Multi-Tower Reinsurance Contracts: Pros and Cons for Reinsurance Companies
In the previous article, we have read about what multi-year reinsurance contracts are. We now know what these unconventional contracts are and why they are becoming increasingly popular with the passage of time. However, we only understood the arrangement from the point of view of the ceding insurer.
It is important for us to also understand the pros and cons from the point of view of reinsurance companies. This is because reinsurance companies across the world are giving a mixed reactions. While some of them have been embracing the idea of multi-tower non-conventional reinsurance contracts, others have been trying to avoid it. This is possible because of the fact that some reinsurance companies are focusing on the pros of the arrangement whereas others are focusing on the cons.
In this article, we have a closer look at what those pros and cons are and how they impact the business of the reinsurance company.
Advantages to Reinsurer
The approach of consolidating various insurance towers into a single non-conventional contract has several benefits for the reinsurer as well. Some of the important benefits have been listed below:
- Diversified Portfolio: The first important benefit is that when reinsurance companies acquire risks, these risks are already diversified. This is because the portfolio contains several risks such as marine insurance, workmens compensation insurance, etc.
The traditional financial theory believes that a diversified portfolio has a lower chance of loss. Up until now, reinsurance companies had to look for risks that were not correlated to each other in order to create a diversified portfolio. However, when it comes to multi-tower contracts, no additional actions need to be taken to ensure that the portfolio is diversified. Reinsurance companies are able to easily obtain a pre-diversified portfolio.
- Higher Sales: The ticket size of a multi-tower contract is much higher as compared to a single-tower contract. This is because of the fact that the entire business of the ceding insurance company is rolled into one single contract. This means that if the reinsurer is able to bag this contract, the value of the policies being underwritten by them increases exponentially. Multi-tower contracts are generally associated with bigger sales volumes and hence are preferred by reinsurance companies who are looking for quick revenue growth.
- Higher Margins: Multi-tower reinsurance contracts combine a lot of different lines of business. When a reinsurance company quotes a price to the ceding insurer for a single tower, they need to maintain a lower profit margin. However, when bundling of different products is done, many towers with very high-profit margins are also included in the contract. As a result, the profit margin of the overall contract tends to be higher as compared to contracts that only contain a single risk.
- Multi-Year Contracts: Traditional reinsurance contracts last for a period of one year. However, since multi-tower reinsurance contracts are unconventional, many reinsurance companies increase the duration of these contracts as well.
Most multi-tower contracts are for a period of greater than one year. This means that not only does the reinsurance company bag the sale immediately, but they are also relieved of the effort which needs to be put in while renewing the contract.
- Lower Administrative Costs: When reinsurance companies have multiple contracts, they need to maintain a lot of paperwork. Hence, when reinsurance companies sign a multi-year contract, they are able to drastically reduce their administrative as well as legal costs associated with the creation and renewal of multiple contracts.
Disadvantages to Reinsurers
There are many reinsurance companies that are opposed to the idea of multi-tower reinsurance contracts. This is because of the following disadvantages.
- Higher Risks: When reinsurance companies sign a single tower contract, they are able to choose the risks that they want to undertake. However, when they bundle multiple towers into a single contract, it becomes an all-or-none game.
Reinsurance companies find themselves pressurized to take on additional risk which is associated with product bundles. Many reinsurance providers would not accept such a high risk if it were in a single-tower contract. It is for this reason that traditional service providers generally steer clear of such non-conventional contracts.
- More Competition: It is also important to note that many reinsurance companies have now become accustomed to the idea of multi-tower reinsurance contracts. As a result, the competition for such contracts is increasing fiercely because of the high dollar value associated with such contracts.
- Complicated Structures: It is also important to note that drawing up a multi-tower reinsurance contract is not simple. These contracts are often complex and customized. This is because various factors such as the triggers and sub-limits for the various towers are negotiated between the two parties. On the other hand, standard reinsurance contracts have been around for a long time. As a result, they are easy to draw up since both parties agree to the implications of the various clauses associated with the contract.
The bottom line is that even though the reinsurance industry as a whole is moving towards multi-tower non-conventional reinsurance contracts, there are many reinsurance companies that are still averse to doing so. This is because there are many pros and cons of multi-tower contracts and each reinsurance company must make an individual decision based on its own internal decision-making parameters.