The Insurance Regulatory and Development Authority of India (IRDA) has issued an advisory to non-life insurance companies asking them to carry out proper due diligence when they enter into reinsurance contracts through brokers. Mint tells you why.

What prompted IRDA to issue an advisory?

An insurance firm that employed the services of a broker to reinsure its business through overseas reinsurers recently realized that the broker hadn’t placed the business with the reinsurance companies, according to some insurers and brokers.

This prompted IRDA to issue an advisory asking non-life insurance firms to be vigilant while taking reinsurance cover from overseas. An IRDA official said the advisory was issued to ensure that insurance firms carry out proper due diligence when they contract reinsurance through an intermediary and that they vet and cross-check reinsurance contracts.

Why do insurers need reinsurance?

Just as people take insurance cover to ensure mishaps don’t cause a financial dent in their lives, insurance firms, though they are in the business of paying insurance claims, need to insure themselves to ensure that a catastrophic event doesn’t leave them bankrupt. As such, insurance firms reinsure themselves to ensure they are able to pay claims even in catastrophic events.

Being reinsured also means that insurance companies can insure newer or much larger risks. However, just as people employ the services of a broker to get insurance cover, insurance companies employ the services of an intermediary for reinsurance.

What are the rules regarding reinsurance?

Non-life insurance firms have to reinsure 5% of their portfolio with GIC. They do this by ceding 5% of their gross written premiums to the reinsurer, which then insures the risk in the same share.

Can insurers reinsure beyond 5%?

Insurers have to reinsure at least 5% of their business. This is called obligatory insurance. Voluntarily, they can exceed 5%. Some insurers say the tendency is to go beyond the obligatory limit, especially in the case of corporate fire and marine insurance due to the large size of the risk.

Insurers can also reinsure themselves through a reinsurance firm operating in India or abroad. About 10 overseas reinsurance firms operate in India. Insurance firms can also tap overseas reinsurance companies, though this is subject to limits.

Does reinsurance ease capital pressure?

It does to an extent. IRDA mandates insurers to maintain a minimum solvency margin—the margin of assets a company owns over its liabilities. It is thus a measure of how much premium the company underwrites.

If the firm cedes a greater portion of risk to the reinsurer, it is able to maintain IRDA’s requirement of minimum solvency ratio with less capital. Insurers are thus able to ease capital pressure while maintaining the solvency ratio. This is akin to financial reinsurance, a practice not encouraged by the regulator.