Simplifying the captive reinsurance process

In a hardening market with terms and conditions being tightened and exclusions increasing, it is perhaps not surprising that organisations are increasingly considering the use of captives.

Two recent surveys of risk and insurance managers in the UK and Germany, carried out by Airmic and GVNW, showed that many businesses (65% UK, 53% Germany) are exploring alternative risk transfer solutions, including starting to or increasing the use of captives, for their 2020 renewals.

A captive can play an important role in a global insurance programme, but also adds additional complexity because the reinsurance element needs to be managed – in terms of claims, premiums, financial and legal aspects. Captives are looking for cost efficiencies, faster processes and simpler administration, together with clear, consistent data. And one way to achieve this is to have a single fronting structure and a centralised clearing house bringing together all the insurance programmes across the globe, which then reinsures to the captive in one cession.

As will be shown below, there are many advantages to this approach, relating to reinsurance agreements, consistent data, claims monitoring, reinsurance arbitrage and cashflow.

Reinsurance agreements
When a reinsurer wishes to participate in a programme on the reinsurance side, a reinsurance agreement needs to be set up, covering reinsurance premium flows, claims information, claim reserves notifications, pre-payments and so on. If there is no centralised clearing house, this may involve four or five different regional reinsurance units, each requiring separate reinsurance agreements.

Potentially, the captive will receive several different cessions for the same line of business. If there are different systems involved, then the bordereaux may all be very different, as one may be issued by the APAC system, another by the North American system and so on. The captive will therefore have to accommodate the different layouts of the various bordereaux. If there is a single clearing house, there is just one source for the reinsurer, with one reinsurance agreement and one type of reinsurance bordereau. From an operational point of view, this makes everything much simpler.

Consistent information
Captives are looking for consistent information on premiums and claims. For example, a captive may receive a claims bordereau with regards to a claim in Singapore. The captive owner will then check with its own network in order to verify locally whether the claim has actually occurred. If this information is not reported in a consistent manner, reconciliation by the captive may be very difficult.

However, with a single clearing house, there is just one process providing the information. And there is just one IT system, which is able to provide consistent, concise and timely information. This is especially important when it comes to the captive taking up emerging risks or risks where insurers/reinsurers are reluctant to provide capacity, and the captive is looking to collect risk information to potentially take the risk to the re/insurance market at some point in the future.

Financial risks
In addition to underwriting risks, reinsurance also involves financial risks . When a reinsurance agreement is set up, the insurer needs to check the financial strength of the counterparty. If there are four regional clearing houses, there will be four separate checks and four different reinsurance agreements, because separate legal entities are involved.

At the same time, large corporates are increasingly looking to take a more holistic view of risk, combining life and non-life risks in order to capitalise on their purchasing power. Once again, a single clearing house makes the combination of non-life and life risks from around the globe into a captive much simpler and more efficient.

Stop-loss agreements
Captives are naturally interested in limiting their exposure on the net side, and accordingly will often have a standalone stop-loss agreement covering the captive. The insurer reports all the claims to the captive, which then has to assess whether the threshold for all of the stop-loss agreements is reached. With just one ceding unit, the insurer is able to set up a system with an automatic notification when the threshold is reached and the stop-loss agreement comes into force. This means that no more claims will be ceded to the captive from that point on, rather than the captive having to check, thus reducing their claims monitoring costs.

Cashflow
Corporates want to ensure that premiums paid locally flow immediately into the captive. Accordingly, it is important for them to be able to monitor the cashflow at any point in time. With a central clearing house, the insurer can see instantly when it has been paid locally and the funds can be transferred as quickly as possible into the captive. The insurer has a global view, not just a regional view, of the programme, so cash can be transferred faster and more efficiently.

Arbitrage
The use of arbitrage strategies with reinsurance markets has become more and more popular for captive owners. But obtaining access to attractive retrocession terms and conditions is only possible when an efficient ceding process from local level to a captive has been established. In addition, captive customers need precise information to be able to negotiate terms and conditions in the reinsurance market. All of this is only possible when enabled by a centralised reinsurance clearing house.

In the end, it is about making the reinsurance process as simple as possible for the captive, with one cession, one source of information and one agreement. Captive owners want transparency, efficiencies and simplicity in terms of administration, resulting in a cost-efficient solution, which is what a single clearing house can achieve from an operational point of view.

Contributed by Marcel Dubach, head of clearing house, commercial insurance, and Paul Wöhrmann, head of captive services EMEA, APAC and LATAM, commercial insurance, Zurich Insurance Group