The Central Bank of Nigeria (CBN) had recently released the framework for re-introduction of managed float exchange rate system. The new flexible foreign exchange (FX) interbank trading window will be purely driven by the Market forces.
The new FX system is expected to eliminate the widened gap between the official and parallel FX market rates which existed in the preceding fixed FX policy regime that created arbitrage opportunities. In addition, the new flexible FX policy has removed the controls on the naira (i.e. currency peg), thereby increasing the supply of foreign currency and hence the liquidity in the FX market, which would strengthen the Nigerian economy.
The increased liquidity would be achieved through the CBN’s secondary market intervention of sales in spot and forward contracts via the Over-The-Counter (OTC) market periodically and/or the expected increasing inflow of foreign portfolio investors to the country. Furthermore, the attraction of Foreign Direct Investment (FDI) will increase merger and acquisition (M & A) activities in different sectors of the economy including the insurance industry. This would require more regulation and supervision from the regulators including NAICOM.
The liquidity in FX market will also cause the exchange rates to rise in favour of the naira and this will enable the importers of goods that are essential but not produced in Nigeria to import them through their banks, leading to an increase in demand for marine insurance.
The flexible FX system is expected to bolster investors’ confidence in the country’s stock market which will result in high expected investment returns over the longer term.
Furthermore, certain economic activities within the economy are likely to increase as a result of the new FX policy which will lead to a high demand for insurance. For example, the resumption of trade & project financing transactions through the banks, foreign airline operators would resume full operations in the country, manufacturers are no longer starved with foreign currency to buy raw materials and equipment etc.
Above all, the extent to which the CBN new policy affects the(re)insurers (the reinsurance / insurance companies respectively)depends on the type of insurance business underwritten which, for the purpose of this discussion, can be broadly classified into two categories, namely local currency (Nigeria naira) denominated insurance policy and foreign currency (US dollar) denominated insurance policy.
The impact of the CBN new policy on each category of business and resultant risks facing the (re)insurers are highlighted below.
Impact of FX policy on local currency denominated insurance policy
A local currency denominated insurance policy is a policy underwritten with the premium, sum insured or reinsurance recoveries and claims settlements payable in Nigeria naira e.g. Marine (Hull and Cargo) insurance, engineering, insurance bonds, domesticated reinsurance contracts etc.
The new floating exchange rate regime is likely to result in high inflation rate and thus, individuals will be conscious of their spending patterns thereby not spending so much on non-essential goods and services such as taking up an insurance policy except for Motor insurance which is compulsory. This will reduce the insurance premium income for the insurer.
The government, having converted dollar earnings from the sale of crude oil using the floating currency rate instead of the fixed currency rate, would have more funds to finance capital projects that does not require foreign transactions such as construction of buildings, roads, hospitals etc. all of which will require the contractors to submit evidence of some insurances to the Government such as insurance bond contracts, contractors’ all risk insurance, erection all risk insurance, life assurance policy, motor insurance, employers’ liability insurance etc. This will increase gross premium income for (re)insurers.
The availability of foreign exchange through the CBN new FX policy will encourage importers with genuine need for importation of raw materials and other commodities thereby increasing marine insurance patronage. It is mandatory for all imported goods to be insured by Nigerian underwriters.
Marine cargo insurance is underwritten on agreed value basis with the imported value (in US dollar) being converted to naira to determine the amount to be insured (Sum Insured) at inception of the contract. The premium payable will also be in naira value. In the event of a claim, irrespective of the dollar exchange rate at the time of claim, the sum insured (in naira) at the policy inception will be the basis of indemnity and not the naira equivalent of the current dollar figure.
The Nigerian economic crisis is playing havoc with currency exchange rates. Currency fluctuations can create inadequate marine insured values for the policyholder. The implications of significant fluctuations in currency exchange rates can be serious, particularly for ship-owners, importers and exporters because their marine insurance may no longer cover them for the full amount in the case of loss or damage.
For example, a recent Nigerian marine insurance claim involved the total loss of a key piece of machinery enroute from the US. The importer received the claim payment but when the importer reordered the machinery, the cost was 70% higher because of changes in the exchange rate. This was not covered by the importer’s insurance policy which leads to a foreign exchange transaction risk facing the importer (i.e. the insured).
In addition to the higher re-order cost, the importer suffered further extra amount which had to be paid in interest to the bank that financed the original purchase, not to mention the Loss of Profit or Consequential Loss insurance, which an experienced insurance broker would not forget to recommend to the importer for an additional premium.
Under a reinsurance arrangement, the insurer still pays reinsurance premium in naira value for the capacity agreed and also receives the recoveries in naira value. Thus, the insurer is not directly and adversely affected by the CBN new FX policy when having (re)insurance arrangements to cover the marine insurance contracts. The risks associated with this category of business underwritten, arising from the CBN new FX policy, could be within the insurers’ risk appetite.
- To be Continued tomorrow
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