When it comes to selecting a reinsurer, cedants must choose carefully if they want to ensure reliable coverage. Sometimes the soft information is as important as the cold hard financial facts. We present the savvy shopper’s guide

While the number of reinsurers has dwindled through mergers and acquisitions in recent years, reinsurance buyers still have a wide array of counterparties to choose from when putting together their programmes. Buyers can cede risks to large, global powerhouses or specialists that write only one or a handful of business lines in select geographies, depending on their needs.

Making the wrong choice, however, can be disastrous. As buyers frequently point out, having a reinsurance policy that does not pay out is worse than not having coverage at all. As a result, cedants have to pay close attention to the companies they entrust their business to.

Insurer financial strength ratings from the main four rating agencies – Standard & Poor’s (S&P), AM Best, Moody’s and Fitch – have long played a central role in helping buyers and the brokers advising them to determine which reinsurers to use for which types of risks. For example, cedants tend to prefer higher rated carriers for long-tail risks, but are slightly less fussy when it comes to shorter tail business.

However, as the agencies themselves admit, financial ratings are only a guide, and need to be used in conjunction with other information sources to enable security committees at cedants and brokers to make informed choices. Some of the qualities buyers look for in a reinsurer can be easily measured with hard data,

while determining other characteristics requires a reliance on more subjective information, such as a company’s track record.

There is no single tool that can effectively do the job. “I am not sure there is a system out there to deal with that,” Lloyd’s insurer Beazley’s reinsurance manager Christian Tolle says. “That is why we use the tools we have to get as good a picture as we can.”

Here, Global Reinsurance highlights cedants’ top indicators and information sources for evaluating the quality of their reinsurance counterparties.

1 Financial strength ratings

Although much-maligned, financial strength ratings from the four main rating agencies remain the single most important indicator for cedants. “On the quantitative numbers side, we must look at the financial strength. Whether it’s an S&P or an AM Best or a Fitch rating, it obviously has an impact,” Tolle says. “But we tend to use S&P more than anything else.”

Lloyd’s insurer Canopius’s reinsurance manager Chris Swan says his company also uses financial strength ratings from S&P and AM Best as a key indicator of security. “They need money in the bank to pay out so the financial strength rating goes without saying.”

Although buyers use more than just ratings to make their choice of reinsurer, doing business with a poorly rated counterparty simply isn’t an option.

“We wouldn’t entertain having our reinsurance placed with someone who wasn’t financially secure,” Lloyd’s insurer Barbican’s commercial deputy underwriter Conor Finn says. “Financial strength is the top priority in our eyes. It has to be.”

2 Other financial indicators

While ratings can provide an indication of reinsurer financial strength, some cedants prefer to back them up with data from counterparties’ financial statements.

“We have a broker that acts as a security adviser to us and it runs all the company reports through its models. This gives us various key ratios, on single-year and historic-year data,” Tolle says.

Credit default swap spreads are also used sparingly by some cedants to help spot potential problems at listed reinsurers. “We use credit default swaps but I must admit we use them for information more than anything else,” Tolle says. “The problem with credit default swaps is that they tend to be more reactionary. Unfortunately, it comes a bit late in the process.”

One of the biggest drawbacks of using a variety of financial indicators is that it is quite complicated to get approval to use a particular reinsurer. “We’re probably too careful sometimes. That means we have a very short list of reinsurers for our long-term business that are deemed acceptable,” Tolle says.

3 Long-term secure relationships

Ratings and financial indicators reveal much about a reinsurer’s ability to pay. But willingness to pay is equally, if not more, important to cedants. “For us, security is the most important thing when we pick our reinsurers. There is no point whatsoever in having a reinsurer who can’t pay the day there is a loss,” Tolle says. “For that reason, we are comfortable with being as conservative as we are about choosing reinsurers. It works well for us and, historically, we have had very few issues with counterparty risk.”

Canopius’s Swan agrees: “We also look at the willingness to pay. It’s no good someone having pots of cash if you can’t get your hands on it. Of course, that is a little bit subjective so it’s hard to use a formula to measure that.”

Given the difficulty of measuring willingness to pay, cedants tend to prefer reinsurers they have dealt with for many years. “Willingness to pay is based on experience,” Swedish insurer Länsförsäkringar’s general manager of reinsurance Tor Mellbye says. “You can’t really risk that. Our choices are based on experiences with companies.”

“Our trading history with the reinsurers is important,” Tolle agrees. “If historically we have had problems with someone, we are obviously far more reluctant to deal with them going forward.”

Long-term corporate partnerships are paramount to Finn. He says: “We are only interested in people willing to commit large capacity to Barbican on one line or, ideally, across a couple of lines.”

Just as cedants need to understand their reinsurers when making choices, they also have to be confident that their reinsurers will understand them. For US insurer Argo’s senior vice-president of business development, Barbara Bufkin, a key feature is “having a senior relationship manager in the reinsurer, where there is a clear understanding of our company’s needs. And the ability, with a lot of transparency, to present our reinsurance needs and engage with those from a senior management perspective.”

4 External opinions

Cedants often support their own opinions of reinsurers’ ability and willingness to pay with views from the outside, such as from trusted brokers. “We speak to brokers and get their feedback and opinions on companies sometimes,” Swan says.

Another source is rating agencies, which, as part of the rating process, offer opinions on the strategy and management of reinsurance companies.

Swan says Canopius uses such soft indicators from S&P. “It’s not just looking at the financials and applying formula to it,” he says. “S&P looks at calibre of the individual strategy of the organisation. Have they got a dominant position in their marketplace?”

He adds: “These days, we have access to massive amounts of financial data but sometimes it’s more soft information that matters. Someone might be under review or in a big change of management or ownership, or having problems in a certain class of business.”

In addition to its own security committee, which pools knowledge from staff about reinsurers and measures each counterparty risk, Beazley also uses an outside perspective, according to Tolle. “We have a second security consultant who gives us a more subjective view on life at the reinsurers,” he says. GR