September 07, 2016

An Introduction To Reinsurance

Win Myint Han ( F.N.I)

It is said ( maybe by reinsurers themselves ) that most of the reinsurers are born and only some made. Even though we are a little bit skeptical about that claim, we have to acknowledge that reinsurance is very, very important. It is so essential that many insurance scholars advocate that an insurer cannot last long unless protected by adequate reinsurances. If we want to find out how true and reasonable that statement  is, we have to trace the origin of why people buy insurance. In a shortest possible explanation we can say that an insured buys insurance in order not to lose his/her current financial position all of a sudden. That is why Principle of Indemnity stipulates that Indemnity is to restore the insured as much as possible into his/her financial position he/she was in just before the occurrence of loss or damage , after the loss or damage.
Likewise, the financial stability of an insurer can be seriously imperilled by unexpected frequency and severity of losses . As a rule each and every insurer knows that it is bound to pay claims but they are expected and estimated not to be frequent and severe. The opposite of that estimate in 2, 3 consecutive years could easily send an insurer packing. Moreover, a catastrophic event like Nargis, Sandy or Katrina would wreak havoc, causing unfathomable financial strain to the insurers affected even in a year. For instance the extraordinarily long and severe floods in Bangkok some years ago had caused the reinsurer concerned even to seek recapitalization.
That is why insurers protect themselves by establishing almost impregnable defense of reinsurance around them. Here we would not confuse the readers with technical complexities of reinsurance. Only its pros will be discussed as there are no cons.
By purchasing sufficient amount of reinsurance, an insurer enjoys the benefits as shown below:- (How to determine sufficient or not is a technical problem to be solved on the basis of experience, expertise and financial strength (net worth) of an insurer):—
1.     The very first good is peace of mind like that experienced by an insured just after purchasing an insurance. (being assured of recovering part of or full value of the subject matter of insurance lost or damaged even in a worst-case scenario).
2.     No excessive fluctuations of claims costs year to year (despite frequency and severity of losses)
3.     The ceding company’s capacity for underwriting is considerably enhanced to accept larger sums insured or a different class which it does not usually write.
4.     In countries where Solvency Margin is strictly maintained and enforced by the authorities ,   adjustment can be made by using reinsurance.
In short the technical role of reinsurance is to protect insurers from financial ruin or insolvency by producing greater stability in underwriting results. Dr F.L.Tuma had aptly expressed as follows :—–
The purpose of reinsurance is purely technical . It is a means which an Insurance Company uses to reduce, from the point of view of possible material losses, the perils which it has accepted. When a carriage fitted with a shock absorber passes over a rough street, the road becomes no smoother but the passenger will feel the jerks less as these are absorbed by the contrivance carried as a special addition to the vehicle. So it is with Reinsurance; it does not reduce losses but it makes it easier for insurance to carry the material consequences.
At present the newly – born private insurers in Myanmar have to rely on co-insurance only, reciprocally effected amongst themselves and Myanma Insurance as required by the Insurance Business Regulatory Board owing to a variety of reasons. The spreading of risk as far and wide as possible is the essence of insurance and reinsurance. But under the present co-insurance system with only 13 insurers at the most and in the same country (Myanmar) the spreading of risk is very much limited in sharp contrast to reinsurance which is international in character and spread across as many borders as possible. In the worst –case scenario like Nargis ,Sandy or Katrina catastrophe the very young and self-placed market like Myanma would surely collapse as all the risks were assumed by all the 13 insurers.    The Board knows pretty well that the Myanma insurance market is too young and too inexperienced to make use of reinsurance. In order to practice it the market must have 2 very important elements: Technical Expertise and Resources. As the private insurers cannot be expected to directly deal with foreign reinsurers, there must be a local specific reinsurer  who is technically competent to write both inward and outward reinsurances. The latter would be sold to all private insurers and some cessions are to be retroceded to the foreign reinsurers. It is learnt that in some of our neighboring countries all private insurance companies are required by law to compulsorily cede some percentage, say 5%, 10% of all their written business to the state-run reinsurer or insurer before ceding some of the remainder worldwide, if they resort to buying reinsurance.
The state-owned Myanma Insurance with its very long service in insurance business mostly as the one and only underwriter in Myanmar since 1953 is automatically qualified and would be assigned (I believe so) to play the role of the local specific reinsurer between the private insurers and foreign reinsurers, as there is no other insurer qualified enough to do so in Myanmar. Despite having monopolized unchallenged on all insurance business available in the country, the Myanma Insurance, itself a pure  cedent
(reinsurance buyer) was not experienced in the sale of reinsurance.
The purchase of a physical commodity in our daily life is not that difficult and different from the sale thereof and people are doing so now and again. But as far as reinsurance is concerned the purchase is very much different from the sale which is most difficult (at least for me).
In the case of purchase you as a buyer will be presented equal or different terms, conditions (forms, methods) and recommendations by some experienced international brokers. Out of those you may choose what you believe to be the best for you (no, no) your company, comparing and contrasting one proposition from another and one broker from another. For sale you as a reinsurer have to make terms, conditions (contract wording in English) and everything as shown above for the reinsurance which you are selling. If you accept proportional reinsurance only such as Quota Share or Surplus, as original premium rates are accepted as proposed, you need not fix the premium rates yourself, no problem. But if excess of loss is proposed by the cedent, you have to fix the premium rates which is the biggest problem. For insurance or reinsurance premium rating is the most difficult and needs the combined knowledge of actuarial science, past history of losses, particular nature of the subject –matter of insurance and geographical conditions concerned etc. (and mortality rates for life assurance). In Myanmar no one has ever done premium rating for excess of loss reinsurance, as outward  reinsurance has never been effected. Accordingly, we can for the time being safely jump to the conclusion that our market cannot have the necessary Technical Expertise. But the IBRB could cope with the situation by helping the insurers to learn the requisite basic knowledge just to be able to obtain necessary reinsurance protection .
In order to buy reinsurance a ceding company needs as Resources freely convertible currencies like US dollars, euros or pounds sterling etc. The private insurers would like to buy reinsurances in the same currency in which they write direct insurances ceded to the reinsurers i.e If the premiums for direct insurances are in kyats, they want the reinsurance premiums to be so. But the local reinsurer (Myanma Insurance) who would write cessions and retrocede some of them, would not like to accept the local currency because it has to pay reinsurance premiums in foreign exchange. Consequently, only 2 ways seem readily available to solve that problem one of which should be adopted:–
(1)     Even for the business written in kyats, reinsurance premiums are to be paid in foreign exchange by the direct insurers , when ceded, or
(2)     The Union Government has to subsidize the requisite amount of foreign exchange to the  local reinsurer to pay reinsurance premiums.
Whenever foreign reinsurers reimburse the  local reinsurer or direct  insurers (cedents) the claims paid, the payments will be in foreign exchange which the Government can recover.


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