Minimizing Reinsurance Risks

Given that reinsurance exists for the purpose of minimizing risk, it may be natural for primary insurers to underestimate the risks associated with their management of the reinsurance process itself. But while companies have been pouring investment into technology associated with primary insurance, they have all too often neglected their reinsurance operations, putting a substantial portion of their surplus at risk, according to a new report, "Property/Casualty Reinsurance Cedent Technology Strategies," authored by Donald Light, a San Francisco-based analyst with Celent Communications.

The report asserts that any primary insurer that has not made appropriate investments in reinsurance people, processes and technology is hurting its financial results. The risk primary insurers run, says Light, is that "the total of insurance recoverables that some companies have is so big that if a portion of that total goes bad, it's going to hurt their surplus in a noticeable way."

But that also means that technology currently offers cedents an opportunity to improve results. Looked at from an industry-wide perspective, the implementation of proper technology could result in increasing insurance recoverables by two to four percent, or $420 million to $480 million annually (based on 2003 U.S. reinsurance losses), according to the study.

Feeling the Pain

Individual companies' reinsurance management suffers three primary types of process "pain," according to the study: poor program design, owing to too much or too little reinsurance or the wrong coverages; unmanaged counter-party risk, associated with choosing the wrong set of reinsurance partners; and leakage that occurs through failing to realize all of the financial benefits from reinsurance actually purchased.

"It may seem odd that an insurance company could actually not know that it was due a recoverable or had a valid claim against a reinsurance company, but [managing reinsurance] is a complicated, difficult information processing job," says Light.

On the front end of the reinsurance cycle, within the issuance and contract administration phase, "systems have to be able to review all policies that are issued, by month or by quarter, and successfully identify which ones are and are not covered," Light explains. And later on, within the claims and recoverables management phase, some of the same challenges must be faced again. "Any policy issued can have a claim on it, and some subset of those claims will be covered by reinsurance policies, so you have to be able to screen all those claims, by month or quarter, to figure out which ones become claims from the primary company up to its reinsurer."

Cedents looking to improve how they handle reinsurance should begin with an assessment of their current process pain and potential financial gain, according to the study. "Realistically, such an assessment will be a mix of quantitative data and qualitative information," counsels Light. "How many years are covered by contracts still in effect? How many brokers, reinsurers and attachment points are involved? How large are reinsurance recoverables, and how are they aged? How much information is on paper or uncatalogued images?"

By locating its position relative to "pain" and "gain" axes, an insurer can arrive at a likely technology strategy with reference to four technology option areas: standards, components, point solutions and BPO, and integrated reinsurance solutions. All companies should try to leverage horizontal and industry standards, the study advises, but those suffering little process pain and little gain might otherwise just seek to maintain their current systems; those with more pain but little prospect to gain might additionally look to point solutions. Companies with less pain and more to gain are more likely to profit from a wrap-and-extend strategy leveraging component solutions, and those with a maximum of pain and potential gain may benefit from a replacement strategy that leverages integrated reinsurance solutions.

Anthony O'Donnell has covered technology in the insurance industry since 2000, when he joined the editorial staff of Insurance & Technology. As an editor and reporter for I&T and the InformationWeek Financial Services of TechWeb he has written on all areas of information ... View Full Bio