Time to re-examine reinsurance as a form of contingent capital: JLT Re

by Artemis on January 27, 2017

Given the fact that reinsurance cession rates remain near record lows, thanks to the softened state of the market, it is time for re/insurers to re-examine reinsurance as a form of contingent capital, JLT Re suggests.

Cession rates and reinsurance pricing has been on a steep and then steady decline over the last few years, a decline that continues despite more stability being seen. As a result ceding companies could find that conditions to upsize on their reinsurance or retrocession are about as conducive, and cost-effective, as they have ever been.

It’s not just the historically low cession rates of course, other factors tied to this such as the increasing efficiency of reinsurance capital, the expanding wealth of risk transfer options available, the highly competitive market environment which pushes reinsurers to offer more and of course the option to transfer risks directly to the capital market, all of which together should make reinsurance risk transfer incredibly attractive right now.

But of course reinsurance buying has been rationalised and centralised, resulting in stagnant demand and perhaps even contracting demand in some lines.

While this has been a necessary and positive step for the insurance and reinsurance market to make, as it’s enhanced the ability to buy protection more efficiently, it does mean that some ceding companies may have been missing out on an ability to buy more cover, or to treat reinsurance differently.

But the opportunity to do this remains, as the market bounces along the bottom of the cycle, and broker JLT Re suggests that viewing reinsurance as a form of contingent capital would be a sensible approach for ceding insurers right now.

“Given that cession rates remain at historically low levels, now is the time for insurance carriers to re-examine reinsurance as a form of contingent capital,” JLT Re explains in the firms latest reinsurance report (which we covered here).

With reinsurance pricing at or near lows “the value and efficiency of reinsurance is enforced” JLT Re said in its report, going on to explain that there is growing evidence of cedents taking a fresh look at reinsurance capital.

“Evidence emerged in 2016 that this had started to happen as insurance carriers bought new quota share programmes, aggregate covers, excess of loss buy-downs and adverse developments covers (ADCs).

“Moreover, interest in structured reinsurance products is also growing as cedents look to work with trusted markets to develop alternative and tailored solutions that minimise earnings volatility and secure competitive advantages,” the broker explains.

When the conversation shifts to viewing reinsurance as a form of contingent capital it, of course, brings to mind the use of parametric and index triggers, which can offer a form of capital that is truly contingent on a specified disaster taking place.

Where indemnity triggers are contingent on a ceding company facing a specific level of loss, as assessed by the cedent itself, often a claims company and perhaps some sort of validation of a report, a parametric or index trigger reinsurance product offers capital at a time truly contingent on an event or loss occurring, often with only a very efficiency validation required.

That would be a real contingent reinsurance cover and interestingly some ceding insurers are looking at reinsurance capacity and also the capital markets more like this today.

One example would be the recent purchase by Florida based primary insurance group Universal of a risk-linked parametric catastrophe insurance cover.

This transaction is interesting as it features an insurer as cedent buying what it termed insurance to “protects its own assets against diminution in value due to catastrophe events,” rather than reinsurance to protect it against losses.

If more insurers thought like this and realised the efficiency and effectiveness of having a truly catastrophe contingent source of capital relief waiting in the wings, the parametric trigger would gain increased adoption and of course the ILS markets would be only too ready to supply the capital to back these deals.

Index triggers also provide a way to make retrocessional reinsurance more responsive for reinsurers, again providing a payout contingent on a pre-defined loss, rather than a claims assessed loss.

Of course basis risk remains an issue for many, but here is where the re-examination of reinsurance as a form of contingent capital is key. There is evidence that a change of heart is beginning and that re/insurers may begin to buy more protection at the CFO level, rather than reinsurance or retro buyer level.

If ceding companies can reconcile themselves with the need to buy protection for the value of their business and assets, perhaps more of them would look to truly contingent catastrophe or weather protection through index and parametric triggers.

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