A dynamic approach to managing life reinsurance arrangements. Part II: Treaty design and implementation

Continuing on from Part I, this article discusses how information asymmetry between insurer and reinsurer emerges over the lifetime of a treaty due to capital concerns, increasing access to data, and treaty provisions for repricing, recaptures and errors and omissions. 

This article first appeared in the May 2019 issue of Asia Insurance Review.

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 sub-standard day-to-day management of the reinsurance programme, 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 capitalise on reinsurance pricing cycles and access more diverse capital pools. Reinsurers typically construct life treaties to maintain their margin over time - if a treaty is written during a capacity shortage the margin is higher than it would be in an environment of abundant capacity. 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 off 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.