Reinsurance - a bob each way?
Someone once likened reinsurance to a smart gambler laying off his bets, or placing an each-way wager - just in case the first prize proved elusive. In this instance, the 'gambler' is meant to be the insurance company, reducing the burden of risk-taking by buying cover from a 'wholesale' reinsurer - an insurance company's insurance company, if you like.
My actuarial colleagues will, of course, take issue with the terminology, as gambling implies random chance, and from their perspective, calculated probabilities based on statistical analysis, minimise the element of chance and reduce the risk of financial over-exposure.
The Reserve Bank of NZ, now responsible for regulating insurance companies, is currently examining the relationships which exist between reinsurers and their NZ client companies, and is examining the reinsurance support and financial arrangements in light of the new solvency and capital management standards.
These relationships have never been high-profile, seldom appear in the media, and many Kiwis will have heard the term 'reinsurance' for the first time - if at all - in relation to the shortfall in (catastrophe) reinsurance cover revealed by AMI insurance in the context of the Canterbury Earthquake disaster.
Reinsurance is also not a subject that is ever likely to be the subject of a blockbuster Hollywood movie - but it is a vital component in the insurance and financial services industry, without which private and corporate citizens of New Zealand (and elsewhere, for that matter) would be exposed to considerably greater risk than is presently the case.
There are some key facts to appreciate when considering the importance of reinsurance;
- The agreement is between the reinsurer, e.g. Swiss Reinsurance, Munich Reinsurance, etc., and the 'writing' company, say Sovereign, IAG, QBE, AMP, etc. - the consumer has no direct relationship with the reinsurer, and (usually) has no right of recourse in the event that the writing company cannot meet its obligations - more of this later.
- Some insurance companies have little need for reinsurance, unless there are high value risks - big life insurance policies, for example - as their capital adequacy can absorb most claims, without reducing solvency. Therefore, by and large, the older, larger, and well-established insurance companies are less likely to buy reinsurance - but beware, as this is not always the case. Reinsurers operate on the international stage, and the capital at their disposal seeks to maximise shareholder returns as with any commercial enterprise of scale. In some instances, complex financial instruments have been devised to leverage higher returns - but which usually entail higher risk.
- While both Fire & General insurance companies, and Life Insurance companies utilise reinsurance in varying degrees, the nature of this usage differs substantially, as you might expect. Natural disasters such as hurricanes. tempests, and earthquakes will impact on the Fire & General insurance and reinsurance companies abilities to provide stable pricing and cover, as will events such as the BP oil spillage in the Gulf of Mexico. But on the life insurance side, as tragic and sad as the events of 9/11 in New York were, with the terrible loss of life in the attack, the life insurance and reinsurance companies were not so adversely impacted as to cause any pricing volatility. As we are experiencing now with household insurance in New Zealand following events in Christchurch, the general insurance companies are most certainly susceptible to wholesale changes in practice and pricing.
The R.B.N.Z. has taken an interest in the relationships between some life insurance companies in NZ and their reinsurance partners, due mainly to the financial support provided by a variety of methods, to encourage the use of reinsurance and provide access to the capital necessary to stimulate the growth of emerging life insurance client companies.
While the Reserve Bank has every right to test the validity of that financial support, some caution needs to be exercised when examining the various methodologies deployed to support life insurance companies in particular, so that they can continue to provide consumers ultimately with sustainable, affordable, and vital financial protection.
Any rules and regulations which put honest, well-grounded practitioners at risk of going out of business need to be re-considered in the light of the potential loss of consumer choice, the likelihood of financial difficulties occurring, and the NZ experience since becoming a recognised global player - albeit small - in world markets.
The time for submissions has past, and the Reserve Bank must now deliberate on the complex and intricate arrangements which exist in the market.
Against the new prudent management legislative backcloth, the product providers should be give ample time and opportunity to make any adjustments necessary, but an in-depth understanding of the nature, intent, and impact of the financial inter-dependence between insurer and reinsurer is essential before any hard-and-fast decisions are taken.