Political tensions have been rising. The climate has been changing. Cyber risks have become more complex than ever. We do not know if this is the end of the world. But we do know that this has made the reinsurance market more complex than ever.
To add to the complexity, there have been new interesting market dynamics. For example, there has been surge in alternative financing. This is changing the reinsurance landscape and creating new opportunities.
In this environment, technology will be key to helping Reinsurers in their mission. In this article, we will talk about how we see this happening. Are you unfamiliar with Reinsurance? Don’t worry, before we jump into our expectations, we will explain what Reinsurance is.
What is Reinsurance?
In essence, reinsurance is insurance for insurance companies. With reinsurance, insurers can offer coverage at affordable prices. Risks are transferred from individuals and companies through primary insurers to the reinsurer. Reinsurance allows those parties to reduce their risk exposure and own capital requirements. This allows insurers to write more business.
Reinsurers are experts in analyzing, identifying and modeling risks. They have a deep understanding of a wide variety of insurance markets and products. Their global reach also provides them with superior data.
Reinsurers have established a reputation as trusted advisors to the insurance industry. Insurers who are looking into new markets or products may seek reinsurers’ expertise. Reinsurers are also key drivers in the adoption of better risk management practices.
How does it work?
Under a reinsurance agreement, a reinsurer takes on part of the risk that an insurer has written. The party transferring the risk, for example, a primary insurer, is known as a cedent. The original policyholder is not involved in the transaction.
There are many different forms and types of reinsurance contracts. They either cover entire insurance portfolios or relate to single risks. They may involve a sharing of all premiums and losses. Or they may cover losses exceeding a certain threshold. All contracts have the same ultimate goal:
- Provide capital relief
- Smooth the volatility in an insurance company’s earnings
- Protect primary insurance’s balance sheet
Reinsurers play a crucial role in stabilizing local insurance markets because they spread their risks around the world. They are also able to cover large one-off risks (a big bridge falling, for example).
Tech opportunities in Reinsurance
There are three key opportunities in reinsurance for tech disruption in our view. First, reinsurances are shifting to value-added services. Second, there has been an influx of alternative capital in the industry. Finally, the placement process holds huge automation potential. We will look at each one of them in more detail below
Shift to Value-Added Services
Insurance companies have become more sophisticated at managing risk. Additionally, they have increased in size and capitalization. As a result, they need less capacity than in the past. Thus, the proportion of primary insurance ceded to reinsurers has been falling.
Nevertheless, insurers still need access to reinsurance expertise. Especially to expand into new regions and products.
This expertise is even more necessary for cyber and climate risks. Why? Well, understanding risks is challenging when there is a lack of historical data on losses. And even reinsurers do not have enough quality data on cyber and climate risks. To overcome this, reinsurers can partner and collaborate with Insurtech companies.
Insurtechs can help reinsurers gather quality cyber risk data. Not only data, but they can also leverage their AI expertise to provide quality insights. For example, CyberCube’s platform provides an ecosystem of data, signals, and models. This helps reinsurers and insurers with cyber risk quantification.
Shift to alternative capital
There has been an influx of alternative reinsurance capital. “Alternative capital**”** refers to capital from non-traditional sources that support reinsurance risk transfer. This capital typically comes from institutional investors who are seeking non-correlated returns.
Alternative capital is often deployed through various insurance-linked securities (ILS). These can have different structures. The most common are catastrophe bonds (also known as “cat bonds”). In these bonds, investors lose their principal if the specified disaster occurs. In return, they receive attractive interest rates. There are also other structures. For example, collateralized reinsurance contracts, sidecars, and industry loss warranties (ILWs).
Risks outside of property catastrophe are still too opaque for capital market investors. They are also too long in duration. There is a need to reduce the burden of trapped collateral and to standardize risk. This can be done through innovations in data, technology and structuring techniques. Moreover, there is also a need to create ways to increase the frequency of the reporting of positions. This would create more confidence in the securities’ valuation measures.
Secondary ILS markets are still underdeveloped. For these exchanges to happen, securities need to be standardized and simplified. Parametric products could help to achieve this. This is because they provide straightforward, easily measurable criteria for triggering payouts.
FloodFlash provides parametric flood insurance. This technology could help create cat bonds that would trigger if water levels reached a certain height.
Automated Placement
The reinsurance placement process is complex, slow, and expensive. Traditional processes involve in-person meetings, many steps, and many handovers. This creates inefficiency and opacity. Don’t believe in me? Below is the typical life cycle for a reinsurance treaty in the US market. See it for yourself:
Insurtechs may drive the adoption of automated reinsurance placement. For example, by leveraging blockchain to issue and execute smart contracts.
Incumbents may resist these changes. Especially if it cannibalizes their existing and profitable multi-year relationships. Reinsurance companies rely on their pricing strategies as a significant competitive advantage. Thus, underwriters can also be worried about automated systems revealing their pricing.
Automated placement would fit well for alternative capital providers. It would be even more relevant for those with a model based on global access to risk.
Bifröst exemplifies how insurtech is facilitating the shift towards automated reinsurance placements. It streamlines the placement and accounting operations for cedents, brokers, and reinsurers.
Are you disrupting the reinsurance industry? Reach out to us!
By: Nuno Marques Afonso, Analyst
