Many countries are reluctant to allow premiums to flow out of their borders, but lobbyists argue that compulsory cessions are a barrier to free trade. And even local reinsurers are beginning to see the benefits of a liberalised market

The world of compulsory reinsurance cessions is a controversial one. Many countries, especially in the developing continents of Asia and Africa, see these as a way to keep money in the country and take a dim view to reinsurance premiums flowing out of their borders to foreign reinsurers. Therefore, a number of these countries have traditionally insisted that a fixed percentage of all reinsurance payments go to a domestic or state-run reinsurer.

But as markets open up and lobbyists including Lloyd’s get their way, this is all changing. Already a number of major markets have been deregulated – China in 2005, for example. And this opens the door for foreign reinsurers to pile in, although in practice it is often a while before the state-backed reinsurer’s monopoly fades.

Although compulsory cession countries individually represent a small part of the global reinsurance market, together they are a significant chunk of world premium, especially the markets in Asia. Asia cedes about $14bn and much of the region has compulsory or preferential cessions to domestic reinsurers. Africa is dominated by compulsory cession arrangements and cedes about $5bn a year in reinsurance.

Good to share

The CEA (the European Federation of Insurers and Reinsurers), the International Underwriting Association (IUA) and Lloyd’s have all been campaigning for the dissolution of compulsory reinsurance payments in various domiciles, stressing that the removal of compulsory reinsurance cessions to local reinsurers would mean fewer barriers to free trade.

A London-based spokesman for the IUA says: “Any further reduction in the need for compulsory cessions would be welcomed. especially if it means opportunities for our members who have no form of establishment in the country.”

While the International Association of Insurance Supervisors (IAIS) does not officially oppose compulsory cession arrangements, a source said that the organisation’s work would appear to promote a freer alternative.

“Clearly the IAIS in its work regarding supervisory recognition aims to promote the best possible risk framework of sharing risks internationally, with transparency and with mutual recognition on a regulatory basis.”

The IAIS spokesman added that the principle also extends to other protectionist measures such as high collateral requirements for foreign insurers. “If countries are saying they wish to protect their own turf, then this could be seen as not compatible with the concept of risk sharing.”

Free and easy

Meanwhile, that bastion of free markets, the World Trade Organisation (WTO), has had a hand too. The WTO has put insurance and reinsurance market liberalisation on the table with new or prospective members, sometimes even as a feature of accession negotiations.

However, while supporting it, the WTO does not actually insist on the removal of compulsory or preferential reinsurance arrangements in favour of a local reinsurer. Indeed, some WTO members still retain these arrangements.

More often, though, the WTO gets its way. Since China entered the WTO in 2001, it has removed the compulsory reinsurance payments to which China Re was entitled, and converted the company from a state-run organisation into a joint stock company.

Paradoxically, an end to compulsory cessions can prove beneficial for markets – even if they oppose it and initially regard it as an economic threat.

In Turkey, for example, the end of compulsory reinsurance cessions in 2006 was seen as a positive thing for Milli Re, which previously took 20% of reinsurance contracts. The Turkish reinsurer was able to be more selective over its reinsurance deals.

Standard & Poor’s said the company, which has enjoyed longstanding reinsurance relationships and an excellent reputation, was able to benefit from the liberalised market and focus its underwriting capability in a more strategic way.

A further advantage is that a liberalised reinsurance market, when coupled with WTO membership, also enables the former beneficiary of compulsory reinsurance to compete overseas in other WTO member states.

Slow to change

But even if a government decides to abolish compulsory reinsurance cessions, progress can still be slow. China Re previously had a state monopoly, with 20% compulsory reinsurance providing 97% of the group’s income until the rule was abolished at the end of 2005.

Then, direct insurers were still obliged to reinsure with domestic insurers or reinsurers on a priority basis, with a minimum of 50% treaty and facultative cessions, but this was phased out in 2009. According to the Society of Actuaries, the liberalisation of the Chinese reinsurance market “is still in its initial stages”.

In Brazil, the new reinsurance legislation that came into effect in April 2008 stipulates a ‘preferential right’ rule, which gives local reinsurers a preferential right on 40% of ceded reinsurance. This was reduced from 60% in January 2010, but no further reduction from 40% is foreseen. Six locally registered reinsurers benefit from this arrangement: Munich Re, Mapfre Re, ACE Tempest Re, XL Re, JMalucelli Re and IRB Brasil Re.

A Lloyd’s spokesman says: “The ‘preferential right’ rule works like a right of first refusal, whereby the cedant has to offer 40% of their business to local reinsurers under certain terms and conditions, and the local reinsurers have to either match the terms and conditions to get the cession, or decline, which will then allow the cedant to place the risk with any other licensed reinsurer.”

It seems even in those markets where legislation has already been passed, there is a long way to go before there is truly free trade. Still, as one barrier after another falls, it’s very clear which way the world is turning. GR