The Insurance Regulatory and Development Authority of India (IRDAI) has recently released exposure draft of the guidelines on collateralized reinsurance transactions for placement of reinsurance business with cross border reinsurers (CBRs), (Proposed Guidelines). By way of the Proposed Guidelines, IRDAI proposes to introduce collaterals for reinsurance transactions with CBRs in the Indian insurance industry.
Reinsurance plays an important role in risk management as it is one of the key capital management tools available to the insurers / cedants and allows insurers to transfer a portion of their risk, thereby increasing the insurer’s capacity to underwrite more risk and innovate. In mature insurance markets, collateralised reinsurance transactions are a preferred tool to mitigate against counterparty default risk. Letters of credit (LC), withholding funds, trust arrangements, cash or other securities, third party sureties, etc. are different types of collaterals which are typically used to back reinsurance transactions.
The IRDAI is proposing the collateral as a percentage of outstanding claims and IBNR reserves. The percentage proposed is high ((i) irrevocable LC for 80% for a A- or above rated CBR and 100% for below A- rated CBR; or (ii) 50% of premiums ceded). IRDAI is also proposing that acceptable LC’s are those issued by any IFSC Banking Unit in GIFT-IFSC or a scheduled commercial bank regulated by the Reserve Bank of India.
The impacts of the Proposed Guidelines are:
- Indian cedants to have access to a larger pool of CBRs (currently CBRs must be rated A- and above).
- reduced recovery risks on Indian cedants.
- increased costs to CBRs doing Indian business, thereby negatively impacting pricing and available capacity.
- possibility of increased balance sheet risk on Indian cedants, if capacity is not available / reduced.
- greater opportunity for branch offices of foreign reinsurers in India (FRBs), reinsurers in IFSC-Gift City and GIC Re.
On balance, the proposal appears to be a nudge by the IRDAI to push CBRs to incorporate in India, bring reinsurance capacity within its regulatory oversight and retain reinsurance premiums in the country. CBRs having a long-term view on India are likely to do so. The likely beneficiary on the short term is likely to be FRBs and in the medium term the reinsurers in IFSC – Gift City.
For more information on the topic, please get in touch with Sakate Khaitan, Senior Partner at sakate.khaitan@khaitanlegal.com and Arushi Arora, Senior Associate at arushi.arora@khaitanlegal.com
AUTHORS: Sakate Khaitan (Senior Partner) | Arushi Arora (Senior Associate)