Reinsurance Law And Practice In Malaysia
Legal News & Analysis - Asia Pacific - Malaysia - Insurance & Reinsurance
9 January, 2019
The Reinsurance industry in Malaysia, comprising of approximately 200 reinsurers, is regulated by the Labuan Financial Services Authority (“LFSA”), a statutory body under the Labuan Financial Services and Securities Act 2010 (“LFSSA 2010”). Under the LFSSA 2010, reinsurance business is defined as a business where the reinsurer assumes a portion of risk/liability arising from the original insurance policy of an insured party.
Generally, the following are the prerequisites to be satisfied if an insurer is to carry out reinsurance business under the LFSSA 2010:
- Maintains a minimum paid-up capital of RM 10 million (or its equivalent in foreign currency) within Labuan;
- Participates as a member of the Labuan International Insurance Association;
- Establish and maintains an operational management office in Labuan;
- Appoints LFSA-licensed underwriting managers;
- Similar to the banking industry, insurance may also come in the form of conventional insurance and Islamic/Shari’ah compliant insurance known as Takaful.
The reinsurance form of Shari’ah compliant insurance is referred to as Re-Takaful. Re-Takaful in Malaysia is regulated under the Labuan Islamic Financial Services and Securities Act 2010 (“LIFSSA 2010”). The purpose of reinsurance is to preserve the financial stability of the insurance industry, in particular one of its main players, being insurance providers.
The concept of reinsurance serves as a risk management tool which can potentially reduce insurance risk and at the same time, maximize the underwriting potential of an insurer through effective usage of capital. This is because the availability of reinsurance enables an insurer to accept risks that would otherwise be beyond its underwriting capacity by allowing the ceding insurer to “reinsure” a portion of the risk/loss, and at the same time spread the risk of a major loss.
The principles of insurance apply similarly to a reinsurance transaction, among others being the contract of indemnity creates an insurable interest in the property and that parties are responsible to ensure the duty of utmost good faith is upheld.
In the landmark Court of Appeal case of Mary Colete John v. South East Asia Insurance Berhad  2 MLJ 222, the requirements to form a contract of insurance is summarized as follows:
- The contract must provide that the assured will become entitled to something on the occurrence of some event;
- The event must be one which involves some element of uncertainty; and
- The assured must have an insurable interest in the subject matter of the contract.
Concept of Reinsurance “A reinsurance contract is one where an insurance company passes a proportion of its obligation under the main insurance contract to another insurance company” – unreported, 2018. Reinsurance, in simpler terms, is the insurance of an insurer by another insurer. In a general insurance arrangement, an insurer would typically indemnify its original insured under a specific insurance policy. Reinsurance comes into play when the insurer becomes the reinsured, seeking to insure the risk of its original insured to another insurer (the reinsurer) in order to spread the risk which it had agreed to indemnify. The risk may then be passed/ceded to another insurer, commonly referred to as retrocessionaires.
There are several branches or types of reinsurance. The type of risk to be reinsured is divided into coverage of a proportional loss (pro rata) or on an “excess of loss” basis. Coverage of a proportional loss arises when the reinsurer has agreed to indemnify the ceding insurer/reinsured for a certain percentage/portion of a loss suffered by an original insured. As for an “excess of loss” reinsurance contract, the reinsurer would agree to indemnify a reinsured for a potion or value exceeding the agreed limit.
For example, where A agrees to indemnify B for any loss exceeding RM 10,000 of C’s property which B is insuring, this is known as an “excess of loss” reinsurance arrangement between A and B. Where A agrees to indemnify B for 20% of the total value of C’s property which B is insuring, this would be deemed as a proportional reinsurance coverage of A over B. The manner in which reinsurance is accepted by a reinsurer can also be categorized into 2 main forms being facultative reinsurance and treaty reinsurance.
The manner in which reinsurance is underwritten would normally depend on the market’s demand. Treaty reinsurance can be equated to a reinsurer accepting the entire risk of a particular class.
An illustration would be if A were to reinsure B, in particular for any loss arising from the headlights of C-type cars for the year 2018. In this example, the tires or the engine of the C-type cars may be reinsured with a different reinsurer, D, for the year 2018. As for facultative reinsurance, it is designed to protect a specific risk underwritten by the reinsured. Facultative reinsurance would be an easier concept to grasp whereby the reinsurer would agree to indemnify a specific risk of a particular insured for a certain expressed period.
In other words, facultative reinsurance agreements/contracts cover individual underlying policies and are written on a policy/risk specific basis, because this type of reinsurance is usually applied for unusual risk exposures, the terms and conditions are individually negotiated between parties, separate from the terms of some other reinsurance contract. For example, when B agrees to indemnify C’s oil rig construction project, A may reinsure B, in particular, for losses to be suffered by C arising from bad weather or rough sea conditions.
In all instances, the payment of premium would form a substantial part of the contract, being the consideration to be paid by the reinsured for risk accepted by the reinsurer, without which the reinsurance coverage would not be operative. Under a reinsurance contract, the reinsured, also the insurer, would pay a particular sum as premium to its reinsurer in return for future reimbursement of the reinsurer’s portion of the risk exposure of the original insurance policyholder. Premium payments would also relate to parties responsibility towards the duty of utmost good faith, which is a trite principle in insurance and reinsurance. Captive Insurance Labuan is also home to captive insurers.
A captive insurance is a company that is wholly owned and controlled by its insureds. The main function is to insure the risks of its owners, and its insureds benefit from the captive insurer’s underwriting profits. A captive is essentially a wholly-owned insurance company, usually located in a jurisdiction where taxation, solvency and reporting requirements are relaxed. They are usually managed by specialist companies that act as accountants and administrators. However, much of the decisionmaking pertaining to the risks being retained by the subsidiary company or transferred to the conventional insurance market, are undertaken by the parent company (parent).
Captive insurance is utilized by insureds that choose to put their own capital at risk by creating their own insurance company. The insured in a captive insurance company not only has ownership in and control of the company but also benefits from its profitability. Besides that, captive insurers often have significantly less capital than commercial insurers and no protection for the insureds from state guaranty funds allowing insureds to work outside the commercial insurance market place. Since they are not traditional commercial insurers, captives are considered a part of what is often called the “alternative market,” or “alternative risk transfer (ART) market.”
On top of that, the main reasons why organizations wish to better control their risk management programs are excessive pricing, limited capacity, coverage that is unavailable in the "traditional" insurance market, or the desire for a more cost efficient risk financing mechanism.
Other reasons for utilizing captive insurance include broader coverage, stability in pricing and availability of coverage, improvement in cash flow and to increase control over the services. There are two types of captive insurer: Pure captive insurers: captive insurers that are 100 percent owned, directly or indirectly, by their insureds. Sponsored captive insurers: captives owned and controlled by parties unrelated to the insureds.
The benefits of establishing a captive in Labuan include: Robust and internationally recognised regulatory framework Facilitative and business-friendly legislation Wide choice of entities Strategic location in the Asia Pacific region Tax efficiency Penetration into Malaysia’s insurance market.
FACULTATIVE (Individual Risk)
- Risk is reviewed on a separate and individual basis
- Profit is dependent on the manner of the reinsurer’s risk selection
- Can reinsure a specific risk that is otherwise excluded from a treaty
TREATY (Book of Business)
- A class of business risk is accepted by the reinsurer as a whole
- Profit is based on long term relationship which is measured and adjusted over an extended period of time
- One treaty contract comprises of all subject risk under the subject matter.
For further information, please contact:
Philip Teoh, Partner, Azmi & Associates