Another world: more reinsurers are dipping their toes into the microinsurance market.

Microfinance plays a vital role in providing financial services to the poor in developing countries. A significant development within microfinance has been the increased offerings of microinsurance products.

Reinsurance has not yet played a major role in providing financing and capital to microinsurers, even though developing countries represent a potentially lucrative and growing market. Of late, there has been increasing interest in this area from market players.

For instance, in February, Guy Carpenter & Co. announced that it would create a multiline microreinsurance risk-pooling facility that will provide risk transfer solutions for microinsurance. Three months later, Munich Re announced a pilot product in conjunction with the Indonesian insurer Asuransi Wahana Tata and the Deutsche Gesellschaft fur Technische Zusammenarbeit GmbH on behalf of the German Federal Ministry for Economic Cooperation and Development. The new product offers flood insurance to low-income households in Jakarta, Indonesia; Munich Re will be the product's sole reinsurer.

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Nonetheless, microreinsurance--reinsurance for microinsurance--remains in its nascency.

Potential for Growth

Microinsurancc is a crucial part of the financial serviccs necded by the poor in developing countries, and includes life, health, agricultural and property insurance.

Unpredictable events, such as illness, accidental death or disability, can bring devastating consequences to poor households, particularly in developing countries. Worse, entire communities face upheaval from catastrophes such as droughts, tsunamis, hurricanes and earthquakes in areas without protections from the government and private sector that are readily available in developed countries. Microinsurance can help the poor--and the tenuous markets in developing countries--recover if one of these events occurs.

Developing countries offer insurers and reinsurers enormous economic potential. They hold an estimated 86% of the world's population, and they are developing middle classes with disposable income.

Microinsurance is often provided in developing countries by non-governmental organizations, including development organizations, trade unions and microfinance institutions. "Mutuals" are professionally managed, regulated, member-owned insurers, often owned by credit unions or cooperatives. They tend to be closer to the poor and therefore to the market for microinsumnce.

Community-based organizations are member owned and managed; thus, they are comprised of the poor they insure. Such entities are unregulated and often lack the professional management experience to be stable and effective insurers.

Pioneering Coverage

Some insurers have already seized upon the opportunities offered by developing markets. Financial institutions, such as commercial banks and insurance companies, alone and in conjunction with various organizations and microfinance institutions, have begun to offer microinsurance products within developing countries.

Munich Re and Swiss Re are involved in a number of microinsurance initiatives. AIG Uganda Ltd., Delta Life Insurance Co. in Bangladesh and almost all insurance companies in India offer microinsurance to those countries' poor. Further, Allianz recently launched an initiative with the United Nations Development Programme and GTZ to provide insurance to the poor in India and Indonesia.

Many developing countries have encouraged microinsurance products by adopting laws and regulations to foster the expansion of microinsurance offerings. For example, India established microinsurance agent regulators to facilitate the link between formal insurers and village-based NGOs. In the Philippines, mutual benefit associations have been organized and classified as microinsurance institutions under that country's insurance laws and are therefore now supervised by the Philippines Insurance Commission.

Despite the growth of microinsurance, there has not yet been a similar growth in microreinsurance. However, as demand for microinsurance grows considerably, microinsurers will need reinsurance to increase capacity and meet financial and regulatory requirements.

Generally, reinsurance would be advantageous for a microinsurer if the reinsurance premium is cheaper than the safety margin that the microinsurer must maintain to ensure the level of solvency that the reinsurance guarantees. Ceding all or a portion of the risk to reinsurers would help minimize the effect of abnormal attritional or catastrophic losses, which could threaten a microinsurer's financial stability.

Reinsurance also decreases or removes the microinsurer's obligation to maintain contingency reserves, which allows the microinsurer to reinvest surplus in the developing markets. That will encourage further growth of microinsurance.

Moreover, in cases where the microinsurer is not experienced in the insurance business, the microinsurer can draw upon the reinsurer's knowledge and experience from developed markets for guidance in establishing proper administration of the products and refining actuarial skills.

In exchange, reinsurers can reach growing markets in developing countries. Providing reinsurance cover for microinsurance can be a significant way for reinsurers to expand their geographic reach outside of their mature, and sometimes saturated, developed markets. Perhaps more importantly, entering developing countries through reinsurance coverage for microinsurers can place reinsurers in a strong position to grow as those countries develop.

Identifying Potential Markets

Certain countries that already have significant microinsurance product offerings, such as India, Sri Lanka, and Uganda, may present good points of entry into microreinsurance. Selecting countries and regions of focus usually ties in with a reinsurer's existing presence in particular regions or product areas, as well as their growth strategies for particular countries or regions.

Potential Ceding Companies

As a threshold matter, a reinsurer considering the microinsurance market must consider what types of microinsurers it will reinsure. The types of microinsurers active in a particular country can range from formal financial services providers, such as affiliates of insurers, reinsurers and other financial institutions, to NGOs and community-based organizations. Identifying potential microinsurer ceding companies involves many different factors, such as the microinsurer's experience in the particular country and its processes and experience with underwriting, claims and other aspects of the business.

While NGOs and such microinsurance providers may have the advantage of operating close to the market, thus making them good delivery channels offering more business opportunities, such players often operate without a license and are not regulated and supervised by the government.

Licensing and Authorization

A key concern is the need to comply with regulatory, licensing and authorization requirements imposed on reinsurers by the developing country.

As an initial matter, most reinsurers probably would prefer not to become licensed in all or most of the developing countries, to avoid the concomitant regulatory and compliance requirements. However, reinsurers must be wary of certain developing countries' laws and regulations that only allow licensed or otherwise authorized reinsurers to provide reinsurance. A reinsurer could run afoul of these restrictions simply by providing reinsurance to ceding companies located within such jurisdictions--even if the reinsurer doesn't physically undertake any acts there.

A developing country that allows its ceding companies to obtain reinsurance from unauthorized reinsurers may nonetheless restrict the activities that an unauthorized reinsurer may undertake within its borders. Such a jurisdiction may broadly regulate acts conducted even from outside the jurisdiction. Regulations may prohibit unauthorized reinsurers from solicitation, marketing or discussions with ceding companies in the jurisdiction. For instance, communications with ceding companies conducted by phone, mail or the Internet from outside the jurisdiction could be deemed to be doing insurance business without a license.

Reinsurance Credit

A related issue is whether ceding insurers in a given jurisdiction would be able to cede reinsurance to an unauthorized reinsurer--and obtain credit for it on financial statements and for regulatory purposes. A threshold question is whether there is a regulatory benefit in obtaining reinsurance to a ceding microinsurer in the specific jurisdiction, such as receiving credit for the reinsurance--either as an asset or a reduction in liabilities--on the statutory financial statements of the ceding company. The unregulated microinsurers currently dominating the sector may not need regulatory credit for reinsurance. Regardless of the regulatory benefit from reinsurance, there are financial and risk-sharing benefits to any ceding microinsurer from obtaining reinsurance.

In situations where the microinsurer needs regulatory credit for reinsurance, the reinsurer will need to understand the requirements it must fulfill, such as:

* Whether the reinsurer must post collateral, and if so, in what amounts.

* What types of collateral may be acceptable: trust accounts (including the types of allowable assets in such accounts), funds withheld by the ceding microinsurer or letters of credit.

* Where the collateral may be located: the ceding microinsurer's domicile, the rcinsurer's domicile or another jurisdiction.

Lack of Regulatory Framework

Developing countries may lack a regulatory framework for reinsurance, either generally or for private or unauthorized reinsurers. Absent an established regulatory framework, reinsurers providing cover to microinsurers would face significant uncertainty and risks regarding the legal and regulatory status of their reinsurance agreements and cover. Without at least some clear, established reinsurance laws and regulations, reinsurers understandably would be hesitant to enter such a market.

These risks might be mitigated, however, by making the reinsurance documents subject to the laws of another jurisdiction, such as the domiciliary jurisdiction of the reinsurer, if doing so is permitted by the microinsurer's domicile. This would provide the microinsurer its desired reinsurance benefits and satisfy the reinsurer's concerns.

Lack of Legal Framework

The lack of a developed legal framework and institutions could cause a great deal of uncertainty for the reinsurer. The developing country may lack experience with reinsurance agreements and relationships. It may lack established or dependable courts or other recognized dispute-resolution structures, and arbitration may be unavailable or not recognized there.

While a reinsurer could require that all disputes concerning its coverage be brought in its home country, such a mandate could be impossible financially for most microinsurers and make reinsurance unattractive to ceding companies.

In addition, obtaining enforcement of foreign judgments or arbitration awards in the microinsurer's country may be difficult. One potential remedy would be to require arbitration of all reinsurance disputes by including very detailed arbitration provisions in the reinsurance contract--covering specifics regarding initiation of arbitration, selection of members of the arbitration panel and procedural aspects.

Home Jurisdiction Restrictions

Beyond the legal and regulatory requirements of developing countries, reinsurers may face restrictions in their domiciliary jurisdiction. Reinsurers need to evaluate how microreinsurance cover would be treated for purposes of their statutory financial statements.

A related point would be how rating agencies and other relevant constituencies might evaluate the microreinsurance segment of their business.

Most large reinsurers operate in jurisdictions that regulate corrupt practices, or restrict transactions with certain jurisdictions. For instance in the United States, the Foreign Corrupt Practices Act prohibits corrupt payments to foreign officials in order to obtain or keep business and the Office of Foreign Assets Control enforces economic and trade sanctions based on U.S. foreign policy and national security.

Reinsurers considering coverage for microinsurers must fully understand all the laws, requirements and obligations involved.

* The Situation: Reinsurance for microinsurance offers significant growth opportunities for reinsurers.

* The Issue: Reinsurers exploring opportunities in this sector must consider various legal, regulatory and commercial issues. * The Way Ahead: Addressing these issues can ensure a successful venture into the developing countries.

Contributors Maria Orecchio and Vikram Sidhu are senior associates in the New York office of Lovells LLP. She may be reached at maria. [e-mail]; he may be reached at [e-mail].