There was a time when facultative reinsurance was little more than an afterthought in a group's overall buying strategy. Not anymore, explains Marcus Hopkins.
Facultative reinsurance existed in the past as a post-placement service to treaty, a largely reactive and opportunistic purchase. It was a complement to a buyer's strategy, eg to sustain a market position or merely to leverage a good purchase against a negative write. More recently there has been a push to capture the essence of what facultative (fac) reinsurance is and to make it more process driven, to align it more closely with a client's treaty purchase and to seek the potential benefits of cross collateral in either class or product.
Often the main focus of any strategic facultative purchase would be the client's need to have complete control over all business ceded and reinsurance purchased. This involved understanding the efficacy of the product, understanding whether fac reinsurance purchase was driven by the treaty programme capacity, or lack of it, and understanding the underwriter and the broker. Often this is against a backdrop whereby the facultative element of the overall reinsurance spend far exceeds the risk and catastrophe programme.
A strategic approach
Assumptions are frequently made as to the overall performance (loss ratio), the total spend and best use of reinsurance partners. This creates the need for greater management control in developing a formulated strategy for fac reinsurance purchases, to make the process more efficient and to make it cheaper. More should also be made of the standard advantage that a consolidated facultative purchase has over a treaty purchase. Flexibility and benefit is achieved in various areas (summarised opposite) but an occurrence form and risks attaching cover, if done on a full follow basis, is sometimes hard to beat.
Some of the benefits of a strategic facultative purchase include:
- An improvement to the top and bottom line;
- Maximising clients' purchasing power;
- Greater strength and influence in a variable market - in many cases a well-planned, well-maintained and well-supported market facility can outperform the curve;
- Significant cost savings. This is achieved by creating greater leverage with participating markets and by placing more importance on the process role, thus reducing the cost of distribution and/or acquisition, creating a service standard and maintaining it, and where necessary an enhanced technology platform;
- A reduction in credit exposure. Any workflow would also include clients' security listings; which get reviewed just like any other management information summary on a regular basis;
- Greater efficiency - a consistent service standard and use of contract clauses, together with an established pre-agreed priority and limit, makes for an efficient process;
- The development of relationships. In many cases clients are not using the reinsurance partner relationship to its fullest and often the vast majority of a clients' (profitable) ceded premium is being distributed to a minority of players without any real push for leverage;
- Enhanced information and greater management control. All purchase data (including claims and accounting) is collated by a centralised service team, which conducts a quarterly review of purchasing trends, constantly reviews opportunities - eg new markets - as they arise, provides continued market and account information, plus an agreed technology platform to facilitate best practice, reporting and management information; and
- Strategic purchase (eg London versus Continental Europe or treaty catastrophe markets versus single risk and vice versa). In essence this is the challenge of any placement by balancing the best end of any deal and combining them to provide one packaged product.
By utilising broker (proprietary) analytical tools, any review of a client's base data will show portfolio peaks, which can otherwise be described as the 80/20 rule whereby 20% of a client's portfolio drives 80% of the probable maximum losses (PMLs). A dynamic model will attribute premium by location, occupancy and territory, and is usually provided via electronic data management. Recently, the cost of reinsuring the natural peril peaks has been punitive, but there is an increasing amount of surplus market now, certainly for international exposures and also (but to a lesser degree) the US.
Other ways of delineating a portfolio for the purposes of a consolidated facultative facility could be by the client's acceptance categories, occupancy types and/or historical losses on specific industry groups or product types. It should not be forgotten that the primary purpose is for the buyers to see for themselves the benefit of a good purchase or good retention, and therefore the value of an in-fill (a purchase which provides a good retained layer price or a good purchase) based on the pre-designed layer and attachment.
Some contemporary examples of facilities, in addition to the consolidated facultative purchase, include:
Clash/Co-venture - This is a facultative purchase but with base parameters, thus enabling the buyer to forecast year-on-year cost. It can address the exposure to co-venture exposures (which is very common within the petrochemical and energy sectors).
This further provides a smoothing on exposures including the often complex interdependencies which make quantification of business interruption losses and exposures difficult for clients. All of this can be resolved by a facultative (facility) purchase. This also provides back-to-back terrorism coverage.
Terrorism - This is largely process-driven and ideal for a majority of the per risk business written in the direct and facultative market. Facultative reinsurance solutions can offer (in this instance) a whole account product which provides reinsurance rates as a percentage of the client's original net premium.
The aggregate of cover on a pay as you go basis - There have been a few examples in recent times of reinsurance being purchased on a global basis, mostly according to exposure rather than the domicile of the insured. This is no longer the case and we have reverted to geographically segmenting as much of a placement or portfolio as possible. In conjunction with the base retention and secondary facultative markets it has become possible to obtain coverage in excess of an aggregate of losses (and sometimes vertical as well as horizontal cover) on a book, but not paying for it all up front.
Run-off - This is the ability to buy finality but without the punitive expense of the original carrier(s) need to get pay back. The benefit of an unlimited sideways protection, coupled with a waiver on penalty charges if the claims become adverse, have become a proven and successful product. Coverage is always back-to-back and the limits flexible and based on scheduled exposures with unlimited sideways protection.
A good starting point when considering any product (facility) is to make the business case for it. An inherent doubt tends to exist in some reinsurers' minds that in all cases any block buyer is potentially selecting bad risks to cede to the reinsurer. It is therefore important to demonstrate why this is not happening. It is also important to understand a buying office or region's appetite for retention, as this helps to map out your reinsurance market participants.
As the existence of naive capacity becomes more myth than fact, the need to create markets becomes more important than ever. In all cases, the broker's ability to have reinsurance partners at the table should be tested. In many cases reinsurance markets exist that would not normally get to have the first choice of risks, possibly as a result of inadequate distribution or location.
On the whole, with account cession (either by product or territory) the consideration of some middle market players can also benefit the balance of the market, such as a full value policy forming part of a (whole cession) primary account for example.
Use of percentage line triggers is another good way of developing a market balance between a treaty and facultative placement. For example, 10% of a programme placement within the first $100m of reinsurance limit purchased and additional (facultative market) coverage for the balance, with set parameters.
Many clients are considering the benefits of diversification, both geographically and by product, and one key benefit is the cost of capital. In some cases a strategy of diversification into new areas may introduce lower margin business to, say, an existing high margin (and volatile) book such as property risk and catastrophe. But to take a strategic view of fac in this instance will allow a smoothing of the margin pressure and even allow for growth in a non-core book.
In many cases facultative reinsurance has become and will continue to be a key component for the market. But it has also evolved in many ways. Brokers should strive to be a partner for facultative purchases, not just a broker "selling" fac.
- Marcus Hopkins is head of UK facultative at GCFac.