Matthew Rose, Justin Ward and Victor Hai discuss how the structure of perpetual treaties in the traditional life reinsurance model may reduce alignment between the insurer and reinsurer, to the insurer’s detriment.
This article first appeared in the May 2019 issue of Asia Insurance Review.
The traditional life reinsurance model typically involves perpetual treaties linked to an underlying product. In order to create alignment between the contracting parties, the treaty would follow the underlying terms of the product. However, the treaty structure may concurrently include provisions that reduce alignment between the insurer and reinsurer, to the insurer’s detriment. This approach is often wrapped in the reinsurer’s “value proposition” – providing services to support the pricing, underwriting and claims management of the underlying product.
In today’s operating environment, that “value proposition” is becoming less relevant as insurers now have the capabilities to develop their own customer proposition through improved access to data, market knowledge and skills for pricing, analytics and underwriting.
Arguably, insurers no longer need to pay a premium for value-added services. The purchase of service and advisory capabilities from a reinsurer through a reinsurance treaty is an expensive way to access these skills; this is even more so in mature markets.
At the same time and of particular reference to emerging markets is the reduced cost of capital and the convergence between reinsurers and insurers. Capital is entering the global reinsurance market from pension funds and other non-traditional sources. This capital, searching for non-correlated return rather than absolute return, is comfortable with longer-term durations and is effectively entering as debt rather than equity. This changes the fundamental return characteristics of the market as the capital moves between different classes and regions.
The current life reinsurance model has at best been managed passively; and at worst, has been a “set-and-forget” exercise. Notably, neither approach will fully satisfy risk management, capital management and relationship management objectives. Operationally, this approach limits insurers’ ability to manage risks from a top down perspective and actively adjust the underlying portfolio (and associated economic capital) from a strategic and tactical perspective that is reflective of a contemporary view of the risk.
This model does not adequately link strategy, risk appetite and capital management to the resultant reinsurance purchase. The manner in which reinsurance is typically purchased is the function of a legacy process – solely because it has always been done a certain way, usually overseen by product and pricing professionals, with little understanding of the strategy, risk appetite and capital objectives of the complete organisation.
Inadvertently, these actions have resulted in increased operational risk. Multiple treaties written by reinsurers have accumulated over time and each has vastly different terms and conditions despite the fact that they cover the same risk. These treaties have to be interpreted by a variety of internal stakeholders – valuation actuaries, pricing actuaries, financial controllers, reinsurance administration and product managers – creating multi-dimensional frictional costs that are not often incorporated in any profit or valuation metrics. With some insurers managing more than 30 reinsurance treaties simultaneously, and administration and valuation engines usually confined to “off the shelf” solutions, there is a greater chance of human error and deterioration of data quality.
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