Increasingly, reinsurance is seen as an important element of capital management. Reinsurance decisions are moving away from the reinsurance buyer and towards the finance teams. These teams need to find a way of comparing reinsurance in a straightforward way. Defining the cost of capital for reinsurance means that it can be compared with other capital sources.
In a Solvency II context, Cost of Capital is a widely used metric for assessing reinsurance. Guy Carpenter has seen this in practice in a number of capital related transactions we have worked on and this note is based on that experience. In it we cover:
- What is cost of capital?
- How is it applied to reinsurance?
- What are the benefits and pitfalls?