It Takes Two to Tango.
The quest for higher margins, steady growth and few surprises has focused attention on an old but now increasingly popular concept: first-dollar quota-share reinsurance. First-dollar quota-share reinsurance transfers a percentage of risk on each policy from the ceding company to the reinsurer and shares all premiums and losses accordingly.
Like other milestones in insurance history--universal life, variable life and joint and last survivor--first-dollar quota-share reinsurance is one of those concepts that change the way we do business. But the chance for success in such arrangements depends on diligent underwriting and prudent claims management by ceding companies and reinsurers.
First-dollar quota-share reinsurance works like this: The direct carriers might keep 10% of every policy written, up to their normal retention, and reinsure the balance on some percentage basis to a pool of reinsurers. Put another way, a direct carrier has a $1 million policy and might keep $100,000 (10%) and reinsures the remaining $900,000 (90%) to the pool. This approach has become extremely popular in recent years.
Both reinsurers and direct writers reap benefits from a first-dollar quota-share arrangement. From a direct writer's perspective, less mortality risk translates into less volatility of earnings. Since 90% of the mortality risk is being transferred to the reinsurers, any fluctuation in mortality is likely to have a fraction of the effect on the direct writer than if the writer had carried the full retention. In addition, by retaining less of the risk, the direct writers are able to free up capital that would have been directed toward increased reserves had they retained 100% of the risk. The only real risk for the direct writer might be in giving up the potential profits that could be generated from this business. Again, as in the excess-of-retention arrangement, sound risk-management practices are key to profitability.
For reinsurers, quota-share arrangements create a new means for growth. Wide fluctuations in mortality are tamed, because quota-share arrangements give reinsurers a piece of every policy. Therefore, the spread of risk is much greater.
If both parties are to benefit, three conditions must be in place:
* The direct carriers are depending on the reinsurers to step to the plate for their proportion at claim time.
* The reinsurers are counting on the direct writers to approach underwriting with the same zeal they would have had they retained the entire risk.
* The reinsurers are assuming that the direct carriers will investigate claims with the same diligence as they would have had they retained the entire risk.
Because so many more policies are being reinsured, these first-dollar quota-share arrangements are creating enormous amounts of automatic reinsurance. Automatic reinsurance allows direct writers to pass risk on to reinsurers based on their own underwriting opinion, without seeking approval from the reinsurers. Limits on automatic reinsurance keep the reinsurers' risk at the proper level.
In 1998, U.S. insurers brought $203 billion of in-force reinsurance to the market, partially due to restructuring and demutualization. It was the biggest year in history for life reinsurers. For the first time ever, the amount of mortality risk ceded to reinsurers exceeded the amount of risk retained by U.S. insurers.
Research funded by the Society of Actuaries indicates a 29.5% compound annual growth rate for ceded risk from 1994 to 1999, while the amount of risk retained by U.S. insurers fell during the same period by 7.3% annually.
With the volume of business coming to the reinsurance market, the onus is on the reinsurers to prudently manage these blocks. One method of managing the blocks of business is through routine underwriting audits. Because selected random samples of policies can exhibit both favorable and unfavorable findings, a single sampling is not the best course of action. Multiple reviews or a larger sampling will give the auditor a better picture of how the mortality for a given block of business might emerge.
Underwriting is all about managing risk. It cannot be optimally managed without the total cooperation between direct writers and reinsurers. Like almost any endeavor we undertake as an industry, when both parties "do it right," all parties benefit, including the consumer.
Barry A. Wilkinson, a Best's Review columnist, is vice president and chief executive underwriting officer at Lincoln Re, Fort Wayne, Ind.
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|Title Annotation:||first-dollar quota-share reinsurance|
|Comment:||It Takes Two to Tango.(first-dollar quota-share reinsurance)|
|Author:||Wilkinson, Barry A.|
|Article Type:||Brief Article|
|Date:||Feb 1, 2001|
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