Conventional wisdom has it that money makes the world go round. But, ask an underwriter, and they might say it is really reinsurance that keeps us spinning.
Behind many insurance policies is the added financial strength of reinsurance, insurance for insurance companies. And by providing the capital which allows insurers to take on more risk than would be possible without reinsurance support, it truly does keep the economic world turning.
Reinsurance comes in several different forms, but most policies, or “treaties”, fall into one of two categories: proportional or excess of loss.
Under a proportional treaty, also known as a “quota share” treaty, the insurer pays, or “cedes”, to its reinsurer a proportion of the premium it gains for each policy it sells. In return, the reinsurer takes on the responsibility of paying a specified proportion of claims. Proportional treaties have evolved in recent years. Historically most operated on an original terms basis. The reinsurer would take a proportion of the premium exactly equal to the share of claims and attempt to match the insurer’s investment strategy to cover future claims. The only difference in premium income would be the commissions paid. However, a newer form of pricing now dominates. Risk premium pricing is now the norm in long term business. The reinsurer considers only the health or mortality risks on the insurer’s book of business, and calculates risk rates based on them.
“The change has been beneficial to both insurers and reinsurers,” explains Robert Douglas, executive director in charge of life and health reinsurance operations at Liberty Re. “The direct offices are able to retain the investment risk, which suits them, while the reinsurers do not have to match the insurer’s investment policies.”
Excess of loss
The other broad category of reinsurance policies are known as “excess of loss treaties”. They are essentially stop-loss policies, and their structure is more like conventional insurance. As the name implies, excess of loss cover pays losses incurred by an insurer which exceed a certain amount, much like the excess on a retail insurance policy. For example, an insurer may buy a “whole account” excess of loss policy which would guarantee that, should the insurer have total aggregate losses in one year which exceed, say, £50 million, the reinsurer will pay to the insurer an amount equal to all the insurer’s losses in excess of £50 million. Such a policy would be deemed unlimited –- that is, the reinsurer would pay any and all losses in excess of the £50 million attachment point. However, many excess of loss treaties provide a layer of cover, say £10 million excess of £50 million. The insurer may then buy a second excess of loss treaty, perhaps for £20 million excess of £60 million.
Because most insurers writing annual business now wish to retain more premium, stop-loss covers are becoming a more popular form of protection for annual health business. As well as providing whole account protection, excess of loss treaties can be used on a single claim basis, under which any claim that exceeds a specified amount would trigger the policy, and the reinsurer would pay any portion of the claim which exceeds the specified retention. Some treaties may limit the number of such claims which may be made during the year.
Alan Tyler, UK health market•manager for Swiss Re Life & Health, explains that the kind of reinsurance used will depend on exposures and experience: “If it is business where you can happily meet almost every claim to which you are exposed from your own financial resources, but feel particularly exposed to large claims, you may want to identify the potential cause of those large claims and arrange a non-proportional cover to meet that particular need.”
“You might identify a whole line as volatile, or be new to it. In that case a reinsurance partner is quite attractive. Or you could be in a situation where you are only prepared to take part of a risk. Then you might retain a portion and confer the balance onto the reinsurer.”
He adds: “If you expect to sell so much business it would produce a financial drain, it is a good idea to reinsure a proportion onwards under a proportional treaty.”
The commission the reinsurer pays to the insurer, deducted from the ceded premium, gives the insurer extra financial support, and spreads the risk, freeing capital for use in other places. Tyler provides a breakdown of the common specific types of reinsurance used to protect different lines: “For income protection, which is quite volatile, proportional covers are the norm. For long term care, which is pretty much an unknown risk, proportional solutions are the most common. But insurers are prepared to retain more risk on critical illness.
“That leaves PMI, where non proportional cover is dominant. Volatility is less, claims don’t tend to get very high, and insurers are not locked into long term commitments. Non-proportional cover provides a smoothing of exceptional results.”
However, little PMI reinsurance is purchased by UK insurers.
As Tyler explains, proportional treaties remain the most common sort of reinsurance protection for long term health insurers. That said, more insurers are considering whole account excess of loss treaties, written on an annual basis, to protect themselves from large loss experiences. Increasingly such products are being offered by reinsurers.
“A large book of group business would be a good candidate for whole account excess of loss protection,” says Liberty Re’s Douglas. “The variability in such a book will not be too great, so the insurer can have an accurate idea of expected losses. But the insurer may still want protection, and can protect the whole account with a stop loss policy, rather than giving away profit from every scheme.”
John Castagno, general manager, marketing, at BUPA, explains the role reinsurance plays in his company’s financial arrangements: “BUPA retains all risks in PMI. We are able to absorb the fluctuations of the cycle. But we do reinsure permanent health insurance, critical illness and long term care, with selected reinsurers, on a quota share basis,” he says. “With the reinsurance we don’t need to put as much money aside in reserves.”
David Ashdown, a director at Western Provident Association, explains how his company, in contrast to BUPA, uses excess of loss reinsurance exclusively. While almost all WPA claims are met from premium, some fall to reinsurers.
“If a claim goes over £30,000, reinsurance plays a role,” says Ashdown. “We pay an annual premium, and, in turn, when a claim exceeds £30,000, the difference is met by reinsurance. It is just to keep some control but claims over £30,000 are very rare.” With 80-85% of income going out in claims, the non-profit Western Provident has little room to deal with substantial claims on its own, so the cover is ideal.
Reinsurers’ contribution to the success of the health insurance industry goes far beyond extension of capital. Because reinsurers tend to have multiple clients doing similar kinds of business, they have access to much more data than a single insurer will hold. They also tend to be much larger, so they have more resources to tackle the challenges of pricing and product development.
“Reinsurers are giving more and more technical and office support to insurers,” Castagno says. “They offer actuarial services, plus marketing support, market analysis, and even consumer research.” BUPA is going even further by using the services of reinsurers to develop new products. “On long term care, permanent health, and critical illness, we use our partners in reinsurance to assist in launching products,” he says.
In the extremely competitive reinsurance environment, rates are as soft as in other sectors of the market and many reinsurers are now differentiating themselves from their competitors by providing unique and extended services. Some are full service reinsurers, providing both capacity extending capital and actuarial, product development, underwriting and marketing services. Some even specialise in software development. Others, however, are very specialised and this latter group will focus on a specific niche, or work in specific product lines. Some have specialised in technical support, specifically in assisting with product pricing.
“Such specialists can provide pure risk rates, from their own actuarial studies, which can be used by the insurer to set its own office rates,” Castagno states. “If a reinsurer has seven or eight clients in critical illness, for example, he has a powerful pool of data to use to modify pricing assumptions.”
Tony Worthington, marketing manager for Swiss Re Life & Health, says his company, the world’s largest life and health reinsurer, has all the bases covered. “We are a full service reinsurer,” he says. “We won’t always compete based on the lowest price. Instead we will provide a considerable degree of service, such as underwriting training, help with claims, distribution consultancy, or anything the client wants. In product development, for example, the company (largely in its previous incarnation as Mercantile & General Reinsurance) was instrumental in introducing critical illness insurance from South Africa to the UK.”
But no matter what service is provided, reinsurers are an essential part of the health insurance market. “The role of the reinsurer has always been important, and they have always been there providing a very good service,” BUPA’s Castagno says.
“I don’t see how the voluntary insurance sector could work without a good reinsurance presence.”