CHAPTER ONE

1.1 BACKGROUND TO THE STUDY

Over the years, human beings have come to accept the fact that misfortunes, either resulting from personal choices, external factors or natural events are inherent part of life.  The recurrent misfortunes created a universal need for security in anticipation of the occurrence of a risk. In order to cope with these misfortunes, communities developed the concept of insurance. Insurance is a social institution as well as an economic device or mechanism used in handling risks related to life and property.[1]  The sole purpose of insurance is to compensate or indemnify the victim for his financial losses.[2] Providing security to societies constitutes the raison d’être of insurance. Over the years, insurance has proven to be beneficial to anyone looking to protect their family, assets/property and themselves from financial risk or losses.[3] Today, building a house, marketing a product, or simply driving a vehicle, all would be unthinkable without taking appropriate insurance cover.[4]

Originally, insurers’ main business activities were their underwriting activities which consist of evaluating and assuming the risk of an insurance policy.[5] If the risk is deemed acceptable, the insurer then issues an insurance policy to the policyholder which serves as a contract between the insurer and the policyholder. Professor E.R.H Ivamy defines an insurance contract as “A contract whereby one person called the ‘insurer’ undertakes in return for an agreed consideration, called the ‘premium’ to pay to another person called the assured a sum of money, or its equivalent, on the happening of a specified event.[6] However, with the growing risks in fire insurance, the financial stability of insurance companies was threatened. Instances of great loss in the underwriting business like the Hambourg fire on May 4, 1842 in Germany made a number of German fire companies and British insurers seriously embarrassed as they were not in position to handle the whole of the claims, and many insurance companies became insolvent and began to demand reinsurance facilities.[7] Similarly, the Glarus fire in 1861 made a number of Swiss companies become insolvent and some even went bankrupt.[8]

Private insurance companies faced declining profits due to growing risks in underwriting activities. They felt the need to develop strategies to minimize underwriting losses and increase profits to provide shareholders with adequate return on their investment. To achieve this, insurance companies engaged in financial activities by reinvesting premiums generated from their underwriting activities into interest-generating assets.[9] Profits made from investments were used to cover the losses incurred in the underwriting business.[10] This practice enabled insurers to achieve their purpose of indemnifying victims, all while remaining profitable. By 1990, most insurers engaged in financial activities and they became important investors and intermediaries in a broad range of financial markets, investing in assets such as; bonds, unit-linked services, real estate and other asset-backed securities.[11]

However, the threat of financial instability was still looming as the investments of underwriting premiums in financial activities created a liquidity risk.[12] In addition to that, the growing risks in underwriting activities coupled with risks associated to financial activities made it difficult for insurance companies to maintain financial stability. Many insurance companies were faced with insolvency or bankruptcy resulting from their involvement in financial activities. This is evident by the number of insurance companies that went bankrupt following the deterioration in credit and equity markets in 2001.[13] Other cases like the Conseco[14] that went bankrupt due to bad investments and Executive Life Insurance Company that went bankrupt following disastrous investments in junk bonds.[15]

Over time, the level of insured risks continued to increase beyond the risk tolerance of insurers thus, increasing insurers’ exposure to potential losses. In order to manage these larger pools of risks, insurers traditionally resorted to sharing risks among each other (the practice of reciprocity).[16]  However, this practice proved to be unsuccessful as it required competitors to grant each other access to their books. This practice also increased the likelihood of accumulating risks regionally and in certain lines of business. An alternative measure was cross-border reinsurance but that meant capital will flow out of national economies.[17]

Reinsurance is insurance of insurance companies.[18] The oldest reinsurance contract on record was signed in July 1370, when an underwriter named Guilano Grillo contracted with Goffredo Benaira and Martino Sacco to reinsure a ship on part of the voyage from Genoa to the harbor of Bruges.[19] James Allen Park states that “re-assurance, as understood by the law of England may be said to be a contract, which the first insurer enters into, in order to relieve himself from those risks which he has incautiously undertaken, by throwing them upon other underwriters who are called Re-assurers.”^[20] Insurers use reinsurance to achieve an optimal targeted risk profile[21] which will enable them to remain solvent. Reinsurance is a risk management tool that makes use of risk sharing measures to limit insurers’ risk exposure, increase its underwriting capacity, offers capital relief, and improves insurers’ solvency ratio and profitability.[22] Though reinsurers typically assumed insurers’ insurance related risks, in the 1990s, reinsurers started providing reinsurance investment-related products (such as financial reinsurance) which could be used to support investment risks. This innovation coupled with the fact that reinsurance already provided capital relief which helped increase insurers’ financial activities, extremely increased the overall profitability of insurance companies.[23] By so doing, reinsurance played a vital role both for insurers’ underwriting activities and financial activities. The raison d’etre of Reinsurance is to protect and promote the insurance industry.

Until recently, California’s state laws restricted insurers to impute the cost of reinsurance in fixing the premium price. This greatly limited reinsurance cessions abroad thus, ensuring domestic risk retention capacity. However, the recent California fires brought another huge blow to the California insurance industry with a loss of about 30Billion USD dollars.[24] Though there is no report of insurance company that went bankrupt due to the fire, it greatly affected their solvency. This was the last straw that led many insurance companies to leave the state thus, weakening the insurance industry. It is only thanks to the reinsurance program subscribed by the California State FAIR Plan[25] that stabilised the losses and enabled the FAIR Plan to remain afloat. Today, the state of California tries to tailor its law to encourage cross-border reinsurance while still maintaining an average level of local reinsurance capacity.[26]

The impact of cross-border reinsurance on capital outflow feared by western insurance companies at the time became a reality in Africa. By 1974, Africa had exported more than 200Billion FCFA in reinsurance premiums.[27] This was attributable to the fact that during the colonial period, Africa’s insurance industry was dominated by foreign insurance companies from colonizing nations who reinsured in their home countries. This greatly affected the local insurers’ over-all risk sharing capacity and financial activities.[28] Reinsurance seemed to be a plausible solution to the growing level of insured risks and to promote financial activities, but its global unregulated nature made countries to reconsider. To ensure that insurance industries could get the most out of reinsurance’ risk sharing capacity and ability to sustain financial activities without threatening the domestic industry, countries felt the need to establish solid domestic legal and institutional reinsurance frameworks to promote local reinsurance industry. This led to the birth of regional, sub-regional and national reinsurance companies such as Africa Re, CICA-RE and Nigeria-Re.

The situation of California demonstrates an example of how reinsurance laws and regulations when adequately drawn and implemented in relation to the country, effectively ensures coverage of insurance risks and sustains financial activities, protecting the insurance industry.

1.2 STATEMENT OF THE PROBLEM

Originally, reinsurance was established as a mechanism to ensure coverage of insurance risks through risk sharing. Today, reinsurance is also an important tool in promoting financial activities which promotes economic growth. Cameroon reinsurance laws are tailored to enhance local reinsurance industry, since effective risk sharing through reinsurance is highly dependent on the local reinsurance industry. Article 308 of the CIMA Code[29] for example, sets a limit to the portion of risks ceded abroad however, many insurance companies in Cameroon still tend to excessively rely on foreign reinsurers as they continue to cede most of their risks abroad. Moreover, leading insurance companies in Cameroon are foreign owned and they mostly rely on their home reinsurers abroad. Despite these laws, the Cameroon local reinsurance industry is still weak. In 2021 non-life reinsurance and life reinsurance in Cameroon was close to 50Billion FCFA[30] and 3Billion FCFA[31] respectively with more than half being reinsurance cessions abroad. This leads to huge premium outflow which negatively impacts financial activities.

1.3 RESEARCH QUESTIONS

1.3.1 General Research Question

To what extent does legal mechanisms governing reinsurance promote risk sharing and financial activities in Cameroon?

1.3.2 Specific Research Questions

• What are the concept and measures of reinsurance?
• What is the legal, institutional and policy framework governing reinsurance in Cameroon?
• How effective are reinsurance laws in ensuring risk sharing and financial activities?
• What policy recommendations can be made to ameliorate the situation?

1.4. RESEARCH OBJECTIVES

1.4.1 General Research Objective

To determine the extent to which legal mechanisms governing reinsurance promote risk sharing and financial activities in Cameroon.

1.4.2 Specific Research Objectives

• To discuss the concept and measures of reinsurance.
• To examine the legal, institutional and policy framework governing reinsurance in Cameroon.
• To assess the effectiveness of reinsurance laws in ensuring risk sharing and financial activities.
• To propose policy recommendations to remedy the current situation.

[1] M. S. Tumnde, Insurance Law in Cameroon, 1st ed. (Limbe: Presses Universitaire d’Afrique) 2012 at p.21.

[2] Op Cit at p. 25.

[3] Amish Tripathi, “Importance of insurance-Need for insurance”, Available at https;//www.iciciprulife.com/amp/insurance/insurance-importance.html (Visited on the 17/02/2025).

[4] Charles Farley Trenerry., “A History of Insurance” (2017) Available at https;//www.swissre.com (Visited on the 17/02/2025).

[5] M. Maggioni and G. Turcheti, “Underwriting Process” Springer, (2024), pp 453-470

[6] E.R.H. Ivamy, General Principles of Insurance Law. 4^th ed., London: Butterworths, 1979 at p. 3.

[7] Edwin W. Kopf, FCAS, “The Origin and Development of Reinsurance,” Proceedings of the Casualty Actuarial Society (Casualty Actuarial Society) XVI (1929), p. 29.

[8] Charles Farley Trenerry., “A History of Insurance” (2017) Available at https;//www.swissre.com (Visited on the 17/02/2025).

[9] S. Ross, “How do insurance companies make money? Business Model Explained”(2024) Available at https://www.investopedia.com/ask/answers/052015/what-main-business-model-insurance-companies.asp (Visited on the 17/02/2025).

[10] International Monetary Fund, Global Financial Stability Report, (June 2002). Available at https://www.elibrary.imf.org/display/book/9781589061316/C3.xml (accessed on 17/02/2025).

[11] ibid

[12] Insurance companies need to hold liquid to be able to compensate victims in case the insured event occurs. However, by investing premiums in fixed assets, it considerably reduced their liquidity at hand.

[13] International Monetary Fund, “Global Financial Stability Report”, (June 2002). Available at https://www.imf.org (visited on the 18/02/2025).

[14] ALTA, “Conseco Bankruptcy Among Largest in U.S. History” available at https://www.alta.org (accessed on 18/02/2025).

[15] Atlas Magazine, “Bankruptcy of insurance and reinsurance companies in the United States” available at https://www.atlas-mag.net (accessed on 18/02/2025).

[16] Charles Farley Trenerry., “A History of Insurance” (2017) Available at https;//www.swissre.com (Visited on the 18/02/2025).

[17] Ibid premium outflow is a determinant of the level of risk cessions abroad.

[18] National Association of Insurance Commissioners, Reinsurance, available at https://content.naic.org (accessed 15/02/2025).

[19] Edwin W. Kopf, FCAS, “The Origin and Development of Reinsurance,” Proceedings of the Casualty Actuarial Society (Casualty Actuarial Society) XVI (1929), p. 29.

[20] J. A. Park, A System of the Law of Marine Insurances, 2^ND Ed., (Massachusetts, 1799) p 277.

[21] An optimal targeted risk profile is the ideal level of risks that an insurer aims to retain based on their risk tolerance, business objectives and market conditions.

[22] I. M. Ondo, Reinsurance in the CIMA Zone, (France: Edilivre, 2017), p 40.

[23] They provided Alternative Risk Transfer products, Finite Reinsurance, Reinsurance-backed securities, Asset-management, Specialized reinsurance programs for investment risks and investments.

[24] ABC News, “LA Fires insured loss estimation” available at https://abcnews.go.com (Accessed on 19/02/2025).

[25] Insurance Insider, Reinsurance program of California FAIR Plan available at https://www.insuranceinsider.com/article/2eb647pie0zix5vq0qwow/all-topics/catastrophe-losses/california-fair-plan-confirms-900mn-retention-5-78bn-re-limit accessed on (14/02/2025).

[26] Reinsurance is meant to facilitate risk sharing between insurers and reinsurers, allowing them to pool and manage risks more efficiently. It is created to support/maintain insurance industry by assuming risks (underwriting or investment risks). However, excessive reliance on foreign reinsurers as was the case for Africa, caused huge premium outflow which meant that a significant portion of risks were ceded abroad. This reduces the domestic risk retention capacity of insurance companies leading to reduced competitiveness, higher premiums, reduced product offerings, decreased financial stability, reduced contribution to economic growth. It also reduces financial activities of insurance companies since they do not have enough premium to invest. Conversely, California’s non reliance on cross-border reinsurance affected its insurance industry demonstrating that domestic insurers risk tolerance could not support the domestic risks.

[27] M. Pilon and C. Brenery, “Le soleil des Assurances” Politique Africaine, (1988), p.102-107 Available at www.persee.fr  (Visited on the 18/02/2025).

[28] Large premium outflow results from large risks ceded abroad risks that could be shared among local insurers. This reduces the risk retention capacity of local insurers. Premium outflow also leads to reduced capital adequacy of insurance industry thus, undermining its financial stability.

[29] States that more than 75% of the risk located in a member State should not be reinsured out of the Member State without the approval of the minister in charge of insurance of that state.

[30] Association des Sociétés d’Assurances du Cameroun (ASAC), ASAC Rapport Statistiques et Financier 2021. Available at https://www.asac-cameroon.org (accessed on 14/02/2025). p.99.

[31] Ibid p. 130.