REINSURANCE PRACTICES AND UNDERWRITING CAPACITY OF

INSURERS IN NIGERIA
 CHAPTER ONE

1.0 INTRODUCTION

1.1 BACKGROUND TO THE STUDY

Every sphere of life endeavour is faced with one risk or the other. These risks

are so numerous and affect everyone either as individuals, corporate

organisations, society or nation as a whole. Hence, risk is an uncertainty

concerning loss, injury or gain (Loomba, 2014). This assertion presumes that

the thrust of risk from insurance point of view includes unpredictability, adverse

deviation, uncertainty and possibility of unfortunate occurrence which are all

linked to economic losses. Though, unpredictability of risk may not be

eradicated, it may however be reduced or managed. The process of managing

risk is known as risk management. Insurance therefore is seen as the driving

force of modern or formal risk management because it seeks to discover the

source, from which risk may emanate, evaluates its impact on an organization or

individual and apply appropriate treatment to it (Loomba, 2014; Oluoma, 2014).

Insurance is a form of risk management in which the insured transfers the cost

of potential loss to another entity in exchange for monetary compensation

known as the premium. Insurance In economic terms is refers to the pooling

mechanism for reducing the down-side of risk through resource reallocation

from good to stormy states of the world (Masci, Tejerina and Webb, 2007).

Insurance facilitates financial protection against by reimbursing losses during

crisis. It is designed to protect the financial well-being of an individual,

company or other entity in the case of unexpected loss. This protection is

accomplished through a pooling mechanism whereby many individuals who are

vulnerable to the particular risk are joined together into a risk pool. Each person

pays a small amount of money, known as a premium, into the pool, which is

then used to compensate the unfortunate individuals who do actually suffer a

loss. (Churchill, Craig, Liber, McCord, and Roth, 2003)

In the Nigerian context, the insurance sector holds immense potential due to its

fast-growing economy, expanding population, and increased need for risk

management. The industry is integral to the country's financial ecosystem, yet it

remains significantly underdeveloped compared to its potential (Olowe, 2023).

Nigeria has one of the lowest insurance penetration rates in the world, currently

estimated at less than 1% of the gross domestic product (GDP), compared to

over 7% in some developed countries (Agusto & Co, 2023). This is despite the

country's vulnerability to various risks, including natural disasters like flooding,

agricultural risks, health emergencies, and socio-political uncertainties.

Several factors contribute to this low insurance penetration in Nigeria. First,

there is widespread ignorance and mistrust of insurance among the general

population, which limits market growth. Cultural beliefs and misconceptions

about insurance also play a role in the lack of adoption, with many Nigerians

viewing it as unnecessary or untrustworthy (Babalola, 2023). Moreover,

operational inefficiencies, outdated technology, and weak regulatory

frameworks have also hindered the industry's development (Oseni, Adeoye, &

Ajayi, 2023). The lack of adequate risk assessment tools and skilled personnel

in the insurance sector has further compounded the problem, making it difficult

for companies to underwrite risks effectively and grow their portfolios

sustainably.

In this challenging environment, reinsurance has emerged as a vital risk

management tool for insurance companies. Reinsurance allows insurers to

transfer portions of their risks to larger, more specialized firms, thereby

reducing the financial burden of large or unpredictable claims (Niehaus &

Terry, 2020). It provides a buffer that enables insurers to absorb losses from

significant claims without compromising their solvency or financial stability.

This mechanism not only helps insurers manage their risk portfolios but also

enhances their capacity to underwrite larger or more complex risks (Cummins

& Song, 2008). Reinsurance has become increasingly important in markets like
Nigeria, where local insurers are often financially constrained and lack the

technical expertise to handle large-scale risks on their own (Ogunleye, 2021).

In the global insurance market, reinsurance plays a central role in safeguarding

the solvency of insurers and ensuring market stability. The reinsurance industry

has evolved significantly over the past century, adapting to new and emerging

risks such as climate change, cyberattacks, and global pandemics (Swiss Re,

2021). Major reinsurance companies like Munich Re, Swiss Re, and Hannover

Re dominate the global market, providing coverage for a wide array of risks,

including natural disasters, industrial accidents, and political risks. These

companies possess extensive financial resources and expertise, allowing them to

absorb large losses that would be catastrophic for primary insurers (Doherty,

2019).

In developing economies like Nigeria, reinsurance serves as a critical tool for

insurers to manage risk effectively. The country is prone to various forms of

catastrophic risks, including floods, droughts, and other weather-related

disasters exacerbated by climate change (Olawoye et al., 2023). These risks

have placed tremendous pressure on local insurers, many of whom struggle to

stay afloat in the wake of large claims. As a result, the demand for reinsurance

has grown steadily over the past decade, as Nigerian insurers seek to protect

themselves from major financial shocks and improve their operational resilience

(Akinyemi & Olajide, 2022).

Despite this growing awareness, the reinsurance market in Nigeria is still in its

nascent stages, with limited local capacity to absorb large-scale risks. Local

reinsurance companies, such as Africa Re and Nigerian Reinsurance

Corporation, often lack the financial strength to provide adequate coverage for

large risks. As a result, Nigerian insurers frequently turn to international

reinsurers for support, leading to significant capital flight as premiums are paid

to foreign firms (Akinwale & Thompson, 2021). This has prompted calls for

greater investment in the local reinsurance market to retain capital within the

country and improve the overall capacity of the Nigerian insurance industry.

Underwriting is a core function of any insurance operation. It involves assessing

and evaluating the risks presented by potential policyholders and determining

the terms and pricing of insurance coverage. Effective underwriting ensures that

insurers only take on risks that are adequately priced, thereby safeguarding their

financial stability. However, the underwriting capacity of insurers in Nigeria is

often constrained by several factors, including limited access to reliable data,

outdated risk assessment methodologies, and a shortage of skilled personnel

(Ajiboye, 2023).

Many Nigerian insurance companies still rely on manual processes and outdated

tools for risk assessment, which limits their ability to underwrite large or

complex risks accurately. This is particularly evident in sectors such as

agriculture and health, where the absence of reliable historical data makes it
difficult to price risks effectively (Ekanem, 2022). Furthermore, political and

economic instability in Nigeria creates additional challenges for underwriters.

The unpredictability of these external factors makes it harder to forecast risks,

leading to inefficiencies in pricing policies and managing claims (Ugbomoiko,

2023).

In the face of these challenges, many insurers in Nigeria have turned to

reinsurance as a way to bolster their underwriting capacity. Reinsurance

agreements allow insurers to transfer some of their risks to specialized

reinsurance firms, which possess more advanced risk assessment tools and

greater financial resources (Ayinde et al., 2022). By partnering with reinsurers,

Nigerian insurers can manage larger risks, improve their operational efficiency,

and reduce their exposure to catastrophic losses. This has become especially

important in the face of increasing climate-related risks, which have

significantly impacted the Nigerian insurance market in recent years (Olawoye

et al., 2023).

Reinsurance is not only a tool for risk transfer but also a critical resource for

improving underwriting practices. Reinsurers typically offer technical support

and expertise to their clients, helping them to improve their risk assessment

processes and enhance their pricing models (Kavussanos, Visvikis &

Dimitrakopoulos, 2017). This partnership between primary insurers and

reinsurers leads to better decision-making and more accurate pricing of risks,

thereby increasing the capacity of insurers to handle large-scale claims.

In Nigeria, reinsurance has played a pivotal role in stabilizing the insurance

market by enabling local insurers to manage larger risks more effectively. For

instance, a study by Njoku and Agwu (2023) found that reinsurance has helped

Nigerian insurers mitigate the financial impact of large claims, thereby reducing

the volatility of their financial performance. The study also emphasized the

importance of reinsurance in enhancing the operational efficiency and

profitability of insurers, particularly in markets characterized by economic

uncertainties and evolving risks.

Moreover, reinsurance agreements often come with clauses that provide primary

insurers with access to the reinsurer's technical expertise. This includes

assistance with risk assessment, pricing strategies, and loss prevention

measures, which can significantly improve the underwriting processes of the

primary insurer (Akinwale & Thompson, 2021). This collaborative approach

has been especially beneficial for Nigerian insurers, who often lack the

technical capacity to accurately assess complex risks on their own.

The Nigerian insurance industry is regulated by the National Insurance

Commission (NAICOM), which oversees both the primary insurance and

reinsurance markets. In recent years, NAICOM has implemented several

reforms aimed at improving the regulatory framework for reinsurance and

strengthening the capacity of local insurers to manage risks. These reforms

include guidelines for minimum capital requirements, solvency margins, and

risk-based supervision, all designed to enhance the stability and resilience of the

industry (NAICOM, 2021).

One of NAICOM's key objectives has been to encourage greater collaboration

between local and international reinsurers. This is seen as a way to improve

knowledge transfer, enhance underwriting standards, and reduce the reliance on

foreign reinsurers, which has led to significant capital outflows from the

Nigerian economy (Odewunmi, 2022). To support this initiative, NAICOM has

introduced policies that incentivize the use of local reinsurers and has called for

increased investment in the domestic reinsurance market to boost its capacity.

Despite these efforts, challenges remain. Many smaller insurance companies in

Nigeria struggle to afford the premiums required for adequate reinsurance

coverage, leaving them overexposed to large-scale risks. This has raised

concerns about the long-term sustainability of the industry, particularly in light

of the increasing frequency of catastrophic events such as floods and droughts

(Fadeyibi & Abdullahi, 2023). As a result, industry experts have suggested that

the Nigerian government should consider providing subsidies or other forms of

financial support to help local insurers access reinsurance and improve their risk

management capabilities (Olawoye et al., 2023).

The performance of an insurance industry depends to some extent on the

fundamental financial risk-spreading function of and sort of underwriting

services provided. Over-pricing of risk may lead to fewer customers joining the

insurer for insurance cover, while under-pricing of risk on the other hand may

result to loss or low performance for the insurance industry in Nigeria

(Dorfman, 2005; Teale, 2008). In fact whether reinsurance practice impacts

negatively or positively on underwriting capacity among insurance firms in

Nigeria is an empirical fact that this study hopes to reveal. Hence, the

undertaking of this research study will critically assess the effect of reinsurance

practices on underwriting capacity of insurers in Nigeria.

Insurance companies strive to remain solvent and profitable so they can pay out

claims when necessary. Reinsurance, effective underwriting, and proper claims

management are vital tools that enable insurers to meet these objectives.

However, in Nigeria, many insurance companies face challenges in assessing

risks accurately, leading to early claim settlements that strain their financial

resources. Poor underwriting practices often result in adverse risk selection,

which undermines the insurer's profitability and solvency.

The failure of several insurance companies in Nigeria can be traced to

deficiencies in underwriting capacity and an inability to manage risks

effectively (Irekwu, 1985; Uche, 1997). This issue becomes particularly

problematic when insurance companies rely on outdated risk assessment

methods and lack access to continuous education and professional development

for underwriters. Moreover, past research on this subject has been limited in

scope and depth, offering little insight into the practical relationship between

reinsurance and underwriting capacity in Nigeria (Chibuike & Chikeleze, 2001).

This study aims to fill this gap by providing a comprehensive analysis of how

reinsurance practices influence the underwriting capacity of insurers in Nigeria,

with a focus on strategies that can improve the efficiency and profitability of the

insurance sector.

1.2 STATEMENT OF THE PROBLEM

The primary aim of any insurance company is to attain profitability while

ensuring solvency to fulfill claims when insured events arise. This solvency is

accomplished through a combination of effective reinsurance, robust

underwriting practices, and efficient claims management, which together

enhance the financial performance and sustainability of insurance firms (Bohn

& Hall, 2020; Lechner, 2019).

While reinsurance serves as a vital tool to shield insurers from significant

losses, there is an increasing necessity to evaluate the capabilities of

underwriters in selecting and assessing risks. Effective underwriting entails

recognizing risks that correspond with the insurer’s risk appetite while

establishing appropriate conditions for those that do not. This aspect is

particularly crucial, as the financial stability of an insurer is contingent upon

these underwriting choices (Dionne & Triki, 2013; Biener & Eling, 2019).

In Nigeria, the collapse of numerous insurance companies can be attributed to

underwriters' failure to adequately evaluate risks, resulting in premature claims

settlements that ultimately diminish company profits. For example, in the realm

of motor insurance, premiums fluctuate based on factors such as driver risk and

vehicle characteristics. In the absence of thorough risk assessment, insurers are

confronted with early claims payouts, leading to financial detriment (Adeleke &

Shittu, 2022). To address this issue, it is imperative that underwriters engage in

ongoing professional development and that independent study programs be

made accessible. Such initiatives would improve their capacity to effectively

analyze insurance applications and assess risks (Olowu & Obafemi, 2021).

Despite the essential functions of reinsurance and underwriting, research on this

topic in Nigeria remains scarce. Existing studies, including those by Irekwu

(1985), Uche (1997), and Chibuike & Chikeleze (2001), are predominantly

outdated, theoretical, and lacking in depth. Furthermore, these studies provide

subjective perspectives rather than objective, data-driven insights.

1.3 OBJECTIVES OF THE STUDY

The objectives of this study are:

 i. To examine the relationship between reinsurance practices and the

underwriting capacity of insurers in Nigeria.

ii. To analyze how risk selection by underwriters impacts the profitability

of insurance companies.

iii. To propose actionable recommendations for improving the

underwriting capacity of insurance companies in Nigeria.

1.4 RESEARCH QUESTIONS

i. Is there a relationship between reinsurance practices and the

underwriting capacity of insurers in Nigeria?

ii. How does the risk selection process by underwriters affect the

profitability of insurance companies?

iii. What strategies can improve the underwriting capacity of insurance

companies in Nigeria?

1.5 RESEARCH HYPOTHESES

Hypothesis One:

 Ho: There is no significant relationship between reinsurance practices

and the underwriting capacity of insurers in Nigeria.

 Hi: There is a significant relationship between reinsurance practices and

the underwriting capacity of insurers in Nigeria.

Hypothesis Two:

 Ho: Risk selection by underwriters does not significantly impact the

profitability of insurance companies.

 Hi: Risk selection by underwriters significantly impacts the profitability

of insurance companies.

1.6 SIGNIFICANCE OF THE STUDY

This research will combine both financial and non-financial performance

metrics to assess the impact of reinsurance on the underwriting capacity of

insurers in Nigeria. The findings will provide valuable insights for insurance

companies looking to improve their risk management and capital utilization.

Additionally, regulatory bodies and industry stakeholders will benefit from the

study’s recommendations on enhancing underwriting practices and ensuring the

long-term stability of the Nigerian insurance industry.

Furthermore, this study will contribute to the academic literature on reinsurance

and underwriting by providing empirical evidence on the relationship between

these two critical components of the insurance sector in Nigeria. The findings

will also be useful to policymakers aiming to strengthen the regulatory

framework governing the Nigerian insurance industry.