February 12th, 2013

The Growing Role of the Reinsurance Broker in the Life Market

Posted at 1:00 AM ET

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Nick Frankland, Chief Executive Officer, EMEA and Franck Pinette, Chief Executive Officer, European Life Business,
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Life and non-life reinsurance are different. One of the major differences is the prominence of the role of the reinsurance broker in non-life reinsurance - more than 75 percent of non-life business is transacted through brokers. This compares with only 5 percent transacted in life reinsurance. Why is there such a pronounced difference? And why is the life market developing a need for more frequent use of brokers?

There are three reasons that explain why brokers have had a less important role in the life reinsurance market:

The first relates to the size of the market: worldwide life reinsurance total premium volume stands at USD45 billion (roughly 20 percent of the total reinsurance market). The number of providers is quite concentrated with 12 main reinsurers. Is there a need to use the reinsurance broker for placement when life offices have easy access to this small market?

The second reason relates to the lack of specialized, technical life expertise and added value brought by reinsurance brokers in the past. Why would a life insurer use a broker to place reinsurance when the number of brokers with the required expertise is limited?

The third reason is a consequence of the first two, and is reinforced by the message sent by some reinsurers that they are capable of providing all services, such as product development and medical underwriting, to clients. Their message implies that the support of a third party is not really required and may be an additional cost burden.

At Guy Carpenter we see a clear change in the life market, largely in Europe. The rationale for buying reinsurance has always been risk transfer, development of new products, medical underwriting expertise and to a lesser extent, capital management. For a number of continental European life insurers, reinsurance is a small percentage of cession. It is not perceived at all as a capital substitute and therefore not really strategic. But with the implementation of the new Solvency II regime in Europe, the likely consequence for life offices will be requirements for additional levels of capital. Reinsurance may come to be perceived as one of the best and most efficient sources of additional capital.

The purchase of life reinsurance as a capital substitute requires strong expertise in three areas.

First, life insurers will always need to assess the cost of reinsurance and compare that against the cost of capital.

Second, reinsurance structures that are efficient from a capital perspective under Solvency II are much more complex than the traditional proportional cover efficient under Solvency I.

Thirdly, reinsurance structure needs to be customized. Each life insurer has unique requirements regarding its diversification benefit, which is the key component of the capital requirement. Some life insurers experience different levels of exposure to various kinds of risk, such as market, lapse or longevity. Reinsurance cover needs to be designed specifically to address the specific scenarios driving capital requirements.

Successful development and execution of these advanced structures requires a variety of expertise and skills: risk modeling, cost assessment, structuring bespoke solutions and selling new ideas to reinsurers. Most often, these skills may not be present in any one individual, but require a diverse, experienced team. It would be difficult for many small to medium-sized insurers to have this full suite of capabilities, thus reinsurance brokers that do can play a valuable role.

Professional Life Reinsurance brokers also bring a perspective that can be, in itself, valuable - that of an independent advocate who is agnostic about any particular solution or reinsurer. A broker has access to the capabilities and best qualities of the entire market and uses that to the benefit of its clients. Further, a broker has a greater ability to develop a completely new solution and then find the reinsurance markets that can support it.

The ultimate proof that brokers add value? Life insurers that engage the services of a professional broker may change to a different broker, but typically do not go back to a strictly direct basis!

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