Our planning article suggested that reinsurance was the most important building block in protection. It’s effective use should be part of your planning.
All but one of the twelve largest protection insurers use substantial amounts of reinsurance. This has been their successful strategy since the 1990s, with the top insurers reinsuring 100% since c2011.
This article shows why reinsurance works for them and ends with a nightmare scenario. (For balance: two examples of insurers not using much reinsurance.)
Reinsurance? Not so fast!
Our building blocks of protection article notes the importance of reinsurance and distribution, as well as five further items which affect advisers’ profitability.
The need for distribution is obvious; advisers need to have confidence in your products and your new business process. Less clear is the case for 100% reinsurance. Doesn’t that give all the profit away?
Why reinsurance should work for you
Reinsurance has many benefits for the modern protection insurer, especially when 100% reinsurance is used. It can really help smaller insurers and protection specialists.
These benefits can be measured numerically in profit tests, forming a business case for reinsurance.
Reinsurance can help you to:
Boost profitability. Try a simple test. Set your term assurance pricing basis, independently of reinsurance. Derive a retail premium to give, say, profitability of 40% of one annual premium. Observe your resulting market position. Now factor in reinsurance premiums. Almost every deal I’ve seen increases an insurer’s profitability.
Reduce uncertainty and clarify financials. With no net claims profits are affected more by lapses than deaths. Insurer profits can be a simple function of retail and reinsurance premiums.
Simplify operations. Less time worrying about mortality assumptions means more time on essentials: volume, market pricing, underwriting, expenses, lapses and capital.
Make competition work for you. Drive down your biggest cost: claims. Let reinsurance help your pricing actuaries, underwriters, sales and marketing staff.
Avoid the winner’s curse. Specialists know the winner’s curse operates in group risk markets and in reinsurance. Let the curse work for you — or do better still.
Be more ambitious and rigorous. Reinsurers must be convinced up front by your plans, expertise and ability to deliver. The need to match ongoing expected mortality experience requires a focus on distribution and underwriting.
Increase your expertise. The big reinsurer-sponsored conferences are long gone, but they can still provide market knowledge and support in the areas of underwriting, claims, pricing and distribution.
Build a basis. To price business you may need to make mortality/morbidity assumptions, especially you’re not reinsuring 100%. You reinsurer can probably help. On other items e.g. expenses you may be the expert, though the reinsurer may opine. Lapses lie somewhere in between.
Conserve cash. Writing a protection policy usually means a large cash outflow at time 0, not least because of the need to fund substantial adviser initial commission. Reinsurance can mitigate or remove this: it is possible to be cash-positive immediately.
Manage capital. Large composite insurers with general and life insurance operations, including annuities, protection, pensions and investment, may be as well diversified as reinsurers, with consequent capital benefits. More common are:
- Life and pensions insurers e.g. Aegon, L&G and Royal London.
- Protection specialists e.g. AIG, Guardian and Vitality.
- Friendly societies, often with one main product, e.g. Holloway.
Reinsurance passes through the benefit of a reinsurer’s diversification.
The nightmare scenario
Imagine you don’t use much reinsurance and that it becomes evident that your assumptions are too optimistic. Perhaps more people are dying than expected or mortality improvements have slowed or even reversed. Or similarly for the (less predictable) Critical Illness or Income Protection products.
Not only have your profits reduced (or disappeared) the “hit” has to be taken immediately: your corporate actuaries insist you put up extra capital. Worse, your regulator is restless.
Those impacted in this scenario could be:
- Life and pensions insurers, including those most diversified (least)
- Protection specialists
- Friendly societies, especially Income Protection specialists (most)
Where are you on that list?
- Reinsurance is not real magic but it helps.