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9/22 M97/February 2018 Reinsurance

There is also a shift in power in a soft market from reinsurers to insurance companies, who (once again
within reason) are able to obtain more favourable terms from their reinsurers.
In a hard market, reinsurers often force insurance companies to retain higher retentions, but in soft
markets insurance companies sometimes seize the opportunity to purchase reinsurance below the level
of generally accepted prudent financial disciplines. We could call this opportunism, as reinsurance
supply is plentiful, and available at a price acceptable to the insurance company’s financial planning
requirements. Within this equation, there will always be reinsurers willing to participate at such low
levels, whether they are new entrants to the market, or simply that they are existing reinsurers prepared
to compromise their beliefs to maintain premium income levels.
Now that we have explained the background to both hard and soft reinsurance markets, we can look at
some important aspects concerned with managing the reinsurance underwriting cycle.

D3 Managing the cycle
While the cycle takes its course, a reinsurer must be able to diagnose the market situation and
Reinsurer must be
able to diagnose the implement its strategy in order to manage, as best it can, the changes inherent in the cycle. The strategy
market situation should address all aspects of the business risks faced by reinsurers, in particular, underwriting risk and
operational risk. Key elements of that strategy are demonstrated in table 9.4.

Table 9.4: Managing the cycle
Underwriters must know when to walk away from, or even cancel, particular risks,
Maintaining strict control territories and even markets, if prices fall below a prudent, risk-based premium.
of pricing
One tangible benefit of the risk-based capital approach adopted by various regulators,
such as the PRA and the Franchise Board at Lloyd’s, is that each and every reinsurance
agreement must be rated on a basis considered to be technically sufficient, even if such
rate bears little relationship to the so-called commercial price available for that particular
reinsurance deal.
That said, commercial considerations also enter the equation and they may include the
potential future cost of returning to these risks when rates improve. Reference copy for CII Face to Face Training
In pursuit of a balanced portfolio of reinsurance risks, underwriters should rigorously
Actively managing the apply appropriate risk selection techniques and regularly consider the compatibility of
portfolio
those risks as a whole within the portfolio.
A determined stance is often required to maintain underwriting standards in a softening
market. In such circumstances, brokers and clients often place underwriters under
pressure to extend coverage and ease terms, conditions, warranties and exclusions –
even though the underwriter is known to operate within a set of fairly rigid underwriting
guidelines agreed by their management.
It is often a challenge for reinsurers to maintain client relations in the low-price phase.

Investment income over the actuarial life of the resulting liabilities is inherently uncertain
Underwriting for technical and should ideally play no part in the underwriting process. Accordingly, the
profit not investment underwriting operations are usually separated from the asset management operations.
income
At one time, cash deposits would produce a healthy investment return and improve
nominal underwriting profits into even larger ones. In a low interest rate and, more
generally, a low investment return environment, this is no longer possible and further
emphasises the importance of underwriting for technical profit, balancing underwriting
strategies across various lines of business, correct risk selection and a strict control on
operating and administration expenses.
9 It has been said that, in one sense, the low investment return environment is the
Chapter equivalent of a major insured catastrophe occurring every reporting period.

It is important to align the interests of staff with those of shareholders, and incentives –
Gearing staff remuneration
towards profit and not such as bonuses – should be structured to reward value to shareholders over, for
example, premium income alone.
volume
In the past, many underwriters sought market share for its own sake, with little regard
for pricing or quality of the resulting portfolio of reinsurance contracts originating from
that market. Commercially, this approach was, and is, known as a ‘loss leader’
philosophy, with reinsurers literally buying their way into a market at prices considered
totally inadequate by established participants.
In hard markets, staffing levels are often increased, as are the benefits and other
remuneration rewards made to staff. On the other hand, in soft, or softening markets,
operating costs are rigorously controlled. This often leads to redundancies, withdrawal
of benefits and otherwise static pay.