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Given the rate of property-and-casualty insurer insolvencies in recent years, it is no surprise that risk managers and brokers are concerned about the security of the carrier they entrust with their risk. The larger their risk, the larger their concern. Consequently, insurance buyers in industries such as energy, where losses are often catastrophic, are expanding efforts to ensure the security of their insurer by probing deeply into a facet of their insurer's operations that used to garner little attention from insurance buyers: its reinsurer relationships.

Very often a carrier's reinsurance relationships will mean the difference between a long-term capital commitment or fleeting market participation; between year-to-year volatility in the terms, pricing and rates of a carrier's primary policies and its ability to offer consistency and stability through hard and soft market conditions.

How selective is the primary carrier in choosing its reinsurers?

If a carrier has a long list of reinsurance markets it considers qualified to provide its treaties, this should raise a red flag. One must wonder whether the carrier has set the bar high enough when it comes to the security of the reinsurance it purchases, or if the insurer changes markets frequently rather than forging lasting relationships with its chosen reinsurers.

Such a lack of selectivity is particularly dangerous in areas such as energy, where large amounts of quality reinsurance capacity are not easy to come by. A carrier that moves from market to market frequently is likely to have difficulty keeping treaty terms and capacity consistent. In addition, since the reinsurance industry remains volatile, will the reinsurers that the carrier works with be financially able to pay claims when the time comes?

Is the primary carrier sharing risk with its reinsurers?

Real risk sharing creates a spirit of partnership between a reinsurer and ceding company. When a primary carrier demonstrates that it has substantial "skin in the game," it gives its reinsurer confidence that there is a commitment to the served market and to underwriting its risks in a disciplined fashion. Consequently, the primary insurer will be better positioned to negotiate and maintain the reinsurance capacity, terms and conditions it desires.

Does the primary company actively engage the reinsurers in understanding its business and its market advantages?

Before a primary carrier can expect to achieve long-term security from its reinsurers, it must make a concerted effort to ensure that reinsurers understand the business it writes--and how well it is underwritten. This would typically be done through face-to-face meetings between the reinsurer and the primary company's engineering, underwriting and claims professionals.

Such interactions allow the reinsurer to appreciate the depth of a carrier's specialized expertise and gain a comfort level with the risks it is taking on. This is particularly important when the risks involved are large and complex, like those of the energy industry.

Will the primary carrier be surprised at claim time?

Facing unrelenting pressure on their own balance sheets, many reinsurers are not willing to pay claims as quickly to ceding companies as they have in the past. Consequently, it is critical that all parties, including the primary company's insureds, have common expectations of how the reinsurer-insurer relationship will play out at claim time. Inquiring as to a cedent's claims history with its reinsurers and the proportion of reinsurance claims in dispute can help illuminate how smooth the process might be.

So what does an optimal reinsurer-insurer relationship look like in a complex, high-stakes market such as energy?

-It is a relationship the primary insurance company has chosen carefully. If a carrier can point to a limited roster of highly rated reinsurers that it uses on its programs, insurance buyers should be reassured. This is an indication that the ceding company has a conscious strategy of building stable relationships with stable reinsurers. Such stability is likely to translate to the primary insured's business and, subsequently, result in consistency in the terms, conditions, rates and capacity of its insurance programs.

-It is a balanced relationship in which both parties have a substantial stake. Insurers in these relationships look to the reinsurance markets primarily to help build capacity for catastrophic risks, rather than to help arbitrage risk. Hence, the primary insurer actively retains substantial risk--as evidenced by its large net lines and diligent use of both quota share and excess-of-loss reinsurance treaties.

-It is a relationship built on knowledge and respect. The reinsurer in this relationship knows the risk engineering, underwriting and claims expertise that stand behind the primary company's book of business and has a high level of comfort with this insurer's approach. As a result, it is more likely to be comfortable devoting more capacity and more favorable terms and conditions to this ceding company year after year.

-It is a well-established relationship grounded in shared expectations. When reinsurers and cedents have taken the time to get to know each other well, surprises are rare. The reinsurer knows the ceding company's underwriting practices; the primary company knows the reinsurer's track record of paying claims in a timely fashion.

-Most of all, it is a relationship intended to last. Well-established relationships between sound, disciplined insurers and reinsurers are the ones most likely to result in eased, expedited claims payments for all parties. Moreover, when an insurer maintains strong, enduring ties with highly rated reinsurers, it is far less likely to have to alter underwriting terms and conditions to accommodate shifting treaties. It also will be far more likely to be able to secure the sound capacity it needs over the long term.

Secure reinsurance relationships translate to greater security for all parties in an insurance transaction--and these relationships are part of the value an insured buys when it purchases an insurance policy.

Given the financial volatility the reinsurance and insurance industries have experienced in recent years, a more holistic approach to evaluating the security of insurance carriers is prudent. Sure, insurance buyers must continue to carefully evaluate the balance sheet strength, experience and track record of a primary company and its parent.

But considering the relationships that a company has built to enhance its own security and that of its policyholders--its reinsurance relationships--is becoming increasingly common as well. This is a good thing for insurance buyers in the high-risk energy sector, or in any sector.

TOM ANGLEY is senior vice president, reinsurance, for Zurich Global Energy. He has more than 20 years experience in the offshore energy industry and has extensive knowledge of energy reinsurance issues.

February 1, 2005

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