The transfer of reinsurance risk traditionally has been underpinned by deep personal and business relationships. This has been for a couple of reasons. First, the types of risk covered in reinsurance are unpredictable and the information for calculating potential losses is often sparse, providing an uncertain basis for contracts. As a result other mechanisms are developed to counteract uncertainty, such as building trust through long-term relationships; reinsurers trust that cedents will provide them with good information and cedents trust that reinsures will pay for losses and claims. So when we think about reinsurance relationships they are a form of trust that underpins business transactions between cedents and reinsurers.
Second, these trust relationships enable the flow of capital in the industry, particularly after losses. In a long-term relationship reinsurers get to know the cedent and their portfolio – the way they handle their claims and contain their losses – so that in the event of a payout there is a mutual understanding that it is fair, appropriate and should be settled quickly rather than resorting to legal processes. Moreover, the trust in long-term relationships counteracts opportunism in the pricing of reinsurance programs. Reinsurers in long-term relationships are less likely to walk away when prices go down during flat or soft markets, confident that they will make good with shares from trusted cedents when prices increase after losses or in hard markets. That is, neither cedent nor reinsurer ‘shop around’ annually for better prices and this kind of give-and-take in long-term relationships has been important for stabilizing and securing a flow of capital in this industry.
That said, recent changes in the industry put the relationship model under threat or at least changes who is having relationships with whom. Reinsurance relationships can be differentiated according to the significance of cover for both parties. One of the critical findings in our research is that as big global cedents are growing and consolidating, bundling their risk into massive programs, it is progressively becoming very difficult for anyone, except the largest reinsurers in the world, to be truly significant partners to these cedents. The meaning of relationships is changing for these big cedents. Their relationships are being concentrated in a handful of big reinsurers around the world that take the overwhelming majority of their risk across their various programs. These big reinsurers have the technical know-how and the capital to be significant partners for the largest cedents. Then, the rest of the reinsurers on their panel, while they may be long-term, are each only taking a small share, which means they are largely replaceable by other reinsurers or even substitutable by other forms of capital.
As the biggest cedents are shopping around for the best price of capital and for relationships with partners that can help them with the technicalities of their program, small or mid-tier reinsurers essentially become market-followers on those programs. Therefore, mid-tier reinsurers look to consolidate their relationships with the smaller cedents where they can continue to be significant partners. What we are seeing is not only relationship differentiation, with closer relationships between smaller cedents and reinsurers and closer relationships between bigger cedents and reinsurers, but also increased opportunism at the peripheries of these relationships. We expect high prioritization of core relationships while opportunism in the peripheral players is increasing acceptable.
In lots of ways, we see these changes as an opportunity for mutuals and cooperatives to strengthen the relationships that they have with their core partners. As mid-tier reinsurers become less significant for large cedents, their relationships with the smaller, longer-term players become more precious. Competitively, this market change can be advantageous to mutuals and smaller cedents where the relationship model and the capital stability are valued. Sharing information and getting deep knowledge of each other are critical when building relationships to last across the ups-and-downs of the market cycles. Aiming to be the most attractive cedents for long-term relationships, mutual and cooperatives have to do their best to ensure the quality and transparency of the information that they provide to their reinsurers.
This week’s blog has been written by Paula Jarzabkowski, Professor of Strategic Management at Cass Business School, City University London.
Professor Jarzabkowski will be a keynote speaker at the ICMIF Meeting of Reinsurance Officials (MORO), 9-11 June 2014, Miami, USA. The theme of this year’s event is ‘Expect the Unexpected’. For more information about the MORO agenda, please contact Mike Ashurst, Vice-President, Reinsurance. For more information about the event in general, please contact Yvonne Hautenne, Vice-President, Events.
Professor Jarzabkowski has been studying the competitive dynamics of the global reinsurance industry since 2009 with reinsurers, brokers and cedents around the world. Her research has been the subject of many industry presentations, reports, and media articles. The relevance of her work was recognized recently with the prestigious Economic and Social Research Council Outstanding Impact on Business Award.