Factors Governing Reinsurance Programs

Insurance marketplaces are just like other markets. They are full of buyers and sellers i.e. cedant insurance companies as well as reinsurers who have very different objectives.

There might be some cedant insurers who might be very conservative whereas there might be others who might be reckless when it comes to risk-taking. The same thing can also be said about reinsurance companies. Hence, when it comes to designing a reinsurance program, both entities are not working in a vacuum. There are certain factors that exist in the marketplace. These factors influence the decision of both the ceding insurance companies as well as the reinsurers when it comes to creating a reinsurance program.

The details of these factors which influence reinsurance programs have been mentioned in this article below:

1. Nature of Losses: The cedant insurer may need to look at external risk factors to gauge the nature of losses that they are likely to face.

   For example, reports issued by economists or the meteorological department may help the ceding insurance company as well as the reinsurer gauge the expected losses. The expected losses can then be compared with the current risks on the balance sheet of the ceding insurer in order to decide whether or not more reinsurance is required. Also, the nature of losses plays a role in the selection of policy types such as facultative, quota share, or proportional.

2. Competition: It is important to note that competition plays a huge part when it comes to reinsurance programs. Many ceding insurers use reinsurance as a mechanism to gain a competitive advantage.

   For instance, if they are able to pass on most of the risk to a reinsurer via a quote share agreement, then the ceding insurance company is likely to price the premium more aggressively. If one of the competitors in the industry starts following such practices, others are also compelled to do so in order to stay competitive. Hence, each ceding insurance company may have to adjust its retention strategy based on the realities of the market.

   Competitive actions also depend upon the capacity that reinsurance companies have to offer. For instance, if a reinsurance company obtains more capital and has the capacity to offer more reinsurance, ceding insurers may be compelled to expand their reinsurance program in order to ensure that their competitors are not able to gain at their expense.

3. Market Cycles: Market cycles do have a profound effect on each and every business. In the case of a reinsurance program, things become more complicated as there are two market cycles in play. Both the insurance company as well as the reinsurance company have their own market cycles. Both of these cycles are linked to some extent but their movement does not have to be symmetrical. A lot of diversions are possible in these cycles.

   It is possible for the ceding insurance company to be in a good financial position while the reinsurance companies are struggling. Most ceding insurers will try to understand the market cycles so that they can expand their reinsurance program at an opportune time. These market cycles create opportunities wherein it becomes cheaper for the ceding insurer to pass on the risk to a reinsurance company instead of holding the same on their books.

4. Regulatory Factors: Ceding insurance companies face a lot of regulation in most parts of the world. The regulators generally keep a very close watch on the risks being undertaken by the insurer vis-a-vis the funds that they have on their balance sheet.

   The liquidity position of the insurance company may also be closely monitored. Hence, ceding insurance companies are often compelled by regulators to expand their reinsurance program and purchase more reinsurance policies in case they want to expand their own insurance portfolio. In countries where such laws are in place, the growth of reinsurance markets is more or less identical to the growth of the primary insurance markets.

5. Market Intelligence: It is important to note that ceding insurance companies do not necessarily have a transactional or an adversarial relationship with their counterparty reinsurance company. In many cases, the ceding insurer as well as the reinsurer share market intelligence.

   Ceding insurance companies often try to partner with reinsurance companies that are experts in a particular geographical area or in a particular field of business. They try to obtain the latest market intelligence from such companies. The ability to obtain such intelligence helps them adjust their own underwriting criteria and underwrite risks in a more controlled manner. Hence, the strategic knowledge of the reinsurance company also has a huge impact on the size of the reinsurance program.

6. Administrative Challenges: Lastly, many ceding insurance companies opt for temporarily expanding their reinsurance program since they face administrative roadblocks. Some of these companies may not have the manpower or the systems to process the claims arising from an underlying risk.

   It is possible that a company may have just expanded into a new market and is yet to set up the administrative infrastructure. In such cases, ceding insurance companies will take on the underlying business. However, they will simultaneously outsource the same to reinsurance companies.

The bottom line is that there are many factors that play a role in deciding the size and types of risks that will form part of a reinsurance program being created by a ceding insurer. The above-mentioned list is only indicative and there may be many more factors at play.