RGA Template

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Financial Reinsurance ____________________________
__________________________________________________
__________________________________________________
__________________________________________________
__________________________________________________
________________________________ Srinivasa Rao
FIAI, FIA Head of Corporate Actuarial
Services RGA Services India Pvt. Ltd. 27 August
2009 Mumbai
www.rgare.com
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Overview

• Financial Reinsurance why it is always a topic
• Capital Substitution via Reinsurance
• Original terms reinsurance Deficit account
  financing
• Introducing Financial Reinsurance in India
• New Issues Due to Financial Reinsurance
• Solutions to Some of those New Issues
• Conclusion

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What is Financial Reinsurance?

• Fin Re is a common label for reinsurance whose
  primary motivation is to act as a capital
  substitute and where risk transfer is a secondary
  driver.
• A Fin re is only a concept and not an
  identifiable subset
• B No country has found a good definition of fin
  re
• C Lets therefore not try to define it today

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Why is Fin Re a Constant Topic?

• This is a permanent topic globally, not just in
  India. The basic reason is that insurance
  company owners dont want to endlessly contribute
  new capital.
• A Insurers need capital to grow
• B Capital has become more scarce expensive
• C Owners therefore look for alternatives to own
  capital

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Legitimate Capital Substitute

• A prerequisite for any fin re discussion is
  acceptance that reinsurance can be a legitimate
  substitute for shareholders equity.
• A Details of implementation can be debated
• B Philosophical issues can be debated
• C Make issues explicit, dont reject the label

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Yes, Fin Re Transfers Risk

• Fin re transfers the level of risk implicitly
  covered by the existing reserve or capital
  requirements. If that risk materializes, the
  reinsurer pays.
• A Criticism of low risk transfer may arise,
  though
• B Fault is in existing requirements, not in
  fin re
• C Focus should be correct accounting

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There has been bad reinsurance

• Several high profile cases in last 10 years
• These were not fin re, they were simply bad
  contracts
• They had common characteristics
• Lack of disclosure to auditors regulators
• Non-Life reinsurance
• Incorrectly accounted
• Finite reinsurance with explicit reinsurance
  limits
• India can learn from these lessons

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Capital Substitution Effect

• A financial reinsurance contract reduces an
  insurers need for capital via one or more of
  these three routes.
• A Reduction in solvency margin requirement
• B Reduction in reserves
• C Payment of a lump sum consideration

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Insurers Needs for Capital

• Which of the sources of capital requirements
  could be managed down in order to improve ROC?
• A Infrastructure Investments
• B Commissions, Sales Expenses, Staff, Operations
• C Solvency Requirements

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Original Terms Reinsurance

• All elements of original insurance contract are
  shared
• Proportion of the risk is reinsured
• Reinsurance premium is in the same proportion of
  the office premium
• Reinsurer pays Reinsurance commission
• Meet the initial commission
• Meet the initial expenses

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Original Terms Reinsurance

• Reinsurer pays share of commissions
• Possibly even higher than proportionate
• Insurer needs less own capital
• Reinsurer also bears lapse risk
• This could be a major risk borne be insurer

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Deficit account financing

• Reinsurer provides cash advance to finance New
  Business
• Cash advanced reflects the PV of surplus expected
  to emerge from the reinsured block
• Capital portion and Interest (agreed at outset
  could be variable) are first charge on the
  emerging surplus
• Deficit account is created by the insurer
• Cash Advanced is debited
• Reinsurance premium is credited

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Deficit Account Financing

• Cash Advanced by reinsurer increases the assets
• Since the repayment is contingent on surplus
  emerging- not provided for in the liability
• Regulatory capital increased by amount of cash
  advanced

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Deficit Account Financing

• Once the deficit account becomes zero the insurer
  becomes the owner for future profits
• Should the cash advance be not repaid by the
  reinsurance premiums, the reinsurer makes a loss

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Deficit Account Financing

• Risks shared by Reinsurer
• Mortality
• Lapsation
• Interest (if the interest charge is variable)

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How to introduce Fin Re

• Not explicitly prohibited by that name
• Administrative circular from IRDA states
• ..The terms, if coinsurance should be resorted
  to
• treaties involving Financial Reinsurance have
  to be carefully managed..

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How to Introduce Fin Re in India

• Allow/promote original terms reinsurance
• Allow/promote below retention reinsurance
• Other more detailed regulation changes

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Below Retention Reinsurance

• Most business is within risk retention
• Most capital is for retained business
• Reinsuring this business for capital fin re
• Not distinct from original terms
• Just much larger scope for capital impact

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Some suggested changes

• The existing reinsurance requirements state that
  an insurer should retain as much premium as
  possible. This may need to be revised / removed
• "...reinsurance arrangement with an element of
  borrowing in the form of deposit or credit of any
  kind from insurers reinsurers without the prior
  approval of the Authority shall not be treated as
  credit for reinsurance for the purpose of
  determination of required solvency margin. We
  believe this could be removed because this
  prohibits legitimate fin re.

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Some suggested changes

• The current regulations read that "Reinsurers
  balances outstanding for more than three months"
  should be valued at zero. This would unnecessarily
  exclude the proper use of Financial reinsurance.
   
• The current regulation could be re-expressed as
  follows "Cash payments overdue from Reinsurers
  which are not received within three months after
  their original due date" should be valued at
  zero. This change will ensure that balances which
  are properly owed but not settled for longer
  periods of time are appropriately treated.

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New Issues with Fin Re / OT

• Allowing Indian insurers to cede more risks and
  to reduce their capital more will introduces some
  new issues
• A Security, protection, soundness
• B Cost
• C Maintaining Indian Ownership

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Reinsurance Security Options

• Minimum rating
• Acceptable home jurisdiction/regulator
• Minimum absolute capital amount
• Require local Indian registration
• Require some collateral

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Reinsurance capital has a cost

• Capital via reinsurance does have a cost
• But it might cost less than equity owners want as
  their reward
• This helps either or both of Indian shareholder
  or Indian policyholder

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Maintaining Indian Ownership

• Does this contravene 74/26 rule?
• What is ownership?
• Control
• Residual Upside Beneficiary
• Cost of reinsurance is capped and downside is
  large

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Conclusion

• Alternative capital is more wanted than ever
• Reinsurance can be an alternative
• Implementation has challenges, but worth it
• IRDA is supportive of larger reinsurance role

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• Thanks for your attention