Interest is growing in bespoke structured reinsurance products, but what are the actual benefits?
Insurance companies face difficult times. The prolonged soft market, coupled with the low-interest-rate environment, is creating conditions for increased earnings volatility.
When margins are thin, large claims, unfavourable reserve developments and the expansion of perils can cause nasty surprises, depleting capital, denting profits and crushing market/franchise value.
Added to the mix, insurers are having to contend with evolving regulatory and ratings agency requirements, including Solvency II and the update of AM Best's new capital model: Best’s Capital Adequacy Ratio (BCAR).
In this context, one-size-fits-all reinsurance solutions are less appropriate, says Hugo Kostelni, President, JLT Re Structured Products. “Insurers are all being held to a higher standard, from AM Best’s new stochastic model to the various regulations we all have to deal with. Past practices are no longer good enough.”
Big improvements in insurers’ risk management and risk modelling fortunately mean that they have a much better handle on their risks. In addition, tailored-made alternative reinsurance structures, also known as ‘structured products’, offer a much greater range of protection options that can address specific issues or requirements.
Using risk transfer solutions, structured products can help to maintain financial strength ratings, optimise capital, protect against adverse reserve development or large losses, deal with discontinued lines of business, mergers and acquisitions and gaps in traditional cover.
Interest in structured products has grown, particularly as insurers look to manage uncertainty in today’s competitive insurance market, says Ross Howard, Executive Chairman of JLT Re.
“There is an opportunity for insurers to work with reinsurers to develop alternative and targeted solutions to protect their business as they work their way through a difficult market.”
Insurers might have previously managed prolonged soft market conditions by raising retentions and compensating for weaker underwriting results with investment income. In today’s low yield environment this is no longer an attractive option, says Kostelni.
“Raising the retention level appears to be a simple way to save money. But companies that did this in the past paid the price when losses came in and they lost market capitalisation many multiples of the ‘savings’ they achieved.
“Companies now want more sophisticated solutions that reduce volatility and balance cost with protection,” says Kostelni.
Structured products can help insurers deal with issues that are heightened by a soft market, such as rising expense ratios, reserve volatility and increased exposure to large losses.
For example, non-traditional quota share reinsurance can protect capital, reserves and loss ratios, therefore stabilising earnings. And, by protecting outstanding losses and IBNR, capital can be released and used to support new business, explains Howard.
“Insurers used to purchase reinsurance to mainly protect capital, but this is changing. We now see more and more companies purchase cover to protect earnings and to address specific concerns, such as deterioration in prior year claims or an unbudgeted series of large losses,” says Howard.
Due to the sophistication and customisation of structured solutions, such as adverse development and aggregate covers, working with the right reinsurer and advisor is critical. As is the need to adhere to best practices, even when they are not required by regulations, says Kostelni. “Structured reinsurance is not a part-time job or something that should be done as an accommodation to clients.”
For more information, please contact Hugo Kostelni, President, JLT Re Structured Products on +1 415 967 7901 or email firstname.lastname@example.org