Reinsurers warned against risk bundling, urged to keep focus on primary risk

by Artemis on September 28, 2012

A report published following a three-year study which looked at the reinsurance sector and reinsurance trading over three annual market cycles from 2009-2012, urges reinsurers to maintain their focus on the primary risks they are underwriting and warns against the bundling of risks across multiple territories. The study undertaken by the Insurance Intellectual Capital Initiative suggests that reinsurers who bundle risk are potentially leaving themselves and the industry exposed to financial shocks.

There is a growing trend for the merging of reinsurance cedents and for the bundling of risk across multiple territories within reinsurance transactions, which the report ‘Beyond borders: Charting the changing global reinsurance landscape‘ says is reducing transparency and increasing reinsurers exposure to financial shocks. The report also warns reinsurance underwriters not to become over reliant on risk models, which it says pose a threat to the “deep knowledge and judgement on which their evaluation of risk is based”.

According to the report, consolidation among reinsurance cedents is creating huge global buyers of reinsurance coverage and this trend is causing a profound change in the reinsurance industry. The centralisation of reinsurance buying power allows these ‘super-cedents’ to elect to buy bundled, global or multi-territory products such as super cats, instead of local programmes. This bundling reduces transparency for reinsurance underwriters, according to the report, and also these risks more remote from the specific primary markets being covered. In turn, this increases the global connectivity of the reinsurance market and can increase the potential for surprise exposures.

Author of the report, Paula Jarzabkowski, Professor at Aston Business School and Marie Curie Fellow, commented; “Reinsurers are risk carriers not risk traders and should not allow their deep knowledge and judgement to be challenged by an over reliance on models. Most reinsurance underwriters have established rituals for judging the physical properties of the financial risks they take but these judgement rituals are under threat, as complex portfolio modelling generates bundled multi-territory products that are remote from the primary risk.”

“As the industry goes through such profound change as cedents consolidate and look to bundle risk together, it is absolutely imperative that reinsurers adopt extreme caution in how they embrace the increasing complexity and global connectivity of the reinsurance market,” Jarzabkowski continued.

Bronek Masojada, CEO of Hiscox, a joint sponsor of the report, added; “We’ve seen in the banking sector what happens when traders become too detached from the risk they take on. This report sends out a clear message to the reinsurance sector that we cannot allow the increasing bundling of risk and dependence on models to cloud the picture when it comes to evaluating the real risk being underwritten.”

The study urges reinsurers, cedents and brokers to re-evaluate their trading practices and to more clearly define their sources of competitive advantage.

“Our research has clearly defined five different cedent types that differ in their reinsurance buying strategies as well as five different reinsurer types. It is critical that both sides recognise who their natural partners are as they seek to develop the relationships that can yield the highest value. Brokers have a real opportunity here to act as the intelligent matchmaker and add value by increasing the fit between reinsurers and cedent types,” concludes Professor Jarzabkowski.

This type of centralised, multi-territory bundled reinsurance buying tends to be something that buyers do to try to make the reinsurance buying process more efficient and cost-effective. It is certainly true that there are accumulation risks associated with selling these covers to cedents as it increases the complexity and interconnectedness of global reinsurance markets and sellers do need to be aware of that. It’s likely that some of this trend for risk bundling could be being driven by the increasing size of the convergence market where efficient capital deployment is such a strong aim.

Interestingly the IAIS recently looked into the global systemic importance of reinsurance and whether it posed a systemic risk. They found that traditional reinsurance did not generally pose a risk and that non-traditional activities were unlikely to cause systemic issues unless they involved an intermediation of credit. The IAIS did not perhaps look at this growing trend for multi-territory bundled reinsurance covers and it would be interesting to hear an opinion from them.

It’s an interesting report which you should read. We are particularly interested to hear any comments on this from market participants, particularly those selling bundled covers and those in the retro or collateralized markets, including whether you feel there is cause for concern if underwriting diligence is employed. Let us know in the comments below.

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