Financing

Cash Advanced by reinsurer increases

the assets

Since the repayment is contingent on

surplus emerging- not provided for in

the liability

Regulatory capital increased by

amount of cash advanced

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Once the deficit account becomes zero

the insurer becomes the owner for

future profits

Should the cash advance be not repaid

by the reinsurance premiums, the

reinsurer makes a loss

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Risks shared by Reinsurer

Mor tality

Lapsation

Interest (if the interest charge is var iable)

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How to intr oduce Fin Re

Not explicitly prohibited by that name

Administrative circular from IRDA states ±

³..The terms, if coinsurance should be resor ted

to´

³«treaties involving Financial Reinsurance have

to be caref ully managed..´



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How to Intr oduce Fin Re in India

Allow/promote original terms reinsurance

Allow/promote below retentionreinsurance

Other more detailed regulation changes



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Below Retention Reinsurance

Most business is within risk retention

Most capital is for retained business

Reinsuring this business for capital = fin re

Not distinct from original terms

Just much larger scope for capital impact



Some suggested changes

The existing reinsurance requirements state that an

insurer should retain as much premium as possible. This

may need to be revised / removed

"...reinsurance arrangement with an element of borrowing

in the form of deposit or credit of any kind from insurer¶s

reinsurers without the prior approval of the Authority shall

not be treated as credit for reinsurance for the purpose of

determination of required solvency margin³. We believe

this could be removed because this prohibits legitimate fin

re.

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Some suggested changes

The current regulations read that "Reinsurer¶s balances

outstanding for more than three months" should be

valued at zero. This would unnecessarily exclude the

proper use of Financial reinsurance.

The current regulation could be re-expressed as follows:

"Cash payments overdue from Reinsurers which are not

received within three months after their original due date"

should be valued at zero. This change will ensure that

balances which are properly owed but not settled for

longer periods of time are appropriately treated.

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New Issues with Fin Re / OT

Allowing Indian insurer s to cede more r isks and toreduce their capital more will introduces some newissues:

A Security, protection, soundness

B Cost

C Maintaining Indian Ownership



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Reinsurance Security Options

Minimum rating

Acceptable home jurisdiction/regulator

Minimum absolute capital amount Require local Indian registration

Require some collateral



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Reinsurance capital has a cost

Capital via reinsurance does have a

cost

But it might cost less than equity

owners want as their reward

This helps either or both of Indian

shareholder or Indian policyholder



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Maintaining Indian Ownership

Does this contravene 74% /26% rule?

What is ownership?

Cont

rol Residual Upside Benef iciary

Cost of reinsurance is capped and

downside is large



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Conclusion

Alternative capital is more wantedthan ever

Reinsurance can be an alternative

Implementation has challenges, butworth it

IRDA is supportive of larger

reinsurance role



Thanks for your attention

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financial re insurance cila india

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