Non-life insurance firms over-dependent on insurers abroad
KATHMANDU, Feb 26:
Invest Rs 100 million and earn a net profit of more than Rs 60 million in one year. Sounds like some of those shady Ponzi or pyramid schemes? It´s not! This business is called non-life insurance and it´s completely legal.
In the last fiscal year, 17 non-life insurance companies, established with a capital of Rs 100 million each, earned a net profit of Rs 565.9 million, with profit at National Insurance Company Limited standing at Rs 60.5 million, according to data provided by the Insurance Board.
The numbers churned out by insurance companies definitely sound attractive, but how sound are their business models and what exactly are these insurers doing to post high returns?
Non-life insurance companies generate a big portion of revenue by selling policies that cover losses of goods and properties against loss, theft, fire, earthquake and other accidents. Till the end of last fiscal year these firms generated income of Rs 7.17 billion by selling these policies. In return, they have insured goods and assets worth trillions of rupees. Yet the cash reserves of each of these companies do not hold more than Rs 200 million.
So how do these companies pay their clients when the cost of damages from, say, an airplane accident or fire in an industrial complex, exceeds the amount they have parked in their reserve?
To fill this gap, the insurance companies buy policies from reinsurance companies abroad, for which they pay billions of rupees every year. Records show insurance companies are spending up to 72 percent of the total premium amount collected to purchase these policies so that they can repay policyholders in the event of losses.
This means out of every Rs 1,000 paid by policyholders as premiums, over Rs 720 is going to reinsurance companies based in India, Malaysia and South Africa, among others. So, essentially, the non-life insurance companies are only collecting money here to send them aboard.
“The practice of insuring trillions of rupees worth of goods and assets with a few million rupees in the vault makes Nepali non-life insurers mere brokers of foreign reinsurance companies,” Binod Aryal, executive director of the Insurance Board, the insurance sector regulator, told Republica.
Insurance companies argue the practice of relying on reinsurance companies is not uncommon even in the international insurance market. This is a valid point. But insurance companies here do not realize that many insurance companies worldwide do not depend on backstop insurance as much as Nepali companies do.
For instance, in India, only 30 percent of the amount generated as premium goes to the reinsurance company. In the US, the rate stands at 28.29 percent, while in Japan only 0.16 percent of the premium amount collected goes into buying reinsurance policies.
Insurance companies say they have to rely on reinsurance companies because they do not have adequate capital to absorb shock in case policyholders suffer huge losses.
As per the insurance regulations, non-life insurance companies have to deposit in the reserve fund only 50 percent of the net premium amount collected. This means, after deducting the amount paid to reinsurance companies, 50 percent of whatever remains must be placed in the reserve fund. Simply put, a company that collects Rs 1,000 as premium and spends Rs 720 to purchase reinsurance policy must save at least Rs 140 of the remaining Rs 280.
This is too little and shows non-life insurance companies are operating with too little capital but a lot of leverage.
That´s why Dr Fatta Bahadur KC, chairman of the IB, issued a warning at a public forum on Thursday, citing that around 35 percent of insurance companies around the world fail because of weak capital base and reserves.
So what do these companies need to do to strengthen their capital base? One of the options is to retain profits. But companies in Nepal seem more interested in distributing profit in the form of bonuses to shareholders as well as staff “to keep them happy”.
Keeping this tendency in view, the IB, last September, instructed all non-life insurance companies to stop distributing cash dividends until they meet the new minimum capital requirement of Rs 250 million from Rs 100 million at present. It has also asked all non-life insurance companies to meet the new capital requirement target by mid-July 2013. But for companies that are dealing with trillions of rupees worth of goods and assets is this amount enough?
The IB says this is not enough and is planning to raise the capital base of these companies to Rs 1 billion. “But the new measure cannot be implemented unless amendment is made to the current law (a draft of which has already started gathering dust in the Cabinet),” Shekhar Kumar Aryal, acting director of the IB, told Republica.
If the paid-up capital is raised to that extent, there are hopes that many insurance companies may be able to retain more risks with themselves rather than depending upon reinsurance companies.
But there are also those who doubt this would happen as the benefits they get from reinsurance companies are too attractive to simply dump.
Records show that the country´s non-life insurance companies are getting up to 30 percent of the money they pay to reinsurance companies as commission. Since this amount does not have to be parked in the reserve fund, companies can enroll this amount as income in their balance sheets, which gives a boost to their revenue and ultimately net profit.
“So it cannot be ruled out that many companies will continue to rely on reinsurance companies as much as they do now even after boosting the capital base, as many are only focused on giving away dividends," said Khem Prasad Baral, advisor to Nepal Insurance Company, the country´s oldest insurance company.
Source: Republica
