Time to Re-Align: How to Balance Future Insurer/Reinsurer Partnerships
By Alex King
Reinsurance News, July 2021
Reinsurers can bring huge value to insurers; from helping manage volatility and smooth profits, providing much needed capital relief, supporting the development of new propositions, assisting with core services such as underwriting or sharing the latest market intel including acting as a sounding board on complex matters. Both sides, however, need to understand the value delivered and as such the reasons why the reinsurance is bought. Many life reinsurance treaties are written for the long-term and getting this right at the beginning helps to set the balance for the future relationship. I have seen the impact on future relationships if one party takes a one-sided stance at outset, which may feel like a win at the time, however, often leads to challenges in the future.
This article will explore the core areas of a reinsurer/insurer relationship and the important considerations to address the balance both ways to give the relationship a good chance of long-term success.
Data
Reinsurer’s profits rely on being able to appropriately price their reinsurance contracts in aggregate. A key element is being able to utilize relevant data to set their experience assumptions. Many insurers, however, question whether they should share their data when requesting quotes for reinsurance. I have even heard people say, “data is our oil and we will never share it.” I can fully appreciate that a company’s own experience data, particularly for larger ones, is a competitive advantage and therefore sharing it may feel unwise. However, the reinsurers invited are entities seen as a potential long-term partner and therefore sharing past experience information helps build trust and avoids information asymmetry between incumbent reinsurers and new potential companies. This doesn’t have to be the full seriatim data—in fact, I believe sharing summarized experience at a sufficient granular level is more efficient. Seriatim data can then always be provided later only to the successful reinsurer(s) which reduces time-consuming data queries from multiple companies.
Premium Reviewability
Utilizing reinsurance structures that are on a reviewable basis (or reviewable with a cap) can be a cost-efficient way to obtain capital relief or the required protection, especially when there is uncertainty, and the availability or cost of a guarantee is prohibitive. Historically these treaties have been drafted where the reviews are one-sided and only upward movements in experience are reflected with the reinsurer having the sole election to trigger a review. This one-sided review trigger can lead to future bad feeling between the parties if the experience is good and this non-symmetrical reviewability can be avoided by clear treaty wording. There may also be future disagreement on upwards reviews and spending the time at outset to clearly document the methodology will materially reduce the risk of a future disagreement when the parties agreeing to the initial treaty may have moved to a new company. This would typically include when, how, who and what claims history can be used for deriving the revised premium rates. Leaving this open-ended as many do should be avoided.
Treaty Recapture
Life treaties are written to cover liabilities many years into the future. Some insurers understandably wish to give themselves an option to exit the reinsurance in the future if their need for reinsurance changes. One mechanism used by some insurers is to ask for a free recapture option, set at their sole election at a fixed period into the treaty. This request may seem like a good option to include, however, the true stochastic cost of such an option, particularly for treaties with premium guarantees, can be very expensive. This is because you are essentially asking the reinsurer to take on the risk that they are left with all of their poor performing treaties and allowing the profitable ones to be recaptured. This goes against one of their core principles which is that the loss-making business will be offset by the profitable ones, and it also will impact their capital diversification factors. The impact is a loaded premium rate, where the increase can be material with adverse knock-ons to the insurer KPIs.
There are alternative options to better align with the goals driving these recapture provisions which would avoid a material loading to the reinsurance rates. The cleanest is to allow recapture after a certain period of time but to stipulate a calculation mechanism for the recapture payment—if this is done well, the recapture should be able to be offered with little or no cost. If you wish to put a cap on the ultimate cost, this can be done to help narrow negotiations at the time of recapture although this may come with a small cost to the initial premium rates. The result is the payment of a fair value at exit if this option is elected and avoids paying an option cost and damaging the insurer KPIs for something that may never be needed or used.
Profit Share
Many insurers will routinely ask for profit share on all of their reinsurance treaties. This will be seen as a great way to mitigate the risk that the treaty is generating excessive profits for the reinsurer and, therefore, lead to an awkward question in the future from higher management. However, including profit share on a treaty is not free and a reinsurer will usually charge for this. Many reinsurers will also not like it as similar to the recapture option, it creates an asymmetrical profit profile in that they have to absorb losses, but for the profitable ones, they are required to return a proportion to the insurer. If they write material volumes with profit share, it will adversely impact the overall diversification and, therefore, the aggregate loading for capital for all business.
It is recommended that a conscious decision is made on profit commission for each reinsurance transaction and if unsure, quotes should be requested with and without profit share to assess which structure works best given the company needs and circumstances.
An alternative way to approach this is to carefully think at the outset why you are buying reinsurance. A treaty with a high profit share has similar characteristics to a stop-loss arrangement—is this what you are intending to buy? Does it match your goals from the reinsurance? It may be worth exploring a non-proportional treaty if the profile of this reinsurance is what you are seeking as it may be much cheaper than the proportional with profit share. If the treaty is reviewable, following the suggestions in the above paragraph are often a better way to manage the future reinsurance cost relative to profit commission. This will usually come without a premium loading, leading to enhanced KPIs and through the two-way reviewability, the rates will be reset to reflect the latest experience.
Product Ideas
Reinsurers are a great source of new propositions, and it has become the core strength of many. They bring expertise from multiple markets and can help enhance an internal idea to differentiate in a competitive market. The challenge is often that insurers crave the most innovative new solutions from the reinsurer, a first in market proposition. This, however, can mean there is little data to help price the new risks and, therefore, the reinsurer is unlikely to want to offer premium rate guarantees that can create future misalignment between the insurer and reinsurer if the initial pricing estimate is wrong. The insurer has brand and reputational damage should they need to increase future prices and they will, therefore, wish to keep rates unchanged or at least mitigate the level of premium increases. Having this conversation upfront is really important so both sides understand what is acceptable in future. This will help to design reinsurance terms that match to what the insurer will be willing to do to customer rates. This may lead to a soft guarantee on premium rates or amending the product features so this can be accommodated. A final product that is innovative, however, results in a fully reviewable price that not only passes the brand risk onto the insurer, but it is also an expensive way to access a new product idea when you equate the PV of margin within the rates. For products where the pricing is uncertain, the point already made on two-way reviewability is even more important. If this is not possible, you may be better to fully retain this risk and agree to pay a fee to the reinsurer for the idea as it will avoid a reinsurance structure that may not be aligned to how you intend to review customer premium rates and has limited long-term value.
Split Treaties—Lead/Follower
The idea of split reinsurance awards in markets like the US and UK are common. This is less prevalent in other parts of the world, and they, therefore, miss the sustainability this brings. It is extra effort to onboard multiple reinsurers and also to maintain more than one relationship. The payback, however, is that you have some natural competitive tension between your lead and follower, and you can adjust the shares awarded to each overtime, thus maintaining the long-term partnerships. If one of your reinsurers has no capacity or appetite for a certain facultative case, you have an alternative to take this business. You also get the benefit of ideas from another reinsurer and a sounding board on emerging industry matters that can be a valuable comparison to your lead. You may also find that you can use your “full service” reinsurer as the lead and get access to a “follower” who offers lower rates, giving a boost to your KPIs or your ability to price competitively. Big is not always best and the mid-smaller players can complement the services of the major reinsurers.
Reinsurance for Services
One of the drivers for many companies to use reinsurance is to get access to the valuable range of key services they offer. This might be through underwriting, an innovative front-end system or innovative techniques for data analytics. There is clear benefit to using these services, but they can become a habit and insurers should assess both the cost and benefit of these, especially if these are the sole or driving reason for the selection of a reinsurer or reinsuring at all. This is often the case for the reinsurance of medical business, which is generally fully reviewable and provides short term volatility protection but rarely any long-term protection as deviations in experience will result in increases to reinsurance premiums. The cost here in terms of margin for those services is high and an excess of loss arrangement could be included at a materially lower cost if annual volatility protection was the goal. Therefore, a conversation with the reinsurer to match your reinsurance and service needs may lead to an alternative structure with fees paid for the services together with a non-proportional treaty. This feels like a better long-term arrangement with aligned interests and a reasonable cost/benefit between both parties reflecting the services being utilized.
Underwriting Medical Expenses
Reinsurers offer an essential solution by providing capacity for large sums assured and the associated underwriting guidelines and support that comes with this. This helps insurers to write cases much larger than they would otherwise be willing to write. A surplus reinsurance structure is often used where the reinsurer will take the risk beyond an insurer’s own capacity or retention. Given the reinsurer is taking the majority of the risk on these policies, they will usually have material input in the underwriting philosophy including the appropriate non-medical limits and the tests to be conducted. The cost of these tests is usually borne entirely by the insurer.
There can be disagreements in the future between the underwriters within the insurer and the reinsurer on whether the limits remain appropriate and if certain tests should be included. These can escalate to a point where it causes the overall relationship to strain sufficiently that it triggers a re-tender of the business. The lack of alignment between the parties on the cost/benefit of these tests is unhelpful and can be mitigated at the outset of the treaty by requesting the reinsurer to pay for these tests. This will result in a loading to the rates relative to now to cover this cost, however it makes future conversations easier between the respective teams on the efficiency of the tests as the reinsurer will be able to make a clear assessment based on the cost impact to them of changing the underwriting versus the expected impact on future claims.
Conclusion
The way a reinsurance arrangement is positioned and balanced at outset can have a very material impact on the long-term success of the relationship. Too often insufficient time is spent addressing these items upfront and this can create much greater challenges in the future.
A re-alignment of the balance in these areas will help strengthen the future partnership:
- Share data with reinsurers at the outset in summarized form.
- Use two-way reviewable treaties with clear criteria on the mechanisms for the review.
- Include recapture options with a fair recapture payment to avoid damaging KPIs with option costs that you may not utilize.
- Make a conscious decision if profit share is what you want and if in doubt, ask for quotes with and without it.
- For new product solutions, align the intended customer reviewability with the reinsurer or consider amending the product design or whether reinsurance is beneficial for the product.
- Use a lead/follower reinsurance structure to increase the likely longevity of the relationship between two partners.
- Assess the cost/benefit if reinsurance is being used solely for services (especially fully reviewable arrangements).
- Ask the reinsurer to pay for the underwriting medical expenses in exchange for a higher premium to align future discussions on the level of underwriting required.
Statements of fact and opinions expressed herein are those of the individual authors and are not necessarily those of the Society of Actuaries, the newsletter editors, or the respective authors’ employers.
Alex King, FIA, is the CEO of Actuaries OnTap—a consulting company that advises on efficient reinsurance programs and provides actuaries on secondment to meet short term resource needs. He can be contacted at Alex.King@actuariesontap.com