Vicky Carter discusses why a strategic approach to reinsurance is the key to lowering capital costs

The credit crunch, for the short term at least, has made a difficult decision for insurers even more complicated: raise traditional capital, or buy some reinsurance cover? By driving up the price of debt products, it has made raising capital more expensive.

This means that the prospect of buying reinsurance cover is becoming more attractive, especially as rates have fallen in the first half of 2008. So, if more reinsurance is being bought, it will be more important than ever to get maximum value for what you are buying, and programme optimisation is the answer.

Programme optimisation is integral to an insurer’s risk and capital management. By using an economic capital model to quantify its risk exposures, and then by considering reinsurance as a form of capital, insurers can make sure they are getting the best out of their reinsurance programme. In other words they can ensure that they are buying the cover that will have the most beneficial effect on their business.

Insurers are increasingly adopting a more strategic approach to reinsurance buying, and we are seeing programme optimisation as a part of this trend.

They are looking to buy in accordance with corporate (rather than business unit) risk appetite and the leading companies understand that if they can optimise both risk retention and the cost of capital, then they can create significant value for shareholders.

One impact of this shift will be increasing popularity of structured products, such as stop loss reinsurance, which offers cover across an insurer’s lines of business.

Furthermore, insurers that want to use their internal model to calculate capital requirements under Solvency II will need to prove they are using it to make real business decisions. Programme optimisation is also a great way of doing that.

Vicky Carter is chairman of Towers Perrin’s UK reinsurance business.