Carriers thrive on predictability. Risk management techniques, models, and sometimes intricate programs are devised to anticipate insured losses and take the appropriate risk transfer measures. The use of multi-year cover for accident and health lines of business, though in its infancy, could be the next step in mitigating risk and reducing ambiguity. With a longer-term commitment, (re)insurers trade price advantages that come from sharp turns in the market for the predictability that both crave, particularly when the market becomes volatile.
Starting at the life, accident, and health July 1, 2008 renewal, both insurer and reinsurer interest in multi-year cover became noticeable. Few acted on the opportunity, but discussions are becoming increasingly common. Both insurers and reinsurers have reasons for seeking longer coverage timeframes. Insurers struggle with worries of a spike in increased losses that will drive risk transfer pricing higher with alarming speed. Reinsurers, on the other hand, seek to protect revenue streams from the effects of loss-free or low-loss years.
The advantages of multi-year cover are salient. For both sides of the risk transfer equation, it offers stability—which is ultimately the purpose of both insurance and reinsurance. Particularly for working layers, longer coverage periods protect cedents from market volatility and events that could lead to market discontinuity. Personal accident carriers buying catastrophe layers may benefit from steady pricing and guaranteed capacity in the wake of an event that leads to high levels of insured losses. In some cases, multi-year programs can allow insurers with quota share reinsurance coverage to assume risks that they would have to forego otherwise.
For reinsurers, multi-year coverage establishes a fixed (or at least predictable) “spot rate” for reinsurance pricing, helping to offset downward pressure on revenue in a cedent-advantaged market. Multi-year coverage can also reduce reinsurer volatility, by preventing cedents from shopping after an adverse claim year. An automatic renewal at prearranged terms can further reinsurer efforts to contain volatility, as well.
If there is a spike in insured losses on the program—or if prices drop substantially—most multi-year programs do have mechanisms to protect the two parties. Some products renew at identical terms, which speaks to the predictability advantage that (re)insurers value. Others use experience-based formulae to adjust rates according to the losses sustained for the prior year. With this method, neither the insurer nor the reinsurer is held hostage by the agreement if market conditions become unfavorable.
As cedents and reinsurers explore this new approach to accident and health cover, details continue to be in flux. Some cedents, for example, are seeking more than the stability naturally afforded by multi-year protection. Often, they are looking for substantial price breaks, as they are committing to a longer-term contract. Cedents see this as offering reinsurers a predictable revenue stream. Yet, reinsurers tend to perceive multi-year cover as a way for both parties to attain some predictability for a longer period of time. Thus, the reinsurers have not offered additional rate reductions beyond those produced by current market conditions.
In a volatile market, interest in multi-year cover is usually one-sided. After all, a sharp increase or decrease in risk-transfer pricing will benefit only one of the two parties. When rates stabilize, though, insurer and reinsurer interests start to align. If pricing remains low while rates approach a natural floor, both parties are likely to become more interested in multi-year coverage, and deal flow will increase. Reinsurers will seek to protect revenue streams, and insurers may want to trade playing the market for the security of predetermined renewals.