Collateralized Reinsurance In India: Draft Guidelines – Reinsurance

Introduction

The Indian insurance sector has seen significant changes in
recent years, driven by a number of varied regulatory reforms aimed
at enhancing business ease as well as increasing insurance
penetration in India. The Indian insurance sector has also
witnessed a steady growth in recent years, with Indian Insurance
Companies underwriting more risks every year¹. To manage
these underwritten risks, Insurance Companies typically cede a
portion of the risk to reinsurers, which include the Indian
Reinsurer (ie, GIC Re), branches of foreign reinsurers
(“FRBs“), International Financial
Service Centre Insurance Offices
(“IIOs”) as well as overseas reinsurers
registered with the IRDAI as Cross Border Reinsurers
(“CBRs“).

It is relevant to note that the IRDAI’s “Report of
the Reinsurance Expert Committee 2017” of 14 November
2017 (“Report“) observed that cross
border reinsurance (ie, placing reinsurance business with CBRs) is
the most common category of reinsurance in India and the
IRDAI’s regulatory oversight over CBRs is limited. The Report
discussed that similar to any other mechanism for risk transfer and
management, reinsurance is not without its own risks, namely,
counterparty credit risk ie, the risk of reinsurers defaulting on
their obligations under a reinsurance transaction. With regard to
this potential counterparty credit risk in relation to CBRs, the
Report recommended that while the IRDAI should continue to
prescribe minimum eligibility criteria and security rating for
reinsurance placements with CBRs, the IRDAI may require Insurance
Companies to have appropriate safeguards such as collaterals in
respect of any reinsurance with CBRs. However, draft guidance on
the requirement of obtaining collaterals for reinsurance placements
with CBRs did not follow immediately after the issuance of the
Report.

Subsequently, the IRDAI notified the IRDAI (Reinsurance)
Regulations 2018 (“Reinsurance
Regulations“) on 30 November 2018, which expressly
empowered the IRDAI to issue guidelines, inter alia, on
collaterals. Further, the IRDAI recently amended the Reinsurance
Regulations on 28 August 2023, specifying norms related to
reinsurance placement with the CBRs. The amended Reinsurance
Regulations stipulate that IRDAI’s prior approval is required
for any reinsurance placements with any international pool/risk
sharingarrangement involving CBRs (as members, participants, or
administrators), and the IRDAI may review the business
underwritten, claims experience and lines of support given by a CBR
and impose additional conditions on placing reinsurance with
them.

In addition, the IRDAI issued an exposure draft on
“Guidelines on Collateralized reinsurance transactions for
placement of reinsurance business with CBR” on 20
February 2024 (“Draft
Guidelines”)² and invited comments from
all concerned stakeholders. The Draft Guidelines propose that all
Insurers placing reinsurance business with CBRs would be required
to collect collateral for such reinsurance placement. These
guidelines are proposed to be made applicable to all reinsurance
programs in India from the financial year 2025-26
onwards³.

Key Points

The salient points under the Draft Guidelines are as
follows:

• The Draft Guidelines propose that all Cedants placing
  reinsurance business with CBRs should collect collaterals for such
  reinsurance placement. These collaterals can be either an
  irrevocable Letter of Credit (“LoC“)
  from the respective CBR or a withholding of the premium or funds by
  the Cedant from the respective CBR⁴.

• In the case of an LoC, the Draft Guidelines stipulate the
  following norms:

• The LoC should be obtained either through an International
  Financial Services Centre Banking Unit in GIFT City (SEZ in India)
  or a scheduled commercial bank regulated by the Reserve Bank of
  India.

• The LoC can be in any currency as chosen/preferred by the
  Cedant (ie, either in Indian Rupees or any freely convertible
  foreign currency)⁵.

• The Draft Guidelines specify the minimum amount of LoC. This
  amount should cover 80% to 100% of sum total of Cedant’s
  outstanding claims, liabilities and the IBNR (incurred but not
  reported) reserves, depending upon the rating of the concerned
  CBR⁶.

• In case of the Cedant withholding premium/funds, the Draft
  Guidelines stipulate the following norms:

• The Cedant should withhold a minimum of 50% of the premiums
  ceded by the Cedant to the CBR⁷.

• The premium/funds withheld by a Cedant from each CBR should be
  identified, accounted for, kept, and invested separately from the
  Cedant’s funds⁸.

• Any investment income on the same should be credited to the
  withheld funds of the concerned CBR⁹.

• The Draft Guidelines state that a Cedant is required to release
  the corresponding collateral only if all liabilities of the
  concerned CBR under such reinsurance contract are fully
  extinguished. If the Cedant is satisfied that a part of the
  liabilities of the concerned CBR under a reinsurance contract is
  likely to continue, the Cedant may release collateral after
  adjusting for any amounts deemed necessary to cover potential
  claims concerning that reinsurance contract¹⁰.

• For the determination of the available solvency margin, the
  Draft Guidelines state that Cedants are not permitted to take
  credit for the collaterals held by them¹¹.

Concluding Remarks

The Draft Guidelines propose that Insurance Companies obtain
collaterals as a safeguard to address potential counterparty
default risks in cross border reinsurance. These requirements could
take the form of an irrevocable LoC covering 80% to 100% of
outstanding claims liabilities, or in premiums/funds withheld by
the ceding reinsurer, covering 50% of the premiums ceded.

The Draft Guidelines represent an effort towards
safeguarding the interests of the Indian insurance sector, by
focussing on stability and risk mitigation measures.While we
understand that Insurance Companies are generally receptive of the
Draft Guidelines, some overseas reinsurance entities view it as a
market access barrier and have requested that it be
re-considered¹². It remains to be seen whether the Draft
Guidelines, which are open for public consultation, will be
notified in the present form or whether any changes will be made
based on stakeholder comments received.

As the Draft Guidelines are presently open for public
consultation, it will be interesting to observe the feedback and
insights from stakeholders in the local and global insurance
industry. This may well shape the future of the Indian reinsurance
market to a significant extent.

Footnotes

1 The Indian life insurance sector has been growing at a
compound annual growth rate (CAGR) of more than 11% over the past
few years, ET Times, 10 April 2024, https://bfsi.economictimes.indiatimes.com/news/insurance/indian-life-insurance-industry-may-grow-11-13-over-five-years/109178102
(last accessed on 16 April 2024).

2 ¶1(c) of the Draft Guidelines.

3 ¶6 of the Draft Guidelines.

4 ¶4(a) of the Draft Guidelines.

5 ¶4(b) of the Draft Guidelines.

6 ¶4(b)(iii) of the Draft Guidelines.

7 ¶4(c)(iii) of the Draft Guidelines.

8 ¶4(c) of the Draft Guidelines.

9 ¶4(c) of the Draft Guidelines.

10 ¶5 of the Draft Guidelines.

11 ¶5(d) of the Draft Guidelines.

12 The Insurance Europe Reinsurance Advisory Board
(RAB) has provided comments on the Draft Guidelines, 5 March
2024, https://www.insuranceeurope.eu/publications/3077/rab-response-to-irdai-exposure-draft-guidelines-on-collateralized-reinsurance-transactions-for-placement-of-reinsurance-business-with-cross-border-reinsurers/
(last accessed on 16 April 2024).

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.