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The changing landscape of reinsurance in South Africa

Amongst a raft of proposed legislative and regulatory changes impacting the financial services industry in South Africa, the Financial Services Board ("FSB"), the authority that regulates, inter alia, the activities of insurers and reinsurers in South Africa, has proposed a number of changes to the regulatory framework under which reinsurance business will be carried out in South Africa in future.

The majority of the proposed reforms have been included in the Insurance Bill, 2016 ("Insurance Bill"), which was tabled in South Africa's Parliament on 28 January 2016, and which the FSB currently envisages will come into force in the second quarter of 2017.

The Insurance Bill, which primarily deals with licensing and prudential considerations in respect of insurers, aims to provide a consolidated legal framework for the supervision and regulation of insurance that is consistent with international standards for insurance and reinsurance. The Bill also seeks to replace and consolidate substantial parts of the Long-term and Short-term Insurance Acts which currently regulate South Africa's insurance sector.

Prior to the crystallisation of the proposals in respect reinsurance as reflected in the Insurance Bill, the FSB undertook a review process regarding the current reinsurance market in South Africa and interacted with the industry by way of, inter alia, discussion documents setting out various iterations of its proposed amendments to the reinsurance regulatory framework.

Currently, the local insurance laws prohibit any person from carrying on insurance or reinsurance business in South Africa unless that person is licensed to do so and such licence may only be issued to a person that is a public company incorporated in South Africa. Licensed insurers and reinsurers are subject to strict regulation and have to comply with ongoing requirements in order to maintain its licence.

In consequence of the above, foreign reinsurers currently participate in the local market by either establishing and licensing a subsidiary in South Africa or by way of the provision of cross-border reinsurance. The review undertaken by the FSB shows that the majority of reinsurance in respect of South African insurers are placed on a cross-border basis with non-South African reinsurers that largely operate outside of the regulatory purview of the FSB.

The Insurance Bill seeks to discourage the provision of reinsurance on a cross-border basis in the ordinary course by introducing a deeming provision to the effect that a foreign insurer or reinsurer will be deemed to do insurance business in South Africa if it, or another person acting on its behalf, directly or indirectly acts in South Africa in respect of that foreign insurer's or reinsurer's insurance business. Therefore, foreign insurers or reinsurers will in future be deemed to conduct insurance business (and will have to apply for a license) in South Africa even if they do not establish a presence in South Africa and only occasionally travel to South Africa to meet with their clients.

However, as the carrot to the above licensing stick, and with the intention of broadening participation in the South African reinsurance market, the Insurance Bill provides for foreign reinsurers to establish a branch (being an operating entity of a foreign reinsurer that is not a legal entity separate from the foreign reinsurer, and is part of a foreign reinsurer in terms of its organisation) to conduct insurance business in South Africa. While the branch of the foreign reinsurer will be required to be licensed by the regulatory authorities, the operational and capital requirements on branches are proposed to be substantially lower than those placed on reinsurers registered as local public companies, with the latter requirement on branches seemingly to be set at capital equitable to the technical provisions.

In furtherance of the above objectives, initial proposals by the FSB mooted material adjustments to the credit rating of reinsurers within the solvency calculation of the user of the reinsurance, which included (i) a 3-notch downgrade in the credit rating of the foreign reinsurers who were located in jurisdictions with regulatory frameworks equivalent to that of South Africa; (ii) a 2-notch downgrade in the credit rating of branches of foreign reinsurers where the reinsurer was located in jurisdictions with regulatory frameworks equivalent to that of South Africa; and (iii) a 3-notch upgrade in the credit rating of locally licensed reinsurers. Subsequent to this initial proposal however, the FSB has substantially deviated from the aforesaid and the current proposal is that, for purposes of treatment of reinsurance for solvency assessment of reinsurers, there will be no credit rating adjustment for foreign reinsurers or branches of foreign reinsurers in equivalent jurisdictions and locally licensed reinsurers will be assumed to have an upgrade in their credit rating only to the extent that the sovereign cap in place has resulted in a downgrade.

In addition to the above reforms, the FSB has indicated that, likely via subordinate legislation, it intends limiting the extent to which insurers may reinsure or retrocede to prevent fronting arrangements, which have to date not been regulated in the South African market. It has been proposed that a local insurer or reinsurer will not be allowed to reinsure or retrocede more than 75% of premiums underwritten to any other insurance entity (including locally and internationally). Although the precise meaning of the proposed restriction is not clear from the wording contained in the discussion document in which the FSB proposed this, it appears that the intention is for the cap to apply to a local insurer's or reinsurer's total book as opposed to each individual reinsurance or retrocession arrangement. Despite the fact that it has not been regulated to date, this proposal does not come as a surprise as the FSB has openly expressed its concerns regarding insurers reinsuring 100% of its risk.

A notable change to the reinsurance regulatory environment proposed is that no composite licences will be allowed in respect of reinsurance, bar narrow exceptions. This means that both locally licensed reinsurers and branches will only be allowed to conduct reinsurance business and not any direct insurance business.

Having regard to these proposed changes to the South African reinsurance landscape, we expect to see a material increase in the number of foreign reinsurers establishing a presence in South Africa. The introduction of the branch as an option for such presence, and the reduced requirements pertaining thereto, suggests that foreign reinsurers are likely to opt for this structure once the Insurance Bill comes into force.