OREANDA-NEWS. Proposals by Indonesia's financial services authority (OJK) to increase the amount of insurance business placed with domestic reinsurers could potentially add to challenges for both the domestic insurance and reinsurance sectors, says Fitch Ratings. Risk exposures for Indonesian reinsurers are likely to rise as insurance risks are increasingly retained domestically, and this could challenge the domestic sector - given the relatively low level of capitalisation.

The Indonesian reinsurance sector has gradually built up capacity in recent years, and there are plans to restructure the industry and inject additional capital. However, it remains to be seen whether this will be sufficient to meet the expected demand growth.

The OJK proposals stipulate that Indonesian insurers must reinsure all of their motor, health, surety, credit, life and cargo business with domestic reinsurers. For other insurance business lines, a minimum of 25% will have to be allocated to domestic reinsurers, with the minimum level rising over the next few years.

Under existing regulations, Indonesian insurers are only required to cede 10% of their risk to domestic reinsurers. As a result, more than 70% of reinsurance premiums are currently ceded to the international market, creating an insurance trade deficit of IDR5trn (USD400m). The plan is likely to reduce the outflow of reinsurance business to international markets, and could create additional growth opportunities for local reinsurers.

Managing the additional business will add to challenges for the local reinsurance sector, especially as Indonesian firms have limited sophistication in reserving and catastrophe modeling - a particular concern in a market with a relatively high likelihood of natural disasters. Generally, domestic reinsurers and direct insurers have relied on their brokers to generate technical models, and they have also been partially shielded from major insured catastrophe losses due to the ceding of risks to international reinsurers with a high underwriting capacity.

As such, to maintain their existing risk profile, Indonesian reinsurance firms will have to improve their risk management and enhance their technical modeling capabilities to better manage increased risk accumulation. Improving capacity (capitalisation) will also be crucial, to ensure that the domestic reinsurance market will be capable of serving the higher demand from local insurance businesses. It has not yet been stated what options will be available to Indonesian insurance companies if they cannot find a domestic reinsurer.

The government is moving forward on an earlier announced plan to merge state-owned reinsurers PT Reasuransi Internasional Indonesia (Reindo) with PT Asei Reasuransi Indonesia, to create Indonesia Re. The merger of two other local reinsurers, PT Tugu Reasuransi Indonesia and PT Nasional Reasuransi Indonesia, is also planned. This will boost domestic reinsurance capacity, with plans to inject an initial IDR1.5trn (USD120m) in capital for the new company. However, even with the capital boost, this is still less than reinsurance peers in Thailand, Malaysia and Singapore. This initial capital would not be likely to be sufficient to keep pace with the expected growth of the insurance industry nationwide.