The Insurer's Insurance in Brazil

In Brazil people used to say that reinsurance is insurance for insurers. The old cliché became seen as an almost scientific truth, a truth which, inconveniently, explains nothing. To say that reinsurance is the insurance company’s insurance suggests that the reinsurer is the only one who provides protection for the insurance company and that without it, the insurance company would always be in a weak position. And that is not true in many branches of the insurance industry.

After almost 70 years in which the Instituto de Resseguros do Brasil (IRB) had a monopoly in the reinsurance sector, in 2007, Brazil opened up the reinsurance market. It was an important step for consolidation in the insurance market. Furthermore, the widespread social and economic improvement that the country witnessed in the past 15 years has resulted in the need for higher levels of protection and a general expansion in the insurance sector. As just one example, the country is developing microinsurance programmes to provide protection for poorer sections of society, which until now never had any kind of protection except for some government assistance, mainly after disasters.

As the effect of climate change becomes more noticeable and severe, insurance coverage is probably the most efficient way to protect people and corporations from the economic consequences of natural disasters. Without this tool, society would depend solely on government help, which would place a huge burden on state finances and ultimately provide inadequate protection. In the face of severe losses, insurance means that the government’s long-term plans for growth can be maintained, at least in part.

However, no insurance company has the capacity to bear climate losses without reinsurance support. And the Brazilian insurance companies are no different. So the opening of the reinsurance market was not just a significant solution but also a wise one. Liberalisation of the market allowed competition between insurance and reinsurance companies, creating new polices and coverages needed by Brazilian society. Liberalisation was effected by Complementary Law 126/07, which created three types of reinsurers that could operate in the country:

The first is the local reinsurer (resseguradora local). This must be a Brazilian company, operating under Brazilian law, with a legal minimal capital and supervised by the Brazilian authorities.

The second is the admitted reinsurer (resseguradora admitida). This is a subsidiary office of an international reinsurer, opened in Brazil pursuant to specific rules.

The third is the eventual reinsurer (resseguradora eventual). This type of reinsurer requires no legal representation or capital in the country but the reinsurance coverage it can offer is restricted to a maximum.

The first development after the reinsurance market was opened occurred in 2008 when some companies asked for authorisation to operate as local reinsurers. The advantage of becoming a local reinsurer was the legal guarantee of a preferential offering of 60 per cent of the total reinsurance in the Brazilian market. At the same time other companies were created to perform as admitted reinsurers.

The majority of international reinsurers, however, chose to act as eventual reinsurers without subsidiaries or offices in Brazil but allowed to take a certain amount of Brazilian reinsurance risk. Because of this development, 2008 and 2009 brought no major changes or any aggressive movement made by the new players. Even with increased dynamism, mainly among admitted reinsurers in the second half of 2009, the market only began to change after 2010, when the obligatory cession to local reinsurers fell from 60 per cent to 40 per cent. Given the possibility for growth in Brazil and with an international soft market many international reinsurers started to pay attention to the country’s reinsurance market. The admitted and eventual reinsurance companies quickly developed aggressive underwriting polices to increase their business.

By contrast, because of its archaic structure the IRB faced difficulties to compete with the much more modern and technologically prepared international reinsurers. During 2010 the IRB’s market share greatly decreased. The federal government, IRB’s controlling shareholder, started to transfer its shares to Banco do Brasil, aiming to make IRB more competitive. This has not been successful and the state-controlled reinsurer is still losing market share.

During the monopoly period IRB had a very large fire reinsurance agreement with an automatic limit of US$300 million. But that does not mean that the Brazilian reinsurance market had great capacity. For example, the loss of the P-36 oil platform a few years ago cost reinsurers US$500 million. Around US$496 million was paid by the international market and just US$4 million by the Brazilian reinsurers and IRB. That means that the Brazilian national market paid less than 1 per cent of the total loss and the international market paid 99 per cent of the loss. These figures show the size of the Brazilian insurance and reinsurance capacity and this limit remains small today. With the end of the reinsurance monopoly IRB renegotiated its fire reinsurance agreement and has today a much smaller automatic limit. That means that to place some excess in the international market, IRB must negotiate reinsurance coverage for smaller insurances policies than before. This became an advantage for the international reinsurers that have bigger automatic capacities to accept the risks through their international groups.

Returning to the maxim that says that reinsurance is the insurer’s insurance, it could be understood that the insurance company has the same relation to the reinsurer that the insured has to the insurer. But this is not entirely true: the insurance company can sometimes have a completely different position in its relation to the reinsurer. Also, another failure of the old maxim is that it does not explain what reinsurance is, or what reinsurance contracts are for. Just as there are different insurance contracts, there are also different reinsurance contracts. Each one of them has a specific use. This is why it is not true that the reinsurer is just offering operational capacity to the insurance company as the definition implies.

The classical Brazilian view on reinsurance sees it mainly as providing extra financial capacity to enable insurers to underwrite risks beyond their technical limits. But a large number of the insurance companies operating in the country, especially life assurers and vehicle insurers, have the financial capacity to underwrite the majority of the risk.

Adequate finances do not mean that an insurance company has no need of reinsurance contracts to protect its operations. For example, carriers may need to reinsure when starting to provide insurance in areas in which it has little experience or, going further, to protect themselves against great losses in short periods of time. The insurer normally uses reinsurance contracts to regulate the company’s turnover. Every summer many insurance companies in Brazil use reinsurance to face the payments of thousands of vehicle losses caused by the seasonal storms. This kind of reinsurance protects the insurance company from financial unbalance. This is not because the insurance company has a bad underwriting or fewer technical reserves than it needs, but because a huge volume of losses in a very short period can leave it without enough cash to pay all the losses in time. In this case the reinsurance contract is not developed to improve the retention capacity of the company but to give it liquidity to fulfil the contracts.

In Brazil the most common reinsurance contract is facultative reinsurance. It normally guarantees the insurance polices for big risks such as energy, oil, and big projects. Such contracts will be in very high demand in the coming years because of the huge investments the country is making in general infrastructure and for the Football World Cup and the Olympic Games. According to the Brazilian government, the country will invest over 300 billion reais (US$170 billion) to improve infrastructure. It is important to have it clear that these investments need different kinds of insurance, such as financial bonds, bid bonds, performance bonds, plant erection, fire, liability and various other kinds of insurance needed after the operational start-up.

In the coming years the Brazilian insurance market will need all types of reinsurance to support its operations and development. This means that the authorities must handle their supervisory power to make the Brazilian market attractive for all well-rated reinsurance companies. Because of this, the Brazilian insurance authorities must respect international rules. Otherwise Brazilian reinsurance will become more expensive or, worse, the country will not have all the coverage it needs.