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, according to Matthew Rose, BEc FIAA, Managing Director; Justin Ward, Senior Vice President; and Victor Hai, BEc FIAA, Senior Vice President; all of Guy Carpenter, Asia Pacific.
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 the purchase of service and capabilities through a reinsurance treaty is an expensive way to access these skills.
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.
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.
The traditional reinsurance purchase process has also 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, creating multi-dimensional frictional costs that are not often incorporated in any profit or valuation metrics. As administration and valuation engines are usually confined to “off the shelf” solutions, there is a greater chance of human error and deterioration of data quality.
Treaty Design and Implementation
Many treaties were created at the earlier stages of product development with a value proposition whereby the reinsurer co-developed the product, pricing and features. As the relationships with reinsurance partner(s) change over time, the ability to adjust the terms of the relationship may be limited and in many cases an imbalance in the partnership emerges.
This imbalance, or misalignment of interests, results from substandard day-to-day management of the reinsurance program, compounded by the fact that the treaty tends to be written by the reinsurer, not the insurer or the insurer’s intermediary. There exists a significant information asymmetry between the insurer and reinsurer related to cost of capital differentials and treaty provisions for repricing, recaptures and errors and omissions. The cost of this asymmetry emerges over the lifetime of the treaty.
At the same time, insurers lose their ability to capitalize on reinsurance pricing cycles and access more diverse capital pools as reinsurers typically construct life treaties to maintain their margin over time. Current reinsurance market conditions suggest that capacity is abundant in both the life and non-life sectors. However, many life insurers are not able to leverage this pricing cycle.
Despite the long-term nature of the underlying insurance policy, a more dynamic approach to managing reinsurance arrangements and adopting shorter-term/multi-year treaties may provide greater flexibility and speed in responding to industry changes such as regulatory and accounting frameworks, and a benefit from improved price discovery. Reinsurance pricing is more transparent and will better reflect the current market cycle.
Additionally, an insurer’s risk appetite may evolve over time because of societal, environmental and business climate changes. This is illustrated in the changes that have occurred in Asia over the past 50 years of enormous wealth creation and economic growth. The vast amounts of data sources that are now available enable insurers to better understand their risk and achieve a greater level of confidence in managing their risks.
Guy Carpenter is working to help reinsurers and the life reinsurance market better serve the needs of clients by curating partnerships with capital and service providers that highlight the advantages that each party brings.