By Olufemi A. Abass (PhD., AIIN., ACIB)
Insurance is a risk management mechanism that involves transfer of financial loss, contracting from the insured party and another party known as insurer.
The concept of insurance proposes that the redistribution is often done through law of large numbers and homogeneous exposure.
The concept of insurance is based on the principle of large numbers as proposed by Chevalier in 1654 and cited from Swiss Re (2013) “…an ideal laboratory for enlightened business ideas. It involves the process of collecting different types of institutional and personal information and using underwriting to transform it into quantifiable cost.
It creates a vital counterbalance to the new and potentially destabilizing forces that were transforming the division of labour, urbanization, and the economics of trade.”
These definitions differentiate the operations of insurance business from other financial intermediation. This may not be unconnected to the inverse cycle nature of insurance operations. Hence, insurance companies need to form an expectation of future risk before they can be accepted.
However, performance of these expectations among other functions in highly hinged in the risk financing techniques through reinsurance. Just like no modern economy can survive without a virile insurance mechanism, no insurance company can survive without a reinsurance arrangement.
Therefore, reinsurance plays a crucial role in the stability and growth of insurance markets worldwide.
In Nigeria, where the insurance sector faces unique challenges such as economic volatility, regulatory complexities, and an increasing frequency of climate-related risks, the utilisation of reinsurance becomes particularly salient.
Reinsurance is essentially insurance for insurers. It allows insurance companies to transfer portions of their risk portfolios to other insurers, known as reinsurers.
This practice helps primary insurers manage risk exposure, stabilize financial performance, and enhance their capacity to underwrite new business among others.
Interestingly, some researchers have observed the flipside of reinsurance utilisation.
This emerging perception is led by Chen, Hamwi and Hudson (2001) on a publication titled “The effects of ceded reinsurance on the solvency of primary insurer”
The authors hypothesized that reliance on reinsurance as a basic form of risk financing may affect insurance companies’ overall performance.
Their study was hinged on the fact that less solvent insurer tends to use more reinsurance because of its inability to raise needed capital in the financial market.
To buttress on their claim, their study involved Nine hundred and eighty (980) property and liability insurance companies in USA.
They further argued that a less solvent insurer uses more reinsurance protection which might be symptom of insolvency.
Subsequently publications by Lee and Lee (2012) in Taiwan, Iqbal and Rahman (2014) in Pakistan and Cole and Mc Cullogh (2006) in USA have also toed this same line of argument.
The crux of the argument focused on the fact that reinsurance, on a long run may be costly, lead to high transaction cost, reduction in profit and a sign of low retention.
The Nigeria Market experience
According to the financial report released by Nigerian Insurance Association (NIA), Insurance Digest) for a ten-year period of 2013 to 2022 shows the average percentage of reinsurance ceded by all non-life insurance companies in Nigeria as 35%, 56%, 92%, 85%, 70%, 53%, 70%, 70%, 67% and 60% respectively.
These are far higher than the African average of 26.54% and 6% of the world’s average. This might be a sign that a poor financial performing insurance company tends to seek more reinsurance protection because of the perceived difficulty to raise capital in the financial market.
On the other hand, the use of reinsurance might further increase insurer’s risk of being insolvent when its reinsurance contracts are not recovered or delayed.
Hence, over reliance on reinsurance arrangement by an insurer may be considered as a signal that it’s in trouble.
Is reinsurance a blessing or curse?
The question of whether reinsurance is a blessing or a curse for Nigerian insurance companies is nuanced. While reinsurance is a vital tool that enhances risk management, increases underwriting capacity, and provides financial stability. It allows companies to offer competitive products and respond effectively to large claims, particularly in a volatile economic environment. Conversely, challenges such as high costs, dependency risks, and limited local capacity can make reinsurance a burden.
For smaller insurers or those with less sophisticated risk management capabilities, reinsurance can lead to financial strain rather than relief.
Conclusion
Reinsurance in Nigeria presents both opportunities and challenges for insurance companies. While it serves as a critical tool for risk management and financial stability, the associated costs and complexities cannot be overlooked.
Ultimately, the effectiveness of reinsurance utilisation depends on how well Nigerian insurers balance the benefits against the challenges and adapt their strategies to meet the evolving landscape of risks, particularly those associated with climate change.
As the industry matures, fostering a robust local reinsurance market and improving risk management practices will be essential for maximizing the benefits of reinsurance.
Olufemi Abass is an Associate Professor and Former Head, Department of Insurance, Lagos State University (LASU)
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