The wonders of reinsurance

Reinsurance has been—and continues to be—an integral part of the captive insurance industry. Anyone who has spent time in the space will agree that a deeper understanding of the mechanics of reinsurance enhances a captive’s capital position and growth trajectory.

From understanding how a captive’s reinsurance position impacts its front carrier’s balance sheet, to the impact traditional excess of loss and aggregate stop loss reinsurance has on the captive’s risk position, reinsurance is an important aspect of daily captive life. However, reinsurance can be utilised for so much more than that.

Over the past few years, the captive world has experienced another enormous boom period, with growth in just about every segment: single parent entities, groups, and agency captives. The reinsurance world has taken notice—and it wants a piece of the action.

Reinsurers are actively looking to deploy their capital, and are constantly looking for underserved markets in the insurance world. The captive space fits this description because, for the most part, most reinsurance utilised by captives is very traditional: namely, the aforementioned excess of loss and aggregate stop loss.

Yet reinsurance can be used for much more than that. Creative reinsurers can re-think the types of structures they propose, and by doing so, start to address a multitude of ongoing captive concerns, and outright pain points.

At its core, reinsurance is capital. It can be used to provide solutions to several different pieces of the captive puzzle. One of those pieces is the overall expense of the captive programme.

There are a lot of moving parts in a captive programme, and each one carries its own cost. Added together, the overall expense ratio can quickly tip upwards, and each dollar of expense takes away a dollar that could be utilised to pay losses—or worse—eat into the overall margin of the programme.

By taking a proactive approach to a better expense structure, using both quota share and excess of loss options in tandem, overall captive expenses can be reduced by 5 to 10 percent. This can have an enormous impact on the captive’s capital.

A key aspect of reworking a reinsurance structure is making sure the risk-taking position of the captive remains well within the realms of what the captive can absorb. In fact, retention can remain essentially the same.

This is where reinsurance professionals can get creative, by taking the structure back into better expense economics without altering how much risk—and profit—the captive cedes to reinsurers.

In addition to solving a reduction of overall captive expenses, a refined reinsurance structure can address what is perhaps the biggest pain point of them all: collateral.

Most captives are still required to post a certain amount of collateral for their programmes, whether in the form of a line of credit, cash, or any other mechanism. This is done annually, and the anticipated release of a prior year’s collateral is an ongoing struggle.

Furthermore, unexpected trapped collateral can hurt a captive’s capital position and impede its ability to grow. Good reinsurance structures can address this head on. By changing the expense structure, allocation of premium to the loss fund and flow of capital, collateral can be brought down to a much more manageable level.

These are just a few examples of the different ways to view reinsurance. The scope for positively impacting a captive’s capital and growth trajectory is vast.

Legacy reinsurance has become a massive part of the global reinsurance world, with dozens of reinsurers eager to provide solutions to captives with historical reserves on their balance sheets, and trapped collateral that has been compounded over time.

Property reinsurers (and others) have devised ways of using captives within a large tower, so that difficult catastrophe-exposed segments can find a solution that is both reasonable and sustainable.

Captives with multiple lines of business with varying risk positions may find a holistic portfolio-wide solution in the aggregate by utilising insurance-linked securities (ILS) and collateralised reinsurance markets, who are bringing a broader structured approach to their partners.

As more capital flows into the reinsurance world, with numerous new entrants launching in the space, it is not too bold to expect that reinsurance will find other ways to bring new solutions to the captive world.

When a captive works with its reinsurance partners, they should be confident that those reinsurance professionals will be able to determine all the pain points that their captive partners are facing.

By being creative and using a broader perspective of the captive’s needs, they can devise structures which provide solutions for several issues concurrently: ceding risk, refining the captive retention, lowering expenses, and managing collateral.

This holistic approach will have an immediate impact on the captive’s balance sheet, and bring the full value of reinsurance to any programme.

Desmond Bohan is executive vice president at BMS Re. He can be contacted at: desmond.bohan@bmsgroup.com