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PROJECT REPORT ON
Reinsurance
Submitted by:
Arushi Agrawal
BACHELOR OF COMMERCE
BANKING & INSURANCE
SEMESTER VI
MITHIBAI COLLEGE
VILE PARLE (W)
SUBMITTED TO
UNIVERSITY OF MUMBAI
ACADEMIC YEAR
2013 - 2014
NAME OF PROJECT GUIDE
PROF.NARESH SUKHANI
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CERTIFICATE
I, Prof. NARESH SUKHANI, hereby certify that Arushi Agrawal of
MITHIBAI COLLEGE OF TYBBI [Semester VI] has completed the
projected Reinsurance in the academic year 2013 - 14. The
information submitted is true and original to my knowledge.
_______________________
_____________________
Signature of Principal
Project Guide
(Prof. Naresh Sukhani)
_________________________
External Examiner
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DECLARATION
I, Arushi Agrawal of MITHIBAI COLLEGE of TYBBI [Semester VI]
hereby declare that I have compiled this project on Reinsurance in
the academic year 2013 - 14. The information submitted is true and
original to the best of my knowledge.
DATE:
PLACE:
Signature of student
(Arushi Agrawal)
Roll No. - 01
TYBBI
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ACKNOWLEDGEMENT
I would like to thank Mithibai College & the faculty members of
BBI for giving me an opportunity to prepare a project on
"Reinsurance". It has truly been an invaluable learning experience.
Completing a task is never one man's effort. It is often the result of
invaluable contribution of number of individuals in direct or indirect
way in shaping success and achieving it.
I would like to thank principal of the college Dr. KIRAN
MANGAOKAR, the vice principal Dr. ANJU KAPOOR and
Co-coordinator Prof. NARESH SUKHANI for granting permission for this
project. I would like to extend my sincere gratitude and appreciation to
Prof. NARESH SUKHANI who guided me in the study of this project. It
has indeed been a great learning, experiencing and working under
him during the course of the project.
I would like to appreciate all my colleagues and family members who
gave me support and backing and always came forward whenever a
helping hand was needed. I would like to express my gratitude to all
those who gave me the possibility to complete this thesis.
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EXECUTIVE SUMMARY
Beyond considering the impact of reinsurance on the solvency of
domestic companies, reinsurance regulation has not received much
attention, partly because of the absence of significant domestic
reinsurance activity and partly due to the absence of a reinsurance
regulatory model in Europe, on which much of insurance regulation in
economies in transition are based.
The majority of countries give significant freedom to using reinsurers
at home and abroad. However, some restrict placement by individual
insurers beyond a certain proportion to one reinsurer, or to one
market.
The development of domestic reinsurance markets in transition
economies is at an early stage. The numerous reasons which explain
this backwardness include the shortage of capital, lack of experienced
personnel as well as the failure to cooperate with competitors to
establish appropriate market practices.
International insurance and reinsurance brokers are now established
in most of the transition economies, either serving their western clients
or placing reinsurance for local insurers with foreign reinsurers. They
are also an important conduit for reinsurance expertise and training for
local insurers.
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RESEARCH METHODOLOGY
Objectives of the research:
To study Reinsurance and its
various Types and Growth in India
Secondary Data:
The secondary data has been collected from
various reference books and websites which have been mentioned in
the bibliography at the end of the project
Limitations of the Research:
Problems of selection of
right information available from various sources
Scope of the Research:
The main objective of the project is to get to know about the different
types and more about the organizations that provide this service. To
know the shortcomings of this business and its growth prospects.
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TABLE OF CONTENT
SR.NO
PARTICULARS
PAGE NO.
1
Introduction to Introduction
8
2
Characteristics of an Insurable Risk
10
3
History of Insurance Industry
13
4
Types of Insurance
10
5
History of Reinsurance
16
6
What is Reinsurance
18
7
Functions
20
8
Growth of Reinsurance in India
23
9
Types of Reinsurance
27
10
Reinsurance Regulations
36
11
Reinsurance Treaty
45
12
The Reinsurance Markets
47
13
Reinsurance Contracts
53
14
Market Share of Reinsurers
55
15
World’s Top 10 Reinsurers
56
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17
Terrorism & Natural Calamities a
Setback
61
18
Case Study I
64
19
Case Study II
70
20
Case Study III
75
21
Annexure A
84
22
Annexure B
85
23
Annexure C
87
24
Annexure D
89
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INSURANCE
Introduction
People seek security. A sense of security may be the next basic goal after food, clothing, and shelter. An individual with economic security is fairly certain that he can satisfy his needs (food, shelter, medical care, and so on) in the present and in the future. Economic risk (which we will refer to simply as risk) is the possibility of losing economic security. Most economic risk derives from variation from the expected outcome.
Historically, economic risk was managed through informal agreements within a defined community. If someone‘s barn burned down and a herd of milking cows was destroyed, the community would pitch in to rebuild the barn and to provide the farmer with enough cows to replenish the milking stock. This cooperative (pooling) concept became formalized in the insurance industry. Under a formal insurance arrangement, each insurance policy purchaser (policyholder) still implicitly pools his risk with all other policyholders. However, it is no longer necessary for any individual policyholder to know or have any direct connection with any other policyholder.
How Insurance Works
Insurance is an agreement where, for a stipulated payment called the premium, one party (the insurer) agrees to pay to the other (the policyholder or his designated beneficiary) a defined amount (the claim payment or benefit) upon the occurrence of a specific loss. This defined claim payment amount can be a fixed amount or can reimburse all or a part of the loss that occurred. The insurer considers the losses expected for the insurance pool and the potential for variation in order to charge premiums that, in total, will be sufficient to cover all of the projected claim payments for the insurance pool. The premium charged to each of the pool participants is that participant‘s share of the total premium for the pool. Each premium may be adjusted to reflect any special characteristics of the particular policy. As will be seen in the next section, the larger the policy pool, the more predictable its results.
Normally, only a small percentage of policyholders suffer losses. Their losses are paid out of the premiums collected from the pool of policyholders. Thus, the entire pool compensates the unfortunate few. Each policyholder exchanges an unknown loss for the payment of a known premium.
Page | 10 Under the formal arrangement, the party agreeing to make the claim payments is the insurance company or the insurer. The pool participant is the policyholder. The payments that the policyholder makes to the insurer are premiums. The insurance contract is the policy. The risk of any unanticipated losses is transferred from the policyholder to the insurer who has the right to specify the rules and conditions for participating in the insurance pool.
The insurer may restrict the particular kinds of losses covered. For example, a peril is a potential cause of a loss. Perils may include fires, hurricanes, theft, and heart attack. The insurance policy may define specific perils that are covered, or it may cover all perils with certain named exclusions (for example, loss as a result of war or loss of life due to suicide).
In summary, an insurance contract covers a policyholder for economic loss caused by a peril named in the policy. The policyholder pays a known premium to have the insurer guarantee payment for the unknown loss. In this manner, the policyholder transfers the economic risk to the insurance company. Risk, as discussed in Section I, is the variation in potential economic outcomes. It is measured by the variation between possible outcomes and the expected outcome: the greater the standard deviation, the greater the risk.
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Characteristics of an Insurable Risk
We have stated previously that individuals see the purchase of insurance as economically advantageous. The insurer will agree to the arrangement if the risks can be pooled, but will need some safeguards. With these principles in mind, what makes a risk insurable? What kinds of risk would an insurer be willing to insure?
The potential loss must be significant and important enough that substituting a known insurance premium for an unknown economic outcome (given no insurance) is desirable.
The loss and its economic value must be well-defined and out of the policyholder‘s control. The policyholder should not be allowed to cause or encourage a loss that will lead to a benefit or claim payment. After the loss occurs, the policyholder should not be able to unfairly adjust the value of the loss (for example, by lying) in order to increase the amount of the benefit or claim payment.
Covered losses should be reasonably independent. The fact that one policyholder experiences a loss should not have a major effect on whether other policyholders do. For example, an insurer would not insure all the stores in one area against fire, because a fire in one store could spread to the others, resulting in many large claim payments to be made by the insurer.
These criteria, if fully satisfied, mean that the risk is insurable. The fact that a potential loss does not fully satisfy the criteria does not necessarily mean that insurance will not be issued, but some special care or additional risk sharing with other insurers may be necessary.
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History of Insurance Industry
The insurance tradition was performed each year in Norouz (beginning of the Iranian New
Year); the heads of different ethnic groups as well as others willing to take part, presented gifts to the monarch. The most important gift was presented during a special ceremony. When a gift was worth more than 10,000 derrik (Achaemenian gold coin weighing 8.35-8.42) the issue was registered in a special office. This was advantageous to those who presented such special gifts. For others, the presents were fairly assessed by the confidants of the court. Then the assessment was registered. Achaemenian monarchs were the first to insure their people and made it official by in special offices. The purpose of registering was that whenever the person who presented the gift registered by the court was in trouble, the monarch and the court would help him. Jahez, a historian and writer, writes in one of his books on ancient Iran: "Whenever the owner of the present is in trouble or wants to construct a building, set up a feast, have his children married, etc. the one in charge of this in the court would check the registration. If the registered amount exceeded 10,000 derrik, he or she would receive an amount of twice as much."A thousand years later, the inhabitants of Rhodes invented the concept of the 'general average'. Merchants whose goods were being shipped together would pay a proportionally divided premium which would be used to reimburse any merchant whose goods were jettisoned during storm or sinkage. The Greeks and Romans introduced the origins of health and life insurance c. 600 AD when they organized guilds called "benevolent societies" which cared for the families and paid funeral expenses of members upon death. Guilds in the middle ages served a similar
purpose. Separate insurance contracts were invented in Genoa in the 14th century, as were insurance pools
backed by pledges of landed estates. These new insurance contracts allowed insurance to be separated from investment, a separation of roles that first proved useful in marine insurance. Insurance became far more sophisticated in post-renaissance Europe, and specialized varieties developed.
The first insurance company in the United States underwrote fire insurance and was formed in Charles town (modern-day Charleston), South Carolina, in 1732.
Page | 13 Benjamin Franklin helped to popularize and make standard the practice of insurance, particularly against fire in the form of perpetual insurance. In 1752, he founded the Philadelphia contribution ship for the insurance of houses from loss by fire. Franklin's company was the first to make contributions toward fire prevention. Not only did his company warn against certain fire hazards, it refused to insure certain buildings where the risk of fire was too great, such as all wooden houses. Nominee of the assured could get the policy value either at maturity or by installments and an agreed bonus.
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Types of Insurance
1. General Liability Insurance
Every business, even if home-based, needs to have liability insurance. The policy provides both defense and damages if you, your employees or your products or services cause or are alleged to have caused Bodily Injury or Property Damage to a third party.
2. Property Insurance
If you own your building or have business personal property, including office equipment, computers, inventory or tools you should consider purchasing a policy that will protect you if you have a fire, vandalism, theft, smoke damage etc. You may also want to consider business interruption/loss of earning insurance as part of the policy to protect your earnings if the business is unable to operate.
3. Business owner’s policy (BOP
)A business owner policy packages all required coverage a business owner would need. Often, BOP‘s will include business interruption insurance, property insurance, vehicle coverage, liability insurance, and crime insurance . Based on your company‘s specific needs, you can alter what is included in a BOP. Typically, a business owner will save money by choosing a BOP because the bundle of services often costs less than the total cost of all the individual coverage‘s.
4. Commercial Auto Insurance
Commercial auto insurance protects a company‘s vehicles. You can protect vehicles that carry employees, products or equipment. With commercial auto insurance you can insure your work cars, SUVs, vans and trucks from damage and collisions. If you do not have company vehicles, but employees drive their own cars on company business you should have non-owned auto liability to protect the company in case the employee does not have insurance or has inadequate coverage. Many times the non-owned can be added to the BOP policy.
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5. Worker’s Compensation
Worker‘s compensation provides insurance to employees who are injured on the job. This type of insurance provides wage replacement and medical benefits to those who are injured while working. In exchange for these benefits, the employee gives up his rights to sue his employer for the incident. As a business owner, it is very important to have worker‘s compensation insurance because it protects yourself and your company from legal complications. State laws will vary, but all require you to have workers compensation if you have W2 employees. Penalties for non-compliance can be very stiff.
6. Professional Liability Insurance
This type of insurance is also known as Errors and Omissions Insurance. The policy provides defense and damages for failure to or improperly rendering professional services. Your general liability policy does not provide this protection, so it is important to understand the difference. Professional liability insurance is applicable for any professional firm including lawyers, accountants, consultants, notaries, real estate agents, insurance agents, hair salons and technology providers to name a few.
7. Directors and Officers Insurance
This type of insurance protects the directors and officers of a company against their actions that affect the profitability or operations of the company. If a director or officer of your company, as a direct result of their actions on the job, finds him or herself in a legal situation, this type of insurance can cover costs or damages lost as a result of a lawsuit.
8. Data Breach
If the business stores sensitive or non-public information about employees or clients on their computers, servers or in paper files they are responsible for protecting that information. If a breach occurs either electronically or from a paper file a Data Breach policy will provide protection against the loss.
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9. Homeowner’s Insurance
Homeowner‘s insurance is one of the most important kinds of insurance you need. This type of insurance can protect against damage to the home and against damage to items inside the home. Additionally, this type of insurance may protect you from accidents that happen at home or may have occurred due to actions of your own.
10. Renter’s Insurance
Renter‘s insurance is a sub-set of homeowner‘s insurance which applies only to those whose who rent their home. The coverage is protects against damage to the physical property, contents of the property, and personal injury within the home.
11. Life Insurance
Life insurance protects an individual against death. If you have life insurance, the insurer pays a certain amount of money to a beneficiary upon your death. You pay a premium in exchange for the payment of benefits to the beneficiary. This type of insurance is very important because it allows for peace of mind. Having life insurance allows you to know that your loved ones will not be burdened financially upon your death.
12.
Personal Automobile Insurance
Another very important type of insurance is auto insurance. Automobile insurance covers all road vehicles (trucks, cars, motorcycles, etc.). Auto insurance has a dual function, protecting against both physical damage and bodily injury resulting from a crash, and also any liability that might rise from the collision.
13. Personal Umbrella Insurance
You may want some additional coverage, on top of insurance policies you already have. This is where personal umbrella insurance comes into play. This type of insurance is an extension to an already existing insurance policy and covers beyond the regular policy. This insurance can cover different kinds of claims, including homeowner‘s or auto insurance. Generally, it is sold in increments of $1 million and is used only when liability on other policies has been exhausted.
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History of Reinsurance
The development of a reinsurance market took a rockier road. Reinsurance of marine risks is thought to be is old as commercial insurance, but it was not until 1864 that the practice in the UK was legalized and the ban on marine reinsurance was removed. Previously, reinsurance had been considered as a form of gambling.
As reinsurance of fire business appeared unattractive to UK insurers, co-insurance remained a more common way of spreading the risk. Insurers wishing to spread their risks then had to turn to the continental merchant banks for their reinsurance protection.
It was in continental Europe, in the early 1 SOPs, that automatic treaty reinsurance was first developed and there are numerous examples on record of facultative and treaty reinsurance arrangements at that time.
However, it took until 1852 for the first independent reinsurance company to be established, and that company was the Ruchversicherrungs Gesellschaft of Cologne. Several German companies, including the Aachener Ruck, followed suit, proving themselves to he as productive as their forerunner. Unfortunately, British reinsurers‘‘ who decided to enter the field found that their initial experiences were not so fortuitous.
In the 1 870s, quite soon after setting up, a number of UK reinsurance companies went into liquidation. Ike reasons for heir lack of success are not altogether clear, but the UK retained its role as a modest reinsurance market for some time, with its European counterparts continuing to hold the stronger market position.
It is in 1880 that we find the earliest trace of excess of loss reinsurance, as established by Mr Cuthbert Heath of Lloyd‘s, and nor until 1907 do we find the establishment of Britain‘s oldest and longest operating reinsurance company, the Mercantile and General.
Then came the First World War, which brought with it a curtailment in trading relationships between the UK and its primary reinsurance markets. This forced companies to look within their own national boundary for cover and Lloyd‘s, a late entrant to the reinsurance market, began to take a more active role, attracting a large volume of business from the United States of America.
Page | 18 By the end of the Second World War London had successfully established itself at the heart of the international reinsurance market. The City of London had become the center for reinsurance capacity and expertise, with capital provided by British and overseas companies and also those many individuals who were members at Lloyd‘s.
Other reinsurance markets overseas, particularly in Germany and the United States, continued to develop their major domestic reinsurance markets
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What is Reinsurance?
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
Reinsurance helps primary insurers to reduce their capital costs and raise their underwriting capacity since major risks are transferred to reinsurers‘‘; the primary insurer no longer needs to retain capital on its balance sheet to cover them. Reinsurance thus serves the primary insurer as an equity substitute and provides additional underwriting capacity. This indirect capital is cheaper for the primary insurer than borrowing equity, since reinsurers‘‘ can offer to assume risks at more favorable rates thanks to their superior risk diversification. The additional underwriting capacity permits the primary insurers to assume additional risks which without reinsurance they would either have to refuse or which would compel them to provide a lot more of their own capital. In a globalized world, in which potential financial claims are steadily rising and in which the limits of insurability are being constantly extended, reinsurance thus assumes a major significance for the whole economy.
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Functions
Almost all insurance companies have a reinsurance program. The ultimate goal of that program is to reduce their exposure to loss by passing part of the risk of loss to a reinsurer or a group of reinsurers. In the United States, insurance is regulated at the state level, which only allows insurers to issue policies with a maximum limit of 10% of their surplus (net worth), unless those policies are reinsured. In other jurisdictions allowance is typically made for reinsurance when determining statutory required solvency margins.
1. Risk transfer
With reinsurance, the insurer can issue policies with higher limits than would otherwise be allowed, thus being able to take on more risk because some of that risk is now transferred to the reinsurer. The reason for this is the number of insurers that have suffered significant losses and become financially impaired. Over the years there has been a tendency for reinsurance to become a science rather than an art: thus reinsurers have become much more reliant on actuarial models and on tight review of the companies they are willing to reinsure. They review their financials closely, examine the experience of the proposed business to be reinsured, review the underwriters that will write that business, review their rates, and much more.
2. Income smoothing
Reinsurance can make an insurance company's results more predictable by absorbing larger losses and reducing the amount of capital needed to provide coverage. The risks are diversified, with the reinsurer bearing some of the loss incurred by the insurance company. The income smoothing comes forward as the losses of the cedant are essentially limited. This fosters stability in claim payouts and caps indemnification costs.
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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 do one of the following: stop writing new business, increase its capital, or (in the United States) buy "surplus relief".
4. Arbitrage
The insurance company may be motivated by arbitrage in purchasing reinsurance coverage at a lower rate than they charge the insured for the underlying risk, whatever the class of insurance.
In general, the reinsurer may be able to cover the risk at a lower premium than the insurer because:
The reinsurer may have some intrinsic cost advantage due to economies of scale or some other efficiency.
Reinsurers may operate under weaker regulation than their clients. This enables them to use less capital to cover any risk, and to make less prudent assumptions when valuing the risk.
Reinsurers may operate under a more favorable tax regime than their clients.
Reinsurers will often have better access to underwriting expertise and to claims experience data, enabling them to assess the risk more accurately and reduce the need for contingency margins in pricing the risk
Even if the regulatory standards are the same, the reinsurer may be able to hold smaller actuarial reserves than the cedant if it thinks the premiums charged by the cedant are excessively prudent.
The reinsurer may have a more diverse portfolio of assets and especially liabilities than the cedant. This may create opportunities for hedging that the cedant could not exploit alone. Depending on the regulations imposed on the reinsurer, this may mean they can hold fewer assets to cover the risk.
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5.
Reinsurer's expertiseThe insurance company may want to avail itself of the expertise of a reinsurer, or the reinsurer's ability to set an appropriate premium, in regard to a specific (specialized) risk. The reinsurer will also wish to apply this expertise to the underwriting in order to protect their own interests.
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 homogeneous portfolio of insured risks. This would lend greater predictability to the portfolio results on net basis (after reinsurance) and 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.
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GROWTH OF REINSURANCE BUSINESS IN INDIA
For the convenience of the study the growth of reinsurance is classified into three categories-
i. Reinsurance before Nationalization
ii. Reinsurance after Nationalization
iii. Reinsurance after Liberalization.
I. REINSURANCE BEFORE NATIONALIZATION
In India, the period from 1951 onwards was marked by a rapid growth of insurance business; this was because of large scale economic development in the country during the period. The increased insurance business required the reinsurance protection. At that time reinsurance was arranged from the foreign markets mainly British and Continental.
In 1956, Indian Reinsurance Corporation, a professional reinsurance company was formed by general insurers operating in India and it started receiving voluntary quota share cessions from member companies.
In 1961, the government made it completely statute on the part of every insurer to cede 20% in Fire and Marine Cargo 10%, 10% in Marine Hull and Miscellaneous insurance and 5% in Credit and Solvency business to approved Indian reinsurers, namely Indian Reinsurance Corporation and Indian Guarantee and General Company. The above mentioned percentages were, to be allocated equally between the two reinsurers. Thus the reinsurance market was further strengthened by the addition of second professional reinsurers.
In 1966, Indian Insurance Companies Association initiated the formation of Reinsurance Pools in Fire and Hull departments to increase the retained earned premium in the country.
II. REINSURANCE AFTER NATIONALIZATION
At the time of Nationalization of general insurance business in 1971, there were 63 domestic insurers and 44 foreign insurers operating in country and each company had its own reinsurance agreements. In 1973 these companies were reconstituted into four companies. They are:
Page | 25 1. National Insurance Company Limited
ZENITH International Journal of Business Economics & Management Research Vol.2 Issue 1, January 2012, ISSN 2249 8826 Online available at http://zenithresearch.org.in/
www.zenithresearch.org.in 60
2. The New India Assurance Company Limited
3. Oriental Insurance Company Limited
4. United India Insurance company Limited
These four companies were thus left to operate in the country as subsidiaries of a holding company known as GIC (National Reinsurer Act 1972).
After nationalization, GIC became the Indian reinsurer. After nationalization of general insurance the outward reinsurance agreements of the Indian insurance companies were rearranged. The main objectives were rearranged. The main objectives were to maximize domestic retention.
III. REINSURANCE AFTER AND LIBERALIZATION
As a part of the process of liberalization of the insurance industry in India, the Indian Regulatory and Development of India (IRDA) was given the authority of regulating and controlling the conduct of insurance business in India. IRDA frames rules and regulations for various aspects of the Insurance business including reinsurance. The current regulations relevant to reinsurance are attached as an Appendix II at the end of this thesis. The four subsidiaries viz. National Insurance Company Limited, The New India Assurance Company Limited, Oriental Insurance Company Limited, United India insurance company Limited, have been delinked form GIC and private insurance companies have been allowed to do insurance business after obtaining license from IRDA.
Each insurer in India is free to structure his annual reinsurance program in compliance with regulation and solvency requirement. The programmed would need to be approved by the IRDA.
In November 2000, GIC is renotified as the Indian Reinsurer and through administrative instruction, its supervisory role over subsidiaries was ended. With the General Insurance Business (Nationalization) Amendment Act 2002 (40 of 2002) coming into force from March 21, 2003 GIC ceased to be a holding
Page | 26 company of its subsidiaries. Their ownership were vested with Government of India.General Insurance Corporation of India (GIC Re) is the only reinsurance company in India in the domestic reinsurance market. The headquarter and registered office of the GIC is based in Mumbai.
As Indian government had restricted the direct entry of foreign reinsurers some of the companies are working by having joint venture like Munich Re, Swiss Re, Insurance group of America and according to latest news Buffet Berkshier is also coming as an agent with Bajaj Allize to India. GIC Re‘s is providing Reinsurance in the following areas: Property Reinsurance- Fire, Engineering, Accident/Liability Reinsurance, Marine Reinsurance, Aviation Reinsurance, Life Reinsurance and Miscellaneous.
To study the total performance of the GIC Re business, Comparison of the various areas of reinsurance have been studied along with the analysis of the Total Earned premium and profit after Tax of five years (2005-10) are also analyzed.
BUSINESS PERFORMANCE OF GIC: THE INDIAN REINSURER
For analyzing the business performance of the GIC in the period of five years i.e. from 2005- 2010, comparison of Earned Premium and Incurred claims and comparison of different segments of the business were studied. Analysis of Total earned premium and Profit after have been done to analyze the growth trend of GIC business. Analysis is as follows:
i. Comparison between earned premiums of different classes of business.
ii. Comparison of incurred claims of different classes of business.
iii. Five year premium of GIC.
iv. Profit after Tax of Five years.
(I) Comparison between Earned Premiums of Different Classes of Business
In this part of analysis comparison is made between different classes of reinsurance, this include fire, engineering, marine, aviation and miscellaneous on the basis of earned premium of five years i.e. from year 2005 to year 2010. The purpose of this comparative study is to analyze the class of business giving
Page | 27 maximum business to the GIC. Following table describes earned premium from different classes of business. (In Rs Cr)
Year Fire Engineering Marine Life Aviation Misc.
Other 2005 - 06 681.51 173.19 207.61 1.26 34.68 2174.19 2006 - 07 771.55 250.70 158.56 0.48 37.74 1026.16 2007 - 08 817.01 382.51 238.06 9.50 52.00 1606.77 2008 - 09 660.71 394.50 393.61 5.53 48.19 1673.81 2009 - 10 633.57 373.48 278.58 5.50 43.17 1619.40 Total 3564.35 1574.38 1276.42 22.27 215.78 8100.33
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Types of reinsurance
1.
Treaty and Facultative Reinsurance
The two basic types of reinsurance arrangements are treaty and facultative reinsurance.
In treaty reinsurance, the ceding company is contractually bound to cede and the reinsurer is
bound to assume a specified portion of a type or category of risks insured by the ceding company. Treaty reinsurers, including the SCOR Group, do not separately evaluate each of the individual risks assumed under their treaties and, consequently, after a review of the ceding company's underwriting practices, are dependent on the original risk underwriting decisions
made by the ceding primary policy writers.
Such dependence subjects reinsurers in general, including SCOR, to the possibility that the ceding companies have not adequately evaluated the risks to be reinsured and, therefore, that the premiums ceded in connection therewith may not adequately compensate the reinsurer for the
risk assumed.
The reinsurer's evaluation of the ceding company's risk management and underwriting practices as well as claims settlement practices and procedures, therefore, will usually impact the pricing
of the treaty.
In facultative reinsurance, the ceding company cedes and the reinsurer assumes all or part of
the risk assumed by a particular specified insurance policy. Facultative reinsurance is negotiated separately for each insurance contract that is reinsured. Facultative reinsurance normally is purchased by ceding companies for individual risks not covered by their reinsurance treaties, for amounts in excess of the monetary limits of their reinsurance treaties and for unusual risks. Underwriting expenses and, in particular, personnel costs, are higher relative to premiums written on facultative business because each risk is individually underwritten and administered. The ability to separately evaluate each risk reinsured, however, increases the probability that the underwriter can price the contract to more accurately reflect the risks involved.
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o Individual risk review
o Right to accept or reject each risk on its own merit
o A profit is expected by the reinsurer in the short and long term, and depends primarily on the reinsurer‘s risk selection process
o Adapts to short-term ceding philosophy of the insurer
o A contract or certificate is written to confirm each transaction
o Can reinsure a risk that is otherwise excluded from a treaty
o Can protect a treaty from adverse underwriting results
o No individual risk scrutiny by the reinsurer
o Obligatory acceptance by the reinsurer of covered business
o A long-term relationship in which the reinsurer‘s profitability is expected, but measured and adjusted over an extended period of time
o Less costly than ―per risk‖ reinsurance o One contract encompasses all subject
risks
2.
Proportional
and
Non-Proportional
Reinsurance
Both treaty and facultative reinsurance can be written on a proportional, or pro rata, basis or a non-proportional, or excess of loss or stop loss, basis.
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Proportional
Proportional reinsurance (the types of which are quota share & surplus 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 ―line‖ 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.
Non-proportional
Non-proportional reinsurance only responds if the loss suffered by the insurer exceeds a certain amount, 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 purchases a layer of reinsurance of $4m in excess of $1 million - if a loss of $3 million occurs the insurer pays the $3 million to the insured(s), and then recovers $2 million from its reinsurer(s). In this example, the reinsured will retain any loss exceeding $5 million unless they have purchased a
Page | 31 further excess layer (second layer) of say $10 million excess of $5 million. 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 Event 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 cedant‘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 $1m net any one vessel, the cover $10m in the aggregate excess $5m 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. Retrocession
Reinsurance companies themselves also purchase reinsurance and this is known as a retrocession. They purchase this reinsurance from other reinsurance companies. The reinsurance company who sells the reinsurance in this scenario are known as ―retrocessionaires.‖ The reinsurance company that purchases the reinsurance is known as the ―retrocedent.‖
It is not unusual for a reinsurer to buy reinsurance protection from other reinsurers. For example, a reinsurer that provides proportional, or pro rata, reinsurance capacity to insurance companies may wish to protect its own exposure to catastrophes by buying excess of loss protection. Another situation would be that a reinsurer which provides excess of loss reinsurance protection
Page | 32 may wish to protect itself against an accumulation of losses in different branches of business which may all become affected by the same catastrophe. This may happen when a windstorm causes damage to property, automobiles, boats, aircraft and loss of life, for example.
This process can sometimes continue until the original reinsurance company unknowingly gets some of its own business (and therefore its own liabilities) back. This is known as a ―spiral‖ and was common in some specialty lines of business such as marine and aviation. Sophisticated reinsurance companies are aware of this danger and through careful underwriting attempt to avoid it.
Well-written software can either detect reinsurance spirals, or poor software will ignore it, with the latter amplifying the effect of spiraling.
In the 1980s, the London market was badly affected by the creation of reinsurance spirals. This resulted in the same loss going around the market thereby artificially inflating market loss figures of big claims (such as the Piper Alpha oil rig). The LMX spiral (as it was called) has been
stopped by excluding retrocessional business from reinsurance covers protecting direct insurance accounts.
It is important to note that the insurance company is obliged to indemnify its policyholder for the loss under the insurance policy whether or not the reinsurer reimburses the insurer. Many
insurance companies have experienced difficulties by purchasing reinsurance from companies that did not or could not pay their share of the loss (these unpaid claims are known as
uncollectible). This is particularly important on long-tail lines of business where the claims may arise many years after the premium is paid.
4. Treaty
To overcome the high administration costs and uncertainty of reinsuring large numbers of individual risks on a facultative basis, the reinsurance treaty came into being
Proportional treaties include quota shares, various levels of surpluses and facultative obligatory treaties. Non proportional treaties include risk excess of losses, catastrophe excess of losses, stop losses and aggregate excesses.
Page | 33 A proportional treaty may he referred to as a pro-rata or surplus lines or excess lines treaty. A non-proportional treaty may be referred to as an excess of loss, excess or X/L treaty or emit ram.
The party passing on liability may be termed the cedant, insured, reinsured or retrocedant and the party accepting the liability may be termed the reinsurer or retrocessionaire. Apart from the term cedant, which can be applied to all parties passing on liability, the terminology used depends on where the party is in the chain of reinsurance buying and selling.
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5. Financial reinsurance
Financial Reinsurance, also known as 'fin re', is a form of reinsurance which is focused more
on capital management than on risk transfer. In the non-life segment of the insurance industry this class of transactions is often referred to as finite reinsurance.
One of the particular difficulties of running an insurance company is that its financial results - and hence its profitability - tend to be uneven from one year to the next. Since insurance companies generally want to produce consistent results, they may be attracted to ways of hoarding this year's profit to pay for next year's possible losses (within the constraints of the applicable standards for financial reporting). Financial reinsurance is one means by which insurance companies can "smooth" their results.
A pure 'fin re' contract for a non-life insurer tends to cover a multi-year period, during which the premium is held and invested by the reinsurer. It is returned to the ceding company - minus a pre-determined profit-margin for the reinsurer - either when the period has elapsed, or when the ceding company suffers a loss. 'Fin re' therefore differs from conventional reinsurance because most of the premium is returned whether there is a loss or not: little or no risk-transfer has taken place.
In the life insurance segment, fin re is more usually used as a way for the reinsurer to provide financing to a life company, much like a loan except that the reinsurer accepts some risk on the portfolio of business reinsured under the fin re contract. Repayment of the fin re is usually linked to the profit profile of the business reinsured and therefore typically takes a number of years. Fin re is used in preference to a plain loan because repayment is conditional on the future profitable performance of the business reinsured such that, in some regimes, it does not need to be recognized as a liability for published solvency reporting.
'Fin re' has been around since at least the 1960s, when Lloyd's syndicates started sending money overseas as reinsurance premium for what were then called 'roll-overs' - multi-year contracts with specially-established vehicles in tax-light jurisdictions such as the Cayman Islands. These deals were legal and approved by the UK tax-authorities. However they fell into disrepute after
Page | 35 some years, partly because their tax-avoiding motivation became obvious, and partly because of a few cases where the overseas funds were siphoned-off or simply stolen.
More recently, the high-profile bankruptcy of the HIH group of insurance companies in Australia revealed that highly questionable transactions had been propping-up the balance-sheet for some years prior to failure. To be clear, although fin re contracts were involved, it was the fraudulent
accounting for those contracts - and not the actual use of fin re - which was the problem. As of
June 2006, General Re and others are being sued by the HIH liquidator in connection with the fraudulent practices.
Reinsurers
Reinsurer 2012 Gross Written Premiums (GWP) (US millions)
Munich Re $37,251 Swiss Re $31,723 Hannover Re $18,208 Lloyd's of London $15,785 Berkshire Hathaway / General Re $15,059 SCOR $12,576 Reinsurance Group of America $8,233
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China Reinsurance Group $6,708 Korean Reinsurance Company $5,113 PartnerRe $4,712 Everest Re $4,311 Transatlantic Re $3,577 London Reinsurance Group $3,319 General Insurance Corporation of India $625
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Reinsurance regulation
This section describes the current status of reinsurance regulation in the region. The findings of a postal survey of regulatory views gathered in early 1996 for this survey are reported in section IV, B.
A. Current status of regulation
While the regulation of insurance has advanced significantly in Central and Eastern Europe and the CIS countries - albeit with some serious shortcomings - this cannot be said of the regulation of reinsurance.
Although it has not been possible to prepare a comprehensive analysis of legislative and regulatory practices affecting reinsurance of the region on the basis of the postal survey carried out in early 1996, it is evident that the majority of countries have done little to impose controls on reinsurance activity. Appendix A shows some of the regulations which have been mentioned during this survey.
The most frequently mentioned restraint is that reinsurance may be placed abroad only when is not possible to place it with domestic companies. However,
the administration of such conditions is often problematic. There is evidence that these rules are hard to enforce and in fact are often evaded or ignored.
Among the reasons which may be cited for the relative neglect of reinsurance regulation in economies in transition are the early stage of development of reinsurance, the lack of experience by supervisors and ceding companies in the region as well as the fact that this has not been a high priority in the EU, on which much of the region‘s insurance regulation has been modeled. Different countries also take different approaches to reinsurance regulation.
A survey by the OECD in 19961 notes widely divergent practices on the control of reinsurance activity, which differ in many of its principles as well as in its detail. However, the majority of member countries require authorization specific to reinsurance activities of domestic and foreign direct insurers (including Canada, Germany, Italy, Japan and the UK). Several countries (including Australia, Austria, Denmark, Ireland, Netherlands, Norway, Spain, and Switzerland)
Page | 38 require from direct insurers a single authorization for both direct and reinsurance business. On the other hand Belgium, Finland, France and Greece do not require any authorization to do reinsurance business. In New Zealand the only requirement for writing reinsurance is to place a deposit of $500 000.
B. Survey response
In order to gain a better insight to the current practice and attitudes of regulators to reinsurance in the region, a questionnaire was sent to 11 countries and this section summarizes the eight replies (from Estonia, Latvia, Lithuania, Moldova, Romania, Slovakia, Slovenia and Ukraine). It should be stressed that in view of the missing or incomplete responses the findings cannot be regarded as comprehensive. However, further information from the press and market sources has also been included here to present an up-to-date picture since the original survey.
1. Reinsurance regulation
There were very few references from respondents to reinsurance regulation/legislation beyond the requirement of preparing a business plan on authorization which normally demands the setting out an outline of the reinsurance arrangements. Reinsurance is not a separate line of business in most markets (with the exception of Estonia) where separate authorization is needed to write this class as a line of business.
Three countries authorized a specialist reinsurance company: two have been authorized in Ukraine and one each in Bulgaria and Estonia (although it is understood that this is dormant). In two of the successor republics of the former Yugoslavia (Croatia and Slovenia) there are specialist reinsurance companies and there are numerous insurers in Russia which write more reinsurance than direct business.
2. Data collection
The majority of the supervisors responding collected data on reinsurance transactions within their markets. In some instances this is done by insurance company associations. Some supervisors collect this data but do not publish it. Several do not distinguish between reinsurance placed in the home market and placed abroad.
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3. Control powers
Respondents were equally divided between those that have powers to control reinsurance activity at the company level and ask about the nature of reinsurance contracts in force and those that do not. However, it is not clear what powers they have in this regard. Estonia, Latvia and Moldova have powers to specify limits on net retention levels (see Appendix A)
All but one of the respondents indicated that they collect data from companies regarding their solvency status (which takes into account the impact of reinsurance). Two of these do so annually, the rest quarterly. All but one (with the exception of Ukraine) have looked at the ownership relationships of insurers in the solvency context.
4. Reinsurance security
Several supervisors were uncertain if they have adequate technical knowledge to monitor complex reinsurance transactions. An equal number answered ‗yes‘ and ‗no‘ to the question about having adequate expertise. Only one respondent (Estonia) associated potential problems of insolvency and suspensions associated with inappropriate/inadequate reinsurance. Most supervisors monitor domestic companies‘ reinsurance programmes and prepare an analysis of insurance company reserves. However, the only country to report the preparation of a list of approved reinsurers was Ukraine
The majority of respondents also said that they lack adequate powers to issue ―cease and desist‖ orders in the reinsurance context. Ukraine is the only country which reports powers which enables it to refuse placement overseas if the reinsurance purchased is not in line with local regulations. The majority of respondents have kept in touch with supervisors in other countries with regard to the solvency/capital adequacy of foreign domiciled reinsurers, although it is not known if this is done on a regular basis.
Several people consulted referred to the complexity of monitoring reinsurer security and the expertise needed to form correct judgment about their soundness. It became evident that few supervisors in the region have the necessary expertise. One appropriate response to these difficulties could be to make use of the insurance rating services (e.g. AM Best, Standard & Poor). However, the main obstacles to their use are firstly, that few of the domestic reinsurance
Page | 40 companies in the region publish adequate information to enable analysis to be undertaken and secondly, that the cost of these services may be higher than some regulators in the region would be prepared to meet.
5. Minimum Capital
Only one country (Lithuania) referred to adjustment to minimum capitalization to respond to inflation and exchange rate changes, although the fact that solvency minima were or intended to be specified in terms of US dollars or ECU (Russia and Ukraine) goes some way to meet this desideratum.
6. Deposits
In some countries supervisors require that reinsurance treaties concluded domestically contain clauses providing that technical reserves must be left at the disposal of ceding companies. This provides the ceding company with additional security in the event of problems with the reinsurer. However, reinsurers draw attention to the fact that the rates of return on deposits held by ceding companies are often far lower than the rates that could be earned by them. This practice may increase the cost of reinsurance. The survey has not identified any countries in the region demanding deposits
7. Pools
Five countries - Latvia, Lithuania, Romania Slovenia and Ukraine -referred to the existence of insurance pools, all on a voluntary basis. These usually are concerned with the insurance of nuclear facilities within their region. However, there may be several others, not identified due to non-response.
8. State owned reinsurer
The only country which is currently considering the formation of a state owned national reinsurer is the Russian Federation. There have been several proposals put forward, but none of them have come to fruition. The current status of this proposal -which has been debated widely within the market - is not known. In addition, Romania was also proposing to form a specialist reinsurance
Page | 41 company, although there is no information about the suggested ownership, or the current status of this proposal.
9. Limiting reinsurance outflow
There were some obstacles in responding countries to the transfer of a large proportion of the business (via reinsurance) by a foreign controlled domestic company with the main constraints listed in Appendix A. In addition Estonia commented that there was some ―pure fronting with parents‖, but ―so far we have not taken steps against it‖. This would need amendment to the insurance act. However, none of the responding countries controlled the activities of foreign reinsurance companies.
Several countries view the low capitalization and the high volume of reinsurance premium outflow as a problem especially in non-life business. (Lithuania, etc.). The Romanian response refers to the formation of a reinsurance operation ―to increase the proportion of transactions with Romanian insurance/reinsurance companies to approx. 25 per cent next year‖.
At the same time, most respondents are aware of the low volume of domestic reinsurance activity. However, quantitative information is lacking about the split of reinsurance placements between domestic and foreign in most of the countries covered in this survey.
10. Brokers
The activities of insurance/reinsurance brokers were on the whole lightly controlled. However, Estonia and Ukraine are about to introduce broker legislation and Belarus also intends to make foreign reinsurance brokers a subject of regulation/legislation.
However, it is evident that many companies prefer to place domestic reinsurance transactions without the use of brokers. Ukraine noted that they rely on international brokers only when dealing with foreign reinsurers.
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11. Using foreign reinsurance
The majority of companies make use of foreign reinsurance, often on a proportional treaty (quota share) type. The Lithuanian response refers to substantial amount of motor third party liability and green card business being reinsured abroad. But in other markets the principal risks being reinsured are marine and aviation risks as well high exposure property accounts.
The findings of the supervisory survey as well as discussions with other participants in the market indicated that the current state of reinsurance activity in transition economies is in need of further development. There is evidence of a need for better understanding of the techniques as well as the potential dangers and consequences of current reinsurance practices among supervisors as well as for local insurers and reinsurers. In order to assist insurance legislators, supervisors as well as other market practitioners in the improvement of their approach, the present report includes section IX, entitled Reinsurance and its regulation which describes the chief types of reinsurance and their application. Prepared by Professor R. L. Carter, this section also includes suggestions for improving supervisory oversight and monitoring reinsurance security by the use of regulatory techniques which are appropriate in the current state of the development of transition economies.
V. Privatization
The transfer of insurance activity from state ownership to the private sector has made significant progress in most countries, although the rate of progress varies widely.
Privatization has taken various routes. Almost every country has completed the conversion of insurance departments responsible to the state into joint stock companies. Some have sold the majority of these shares as part of the voucher privatization process (Slovakia) or transferred part of the shares to other state owned entities such as banks or holding companies. Albania has also announced that it intends to follow this route with its monopoly company INSIG.
Other routes to full privatization include the splitting up of the original monopoly supplier and selling shares to domestic investors, usually banks, with Romania as an example.
Page | 43 In several republics of the former Soviet Union as well as in Bulgaria and Romania the state sell-off has not gone far due to the absence of local investors.
There are several countries where there is reluctance to allow foreign investors to take a significant stake in these previously state owned units as some governments regard them as strategic assets. Similar situations exist in some of the Baltic republics.
Basis of insurance and Need of Reinsurance
General insurance business is still largely untouched by the discipline of a mathematical base. It is obvious that insurance operates on the law of probability. The risk premium should represent the sum total expected value of loss during a year using the probability of occurrence of losses of different magnitudes affecting the risk. In practice, this estimation is derived from the observed incidence of losses on the insured portfolio. Even if an accurate mathematical determination of the expected value of loss be possible, the actual observed losses will be different from this figure. The extent of variation will depend on the size of the insured portfolio. The financial impact of such variation must be kept within the sustaining reason for limiting exposure to loss on one risk according to a schedule of retentions. Since a large number of risks offered insurance in practice exceed the retention capacity of a company, reinsurance becomes essential for any company‘s operation.
Good Reinsurance Management
Optimization of a company‘s profits and growth prospects involve optimization of its retention and designing of its reinsurance program to best advantage. Reinsurance should not be limited to getting rid of the portion of risk that cannot be retained. It should contribute more positively to the company‘s prosperity. Since the nature of a company‘s portfolio is generally not static, the reinsurance arrangements have to be kept under review continuously. Hence, the concept of dynamic reinsurance management is important.
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The objectives of a good reinsurance program are as follows:
(a) Provide adequate reinsurance capacity to enable the business of different branches to operate without any handicaps.
(b) Provide maximum possible freedom in rating and claims settlement.
(c) Facilitate development of knowledge and skills for the underwriting staff.
(d) Help the company to optimize its retention both in terms of premium as well as profits. Progressive increase in retention without disruption of arrangements should be possible.
(e) Ensure stable reinsurance arrangements both with regard to availability of cover as well as terms.
(f) Help minimize profit ceded on reinsurances placed. Such minimization should be equitable and should not be entirely subject to forces.
(g) Establish business relationships with reinsurers‘‘ of the highest standing. Reinsurers‘‘ who will willingly and readily honor their obligations, who will take a long-term view and stand by the company.
(h) Generate a flow of satisfactory inward reinsurance business. Such business will help to improve the spread and balance the net retained account and should help to increase net premium and profits.
