Financial reinsurance may become a new mechanism for insurance companies to raise capital. A survey by independent consulting firm Milliman showed that 35 percent of life insurers are looking to enter financial reinsurance arrangements.
The insurance regulator is open to allowing life insurers to enter into such arrangements with reinsurance companies.
Under the arrangement, a reinsurer will provide capital in the form of reinsurance commission to an insurance company and as the insurer writes business, it will repay this as reinsurance payouts to the reinsurer.
Sources said one proposal has been sent to the regulator while four others are under consideration. This process is to enable life insurers to tap other forms of raising capital.
"This will be only used selectively because approvals will be tough to get. Global reinsurers may also set tough payment conditions and demand a higher premium for providing capital. Largely, mid-size and small insurers may explore this," said the chief financial officer of a private life insurer.
All such capital raising is subject to approval to regulatory approvals. Detailed guidelines may also be brought out to this effect.
Milliman said in a report that financial reinsurance enabled with approvals to be granted by IRDAI could be on a case-by-case basis.
“While no deals have been announced as yet, we are already seeing active interest from insurers in this area,” said the report.
Globally, financial reinsurance is a popular mechanism to raise capital for insurance companies. Here, the reinsurer takes the risk on its book and gets paid reinsurance premium. However, there is also a sunset clause in these agreements that would force a write-off in 10-15 years, if the capital is not repaid.
For instance, if a reinsurer (R) enters into an agreement with an insurer (I) for 15 years, then the idea is that I will have to repay R within those 15 years. If I does not make any profits during the entire 15 years, R will be required to write it off after that period. This means that R makes a loss on the provided capital.
The capital has to be given upfront and it is likely that Indian insurers would rely on foreign reinsurers for this requirement. Considering the type of risk that is involved, only global reinsurers would have the appetite to agree to be part of such deals.
The profitability clause is typically for one set business which is in need of capital. For instance, if a life insurer wants to write more non-participating business (products where you don’t get bonuses), the financial reinsurance agreement will specifically mention this fact. Only if the non-par business makes a profit do they need to pay reinsurance premium.
However, since this is a new capital raising instrument in India, the initial uptake could be low. The Milliman survey showed that respondents said they preferred shareholder capital injection over other instruments like subordinated debt and financial reinsurance. A total of 17 of 24 life insurers participated in the survey.
As per the insurance regulator, every insurer has to maintain solvency or minimum capital of 150 percent. This is roughly the amount of assets that has to be held versus the liabilities.