Reinsurance renewal: retention on a refinery, catastrophe accumulation and the domestic order of preference
Sahyadri General Insurance is a twelve-year-old private insurer with gross written premium of ₹4,200 crore, of which fire is ₹1,050 crore, and a solvency ratio of 1.62. Its property reinsurance programme for the year beginning 1 April is up for renewal. The fire portfolio carries a total sum insured of ₹2.2 lakh crore; the largest single risk is a coastal Gujarat refinery with a probable maximum loss of ₹9,000 crore and a maximum foreseeable loss of ₹3,200 crore. The present structure is a nine-line surplus treaty plus per-risk catastrophe cover, producing a per-risk net retention of ₹45 crore. The reinsurer has asked for an 18% rate increase, citing a sharp rise in the 1-in-200-year cyclone loss estimate for the insurer's Gujarat and Maharashtra accumulation, which the catastrophe model now puts at ₹1,400 crore net. Capital allocated to catastrophe risk is ₹600 crore. The Chief Underwriting Officer wants to accept the increase; the CFO wants to retain more and buy less.
1. How should the retention on the refinery risk be decided? Set out the reasoning with numbers.
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The governing principle. Retention is a function of capital, not of premium appetite. A single risk must not be capable of impairing solvency, and the whole programme must be consistent with the capital the board has allocated to insurance risk.
Test the present position. A ₹45 crore retention against a PML of ₹9,000 crore means the treaty absorbs 99.5% of the worst-case single risk - that is the right shape. But the catastrophe accumulation is the real constraint: a modelled 1-in-200-year net loss of ₹1,400 crore against ₹600 crore of allocated capital is a multiple of more than 2.3. That is the issue the reinsurer is pricing, and it cannot be answered by arguing about the refinery alone.
The CFO's position is not sustainable on these numbers without new capital. Increasing retention to, say, ₹90 crore would reduce ceded premium, but it would double the volatility borne by a solvency ratio of 1.62 and would require capital that has not been allocated. The marginal test is: cost of the ceded cover versus the cost of holding the additional capital at the implied cost of capital. An 18% increase on the ceded premium is likely to be cheaper than carrying the extra ₹45 crore of retention at 12-14% cost of capital plus a capital charge for the extra catastrophe volatility.
Recommendation. Retain at or near ₹45 crore on a per-risk basis; secure the catastrophe cover first, since it is the binding constraint; and obtain facultative support for the refinery so that the treaty is not eroded by a single risk. Then negotiate the 18% with data: show the reinsurer the risk improvement programme and the line-sizing discipline for coastal accumulations.
2. What does the IRDAI (Reinsurance) Regulations, 2018 require of the insurer in placing this programme, and how should the mandatory cession be handled?
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Board-approved programme. Every insurer must frame a reinsurance programme approved by its board, covering the nature and extent of risks to be ceded and the retention policy, and must file it with IRDAI in the prescribed manner before the start of the financial year.
Order of preference. Capacity must be sourced in the sequence prescribed by the regulations and the reinsurance order issued for the year: obligatory cession to the domestic reinsurer as prescribed; then domestic reinsurers; then cross-border reinsurers; then Indian branches or subsidiaries of foreign reinsurers. An insurer must demonstrate that domestic capacity was exhausted before placing business abroad, and must maintain records of the placement exercise. Reinsurers used must meet the minimum rating and regulatory eligibility criteria set out in the regulations.
The mandatory cession deserves care. The rate of obligatory cession to GIC Re has been reduced in successive steps by government and IRDAI decision, and the exact percentage for a given financial year must be confirmed from that year's reinsurance order or IRDAI circular rather than assumed from memory or from the previous year's treaty wording. Ceding on a stale rate produces either an under-cession (a compliance breach) or an over-cession (unrecovered premium).
Practical controls. Build a cession checklist into the treaty accounting cycle: confirm the current rate, reconcile ceded premium and cession statements quarterly, verify rating of each reinsurer, and keep the domestic-capacity evidence on file. Since the programme must be filed before 1 April, the negotiation with the reinsurer should be completed well before that date, not treated as a post-renewal formality.
3. If the 18% increase is unacceptable, what alternatives should be evaluated, and what are the risks of each?
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1. Facultative cover for the refinery. Place the refinery outside the treaty on a facultative basis, keeping the treaty for the rest of the portfolio. This protects treaty capacity and lets the market price the single worst risk separately. Risk: it must be placed before binding the risk, otherwise the risk sits net; and facultative cover may be exhausted at renewal.
2. Raise the catastrophe attachment point. Take a higher deductible on the catastrophe cover, retaining more of the frequent, smaller events and ceding only the severe tail. Risk: retained losses become more volatile in a bad monsoon or cyclone year.
3. Reduce the accumulation itself rather than reinsure it. Cut line sizes for coastal Gujarat and Maharashtra risks, impose distance-to-coast underwriting rules and non-renew the worst accumulations. Risk: loss of profitable commercial lines and broker relationships.
4. Risk improvement at the refinery. Require deluge systems, foam monitors, water curtains and emergency shutdown investment, and obtain the reinsurer's recognition of the reduced PML. Risk: benefits appear in the following renewal, not this one.
5. Co-insurance and domestic capacity. Look for domestic reinsurers or co-insurers to take a share, satisfying the order of preference while spreading the risk.
Recommendation. Combine (1) and (4) immediately and put (3) in place for the following renewals. Then test the increase quantitatively: if 18% on ceded premium is less than the capital charge on the extra retention needed to replace that cover, accept it and negotiate hard on the accumulation wording rather than on the rate.