Can we stop calling reinsurance reinsurance--please? There are many reasons to mistrust, even hate the word. It is inaccurate, it is vague. Worse yet, the word in its graphic simplicity is an insult to the insurance executives, brokers and the reinsurance executives who perform these useful, creative feats that fall under the category of--excuse the term--reinsurance.
What insurers and their clients have become savvier purchasers of and what's referred to as reinsurance is actually a complicated and layered allocation of capital. Call it contingency capital, call it fiscal gymnastics, if you must call it something, but please don't call it reinsurance.
One of the reasons why the game of buying reinsurance has changed is that buyers with primary carriers are, with the help of their brokers of course, more astute at analyzing the strength of their reinsurers. In fact, they've learned to be just as good as their reinsurers are at analyzing the cedants.
Decisions on the purchase of reinsurance have been quite literally kicked upstairs. Signing a $30 million reinsurance contract is taking place in the C-suite not among buyers representing the insurer or the primary insured.
The implementation of enterprise risk management in financial decisions, which may include the purchase of additional layers of insurance, has elevated the importance of the purchase of reinsurance as a tool to calibrate the capital allocation models required of regulators.
"That is a major change, it has changed completely the way in which we talk about it and the people with whom we are talking about it," says Chris Klein, the London-based head of business intelligence for Guy Carpenter and Associates.
Klein says that the decision on what agreements to sign that are going to augment the capital allocations of an insurance company today are happening in the offices of the insurance company CFO or even the CEO, not the underwriter's cubicle.
"I think it is fair to say that within insurance companies, and certainly the bigger ones, reinsurance is no longer seen as an underwriting decision," says Klein.
Reinsurance is purchased more selectively than in the past, agrees Ron Whyte, the former Guy Carpenter executive who now heads Integro's London-based reinsurance operation. "Things were a little bit more cavalier in the past. There really wasn't that much control over insurance buying within the insured and people weren't sure what reinsurance they had bought."
The softening market has thus restricted the purchase of some pieces of facultative reinsurance that were bought on the part of na´ve buyers in the past, Whyte says. "It is quite an unusual dynamic. I have been around for 20-odd years now and I have not seen a soft market where there was not a very soft facultative market that was helping to drive it."
SCRUTINY GOES BOTH WAYS
Underwriters say they are bringing more scrutiny to bear on their reinsurers and applying just as much face time to the spread of their reinsurers' risk as they are to their own.
"We underwrite the reinsurance as well, but the reinsurers are reinsuring a bunch of folks," said Steve Pozzi, the chief underwriting officer for Chubb Commercial Insurance, in an interview with Risk & Insurance« in April. "The thing that we have to remember is if they make bad decisions, and if the people they reinsure make terrible decisions, I'm dependent upon them later. So, we're really careful about that."
This much is clear: Underwriters don't want the reinsurer "driving the bus," so to speak. In other words, insurers are loathe to have reinsurers become their de facto chief underwriters.
"We've gotten much stricter in terms of the credit worthiness of our reinsurers as one of the key underwriting measures when we look at them," says Don Pickens, chief underwriting officer, national markets, for Liberty Mutual Group.
That tension between insurer and reinsurer is something Philadelphia-based attorney Joe Donley says he tries to help manage frequently. As a litigator, the insurance expert for the Philadelphia offices of Thorp Reed and Armstrong, Donley says he has seen what happens when reinsurers jump the curb.
"We have seen where reinsurers will become the underwriter because in essence you will have a broker come to a cedant and ask them to front on behalf of a reinsurer or a group of reinsurers," says Donley. "I have had several cases where I have represented the cedant where they were the fronting company where they took no retention or a very small retention and a group of foreign reinsurers were driving the bus, so to speak."
All well and good, so long as there are no claims, Donley says. But when claims start crashing in and the cedants turn to their reinsurance carriers only to find they are in runoff or that they've been bought, it becomes more difficult for the fronting carrier to cover the losses.
One way for primary insurers to avoid having their reinsurers drive the bus, says Patty Cella, a senior vice president for reinsurance placing and support for Novato, Calif.-based Fireman's Fund, is to have enough of a reputation as an underwriter that others that you do business with won't be tempted to "muddle," that is, demand to be the underwriter of your entire book just because they are doing business with you on one particular piece.
The other key way to keep at least one hand on the steering wheel is to retain significant retentions.
"I do think you have less of an issue with your reinsurers if you have a high degree of confidence that you do have the right talent and the right management and the right monitoring tools and a strategy that makes sense and that you are clearly executing year in and year out," says Cella.
"When you have a meaningful retention you already have skin in the game and that would preclude a reinsurer from wanting to get in there and muddle," she says.
The more solid the underwriter's reputation with its reinsurance partners, the less tempted reinsurers will be to meddle in the cedant's affairs. "I think that also facilitates an arrangement that is one where they are interested but they don't get in and try to manage what you are doing," she also says.
That's the ideal place to be, according to Whyte. But Whyte says reinsurance brokers have to occasionally engage in some handholding on both sides.
"It depends on if reinsurance is driving the whole deal and the original deal can't get done without the reinsurance," says Whyte. "Then we have to explain to the insurer that he does have to listen a bit more to the reinsurer because the deal won't come together without it."
The way to approach the issue is to treat the cedant and the reinsurer as members in a partnership of equals, he says, sort of like a marriage counselor.
"But where it does get contentious it's our job to sit down and say, 'Well, look, here is the reality of the situation here,' " he says.
Whyte says that it's in the realm of facultative reinsurance, those insurance coverages purchased for a particular deal, or to cover particular lines or pieces of business, where much has changed over the past few years.
A centralized approach to facultative reinsurance purchases is creating savings for primary insurers and top-level executives are paying attention. "I think over the last three years, people are becoming much more savvy about how they purchase facultative and treaty," says Whyte.
Where treaty purchases are traditionally seen to be the larger chunk of an insurance company's reinsurance purchases, Whyte says a more comprehensive approach to the topic of facultative reinsurance is producing results.
"We have gone in and worked with people and they have found out that, actually unbeknownst to them, they were spending sometimes as much, if not more, on facultative reinsurance as they were on the treaty purchase, which everybody knew was a big expense item and strategic purchase within the group," says Whyte.
With roughly 10 or 15 reinsurance carriers around the world raking in 80 percent of the premium on facultative reinsurance deals, he says, a centralized purchasing approach makes a lot more sense.
Times are relatively good for reinsurers, according to Guy Carpenter's 2008 report on the market. Capital is flowing into the industry, reinsurance losses in 2007 were low and the combined ratio for the top 10 reinsurers dipped below 90 percent. Nor was any reinsurance carrier of note--either by luck or by design--dragged into the subprime lending debacle.
An additional $7 billion in publicly disclosed issuances made 2007 a record for investments in catastrophe bonds.
Maybe that's why the conversations between reinsurers and their primary insuring clients tend to be so civil these days.
Cella, a 28-year veteran of the industry, says she's never felt more comfortable with her reinsurers or detected more ease in their relationship with her. Yes, reinsurers are interested in how she is running her business, but they stop short of stepping on her toes, she says.
"I can't think of good examples where reinsurers have made demands that we change what we are doing or that they have imposed requirements that were difficult for us. It could be a little bit chicken and egg in that if we were already imposing those things on ourselves, why would they?"
DAN REYNOLDS is senior editor of Risk & Insurance«.
September 1, 2008
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