Reinsurance: Ensures the “insured”!

Introduction

Reinsurance is a risk management involving transfer of risk from insurer to the reinsurer. Here, the reinsurer takes upon itself a part of the risk exposure to ensure that no single company is overburdened with the financial responsibility of offering coverage to its policyholders.¹ Essentially, it is insurance for insurers made by ceding a part of the premium by the original insurer to the reinsurance for sharing the risk.² Despite numerous events exemplifying the ever increasing burden and associated risk on the insurance sector in India and continuous efforts are being made by the Insurance Regulatory and Development Authority (“IRDA”), reinsurance sector continues to be largely nascent and mostly unregulated. There is a pressing need for the government and regulators to bring out the needed reforms in the reinsurance sector.

The statutory and legal framework currently governing insurers³ and/or reinsurers includes the Insurance Act, 1938 (“Act”), the IRDA Act, 1999, the Marine Insurance Act, 1963 and the regulations, rules, guidelines and circulars issued by the IRDA and the Indian Accounting Standard 104-Insurance Contracts. This bulletin sets out the significance, nature, functions and the current landscape of reinsurance sector in India.

1.0 Reinsurance: the meaning and role

Reinsurance plays a crucial role in the risk management of primary insurers by redistributing the risk of loss. This facility provides additional underwriting capacity, stability, protection, and loss prevention to the primary insurers. It may give off a share of cession which has been ceded to it and if it does so, the transaction is called retrocession⁴ and the reinsurance so accepting the share in the cession is called retrocession. It even allows the primary insurer to outsource its certain functions that are outside its core business. Without it, most primary insurers would be able to cover only the safest of ventures, leaving many risky but important ventures without coverage. Despite the importance of the aspect in the stability of the economy, the proper definition of the concept “re-insurance” has not been provided under any legislation. However, Section 101A of the Act does provide that “Indian re-insurer” is an Indian insurance company which has been granted a certificate of registration by the IRDA to carry on exclusive reinsurance business in India.⁵

2.0       Basic guiding principles of reinsurance contracts

The insurance policy is also a contract of insurance governed by the same doctrines, namely insurable interest, utmost good faith, indemnity subrogation, material fact disclosure which governs other insurance contracts.

The principle that insurance is a contract founded on good faith or Uberrima Fide is of vintage value.⁶ The duty of good faith is of a “continuing nature”⁷ and has to be performed by the parties to the reinsurance contract. In London General Insurance Company v. General Marine Underwriters Association,⁸ the contract of reinsurance was allowed to be avoided by the reinsurer as the cedant was aware that the reinsured cargo was damaged by the fire but failed to disclose it to the reinsurer.

In New India Assurance Co. Ltd. v. B.N. Sainani,⁹ the hon‟ble Supreme Court stated that insurable interest in a property would be such an interest as shall make the loss of the property to cause pecuniary damage to the assured, this principle squarely applies providing that, if the cedant does not have an insurable interest in the „to be reinsured policy,‟ then there cannot exist a valid reinsurance scheme. The meaning of insurable interest was extensively dealt in Contship Container Lines Ltd. v. D.K. Lall and Ors.,¹⁰ where in the subject- matter of dispute was marine insurance. The matter concerned with the insurance industry denying its obligation against the claim regarding „non-delivery‟ of consignment. Section 7 of the Marine Insurance Act defines it in the line that very person has an insurable interest who is interested in a marine adventure. Further, Halsbury Law definition throws light in the nature that an interest would be insurable if the peril would by its proximate effect cause damage to the assured. Celebrated matter of Lucena v. Craufurd¹¹ was relied upon to explicate, whereby “insurable interest” is circumscribed around “to have benefit from its existence, prejudice from its destruction.”

Contracts of insurance are generally in the nature of contracts of indemnity.¹² Even the reinsurance contracts are contracts of indemnity, even if the original policy may not be one of indemnity such as life or personal accident policy or sickness or contracts of contingency insurance.¹³ The reinsurer is entitled to be subrogated¹⁴ to all the rights of the

insurer in respect of the subject-matter of insurance. The reinsurer is liable in respect of claims for which the reinsurer is liable under law and for which the reinsurer is liable under the reinsurance policy. Thus, the reinsurer is not liable where the insurer has made ex-gratia payment to his insured.¹⁵ If the claimant-policy seeker is an individual or even a group of individuals, an insurance company¹⁶ will find it relatively easy to cover the claims. But if there are a huge number of claims at the same time and the loss is massive and wide-spread, this may not be possible. It is in this context that reinsurance plays an important part in determining the success of the insurance business. It is important to emphasize that placement of reinsurance is entirely within the purview of the insurer and neither the direct broker nor the client can direct the insurer where to place reinsurance and how much to reinsure.¹⁷ But in special situations, the reinsurance contract can have a provision called the cut through clause that allows the insured to have a direct legal claim to the reinsurer; for example in case the insurer becomes insolvent.

3.0       Current Landscape – Changing Contours!

In terms of Section 101A¹⁸ (Part IV-A) of the Act, every insurer dealing in insurance business is required to re-insure a specified percentage of sum assured with another insurance company which IRDA determines.¹⁹ IRDA may constitute an advisory committee and examine and call upon the insurer dealing in reinsurance business for investigation. Importance of reinsurance has been appreciated in India since 1956 but it was only on November 3, 2000 that General Insurance Corporation of India was approved as „Indian Reinsurer.‟

Reinsurance facilitates the insurance companies in diversifying their portfolio with same working capital and enhances the capacity. Insurance companies are often offered risks that may surpass their financial strength. Thus, reinsuring part of the risk opens another door to accept the full risk thus satisfying client‟s needs and stabilizing not deferring the profitability. Further, it‟s the financial strength that determines the viability of an insurance company. Reinsurers being professionally better equipped than insurers in catastrophic risks, which have a higher degree of loss in one occurrence. Due to this risk tackling capacity, reinsurers price and underwrite properly the exposure and accept those risks.

Some real life instances setting examples to pursue for advancement and development of the reinsurance sector are: the Mumbai floods in 2005; the 26th November 2008 Mumbai terror attack, wherein GIC had released the first payment of Rs. 25crores in less than 24 hours of receiving the claim.²⁰ The Insurance Laws (Amendment) Bill, 2008passed by Rajya Sabha awaits its approval by the Standing Committee on Finance till date. It seeks to increase the FDI limit in the insurance sector from 26% to 49%. The government may also relax the norms related to mandatory listing of all insurance companies within 10 years of their operations as the clause is being termed as impractical.

Conclusion

Reinsurance, in common parlance is, therefore, understood to be a practice where an original insurer, for a definite premium, contracts to form a „reinsurance contract‟²¹ with another insurer to carry a part or the whole of a risk assumed by the original insurer. However, the higher degree of flexibility served by reinsurance is sometimes abused to expropriate the market. Thus, cautious insurers, aware of the evasive methods adopted for designing tax avoidance, money laundry and other prohibited activities, can employ due diligence and ensure safe encounters in this highly affecting socio-economic venture. Further, depending upon the purpose and degree of security required, virtually every primary insurer utilizes reinsurance to allow flexibility in what it does for its policyholders. However, a reinsurance policy not providing any risk transfer is questionable. Virtually, reinsurance ensures well-functioning of insurance industry by risk-taking, managing, spreading and benefitting from those risks taken. However, since recent financial crisis has focused attention on the financial strength of insurers and reinsurers, it is incumbent upon the authorities to have proper check and balance to foster reinsurance sector in India.

This bulletin is prepared by Chanchal Agrawal (under the supervision of Neeraj Dubey, Sr. Associate), a fourth year law students at Hidayatullah National Law University, Raipur who pursued her internship at PSA.

1 Donald A. McIsaac and David F. Babbel, The World Bank Premier on Reinsurance, The World Bank Financial Sector Development Department, Policy Research Working Paper, 1995 available at http://www- wds.worldbank.org/external.pdf as retrieved on July 14, 2011
2 Bharat General Reinsurance Ltd. v. Commissioner of Income Tax, [2002] 256 ITR 587 (Delhi)
3 Section 2(9) of the Act
4 Regulation 2(g), (General Insurance – Reinsurance) Regulations, 2000
5 Section 101A(8)(ii) of the Act

6 In Carter v. Boehm, (1766) 3 Burr 1905, one of the earliest cases Lord Mansfield stated that “Good Faith forbids either party, by concealing what he privately knows, to draw the other into a bargain from his ignorance of the fact, and his believing the contrary”
7 The United India Insurance Co. Ltd. v. M.K.J. Corporation with M.K.J. Corporation v. The United India Insurance Co. Ltd.,
AIR 1997 SC 408
8 (1921) 1 KB 104
9 AIR 1997 SC 2938
10 AIR 2010 SC 1704
11 (1806) 2 Bos & PNR 269
12 United India Insurance Company Ltd. v. Kantika Colour Lab. and Ors., 2010 (5) SCALE 381
13 Ibid
14 Economic Transport Organization v. Charan Spinning Mills (P) Ltd. and Anr., (2010) 4 SCC 114: Landmark decision by a five judge bench provided that “Subrogation is the substitution of one person for another. The doctrine of subrogation confers upon the insurer the right to receive the benefit of such rights and remedies as the assured have against third parties in regard to the loss to the extent that the insurer has indemnified the loss and made it good”