The reinsurance broker does more than facilitate transactions that transfer risk, though this has long been viewed as the category’s core strength. With the importance of risk modeling, counterparty credit evaluation and other advisory services, the act of transferring risk necessarily involves more than sourcing capital and executing a transaction. The role of the intermediary continues to grow, as primary insurers change their perspective on reinsurance. Fresh memories of the financial crisis remain, and many cedents are taking broader views of their portfolios and seeking ways to optimize their capital and bolster their market capitalizations.
Ultimately, the reinsurance transaction should be focused on protecting (and, ideally, increasing) shareholder value — the transaction itself is intended to reduce the risk carried and minimize the effects of an insured loss. An unanticipated insured loss may start in a remote corner of the cedent’s portfolio, but its effects can be felt all the way to market capitalization. An unexpectedly large insured loss can cause the insurer’s earnings to suffer. Usually, this triggers a reaction among investors, and the company’s share price can fall disproportionately: losses are magnified in company valuation. Thus, protecting capital means preserving shareholder wealth.
For cedents, a comprehensive capital management program is necessary to ensure that a seemingly isolated risk management problem does not affect the entire company. The reinsurance broker, with detailed knowledge of its client’s portfolio, is in a unique position to help cedents identify and implement the measures necessary to prevent the outsized losses that could destroy shareholder value.
ERM is among the practices that intermediaries can employ with insurers to protect their capital. By identifying the wide range of threats to a carrier — on both sides of the balance sheet — an ERM framework supports the development of a comprehensive risk and capital management program that gauges the marginal effects of a particular risk on the company as a whole. Troublesome accumulations are avoided and hidden risks located. As a result, the insurer’s balance sheet and business position becomes more secure.
The importance of a broad, company-wide view of risk management was evident a year ago. The financial crisis drained balance sheets, causing concerns about the adequacy and availability of capital. Property-catastrophe losses from Hurricanes Gustav and Ike came at the same time as asset-side losses from discord in financial markets. While the insurance industry was sufficiently capitalized to absorb these two shocks, thanks to what was considered an “excess capital” position at the beginning of 2008, risk bearers realized the importance of conceiving the inconceivable when evaluating their business. ERM was already establishing itself in the culture and processes of the insurance and reinsurance industry when the 2009 crises struck and was doubtless the reason that there was only one failure and relatively few seriously wounded companies. The case for ERM was proven and brokers with their wide view of the market can identify and bring to bear best practice to their customers.