Should source of reinsurance capital worry corporate insurance buyers?

In an ideal world, should it matter to a corporate buyer of insurance if its insurers reinsurance program is backed by non-traditional reinsurance capital, perhaps third-party or capital market sourced, or traditional reinsurance capital from a rated reinsurers balance sheet?

The answer, of course, is no. In a perfect world (insurance, reinsurance and capital market), it really shouldn’t matter where reinsurance capital is sourced from, as those managing and deploying reinsurance capacity should have the checks, balances and processes in place to ensure that when reinsurance capital is needed it is always available.

Unfortunately, we don’t live in a perfect world and the source of a reinsurers capital is a factor that is increasingly being taken into account by corporate buyers of insurance coverage, according to this article in Business Insurance. How much an insurer uses non-traditional reinsurance capacity is a factor that corporate insurance buyers are beginning to take notice of, according to quoted industry experts.

If we were in a perfect world then the source of a reinsurers capital, whether equity based, from its own reserves or third-party capital that it manages for investors, should not matter. In the case of non-traditional reinsurance capacity, where much of the capital is third-party sourced, the instruments used tend to be fully-collateralized, which some might argue is actually a safer form of capital than others as it’s typically ring-fenced and managed by a custodian.

However, Dennis Sugrue, a director at ratings agency Standard & Poor’s says that insurance buyers need to know that their insurers are not too reliant on non-traditional reinsurance solutions. He said that becoming too dependent on non-traditional reinsurance may mean an insurer cannot acquire all the reinsurance cover it needs, bringing additional costs which could be passed on to insurance buyers.

Of course, this comment really works both ways now. An insurer that is too reliant on traditional reinsurance capacity may not be taking advantage of cost-savings and additional flexibility that it could acquire via the capital markets through non-traditional reinsurance coverage. So perhaps insurance buyers just need more clarity into how their insurers buy reinsurance protection?

The article also cites Allianz reinsurance head Simon Buxton who said that while corporate insurance buyers don’t necessarily need to understand the full details of their insurers reinsurance measures, they do need to understand their insurers financial strength, a factor of which is its capital sources. This of course applies to more than just where its reinsurance comes from, but the strength of its reinsurance capital should perhaps be taken into account.

James Vickers from broker Willis insinuated that ratings agencies should be the ones to worry about this, as they generally assess an insurers counterparty risk which should include the source of its reinsurance capital. That approach would abstract the need for a corporate insurance buyer to fully understand its insurers reinsurance program.

What’s really important, of course, is knowing that, should you need to make a claim on your corporate insurance, your insurer is going to have the protection in place to be able to quickly honor its claims. This goes much wider and deeper than purely whether its reinsurance is sourced from third-party capital or not.

Corporate insurance buyers should have sufficient information and data on an insurers stability to enable them to make an informed decision whether to purchase cover from them or not. This really is where ratings agencies should come into their own, having assessed an insurers credit worthiness and counterparty risk.

We may see in the future a much greater scrutiny of non-traditional reinsurance capacity and where it comes from. As the debate on the stickiness of this third-party reinsurance capital continues, some providers of that capital are thought to perhaps be more reliable and likely to stick around than others, particularly pension fund capital.

This perhaps is most important, whether after major claims are made an insurer is still going to have access to its reinsurance capacity, or whether it is going to have to make other arrangements and go back to the market for more coverage options. Having secure cover in place that can pay out promptly for claims and also be there to either reinstate or provide a new policy after a major loss event is what really matters. That goes for all reinsurance capital sources, not just non-traditional.