The Hindu Business Line : Hardening reinsurance rates hit mega risk covers of energy cos

Hardening of the reinsurance markets had made it difficult for placement of the recent energy mega risk covers acquired by the public sector insurers.

Bangalore , Oct. 7

MEGA risk covers taken by large corporates are faced with difficulties with the hardening of the reinsurance rates for the energy sector.

Sources said the major reason for the hardening in the reinsurance markets was the large claims suffered by the international reinsurance majors due to the hurricanes that struck the US and Mexico. Claims on account of these are estimated between $15 billion and $20 billion.

The sources said that hardening of the reinsurance markets had made it difficult for placement of the recent energy mega risk covers acquired by the public sector insurers. The sources added that resistance from international reinsurers meant that domestic insurers would have to absorb the risks directly on to their balance sheets.

Since absorbing the risk directly on one balance sheet weakens the solvency ratio, the public sector insurers resort to pooling of the risk among them. On the other hand, if the reinsurance were resorted to they would have to face a considerable reduction in the ceding commissions or even negative ceding commissions, the sources said.

Negative ceding commissions would imply that any increase in reinsurance premiums would have to be borne by the insurers themselves.

In fact, since the beginning of this year, most of the corporates had quietly opted out of the tariff-driven covers and opted for mega risk covers. The mega risk covers were chosen in view of the substantially lower premiums, as opposed to tariff-driven premiums that are administered by the Tariff Advisory Committee (TAC) of the Insurance Regulatory and Development Authority (IRDA).

However, sources said, that despite the hardening of the reinsurance rates, none of the corporates has the option of reverting back to the tariff-driven system. This is because corporates are permitted to opt out of the tariff-driven covers if the sum assured was in excess of Rs 1,500 crore. Among the corporates, which opted for mega risk covers, are Bharat Petroleum Corporation Ltd, Hindustan Petroleum Corporation Ltd, Indian Oil Corporation Ltd and National Thermal Power Corporation Ltd.

Most of the corporates, which opted for the mega risk covers, were entities where the sum assured was in excess of the floor limit prescribed. They had increased the ceiling by consolidating all their assets, including refineries in the case of oil companies. Power companies had combined all their plants and accordingly invited bids. This consolidation had helped power utilities to restrict insurance costs to 2.5 per cent of the operation and maintenance expenditure

Besides, most of them, the sources said, also valued the assets on a reinstatement basis as opposed to the market value basis. The difference, being that in the former, the insurance claim settlement is based on the replacement cost value of the asset.

In the latter, the claim settlement is based on the depreciated value. Traditionally, the reinstatement value is far more expensive. But corporates had opted for this method in view of the soft markets prevailing at the period.

Accordingly, the sources said reverting back to tariff-driven covers would imply a substantial scaling down of the asset values or parcelling the asset into smaller blocks.

For reversion to the tariff covers, the corporates would have to obtain the clearance of the regulator, the sources said.