By Philip Teoh
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:
i. Maintains a minimum paid-up capital of RM 10 million (or its equivalent in foreign currency) within Labuan;
ii. Participates as a member of the Labuan International Insurance Association;
iii. Establish and maintains an operational management office in Labuan;
iv. Appoints LFSA-licensed underwriting managers;
Similar to the banking industry, insurance may 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.
Labuan is also home to captive insurers. A captive insurance is a company that wholly owned and controlled by its insureds. The main function is to 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 decision- making pertaining to the risks being retained by the subsidiary company or transferred to the conventional insurance market, are undertaken by the parent company (parent).
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 [2010] 2 MLJ 222, the requirements to form a contract of insurance is summarized as follows:
1) The contract must provide that the assured will become entitled to something on the occurrence of some event;
2) The event must be one which involves some element of uncertainty; and
3) The assured must have an insurable interest in the subject matter of the contract.
“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 two 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 reinsurer 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 a 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.
Malaysian Case Law on Reinsurance
There has been relatively few cases on Reinsurance in the Malaysian Courts. However, the several cases has arisen in the recent years, where the author has been involved as Counsel:
Great Eastern General Insurance (Malaysia) Bhd v Best Re (L) Limited [2020] MLJU 423; Hong Leong Msig Takaful Bhd & Anor v Best Re (L) Ltd [2017] MLJU 1296 and China Pacific Property Insurance Co Ltd v Best Re (L) Ltd [2017] MLJU 2238 In the Labuan High Court case of China Pacific Property Insurance Co Ltd, Ravinthran J held made observations on the nature of Reinsurance :
“Courts have also recognized that reinsurance contracts are “back to back contracts”. In Vesta v Butcher [1989] AC 852,; [1988] 2 All ER 43, Lord Griffiths said as follows in respect of the nature of the reinsurance business:
In the ordinary course of business, reinsurance is referred to as ‘back-to-back’ with the insurance, which means that the reinsurer agrees that if the insurer is liable under the policy the reinsurer will accept liability to pay whatever percentage of the claim he has agreed to reinsure.
A reinsurer could, of course, make a special contract with an insurer and agree only to reinsure some of the risks covered by the policy of insurance, leaving the insurer to bear the full cost of the other risks. Such a contract would I believe be wholly exceptional.”
