Reassuring growth: Consolidation is expected to boost local reinsurance capacity

With limited local underwriting capacity, larger risks have traditionally been ceded offshore. The limited capacity of the four local reinsurers has stunted efforts to domesticate more risk, leading to volatile rates. Consolidating and developing reinsurance capacity will thus be crucial to future efforts to develop the industry, while higher profits are spurring underwriters to seek treaty reinsurance cover to boost their capacity.

LIMITED DOMESTICATION: The existing regulator, Bapepam-LK, has long sought to foster robust domestic reinsurers by enforcing legal cessions. Under the 1992 Insurance Law, underwriters are required to keep 10% of insured risk on their books and to cede an additional 10% to local reinsurance firms. The first reinsurer, Maskapai Reasuransi Indonesia (Marein), was established in 1953 and is now majority held by foreign banks including ABN AMRO, RBS Coutts and UBS. A second player emerged in 1987 when the Tugu Group, owned by state-owned Pertamina, the Finance Ministry and then-President Suharto’s son, established Tugu Reasuransi Indonesia (TuguRe), although it originally only covered Tugu’s in-house business. Following the enactment of the legal cession, the government established two reinsurers in a bid to expand local capacity. Reasuransi Nasional Indonesia (NasionalRe) was established as a subsidiary of state-owned SME credit insurer Askrindo in 1994, while Reasuransi Internasional Indonesia (ReIndo) followed in 1996.

INCREASING CAPACITY: Despite the multiplication of players and a rise in capital requirements to Rp100bn ($10m) by 2010, capacity has remained limited; by 2011 their combined capital reached roughly Rp500bn ($50m). Gross written premiums and net premiums have been growing apace for the reinsurers, rising 14% and 13% y-o-y respectively in 2010, although nominal sums remain relatively small at Rp2.4trn ($240m) and Rp1.9trn ($190m), according to insurance credit rating agency AM Best, which estimates that a mere 14% of total reinsurance risk was domesticated that year. Roughly 90% of the four reinsurer’s premium stems from non-life, with the balance from life cessions. Local players cover smaller, mostly retail, risks as well as corporate lines like marine, motor and liability cover, the most profitable in the past five years.

According to NasionalRe’s estimates, total local reinsurance capacity reached roughly Rp850bn ($85m) in 2011. The two fully state-owned reinsurers, ReIndo and NasionalRe, accounted for the lion’s share of premiums in 2010, with 46% and 26% respectively, while the state-linked firm covered 20% leaving a mere 7% of domesticated risk to the private reinsurer.

OFFSHORE CESSION: Limited local capacity has certainly played a role in prompting capital flight offshore. “The opportunity for growth in the local reinsurance industry is substantial: local insurers would prefer to deal with local players but the capacity is not there,” Moro Budhi, the president director of TuguRe, told OBG. While all underwriters have ceded 10% of risk to one of the local four, their limited capacity has forced them to retrocede much of this risk to offshore markets. Foreign-linked joint venture companies, which account for roughly 70% of premium in life and 30% of premium in non-life, have tended to cede a maximum of risk through their mother companies. Meanwhile, larger policies in the aviation, mining and hydrocarbons sectors are handled by the four foreign reinsurance brokers on the market: Marsh, Aon Benfield, Jardine Lloyd Thompson and WillisRe. Local reinsurance broker IBS also intermediates with offshore reinsurers.

A reinsurance centre for the region, Singapore captures much of this ceded risk both through local players, like Asia Capital Re (ACR), and through branches of leading global reinsurers including a growing number of Lloyd’s syndicates. “Indonesia reinsures the majority of its’ risk through Singapore, primarily through Munich Re, Swiss Re and Lloyds,” Shaifie Zein, the president director of NasionalRe, told OBG.

TuguRe has estimated that around 80% of risk ceded offshore is reinsured through Singapore, which handled some $3.25bn in gross reinsured premiums in 2011 according to Lloyd’s. Global reinsurers have increasingly recruited Indonesians to handle the archipelago’s business, while reinsurance brokers expect growing competition from ASEAN-based brokers as Indonesian premiums continue to grow.

RATE VOLATILITY: This dependence on offshore cover has exposed underwriters to the volatilities of international pricing. Located on the tectonic “Ring of Fire” and exposed to numerous natural risks, from flooding to tsunamis, earthquakes, volcanoes and forest fires, the archipelago is in AM Best’s higher-risk category. The World Bank estimated in 2011 that some 90m Indonesians, or 40% of the population, reside in areas at risk for recurrent natural disasters.

Yet low penetration rates for both life and non-life insurance mean potential losses are limited for the time being. Indeed, a mere 1.5% of the $4.5bn in damages caused by the 2004 tsunami in Aceh were insured, while 6% of the impact of the 2007 tsunami in Bengkulu were covered, according to ratings agency Fitch.

International rates for Asia as a whole have hardened noticeably in 2012 following high losses for global reinsurers caused by near-unprecedented series of natural disasters including Japanese and New Zealand tsunamis and Australian and Thai floods in 2011. WillisRe estimates that Indonesian property rates in particular had risen by between 5% and 15% during the January 2012 treaty renewal period. Despite a paucity of catastrophe modelling tools for Asia-Pacific from the reinsurance industry, Marsh expects foreign players to increasingly protect themselves against unpredictable events through stiffer rates in coming years.

TREATY SIGNING: While facultative cessions are concluded on a case-by-case basis, with the associated rate volatility and the longer claims processing times, reinsurance treaties cover a portion of the underwriter’s whole portfolio and are rolled over on an annual basis. An underwriter’s reinsurance treaty capacity is included in calculations of its total underwriting capacity. Wider-ranging treaties also entail lower average reinsurance rates, given that facultative covers are negotiated on an ad-hoc basis. With 72.5% of the industry’s reinsurance cessions concluded on a facultative basis in 2011 according to TuguRe, there is scope for expansion in the number of treaties in force. As larger underwriters have continued to record strong premium growth, the trend has been to move from facultative reinsurance covers towards treaties. Insurers have an incentive to conclude such treaties during times of healthy operating performance in order to improve their terms of trade. The trend is for underwriters to look for treaties, which is logical: as they become more profitable they seek to retain more of the risk underwritten, according to Askrindo.

BUILDING IT UP: Over the longer term, however, Indonesia will need to drastically expand its domestic reinsurance capacity to keep pace with its rapid and resilient economic growth. A number of ideas have been floated to expand domestic capacity and insulate the sector from excessive rate volatility.

The regulator is incrementally raising capital requirements for reinsurers to Rp150bn ($15m) by end-2012 and Rp200bn ($20m) by 2014. While a combined capital base of Rp800bn ($80m) would be an improvement, this would cover less than three months’ operating capital for the country’s largest mine, Papua’s Grasberg development operated by Freeport-McMoRan. With only one of the four reinsurers publicly listed (Marein, since 1997), TuguRe is entertaining plans to go public by 2015 to expand its capacity.

A more drastic restructuring of the industry is also possible. Despite longstanding plans to merge the three state-linked reinsurers, the new regulator – Otoritas Jasa Keuangan – has announced its intention to implement this long-delayed initiative. Yet such moves spark opposition from the state-owned reinsurers, who argue they should be allowed to expand their capacity organically. “The government is discussing mergers amongst public reinsurance companies but this will only increase the capital and not overall capacity,” said Zein.

Although reinsurance is by nature an international business, local players’ limited capacity means they have only been able to capture domestic risk, if that. On the contrary, Indonesia’s insurance sector has historically been plagued by strong capital flight. As the reinsurance market continues to grow on the back of large-scale infrastructure projects, a better pricing structure for natural catastrophes, as well as sustained growth in non-life, and significant capacity expansion is required to domesticate a larger share of the risk and create a sizeable pool of investable institutional funds.