The average balance of payments in Indonesian reinsurance transactions over the past five years has been in a deficit of IDR5.65 trillion (USD455 million) per year. This has been a point of frustration for the Indonesian government. As such, the Indonesia Financial Services Authority (OJK) has instructed insurers to retain more risk and to reinsure more business with domestic reinsurers, including the recently-formed state reinsurer, Indonesia Re, to “improve and optimize capacity in the country.” The OJK has also encouraged all domestic reinsurers to obtain an international rating in order to improve competitiveness with foreign reinsurers. However, it is anticipated that high cessions to other unrated, domestic companies will increase credit risk charges and pressure capital adequacy ratios.
For treaty business, a minimum cession to domestic reinsurers is mandatory (25 percent of cessions or approximately USD15 million, whichever is higher). Further, the lead market should be a domestic reinsurer and at least two domestic reinsurers should participate on each treaty. One hundred percent cession to international reinsurers is only allowed if all domestic reinsurers and six domestic insurance companies all decline to participate. Some classes of business, including motor, personal accident, surety, credit and cargo must be 100 percent reinsured with local reinsurers.
These issues could potentially emerge in light of these new policies:
- Particularly in light of the current capitalization of domestic reinsurers, the local (re)insurance industry may become increasingly fragile as the level of retained catastrophe risk exposure builds. Indonesia is highly exposed to natural catastrophes, including earthquake and flood losses.
- Domestic reinsurers may not be able to provide lead terms due to lack of technical capabilities.
- Local reinsurers may have challenges in achieving an international rating due to weak capitalization.
- A reduction in knowledge transfer as international reinsurers’ participation in the local market is reduced.
Reinsurance rates have fallen dramatically in the first reinsurance renewals under these rules. While this is positive in the short term for reinsurance buyers, the result contradicts one of the regulator’s stated objectives to encourage market consolidation. Smaller reinsurers that may otherwise struggle to meet risk-based capital requirements may now draw upon devalued reinsurance as capital to temporarily remain in compliance. An eventual market correction, particularly in a shock loss scenario, could be disastrous for policyholders of smaller insurers.