Knowledge is power, but information exchange is definitely king in the cedant-reinsurer relationship.
The exchange of information, a necessary part of any reinsurance agreement, can play a vital role in structuring deals in mutually beneficial ways. As with a commodity, the market value of information waxes and wanes with a number of factors. As with a manufactured good, the quality of information is ensured first through trust, and then by a legal framework. Any breakdown in the flow of necessary data between the parties to a reinsurance transaction may hold far-reaching, negative ramifications for both.
Capacity and information value
The presence of excess capacity in the market causes information demand to soften; if one player asks for too much, there is always another to step in. In any market, a reinsurer will seek the greatest level of detail it can demand; detail helps the underwriter more accurately assess risk. As the market tightens, reinsurers tend to demand more information. Anecdotal experience among reinsurance underwriters confirms that insurers are more likely to share information and are more open to flexible structures in a hard market.
The market consequences of September 11 are well documented: higher rates, a narrowing of contract terms and the introduction of terrorism exclusions. We have not been underwriting in a vacuum since then, however. Corporate governance issues and an unstable stock market in the US, the continued rise of internet-related risks and the prospect of mould liability bring uncertainty. For reinsurers, loss experience hardened the market and lowered the cost of information; uncertainty created a need for more incisive analysis of business opportunities, and highlighted the importance of technical underwriting. Reinsurers are engaging in a careful examination, segment by segment, of each line of business. To do this, they need information. They need a lot of it. A lawyer related recently that a reinsurer had requested information that his client, the cedant, didn't even have to share. We are likely to hear this story again.
Quality and detail
Underwriters are increasingly concerned with profitability, and seek more detailed and higher quality information at the outset of each deal. A recent issue of National Underwriter declared: "[We] have witnessed a quantum leap in the level of detailed information required by the reinsurers going forward." Specifically, reinsurers are looking for:
Some underwriters insist on reaching agreement on crucial terms - payment terms, loss reporting and dispute resolution clauses, for example - even prior to slip signing. Investment income has generally declined, increasing the importance of the terms governing tender of premium payments and the timely receipt of premiums.
New or heightened exposures can most efficiently be managed by re-writing coverage terms, and traditional reinsurance contracts now routinely exclude terrorism, cyberliabilities and mould. Reinsurers are likely to target new liabilities for information collection, for example:
After the contract is bound, reinsurers seek loss information on a more detailed, frequent and timely basis, both to allow an ongoing assessment of program exposure and profitability, and to prepare for renewal negotiations. Claim reviews are taking on a greater significance as reinsurers search for the detail that will allow them to draw conclusions on loss trends and exposure.
The pre-slip agreements and the increasing use of exclusions are both cause and symptom of the need for greater reliance on formally recorded contract terms at the expense of relationships. Stringent scrutiny before the contract is signed can lay the foundation for different, possibly more restrictive, terms, the imposition of specific exclusions or caps, limited capacity or increased rates. Altering terms and provisions that govern relationships, however, invariably modifies the relationship itself. Contractual provisions and their enforcement play more decisive roles in driving the deal than pre-existing relationships.
This is not to suggest that relationships no longer play a role, just that they may not be as central to the outcome as they once were. Cedant-reinsurer relations have been based, to a significant extent, on relationships and a presumed good faith willingness of each party to act in a manner consistent with the best interests of its business partner. This loosely-defined code of conduct is now tempered by a demand for extensive disclosure about the book of business under consideration and a commitment to conduct business according to the terms of the contract that legalises and records that relationship on paper. We may see a shift in the way `relationship' is defined - what previously was understood as `willingness to offer coverage regardless of the market conditions' may come to mean `commitment to sharing information in order to produce a mutually beneficial contract'.
In January 2002, Nissan Fire & Marine Insurance Co commenced legal action against Fortress Re of Burlington, Vermont in federal court in North Carolina. The lawsuit is directly related to losses arising from the September 11 attacks. At issue in the case, among other things, is the quality of information supplied by Fortress and its owners regarding the risks presented by participation in the aviation pool that generated the losses, as well as data related to historical profits generated by the pool.
This is only one example of numerous cases of litigation and arbitration that have been brought over the past year. The events of September 11 have generated a significant portion of this litigation, but by no means all of it. The frequency of resort to formal legal processes to resolve insurer-reinsurer disputes has risen significantly, while reliance on informal business arrangements has diminished. According to Mitch Lathrop, a partner specializing in reinsurance law at Luce, Forward, Hamilton & Scripps of New York and San Diego, litigation between insurers and reinsurers has increased markedly and "the days of the handshake deal are gone." This process is older than the last year, but has seen rapid acceleration since last September.
In light of the magnitude of last year's losses and potential exposures created by corporate fraud, an increase in the incidence of litigation or arbitration is a realistic expectation. However, extensive disclosure of higher quality information may well prevent future disputes by delineating the boundaries of the duty owed by and between parties to a reinsurance contract. Disclosure can identify exposure early, preventing unwelcome surprises. This may fuel an increasing appetite for information on the part of reinsurers but could settle the market in beneficial ways for all parties in the long run.
Applying detail to construct a difficult cover
In one important way, information does not act as a commodity. In some cases, highly detailed information can be used either to place some kind of reinsurance under circumstances where no deal may have been reached, or to structure a more efficient cover. This is particularly important in a hard market or under the threat of unfamiliar exposures-times when a relationship is less likely to be based on trust, and when, ironically, a healthy amount of trust and cooperation can be of benefit to both parties.
Example: examining target markets
A cedant insures a variety of lawyers in 40 US states, in a broad spectrum of practice areas. After a very detailed information exchange, the reinsurer determines that the book sustains a disproportionate level of loss and payout in both indemnity and defence cost from claims of legal malpractice among general practice firms of 20 lawyers or fewer, involving intellectual property (IP) issues.
The geographic distribution of these losses mirror concentrations of technology located throughout the country: San Francisco, Boston, New York, Chicago and Dallas. In a surprising finding, firms of this size located near some major academic institutions involved in research and development also demonstrate similar susceptibility to claims. Those firms that specialise in intellectual property issues, located in the same areas, do not reflect a negative claims history or undue exposure. In the same cities, general practice firms with more than 20 lawyers, even those that list some level of intellectual property practice as part of their business, appear to perform much better than the smaller firms.
The data indicate that intellectual property practice is not the culprit, nor the firms that specialise in it. Losses are concentrated with smaller firms that likely do not have the expertise in-house for the specialised clients and practice that intellectual property demands, but are attempting to capitalise on the easy availability of this class of high-revenue business in their geographic areas. It also appears likely that larger non-IP firms have the resources to maintain one or more in-house IP lawyers. These mini-IP departments appear to possess the requisite competence to handle the intellectual property business that comes in.
Recognising this, the reinsurer may be able to structure the reinsurance coverage to exclude the population of firms responsible for losses, apply a cap to losses sustained thereunder or put in place any number of other mechanisms designed to limit these losses. Disclosure of this information to the reinsurer may cause the cedant to underwrite around the risk posed by the class of firms under discussion and thereby restructure its book or offer risk control services to firms in this category to improve their loss performance.
By Peter Szendro
Peter Szendro is an assistant general counsel for Converium North America. He specialises in internet and intellectual property liabilities.