Why the GIC Re public issue could raise cost of insurance cover

The positive is that massive undercutting of premiums in health, motor biz ?could come to a stop

It is quite possible that the public issue of GIC Re will raise the cost of insurance cover in India.

This means insurance rates for health and accident cover the government is promoting so assiduously, for all Indians will be higher for state budgets. The positive is that the massive undercutting of premiums in health and motor business by insurance companies could now judder to a stop.

India’s national reinsurer has filed the draft red herring prospectus for a public issue with the capital markets regulator, Sebi on Monday. The management of the company led by its chief Alice Vaidyan are on road shows abroad to drum up interest for the expected Rs 10,000 crore issue (of course the share price for the sale has not been notified as yet). By all indications the issue could hit the market around Diwali, this year, India’s festival season.

In the Indian market for re-insurance, the sector regulator has made it mandatory for all insurance companies to give the first preference to GIC Re for their business. In the four tier preference order, drawn up by Insurance Regulatory Development Authority of India (Irdai), the next tier is made up of five (now six) top re-insurance companies of the world including Swiss Re, Scor SE, Munich Re and Lloyds. The next tier is Indian re-insurance companies followed finally by a large number of smaller balance sheet based ‘cross border re-insurers’.

For any insurance company, it makes sense to do a long term business with a re-insurance company, since this allows premiums to remain stable. For this they prefer to deal in what is known as proportional re-insurance business. So if a large fire insurance risk is re-insured, the insuring company has the safety of knowing that even if there is a fire in one year, the premium rates would not shoot up the next year. Proportional treaties keep the balance sheets of insurance companies solvent.

For the same reason, re-insurance companies are not keen on this business. It compresses their earnings. Indian general insurance companies have found that except for GIC Re the big players of second tier re-insurance biz prefer to do business in the non-proportional treaty way. In other words as risks vary they would prefer to recalibrate the premiums they demand from the insurers. It is for this reason that the nuclear risk pool has found no re-insurance cover among them. The risk runs only on the books of GIC Re.

So in business like health or crop insurance where the risks do vary enormously, as epidemics loom or monsoons change, the rates fluctuate yearly. The re-insurance companies with global footprint insist on what is known as Stop Loss system to cover such business. In other words, if the loss turns out to be catastrophic their liability is limited. In this environment the saviours for the Indian insurance companies have turned out to be the smaller in size but more numerous ‘cross border insurers’. For reasons of business they subscribe to the proportional treaties in sackfuls.

But whatever may be the reason for Irdai to come up with the four tier system, in either case the largest risk from low premium based re-insurance is carried by GIC Re. Proportional treat based reinsurance is about 40 per cent of the total re-insurance business in India and in almost each of the cases the role of leader is played by it. It sets the premium rates that others follow. The size of the re-insurance business is above Rs 2 lakh crore as on FY16. A paper prepared at the Institute of Actuaries of India estimates that within this pile, the private sector companies take out re-insurance more aggressively while public sector companies retain upto 30 per cent of the risks on their books.  

Why do the mammoth re-insurers do this cherry picking? Post the 2008 global financial meltdown the share holders of these companies would give them hell if their balance sheet gets hit by mega losses. So they are ultra careful side stepping the proportional treaty business. Once GIC Re walks the same route i.e. gets listed in the share markets, will it be able to offer the same sanctuary for the Indian insurers. Sure, it will pick up the business but only at a higher premium.  

The listing will end the indiscipline in the general insurance business where motor and health insurance business is offered at dirt low rates. Though motor is not offered for re-insurance since the ticket size is small, but it will be costly for an insurance company to cut premiums while also paying for costlier re-insurance in other business. So the signposts are clear. Insurance rates are bound to move Northwards from here.