Policy | The role of reinsurance companies in building resilience

The growing severity and frequency of disasters in recent times presents an important area for policy deliberations. The current state of affairs in developing nations, such as India, places significant pressure on public finances in the event of a disaster, which results in fiscal implications. With a limited tax base combined with high indebtedness, the nations that are vulnerable to perils cannot entirely recover through external aid. Insurance reduces this long-term loss by providing post-disaster liquidity.

In countries with high catastrophic exposure, the role of reinsurance companies is significant in terms of enhancing the capacity of the primary insurance market by providing an additional layer of risk absorption. If a substantial share of losses is covered by reinsurance, the impact on the primary insurer would be much lesser, thereby facilitating the insurance market to confidently operate and expand its business while maintaining solvency.

A report by the Organisation for Economic Co-operation and Development (OECD) based on the calculations of Swiss Re observed that even as volatility in the insured losses remained high, the volatility in the reinsurance pricing has been close to stable with only a mild price increase following a series of catastrophic events in 2011, 2012 and 2017.

The report indicates that there is an abundance of capital in the marketplace and that the capacity continues to exceed the demand keeping the price stable despite experiencing heightened losses in recent years. This shows that the presence of enhanced capacity places an enhanced trust in the system.

When we consider the market in the United States (US), North America alone underwrote 44 per cent of the global reinsurance market, estimated at $247.5 billion. The region sees a high penetration of foreign companies in the reinsurance market. Robust competition in the market has introduced innovative strategies in the form of alternative reinsurance capital, where the bulk of new capital comes from the financial markets namely hedge funds, pension funds, catastrophes bonds, etc. The increase in capital emerging from the new alternative arrangement transfigures to a decrease in the overall reinsurance rates, which in turn trickles down into other insurance lines. Some of these capital arrangements are offered tax advantages by the US.

The government can adopt innovative measures that can leverage the potential insurance industry can offer, if a sound ecosystem for insurance is created on the aforesaid lines. For instance, the State can buy insurance policies for societies that are vulnerable to natural disasters. A development worthy of mention is the practice seen in Africa where a single insurance agency (African Risk Capacity) partners with governments to improve their member-states’ capacity to recover and build resilience in affected regions.

With regards to the implementation, one may raise the concern of insurers facing difficulty in estimating the costs of the damage that translates into an unsound actuarial price, often insufficient to cover the operating costs and unexpected claims arising from a catastrophic event. However, with recent innovations in geospatial technology and predictive data analytics, it has been made possible to better assess a region’s vulnerability, predict disaster occurrences and estimate the loss incurred post-disaster and thereby amicably address any contentions that would otherwise emerge.

India’s Disaster Management System that constitutes the National Disaster Relief Fund (NDRF) and State Disaster Relief Fund (SDRF) provides immediate relief to disaster victims. However, a fundamental flaw in this provision is the lack of focus on the restoration and reconstruction of affected regions in the aftermath of a disaster. These expenses are met by the budgetary heads, which often makes the State financially unstable. India can consider a better investment of its disaster relief funds by buying policies from insurers for vulnerable regions and thereby reducing the accumulation of public debt.

Nevertheless, for this to be operational and successful, a sound regulatory environment is a prerequisite. A strong reinsurance market strengthens the insurance industry. Therefore, a concomitant effort from the government in terms of providing a favourable regulatory environment is necessary for enabling the insurance industry to thrive.

The regulation system of the American reinsurance market is characterised by an open, lenient and secure reinsurance market. The foreign reinsurer is subject to the same regulation as their US counterparts contrary to the case of India where foreign players were prohibited to enter the domestic market until recent times. With respect to India, the market is currently dominated by General Insurance Corporation of India (GIC Re). Easing of norms by the Insurance and Regulatory Authority of India will encourage more foreign players to enter the market. Not only the insurance companies will have multiple choices, but the resultant competition will also breed innovative capital arrangements suitable for India-specific needs.

It is time we adopt global best practices and leverage the contribution of the international reinsurance market. The outcome is a structural transformation of insurance and what it ultimately renders is faster recovery and reconstruction following a catastrophe.

Nissy Solomon is senior research associate, Centre for Comparative Studies of Centre for Public Policy Research (CPPR), Kochi. Views are personal.