Payback (noun) Payback exists because no one gets anything for nothing, and reinsurance is no exception to the rule.

In other words, benevolence is not the primary function of reinsurers. When they have had losses heaped upon them, they generally attempt to recover this money through future premium charges. The period of time when such collections are made is known as payback.

Consider insurers in the Czech Republic. After suffering a 500-year flood in 1997, they bought a lot more reinsurance. This was wise, and lucky: six years later, 2002's 500-year flood nearly swamped them with a cascade of gross losses totalling $1.43bn - equal to about 130% of the capital of all the Czech insurance companies combined. Fortunately, reinsurers saved the market from bankruptcy by paying 97% of the bill. However, it will take more than six months for the reinsurers' memory of the big hit they took to float into oblivion. Despite fervent negotiations prior to the 2003 renewal, average total catastrophe excess of loss rates for Czech insurers increased by more than 200%. Payback time.

France's squally blast

Something similar happened in France after the 1999 storms Lothar and Martin blew the lid off almost every national insurer's catastrophe protection.

French insurers faced reinsurance premium rate increases swirling upwards towards 300% for layers purchased after the back-to-back tempests. Pierre-Denis Champvillard, Directeur General of SCOR at the time, said three factors drove the huge acceleration. First was historic pricing below the technical cost of cover. Second was the realisation that such events were beginning to appear to be more frequent than expected. "Third is the payback," he declared. "We would like to get partial compensation over the years." Anders Grabo, as Executive Vice President of Sorema-Groupama, spoke of a "remarkable convergence of opinion" among reinsurers about pricing following the event.

Airline payback

Payback is best known as a reinsurance phenomenon, but the most extreme recent example must be the remarkable re-pricing of airline insurance cover following the tragic losses of September 2001. In what was more blast-off than uplift, prices soared to new heights. Hapless airlines, which had the double misfortune of having to renew their cover in the month following the loss, were required to pay jumbo rate increases. Insurers said the new rates were essential for the aviation insurance market to land payback for the September 11 loss (as well as for its egregiously low pricing during the preceding several years).

Airline payback continued until at least 2003, although it did so in a climate of declining rates. In the interim, aeroplanes displayed a remarkable tendency to stay aloft, which has cut short the payback period. Brokers insist that rates are too high, and many underwriters seem to agree, having lowered their prices by 15% (again). At least all of them insist that rates are still adequate to cover the risk (if not the payback).

For a long time in continental Europe, back in the old days when relationships lasted more than a year because the client and reinsurer were true business partners, payback was a somewhat less painful proposition. It took place constantly, even before the losses. Premium rates were fixed at levels which allowed insurers to cede volatility, but they were also sufficient for reinsurers to achieve profits over the long term in spite of it, without dramatic fluctuations in pricing (at least as long as swollen tariffs in proportionally-reinsured private lines subsidised the cover). Catastrophic event cover was typically included in pro-rata contracts, while excess of loss cover was priced to cover likely losses. Thus the knee-jerk price corrections of recent times were unnecessary, and no one ever spoke of a correction or an over-correction.

Things have changed. Reinsurers are now expected to achieve escalating profits every quarter, even in the ones when catastrophic losses do occur.

If they do not reach these fiscal hurdles, investors are prone to sell their shares quickly while demanding that the chief executive fall on his sword. Understandably, this has led some reinsurers to abandon the cosy idea of relationships. They have replaced it with a cut-and-run approach, ducking in and out of the markets, from client to client and line to line, to skim the easy profits. Of course this new, opportunistic system makes it much more difficult for the relationship-types to compete (although client loyalty, fortunately, is not completely extinct). Worse, for those who practice it, cut-and-run means foregoing payback. It is incompatible with abandoning your cedants.

A contractual certainty

For others, payback has become a contractual certainty. Finite reinsurance makes payback a formal requirement, rather than a gentlemanly commitment.

Such deals specify that additional contingent premiums must be paid to the reinsurer after a loss is indemnified, in addition to any rates for reinstated or renewed cover. Unfortunately, many of the dealers in such mortgage-like products have discovered that insurers paying contingent premiums have a tendency to seek alternative solutions for future claims, ones where traditional, less structured payback is the norm. In any event, benevolence is still outside the vocabulary.