This article is written by Shloka Shailesh Rasal.
The rudimentary notion of insurance is to enlarge the coverage of risk far and wide for the purpose of compensating economic losses occurred due to Peril (uncertain event). Thus, Insurance is a mechanism that does not avoid a Peril rather reduces the impact of financial loss on the beneficiary of asset. Insurance Companies are hit by Catastrophic Risk that may cause bankruptcy to the Insurer or owner. Therefore, to negate aggravating losses Primary Insurers transfer their risk to Re-insurers by ceding a portion of the premium.
In India, places are hit with floods and droughts due to uneven spread of monsoon. Both events are determined as fore-bode catastrophic losses. Tracing the remote past, Enron scam and Harshad Mehta Scam, Fire in off-shore Rig of ONGC, PNB Scam, Fire in Serum Institute of India are either Engineering Failure or human failure. Organisations are crippled due Surge in Cyber Attacks increasing their data recovery costs along with enormous property losses resulted due to failure of computer-controlled plants.
Hence, the significance of re-insurance can not be over-emphasized. The author elucidates the principles of contractual obligation pertaining to Re-insurance and explains how Re-insurance is the backbone of crop insurance.
Insurance company (signified as insurer) pledges to indemnify the beneficiary of asset or the insured who possess an insurable interest in the subject- matter of insured property, a certain amount of money (referred as sum assured), on the occurrence of an insured peril agreed upon by the insurer and proposer, expressly proposed in the term and conditions of a policy.
The principle of Proximate cause (sed causa proximo non-remold-spectator) is applied by insurers before payment of the claim only in the case of General Insurance. Pertinently, the insured compensates the insurer to bear the risk, called premium. The insurance company act as intermediaries between the group of persons who have the competence to spare money and the group of persons who need the money. Similarly, the grouping of persons is known as Insurance pool wherein, the insurer transfers the risk on a group of people who are endangered by similar risk to ensure fair, equitable and, an accountable framework for all. The insurer collects premiums from the group of persons and reimburses the insured, on the happening of insured peril, known as claims.
Despite the fact that individuals transfer their risk to the insurers, the insurers can similarly transfer a part of their risk to some other insurer. Generally, insurers have abundant funds to repay claims, though, catastrophic events amount to thousands of claims that include extremely huge amount of money hence, insurers cede a proportionate amount of risk to other insurers, established as Re-insurers for the purpose of the reduction in liability that arises while repaying claims. While we date back to the unfortunate and jinxed evening of 26th November, 2008 when terror clouted Mumbai ensuing the ordeal, leading to a massive genocide of human lives.
Similarly, on 11th March, 2020 the World Health Organisation announced the novel of coronavirus as a pandemic. Pursuant to statistical reports dated 18th August, 2020, 21.8 Million have been affected by the noxious virus. Many of us perceived the situation as a horror, but few individuals and companies contemplated to support the victims. These companies are none other than insurers along with their underwriters. However, in ‘India Insurers’ are permitted to retain only up to a specified limit prescribed by the Insurance Regulatory and Development Authority of India, 1999 to assure that insurer settles the claims as promised.
In accordance with the IRDAI Re-insurance Regulations, 2018 “Every Indian insurer transacting life insurance business must now maintain at least 25% of the sum at risk for pure protection life insurance business portfolios and 50% for other portfolios.” Section 2 (16B) of The Insurance Act,1938 explains the modus operandi of re-insurance as a contract between the insurer and the re-insurer wherein the re-insurer accepts a part of risk of the insurer in lieu of a mutually consented premium.
According to Section 101A of the Insurance Act, 1938 it is mandatory for an Insurance company to re-insure maximum 30% of sum-assured with another Indian re-insurer. Section 2(16B) of The Insurance Act, 1938 explains the modus operandi of re-insurance as a contract between the insurer and the re-insurer wherein the re-insurer accepts a part of risk of the insurer in lieu of a mutually consented premium. According to Section 101A of the Insurance Act, 1938 it is mandatory for an Insurance company to re-insure maximum 30% of sum-assured with another Indian re-insurer.
Currently, there are various re-insurer of voluminous size, operating across the world. Amidst dynamic changes in the Corporate world re-insurance companies encounter various challenges in order to sustain their goodwill in the market. This paper navigates through the evolution of Re-insurance in India by endeavouring an overview on the position of re-insurance companies’ pre-liberalisation and post-liberation. It also enlightens judicial interpretation of the Principle of uberrimae fides and the Principle of Insurable Interest under the ambit of Re-insurance.
The regulatory mechanism of re-insurance will be discussed via a comparative study of regulation in force in other countries. The paper also entails to examine the significance of Re-insurance in Crop Insurance after the launch of Pradhan Mantri Fasal Bima Yojna on 18th February, 2016 and the challenges encountered by re-insurance in the area of automation along with the impact of COVID-19.
Growth & development of re-insurance in India
The Constitution of India divides the power between the central government and state government and is thus Federal in nature per se. The central government authorised to regulate the Insurance sector of India and hence the legal provisions pertaining to insurance industries are uniform throughout the Indian territories. The growth and development of insurance industries has undergone three distinct phases:
Pre-nationalization of the Re-insurance industry in India
General insurance companies regulating in India formed India Insurance Corporation in 1956 which started attaining voluntary quota share sessions from Various member companies. Subsequently, in 1967, the Government of India made every re-insurer to cede a minimum percentage of insurance premiums to the Re-Insurance Corporation. The authorized Indian reinsurance companies were:
- Indian guarantee and general insurance company.
- Indian re-insurance corporation.
Post-nationalization of the reinsurance industry in India
In 1972, Government of India established the General Insurance Corporation of India that was a wholly-owned Company of the government. GIC enjoys monopoly in the insurance market of India wherein it wrote a business from 161 countries and was ranked 12th among the best reinsurance companies. It acquired 60% of premium from insurance companies of India and the rest 40% from other countries, which resulted in solvency rate of 1.83 which was more than 1.5 as a standardized rate issued by IRDAI therefore, it was clear that GIC Re alone could sustain huge number of losses along with the setting off claims at the time of a Peril.
Post-Liberalisation of the reinsurance industry in India
Pertaining to the procedure of liberalization of the reinsurance industries, the Indian regulatory and development of India who was authorised to regulate and control the conduct of the entire Indian insurance business. It is established 4 subsidiaries named The New India Assurance Company Limited, National Insurance Company Limited, United India Insurance Company Limited and Oriental Insurance Company Limited which were dealing from GIC. subsequently private insurance players work permitted to join hands with the domestic insurance players bio pertaining legal license from IRDAI.
Subsequent to the General Insurance Business Nationalisation Amendment Act, 2002, came into force on 21st March, 2003 after which GIC supervisory role over the subsidiary companies came to an end. The subsidiary companies’ ownership was vested with the Government of India which made General Insurance Corporation of India as the only reinsurance company in the domestic reinsurance market.
Regulatory Mechanism of Indian Re-insurers
Section 101(a) of the Insurance Act, 1938 provides that every life insurance business must see 30% of the premium amount to the re-entry and general insurance business must seed 5% of the premium amount charged on a policy. this is also known as obligatory cession. IRDAI (General Insurance-Reinsurance) Regulations, 2000 govern the functioning of the reinsurer. regulation 3 (1) can templates that reinsurance program should abide by the undermentioned objectives:
- Expand retention limit within India.
- Simplified business administration.
- Safeguard the best possible option for the re-insurance amount incurred.
GIC re-created a market tourism school on 1st April, 2002 where all the insurers for the members of the pool. The members of the pool voluntary ceded the pool. Initially, the pole had a capacity to procure Rs.200 crore which was subsequently revised to Rs.600 crores.
Pursuant to Regulation 3(10) IRDA (General Insurance-Reinsurance) Regulations, 2000, before placing cessions outside India Every insurance must offer opportunities to Indian insurers to participate in its facultative treaty. Indian reinsurance can place business with only those insurers that have a credit rating of BBB (standard and poor) or any other equivalent rating benchmark by international rating agencies. Minimum 3 reinsurance branches that have procured a legal license from IRDAI and haven’t registered under Regulation 4(a) of the Branch Office Regulations should maintain a minimum retention limit of 50% to the Indian reinsurance business.
Re-insurance market in India
The re-insurance industry is a major contributing variable to the economy and hence envelops sheer importance in Financial Markets. Therefore, the prominence of re-insurance industry is sui generis and is enormously an ally in catastrophe. It is deemed that the birth of Re-insurance took place in 1852 when the first treaty of re-insurance was written by Cologne Re post a decade of Great fire of Hamburg.
Subsequently, Swiss Re was established in 1863 and Munich Re was established in 1880. Re-insurance is an apparatus where an insurer who bears high volume of risk purchases insurance from other insurer to subsume those risks. The insurer that stipulates re-insurance coverage is called re-insurer. Similarly, an insurance company that buys re-insurance is known as a ceding insurer, reinsured or a ceding company.
Therefore, one insurance company cedes a proportionate portion of its risk in consideration of a premium amount, for which the ceding company retains the liability to control the subsequent loss. While entering into a contract of re-insurance, insurer agrees to pay proportionate premium to the re-insurance company in behalf of the financial burden exposed to them under a direct insurance policy that the insurer originally issued to its insured. A reinsurer who procures its own re-insurance is knows as retrocedent. Re-insurance is a channel that reallocates their own risk. Re-insurance primarily is of two kinds:
- Facultative Re-insurance
- Treaty Re-insurance
According to Section 2(d) of The Insurance Regulatory and Development Authority (General Insurance- Reinsurance) Regulations, 2000, facultative re-insurance denotes a certain portion or all of a single policy wherein re-insurer and the insurer can separately negotiate on accepting or declining individual submission. In Unigard Sec. Ins. Co. v. North River Ins. CO. the court held that facultative re-insurance permits the ceding company to purchase a part or a whole of the insurance policy.
According to Section 2(i) of The Insurance Regulatory and Development Authority (General Insurance- Reinsurance) Regulations, 2000, Treaty re-insurance signifies as prearrangement between the reinsurer and insurer which provides financial terms along with technical particulars that would be applied to classes of re-insurance business for one year or more than a year. In the case of Christiana Gen. Ins. Corp. v. Great Am. Ins. Co the court held that treaty re-insurance is a device that seeks to abbreviate the probable financial losses from the policy issued to classes of clients/customers.
The fundamental difference between Facultative Re-insurance and Treaty Re-insurance is that under facultative re-insurance, the reinsurer has an option to undertake a particular risk in a specific policy. On the other hand, under Treaty Re-Insurance the reinsure is obliged to accept the risks mentioned in the contract. To understand the principles of contractual obligation pertaining to Re-insurance it is necessary to examine the Doctrines underpinned in the Contract of Re-insurance. Once there is positive enforcement of the Indian legislature, the language and Intention of the legislature would be applicable to the facts of each case. Moreover, the common law of England relies upon the determination of good conscience, justice, and equity.
- Good Faith
Contract of insurance is determined as a contract uberrimae fidei. Utmost good faith is determined as a fundamental aspect of insurance law wherein parties to a contract are obliged to disclose every relevant and material fact known to them. The burden of proof to prove misrepresentation on non-disclosure lies on the insurer. Material alteration in the terms and conditions of the contract cannot be made by the Insurer without the mutual consent of the reinsurer.
Similarly, the insurer is not permitted to demand an additional premium nor can the re-insurer escape the liability to cover the risk of the insurance company. The contractual liability of good faith is very stringent in India. In the Star Sea Case, the House of Lords ruled that the duty of utmost good faith commences from the enforcement of the contract. Under Treaty re-insurance the ceding company owes a fiduciary obligation to disclose material fact.
Representation compromises of those statements that are induced by one party to the other, either while entering into a contract prior to entering a contract. These statements must be fulfilled on the conveyance of the final accepted policy. Mere recital of Representation made while entering the contract will not constitute to a warranty. If such representations are untrue er se the entire policy can be avoided. The insurance act stipulates three conditions that would establish misrepresentation:
- The statement must compromise a material fact that is suppressed for undisclosed.
- The intention of such suppression of material facts by the insurer must have a fraudulent intent.
- The insurance company must have cognizance of the facts that are suppressed. The onus of proof for establishing that the insurer had suppressed material fact would be on the reinsurance company.
- Contract of indemnity
In a contract of indemnity under reinsurance, the reinsurer indemnifies the insurance company for the proximate losses that would be suffered by them after occurrence of peril that was insured by the insurance company in the original policy. While entering into a reinsurance contract the insurer consents to pay a particular amount of premium to the reinsurance company for subsuming a portion of its financial risk under the direct policy. Through this indemnity relationship, the reinsurance company seeds a portion of risk among one or more re-insurer. Therefore, reinsurance is distinct from direct insurance where the reinsurance company is not directly responsible to the original insured. Hence reinsurance indemnity arises only once the re-insured pays the claim. Here the reinsurance company brings back the reinsurance company to the same position as if the peril never occurred after reimbursing the indemnified amount on certain conditions:
- On the occurrence of the peril, the insurance company must prove financial losses.
- The indemnity limit would be restricted to the amount specified in the contract.
- The insurance company will indemnify the losses pause event to only proximate causes.
Backbone of crop insurance: re-insurance
If we date back to the jinxed incident that took place on 26th November 2008, when Mumbai was struck by terror which observed a descend in the Pall of gloom due to an enormous massacre of human property and lives. Most of us perceived it as horror but few individuals and corporations contemplated on how victims should be supported and brought back to a normal life. These companies are none other than insurers and reinsurers with their expertise in underwriters and claim settlement.
Therefore, nature of reinsurance is Sui generis who are ‘ally in an apocalypse’. Post-liberalization many re-insurance companies encompassing of varied sizes are operating in India. As per the list of top 20 reinsurers from which over 70% of the gross premium from life and non-life reinsurance is written off by top 10 players which depicts that insurance players still continue to enjoy market dominance in India.
Re-insurance business in India is rapidly turning into a force that could be reckoned with. Direct insurance has observed a Spectacular growth of almost 20% CAGR are within the last five years. in 2016 to 17 reinsurance premiums clocked $ 4.574 billion. until 2015 GIC Re was the only reinsurance company that operated in India. However, after liberalisation foreign reinsurance players have opened their branches in India Recent PMFBY granted a boost in reinsurance market with a meteoric Escalation of Crop Insurance.
India’s 58% of the population is engaged in the agricultural sector, contributing 16% of gross domestic product. Approximately 80% of farmers are marginal owning less than 2 ha of land. in India 60% of agricultural land, it is rain fed and only 40% of agricultural land is irrigated. which decipher that the agricultural sector is the riskiest Enterprise prevailing in India Which is exposed to high frequency of catastrophic/ systematic risk. Therefore, while determining this fact, crop Insurance is the only tool that would mitigate the risk. Even though various schemes were Implemented pertaining to Crop Insurance in 1985, Most of the schemes were executed on administration platform wherein the Government contributed only if the claims exceed the premium amount. The only agency that implemented search schemes was AIC/GIC. However, since Kharif 2016 the Indian government Stipulated market-driven schemes such as Pradhan Mantri Fasal Bima Yojana where 18 companies that encompassed 5 Government companies were empaneled to implement the scheme.
Impact of PMFBY on Re-insurance Companies
Unlike the other segments of insurance, Crop Insurance compromises a multi-stakeholder mechanism where state government, insurance companies, farmers, central government, bankers, reinsurance companies are the principal stakeholder. This Crop Insurance country five stages that involve all stakeholders, that repeat each cropping season.
As discussed previously the dimension of risk Under PMFBY has increased the necessity of reinsurance for the insurance companies in India increases due to the surge in the capacity of underwriting and the margin of solvency. Considering Crop Insurance as a seasonal business ultimate loss ratio is high along with a delay in receiving an upfront subsidy on behalf of the government. Due to the non-availability of corpus and low investment revenue 8-year gap is created between premium subsidies and claim settlement. Therefore, underwriting more business would mitigate the systematic risk and bring about stabilization, diversification in the crop insurance sector.
By discussing the impact of PMFBY on the crop insurance business in India, it would be pertinent to mention that it in showrooms companies ceded approximately 75% of risk under quota share treaties and for net retention of 25% the insurance companies purchased Stop Loss Treaties along with Facultative Reinsurance Treaties.
Financing techniques for Re-insurance companies
Insurers transfer the risk to Re-insurers. However, on the event of Catastrophic Events the burden of re-insurers increases which would even result in issues pertaining to insolvency. Contemplating the high/low frequency of Catastrophic event, re-insurer must opt for long-term financing techniques to smoothen the future losses. For example, if we overlook the floods that hit Kerala it was necessary for re-insurance companies to increase their credibility by considering the devices to distribute their risk. Dissemination of peak risk on capital markets or any investor would ease the strain implied on capital position of re-insurer that would ascend due to enormous catastrophe.
Therefore, apart from traditional insurance the two alternatives for the re-insurance companies are Catastrophic Bonds and Alternative Risk Transfer (ART). ART is a tailor-made solution for financing risk which enables re-insurers to transmit risk to capital markets to protect them against certain risks. Moreover, under this financing techniques the re-insurer self-finances the risks that are covered under the traditional policy. Cat Bonds transfer a particular risk to an investor from a sponsor. Cat Bonds enable the re-insurance companies to alleviate the financial risks occurred from huge Catastrophe events, that would incur damages which would be impossible to repay from the invested premiums.
While analysing the impact of catastrophic event it is significant to cogitate the severe consequences encountered by Re-insurance Companies due to the roll-out of the Novel Coronavirus. The re-insurance sector has ancient acquaintance with volatile events. It regularly adapts to unforeseen events by developing qualitative and quantitative risk management techniques. COVID-19 has impacted underwriting risk, liquidity risk, reserve risk, asset risk and operational risk. For a few re-insurers, the decline insolvency rate may impact their required minimum capital, whereas some re-insurers will need to overlook the capital models set by the rating agency to avoid a downgrade.
Discussion & recommendations
The significance of the reinsurance market generally has been to fuel development and stabilize the insurance market which keeps on being legitimate as the economy is developing at 7% and making more risks. Reinsurance will invigorate better development as far as the convergence of risks. There is a gradual task to carry out by the reinsurance market contingent upon the class of business.
With the expansion of insurance and changing guidelines, for example, RERA, there is an intrinsic requirement for more up to date and more extensive coverage for cyber, liability, aviation, energy, unarmed vehicles and so on, and the consequent need of working by and large to create risk and evaluating models and upgrade underwriting principles, valuing and phrasing of policies. The cedants’ desires have likewise advanced and they currently search for capacity suppliers as well as for risk partners too.
The controller keeps on assuming a significant function to advance the market by further investigating administrative systems and works on identifying with reinsurance pools, Alternative Risk Transfer (ART) and such different components and stipulate valid suggestions apart from achieving worldwide prescribed procedures.
In the course of this pandemic, the reinsurance companies must look forward to developing their own strategies. They can raise more debt and equity to settle the dividend pay-out. Although it is impossible to immediately alter the volume of business re-insurers cam underwrite less business which would prove to be an edged strategy to sustain in the financial market. The reinsurance companies must uphold a status quo i.e., they must emphasise on the robustness of existing risk policies. Insurance and Re-insurance Companies have limited amount to retain. Risk pooling diminishes cost of the reinsurance companies due to diversification and consolidation of risks.
The modus operandi of reinsurance is fundamentally construed as a capital supplier to the insurance companies. However, a wider look depicts that the significance of reinsurance amplifies obtaining technology and expertise to write a risk. It begets innovation, novel ideas to alleviate the damages caused due to catastrophe events. Since the aspect of cyber liability has peered out from its nestled in India has comprehended to be a mind-boggling proposition, global reinsurance players maneuver the way.
Irrefutably, reinsurance companies act as a shock absorber of financial risk exposed to the insurance companies and whenever required operates as a crucial component in the wheel of this industry. The scope of crop insurance has elevated since the inception of PMFBY. The premium under this scheme has surged as it intends to insure more than 50% of Indian farmers in 2019-20. Crop Insurance along with re-insurance postulates to be a backbone for mitigating crop risks, poverty and aggregating food security, safeguarding credit, farmers’ income with stabilizing fiscal volatility of the Indian Government.
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