Irdai warns domestic insurers against 'shadow capital' from rogue brokers

India’s insurance regulator has put out a warning to domestic insurance companies, asking them to be vigilant against rogue brokers offering fraud reinsurance cover from overseas. The warning has become necessary as brokers are tapping into cash-strapped domestic insurers to provide them ‘shadow capital’ to expand their business. 

The Insurance Regulatory and Development Authority of India (Irdai) is so worried that it has asked all companies to discuss the topic in their boardrooms. It has described the situation as a breakdown of risk management, the very basis on which insurance companies run their business. 

Too many broker firms have popped up in the highly lucrative reinsurance space. The number of composite brokers exploded once India opened the reinsurance market to foreign firms in 2015. 

Irdai counts 65 such companies that are chasing a handful of global reinsurance companies present in India to solicit business from Indian insurers. As a result, many of them are cutting corners. The letter issued this month says: “There should be regular reviews of the systems involved and in reporting relevant matters to the risk management panel (of the board) for necessary monitoring”.

However, the letter does not mention the names of the insurer and the brokers who were involved in the deal that prompted the Irdai’s warning, though Business Standard has obtained some of the details. 

The warning comes after the regulator received several whistle-blower complaints in the past two months against more than one of the top insurance brokers. It is investigating the serious allegations, which include charges of pay-offs to companies to get business as well as overcharging of commissions. 

Unlike agents who operate on behalf of the insurance companies to gather business, brokers are independent entities. When a company or an individual approaches them to buy insurance, these brokers turn to the insurers to get quotes and finally buy policies by submitting completed applications on behalf of buyers. 

The reinsurance business where an insurance company farms out the risk it takes on to other companies, draws in the large brokers. The principle is the same, as the insurance company is the buyer and the reinsurance companies are the sellers. As there are only about 10 global reinsurance companies in India, well-placed domestic insurers prefer to transact with them without the intervention of brokers. The large reinsurance companies provide what is known as treaty reinsurance, namely, long-term contracts.

But matters have become muddied, as some of India’s general insurance companies are running short of capital. In the insurance business, to write more policies, one needs more capital. Therefore, these companies have turned to the brokers to get short-term arrangements to retain their market share.  

Some of these brokers have used their links with foreign reinsurers not present in India to offer what is known as facultative reinsurance support. So an Indian insurer with a purse of Rs 1,000 crore gets an additional Rs 500 crore for the short-term on the understanding that the premium earned from new business will be shared proportionately.  

The premium includes a plain vanilla cost and an acquisition or marketing cost. These brokers have connived with Indian insurers in not paying the insurance company abroad the full marketing cost. Instead, this is funnelled back as ‘payback’ to the brokers, through higher commissions. 

 Since the global giants mostly offer treaty reinsurance and not facultative business, the brokers go deeper into the world of smaller reinsurers, often from tax havens, to get this business. This is the phenomenon of shadow capital.  

In the case that the Irdai has come down on, the broker went one step further. It informed the Indian insurer that the risk had been reinsured abroad but did nothing of the sort. It stamped a forged receipt, which only came to light when there was a claim. The foreign reinsurer refused to cough up its share of the claim about which it had no clue.  

The regulator has said that for every reinsurance business deal negotiated through brokers, the Indian company must get it confirmed, in the same way that, if you get a cover note for motor insurance from an agent, you still have to ring the company to confirm its genuineness.   

“The genuineness of RI cover notes/signed RI slips submitted by brokers should be confirmed through a thorough check or examination of the documents and a confirmation from the reinsurers obtained of the actual receipt of premium from the brokers,” notes the Irdai letter.  

There is, however, no firm data on these cases. The global Risk Management Society only recognises cyberattacks and incidents of data fraud as the “top risks” for Corporate India owing to the country’s growing dependence on data and digitisation.