One of the most effective ways of strengthening the balance sheet is to accelerate cashflow, argues Peter Wolf.
The heavy demands on the cashflow of reinsurers to meet claims from the World Trade Center atrocities have been followed just a few months later by acute pressures on balance sheets from the savage collapse in equity markets. In addition, boards also face unprecedented scrutiny of accounting methods. Many analysts, who so recently were cheerleaders of ever-rising equity values, are now looking to blow the whistle on the slightest rumour of `creative accounting'.
In these testing times for CEOs, there is one mantra that many are coming to recognise as the zeitgeist: cash is king. Yet, many reinsurers are extraordinarily complacent or indifferent when it comes to sweating a ready source of cash on their own doorstep - working capital. We are talking here about accounts receivable, in respect of premiums written, and amounts due as claims from other reinsurers and retrocessionnaires. For some reinsurers, the combined total of these speaks for more than 15% of gross balance sheet assets.
This cash is tied up in the extended paper chain between cedants, brokers and reinsurers. The delays and burden of reconciliation between these links in the chain are often exacerbated by delays inside the firms themselves, as documents and cash meander through Byzantine - and frequently manual - processes across departments and geographies. According to REL Consultancy Group estimates, the average number of days' premium billings outstanding (DPO) in accounts receivable amongst the top 20 global reinsurers exceeds 150. This is far in excess of typical terms of business. It is estimated that an improvement of only 10% would release net ¤20bn of much-needed additional liquidity to the reinsurance sector.
Why is this low-hanging fruit so often left unharvested?
One reason may be that since insurance receivables are usually admissible in solvency calculations, they do not attract senior management attention. But cash locked up in overdue receivables does not earn interest and increases risk through exchange rate exposure, counter-party credit risk, unenforceability and additional costs at audit time. However, arguably the main explanation is that improving the business processes in the engine room of great financial institutions is seen as unglamorous and rarely makes it onto the CEO's priority list, except under the heading of cost reduction. It is much more appealing to fix solvency and liquidity problems by tapping capital markets than to grapple with the complex and detailed challenges of speeding up cash circulating within the business. Raising fresh capital brings the flattering attention of investment bankers and the kudos of publicity, often a welcome relief from struggles with internal administrative problems.
So what is causing the cash sclerosis and how can a CEO fix it? Insurance administration and settlement departments throughout the globe are permeated with a culture of resignation in the face of seemingly endemic problems of delays, backlogs and reconciliation mountains. "That's the reinsurance market for you", "It's always been done that way", and, "We're waiting for an IT fix real soon" are just some of the common pleas that consultants working in the sector are used to hearing.
As always, the CEO or COO needs to blow away the smoke and emotion, look at the real underlying issues and reach out for practical remedies, which really do exist.
Top of the list for many risk carriers is the moan that, "the brokers sit on our cash", be it in forwarding premiums or in retrocession claims. This implies that it is outside the control of the reinsurer and nothing can be done other than to bring general pressure to bear on the brokers.
In the past there was undoubtedly considerable justification for this view, as even a quick examination of major brokers' income statements will confirm the buoyant level of reported investment income. However, the combination of measures for reform, such as the London Market Principles programme in London, together with pressure for adherence to standard terms of trade and hardening markets, are all beginning to make an impact on the mindset of leading brokers.
In London, a new benchmarking programme being managed by REL will soon reveal, for the first time on a market-wide basis, just how long cash takes to move between clients, brokers and re/insurers, and shed light on the time delays in other key service cycles such as production of policies and handling of claims.
Changes in the balance of power between brokers and underwriters provide a window of opportunity which the savvy CEO needs to exploit while it lasts. Market reforms and service standards will help, but reinsurers would be well-advised not to rely solely on these central initiatives. The current hardening market provides a golden opportunity to introduce robust terms of trade into new signings, so that capacity is thoughtfully deployed to risks and client relationships that offer satisfactory terms in the round.
What to do in practice? Larger reinsurers should establish a senior executive group with the tasks of: formulating global credit policies; developing practical guidelines and wordings; directing how the policies should be driven out into underwriting operations in the field; and monitoring the results. In the heat of time pressure, competition and preoccupation with technical reinsurance details, the busy underwriter will frequently not focus on credit terms before signing, and then the opportunity is lost forever. Hence the need for top-down management attention and monitoring of adherence to corporate policy.
Assuming a reinsurer negotiates sensible credit terms for its major bilateral relationships, adopts market-wide reforms as rapidly as possible and puts in place credit discipline along the above lines, what else can be done internally to speed up collection of cash?
Management and measurement
If you want to improve performance in an area, establish key performance indicators (KPIs) and get them onto the regular agenda of senior managers. The importance of management attention was already emphasised in the context of credit terms, and applies equally to cash collection and the underlying administrative processes. It is remarkable how quickly results can be made to improve, even while basic processes remain flawed, by the application of executive attention and escalation.
Few companies fully exploit the potential to extract meaningful, even vital, management information from their IT systems. Even if your systems are clunky and fragmented, there is a good chance that by applying modern desktop tools such as Brio or Powerplay to file downloads, you will unlock hugely valuable information from the data already in your systems.
Many reinsurers have collections functions in name only. Scratch the surface, and the chances are high of finding little actual collection activity beneath in terms of telephone and other proactive chasing of due debt. Collectors must be organised in dedicated teams, with clearly defined account responsibilities and prioritisation based on value: performance should be monitored on debt collected. The collectors must not be distracted by loading them with other stray administrative tasks looking for a home. Whenever this happens, human nature will ensure that those other duties become an excuse for greatly reduced collections effort.
Some executives assert that carriers cannot operate conventional collections processes, because the debiting process to the client is primarily in the hands of the broker. The reinsurer may not even know exactly what is owed or when it is due until the cash actually arrives accompanied by a bordereau. Similar arguments can be advanced in relation to pursuit of retrocession claims.
These arguments are a smokescreen for failure to establish proactive tracking systems of risks underwritten and claims submitted. Smart reinsurers make it their business to stay closely in touch with brokers, chasing by phone, email and fax, to ensure they have a current and complete picture of the debit notes raised by brokers and their respective settlement due dates. Then it's a matter of keeping on the case and making sure the broker knows it.
For effective collection it is essential to have up-to-date reports with aged balances and with incoming cash correctly and promptly allocated. Net accounting is often cited as a reason for reconciliation and allocation backlogs, but process discipline and good communication and account management with brokers should ensure these are kept to a minimum. The other essential for effective collection is a proper dispute management process.
Disputes and queries tie up large numbers of staff within both brokers and carriers in an unending cycle of duplicated effort, rework and reconciliation. Not only does this generate colossal wasted effort, but it is also a major contributor to delayed payment. In most reinsurers there is no systematic process or IT tool for recording disputes and proactively managing their resolution. As a consequence, there is no ability to prioritise or escalate disputes based on the value of the payment at stake, nor any means of collecting statistics on the reasons for disputes, so that steps can be taken to address the root causes. Resolution comes down to unending telephone calls, voicemails and email tag. We have seen examples of email message threads over 30 levels deep, and extending for months, to solve relatively simple queries.
REL estimates that the introduction of dispute management processes and appropriate IT support can save up to 20% of administrative staff time and speed up resolution cycles by over 60%. Within a major carrier this translates to millions of euros in cost savings and collection acceleration.
Under the heading of dispute management, the opportunity should also be taken to explore the scope for negotiating commutation deals with cedant companies, especially those in run-off. In these situations it will be difficult to motivate the broker to invest much effort in resolving the dispute and the best course will be to establish contact directly with the cedant. However, poor communications and cooperation within a reinsurer between premium collectors and claims handlers is not uncommon. The first step for the CEO is to make sure that there are proper policies and guidelines for selecting and negotiating commutation cases; and to establish a clear process for prioritising, co-ordinating and progress tracking negotiations in the best interests of the company as a whole.
Process quality and control
Surprisingly, we still find many reinsurance organisations with fundamentally poor operational processes. After the vast sums invested in IT systems in recent years, especially in preparation for Y2K, one might have expected these problems to be consigned to history. Yet it is common to encounter issues such as:
In many cases, the effort needed to improve process quality, to achieve reasonably joined up, accurate and efficiently moving workflow, is remarkably little. It may just be a question of properly completing the last 5% of process design, KPI design, system testing, staff training or IT interfacing which was rushed or overlooked in the previous change management project; the devil is in the detail. The challenge is to pinpoint the right changes to make in people, process, organisation or systems; design practical fixes; and implement them rapidly, without dislocation to business throughput. Then it needs patience to tune the system, like a vehicle engine, for optimal performance.
The application of expertise, care and consistent attention to these areas is virtually guaranteed to deliver accelerated cashflow and strengthen the balance sheet. While there will be some cost attached, the business case invariably shows a compelling value proposition. One thing is certain: though it may lack glamour, working capital reduction will be the cheapest incremental cash that a CEO can deliver for his or her shareholders.
By Peter Wolf
Peter Wolf is an account director at REL Consultancy in London. Further information is available at