Sep 10 , 2022

Africa-Re, a continental reinsurance firm, has introduced stringent requirements for domestic insurance firms issuing advance payment guarantees and performance bonds to contractors.

Its executives impose on all insurers to hold collateral with half the value of advance payments and performance bonds they issue before they enter into any reinsurance deals with the firm. The decision comes at the backdrop of growing claims against performance and advance payment guarantee bonds issued to grade-one contractors.

Thirty-six African countries established Africa-Re in 1976; the firm operates with a paid-up capital of 286 million dollars. It provides reinsurance services to 113 insurance firms in 42 countries, including Ethiopia, where it is one of the five reinsurers, claiming a 40pc market share.

Its representative in Ethiopia, Habtamu Debela, wants to see the decision serve as a wake-up call to the growing ranks of insurance firms here.

“Insurance companies are finding themselves in a precarious position due to unserviced bonds,” he told Fortune.

Africa-Re’s new rules come when price-based competition among the 17 insurance firms is at its peak. The problem is more visible in private insurance firms competing against each other to secure clients, says Ebsa Mohammed, an insurance expert and manager at Alpha Consultancy. The cutthroat competition drives insurers to issue advance and performance bonds without collateral.

Although some insurers, such as the state-owned Ethiopian Insurance Corporation, require collateral covering half and full of the bond value to issue guarantees to contractors below grade four, most do not hold sufficient collateral to shelter themselves from risk.

“Africa-Re is the lead reinsurer on the continent,” said Dawit Gebreamanuel, chief executive officer (CEO) of Ethiopian Reinsurance (Ethio-Re). “Other reinsurers must apply similar requirements.”

Insurance companies can only issue conditional guarantee bonds, payable upon proof of breach of the contract terms with project owners. Commercial banks, too, issue both conditional and unconditional guarantees bonds.

Insurance firms charge between one percent and 1.25pc on the value of the performance bonds and advance payment guarantees they issue, respectively. Most insurance firms do not require collateral from construction companies when issuing demand securities. Instead, they transfer up to 90pc of the risk to reinsurers.

Insurance firms shoulder a fraction of the burden, according to Dawit.

With a paid-up capital of over one billion Birr, Ethio-Re maintains a 25pc market share.

Insurers’ retention ratio, which refers to the share of premiums they pass on to reinsurance companies, goes as high as 50pc. However, regulators at the National Bank of Ethiopia (NBE) cap the industry’s gross retention to no more than 10pc of capital and reserves.

Belay Tulu, NBE’s head of the insurance supervision directorate, warned several insurance firms two months ago for violating rules to deal with risks. Industry executives, however, say they find it challenging to comply with the rules.

Project owners like the Ethiopian Roads Administration (ERA) require performance and advance payment guarantee bonds from contractors before awarding contracts, which are often high-value. Disputes over guarantee bonds between financial institutions and project owners have become common in recent years.

The ERA delisted several commercial banks and insurance firms for allegedly failing to fulfil their obligations on time. The list includes Bunna, Lion, Abay, and Berhan insurance companies. Last year, ERA also debarred seven commercial banks from issuing bonds. The Administration lifted the ban on Tsehay Insurance S.C. after the insurer paid a settlement of 4.7 million Br for an advance payment guarantee bond it had issued to Akir Construction more than seven years ago.

Shimeles Gedlegiorgis, chief executive officer (CEO) of Ethio Life & General Insurance (ELiG), concedes that claims against advance payment and performance bonds are rising. Incorporated in 2008, ELiG recorded a profit of 22.7 million Br last year while it ceded 94.7 million Br to reinsurers.

“The collateral should match the contractors’ capacity,” said Shimeles.

Tamrat Wondemu, general manager and principal shareholder of Yirgalem Construction, a grade-one contractor, agrees. He sees rising costs for construction inputs as causing a major concern for the construction industry. Unlike commercial banks, which require collateral, insurance firms issue bonds for advance payments and performance based on the track record of contractors.

Wondemu Assefa, head of general insurance underwriting at Awash Insurance, observes that it will be difficult for most contractors to meet the terms under an inflationary economy and unforeseen issues with projects, such as right-of-way disputes.

An industry leader, Awash maintains its position as one of the highly capitalized firms, boosting its paid-up capital to 755 million Br. The firm reported 270 million Br profits in 2020/21, a 23pc jump. It ceded 466.8 million Br to reinsurers that year.

Ebsa cautioned Africa-Re executives that although introducing the requirement could be an appropriate decision, it is crucial to implement it gradually to get contractors accustomed to it.

PUBLISHED ON Sep 10,2022 [ VOL 23 , NO 1167]

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