In most instances, when A.M. Best issues its Top 200 U.S Property/Casualty Writers results, there is some jockeying for position – up or down a position or two. However, the 2018 results issued in July 2019 revealed something that literally flew off the page. One insurer moved up 28 positions, another 29 and a third a staggering 121 positions. While the upward movement is interesting in and of itself, it was who the insurers are that really caught my attention – reinsurers! Swiss Re jumped 28 spots, Everest Re 29 and Arch 121. And Munich Re is already at number 18.
Now, it is easy to rationalize these position changes – mergers and acquisitions. However, it’s what lies beneath that is critical for all insurers to recognize – and changes the market’s competitive landscape in four critical areas:
Data: Reinsurers have an abundance of data, across numerous categories and geographies. Data is king, and reinsurers have it in spades. This changes the foundation for insights and puts these organizations ahead of the pack because most primary insurers do not have diverse data – at least not yet.
Information: Data generates information. Reinsurers have information about products, segments, buyers, distributors, channels, loss outcomes – you name it. This allows their decision making to be immediately more robust.
Skills: At a time when every insurance executive sees a lack of skill as a major issue for their organization, reinsurers have had skills, particularly data and analytics skills, embedded in their organizations for a long time. This puts them down the road in terms of leveraging the explosion of data and information – and using cutting-edge technology to do so.
Money: Reinsurers have a good deal of money. For a number of years, catastrophe outcomes have not drained coffers, and capital remains abundant. This allows reinsurers to invest in their subsidiaries. And they are doing so, which affects primary insurers directly.
So, the message is not to lock the front door, turn off the lights and send everyone home because the reinsurers are coming. The message is – the competitors of yesterday may not be the competitors of tomorrow. There are competitors that are focused on changing business decisions and how those decisions are made. There are competitors whose DNA is innovation and transformation, and no one can run from that. The bottom-line message is urgency.
If your organization believes it has many years before innovation will transform your operating environment and market position, or that innovation and transformation can be a secondary focus for your organization, consider that there may be a reinsurer just around the corner that has another idea.
The buying of insurance is going to change. The “sold, not bought” view of insurance distribution has run its course for many lines of business. Customer expectations have changed, and the inside-out approach to building silo-ed, exclusion-filled, fixed-term products just doesn’t cut it anymore.
For this month’s InsurTech Insights, let’s look at a new means of distribution that will fundamentally change the insurance supply chain, where insurance will be supplied through ecosystems as part of a wider proposition and not a solo purchase bought in isolation.
After all, people don’t set out to “buy” insurance per se. What they want is a safety net in case something untoward happens.
“Your fat margin is my opportunity”
The insurance supply chain is typically seen as a linear model. Insurance distribution starts with brokers, ARs and MGAs at the front end. Carriers underwrite risk and decide whether to pay a claim. And the buck stops with the reinsurers. Front to back, risk and premium move from one intermediary to another, each one taking its share. It’s a model that hasn’t really changed over the last century.
“Your fat margin is my opportunity” is the Jeff Bezos quote that defines the era of digital disruption. We now see tech-savvy entrepreneurs finding ways to “disrupt” established business models using digital and mobile to streamline out-of-date business models oozing with fat margin.
When you look at the world of insurance, it’s easy to imagine that Bezos was looking at the world’s largest industry when he made that quote. It’s no surprise that insurtech has become the new fintech.
The combination of many intermediaries in the supply chain, each one taking margin, together with the inefficient friction that goes with it has fueled the rise in insurtech. When you add in the shift in agency to the consumer (because of the likes of Bezos and how he built Amazon by putting the customer absolutely and unequivocally at the center), it is easy to see why insurance is a juicy target for digital disruptors.
As the insurance industry catches up and embraces the Fourth Industrial Revolution, we will see a redefining of the insurance supply chain. It’s started already.
It will evolve from the traditional linear model where risk and premium move front to back in a bi-directional flow. In its place, we see new supply chain models for insurance distribution at the front end with efficient management of risk capital at the back.
Of course, as a highly regulated industry, insurance faces a drag on change from the legislature. But just as regulators and lawmakers made adjustments to accommodate the fintech models for alternative finance, they will follow suit in insurtech. And why wouldn’t they?
In the new model for insurance distribution, the supply chain will co-exist with brands and within ecosystems unconnected to insurance.
Customers will be rated as individuals and not members of a risk pool. A greater share of premiums collected will be set aside to pay claims. Instead of sales commissions, there will be platform fees. Time to pay claims will become the KPI of choice for customers to rate their insurance experience. And as convenience replaces price as the key buying criterion, the way that insurance is distributed will change.
Automation is key for insurance distribution
In the new insurance supply chain, there will be fewer handoffs, less friction, less premium erosion. Just like with Amazon, the customer will be absolutely and unequivocally at the center of the ecosystem.
Trusted brands will own the customer relationship. These brands know the meaning of loyalty and will value these relationships highly. They also understand how expensive it is to build them in the first place, and how easily that can be lost.
Of course, someone will need to manage risk capital. This will be the domain of the reinsurers, with the role of the carrier becoming superfluous.
The reinsurers know better than anyone how to manage large pools of risk capital. They’ve been carrying the insurance industry for long enough. In the new insurance supply-chain, firms like Sherpa will own and manage the customer experience.
The Sherpa model is to charge a value-based annual fee to a customer in return for meeting all insurance needs. This removes sales commission from the equation.
The founder and CEO of Sherpa, Chris Kaye, explained to me, “Today, insurers pay sales commission for selling the insurance products that the insurers have created.
“We are turning that on its head and creating a membership organization that is unequivocally on the consumer’s side. No more commissions for products you don’t need, instead a flat fee to assure the risks that matter most are protected.”
How does this work in the Sherpa model?
On behalf of customers, Sherpa goes straight to Gen Re and buys insurance wholesale. Sherpa can distribute personalized insurance products to customers while packaging up parcels of risk at the back end.
This innovative approach is one example of how customer brands will be able to fine tune, personalise and price based on a whole set of new and different risk criteria.
So what? Well today, insurers create the products that they want to sell. Brokers do their best to find the best match of their customer’s needs to the fixed insurance products on offer. But customers end up paying for cover they don’t need. And they don’t always get the specific cover that they do want.
The new approach allows the brand, in this case Sherpa, to personalize the cover specific to the individual while packaging up modules of risk for the expert managers of risk capital.
Go west to see the future of insurance distribution
China’s ZhongAn epitomizes everything that is insurtech.
It is a 100% digital tech business with around 1,500 employees. More than half of them are developers, and none are in sales. The company also happen to provide insurance, and a lot of it!
In the first three years of trading, ZhongAn wrote more than 5 billion policies. It sold 200 million policies in one day alone last November during China’s annual online shopping fest!
The thing that makes ZhongAn the darling of insurtech is that 99% of all operations are automated. Quote, policy, premium collection and claims are all automated, which is why the company can process 18,000 policies a second.
But it’s ZhongAn’s approach to premium pricing and insurance distribution that really set it apart. First, the insurance business is built around retail ecosystems. The products are embedded in the customer buying process through retail sites. The company makes it super easy to buy insurance, simply by checking a box.
Next, the insurance is micro-priced, based on a personalized premium, unique to the individual customer.
ZhongAn does not use the law of large numbers to price risk premium. Instead, ZhongAn uses big data for dynamic and personalized pricing. There is no single price list for insurance products. Customers are risk-assessed individually and priced accordingly.
For ZhongAn, it is more important to build customer loyalty (aka stickiness) through speed and convenience.
A question I get asked a lot is: “Are these insurtechs an insurance firm or a tech firm?” It’s a great question, just like asking if AirBnB is a hotel chain or if Uber is a taxi firm.
Of course, there are many old diehards of the insurance industry who rail against that question and revert back the old mantra of “an insurance company is an insurance company.”
But the reality is that, in this rapidly changing digital world, the fundamental nature of providing a financial safety net is changing, too.
The old “insurance product,” designed by insurance companies to suit their own needs and aimed at customer segments that never claim, is on its way out.
In ZhongAn’s case, it is a tech company first, which is why it can take a fresh approach to insurance, unhampered by old ways of thinking.
When it comes to insurance distribution, ZhongAn’s business model is based on supplying insurance cover through an ecosystem partnership model. The company doesn’t pay broker fees or have to support a huge cost of sale. Instead, it has partnered with leading players that already have a customer base across many different market sectors.
This allows ZhongAn to directly embed insurance products into an online experience, making it really easy for the customer. Customers simply check a box to include the insurance cover. The premium is dynamically, real-time, micro-priced, unique to the customer at that moment. This is all about improving customer experience.
Insurance distribution is going to change, it’s just a matter of time
For many, it is hard to imagine a world where insurance could be any different than how it has been for the past 100 years. To them I say, cast your mind back to 1995.
It was only 20 odd years ago that people were talking about this thing called the World Wide Web and about how everything could change. A lot of it sounded science fiction and the stuff of fantasists at the time. Even so, nobody could have possibly imagined the full extent to which the world would change. And, over such a short span. All because of this thing called the internet.
Just as the supply chains of many industries have changed in the internet era, so will that of the insurance industry. It’s no long a question of “if,” but “when.”
“The paradox of teaching entrepreneurship is that such a formula necessarily cannot exist; because every innovation is new and unique, no authority can prescribe in concrete terms how to be innovative.”
Whether we’re talking about telematics, artificial intelligence (AI), digital distribution or peer-to-peer, investing in insurance-related technology (commonly termed “insuretech” or “insurtech”) is no longer considered boring. In fact, insurtech is one of the hottest investable segments in the market. As a 20-plus-year veteran in insurance, I find it surreal that insurance has become this hip. Twenty years ago, I gulped as I sent an email to the CFO of my company, where I proposed that there was a unique opportunity in renters insurance. That particular email was ignored. Today, that idea is worth millions of dollars.
Insurance seems to be the latest in a string of industries caught in the crosshairs on venture capital. With the success of Uber and AirBnB, VCs are now looking for the next stale industry to disrupt, and the insurance industry carries the reputation of being about as stale as they come. The VCs view the needless paperwork, cumbersome purchasing processes, dramatic claims settlement and overall old-school look and feel of the industry and think they can siphon those trillions of dollars of premium over to Silicon Valley. It seems like a reasonable thesis.
The problem is, it’s not going to happen that way. Insurance will NOT be disrupted. While insurance looks old and antiquated on the exterior, it is actually quite modern and vibrant on the interior. The insurance industry is actually the Uncle Drew of businesses; it’s just getting warmed up!
Much of the reason I think VCs are unaware of their doomed quest for insurance disruption is that they are looking at the market from a premium standpoint and envisioning being able to capture large chunks of it. $5 trillion is a lot of money. Without an appropriate model, an outsider coming into insurance can naively think they can capture even a fraction of this. But premium is strongly tied to losses. Those premium dollars are accounted for in future claims.
I once had a VC ask me what the fastest way to $100 million in revenue was. The answer is easy, “slash the premium.” I had to quickly follow up with, “and be prepared to be go insolvent, as there is no digging yourself out of that hole.” He didn’t quite get it, until I walked him through what happens to a dollar of premium as it enters the system. And it was this that became the basis of the model I use to assess new product formation and insurtech startups.
There are four basic components to my model. Regardless of new entrants, new products or new sources of capital, these four components remain everpresent in any insurance business model. Even if a disruptive force was able to penetrate the industry veil, that force would still need to reflect its value proposition within my four components.
Component 1 – EXPOSURE
This is the component that deals with insurance claims: past, present and future. Companies or products looking to capture value here must be able to reduce, prevent, quantify or economically transfer current or new risks or losses. Subcomponents in this category include expenses arising from fraud and the adjustment of claims, both of which can add substantially to overall losses.
Startups such as Nest are building products that increase home security by decreasing the likelihood of burglary (or increasing the likelihood of capturing the criminals on video) and thus reduce claims associated with burglary or theft. Part of assessing the value proposition of Nest is to first understand the magnitude of the claims associated with burglary and theft and then quantify what relief this product could provide (along with how that relief should be shared among stakeholders).
Another company that is doing some interesting things in this model component is Livegenic (disclaimer: I have become friends with the team). Livegenic allows insurers to adjust claims and capture video and imagery using the mobile phone of the insured. This reduces the expenses associated with having to send an adjuster out to each and every claim. Loss adjustment expenses can be in excess of 10% of all claims, so technology that reduces that by a few basis points can be quite valuable to an insurer’s bottom line and ultimately its prices and competitiveness.
Component 2 – DISTRIBUTION
This component focuses on the expenses associated with getting insurance product into the hands of a customer. Insurtech companies in this space are typically focused on driving down commissions. This can be done by eliminating brokers and going directly to customers. Savings can also be achieved by creating efficient marketplace portals that allow customers to easily buy coverage.
Embroker is one of many companies trying to do just that in the small commercial space by creating a fully digital business insurance experience. Companies such as Denim Labs are providing social and mobile marketing services to companies in insurance. And then there is Lemonade, which is developing AI technology that it hopes will reduce the friction of digitally purchasing (its) insurance and making the buying process “delightful.” Peer-to-peer (P2P) insurance is a fairly new insurtech distribution model that attempts to use the strength of close ties via social methods for friends and close associates to come together to make their own insurance pools.
Distribution expenses in insurance are some of the highest in any industry. As with the risk component, reducing expenses in this component by even a few basis points is incredibly valuable.
Component 3 – CAPITAL
This component focuses on the expenses associated with providing capital or the reinsurance backstop to a risk or portfolio. For many insurers, reinsurance is the largest expense component in the P&L. Capital is such an important component to the business model that the ramifications of it almost always leak into the other components. This was one of my criticisms of Lemonade recently. Lemonade will have a lot of difficulty executing some of the aspects of its business model simply because it cedes 100% of its business to reinsurers. So, when it comes to pricing or its general underwriting guidelines, its reinsurance expenses will overwhelm other initiatives. Lemonade can’t be the low-cost provider AND a peer-to-peer distributor because its reinsurance expenses will force it to choose one or the other. This is a nuance that many VCs will miss in their evaluation of insurtechs!
For those seeking disruption in insurance, we have historical precedent of what that might look like based on the last 20 years of alternative capital flooding into the insurance space. I will devote space to this in future articles, but, in brief, this alternative capital has made reinsurance so inexpensive that smaller reinsurers are facing an existential crisis.
Companies such as Nephila Capital and Fermat Capital are the Ubers of insurance. Their ability to connect investors closer to the insurance customer along with their ability to package and securitize tranches of risk have shrunk capital expenses tremendously. Profit margins for reinsurers are collapsing, and new business models are shrinking the insurance stack. It is even possible today to bypass BOTH veritable insurers and reinsurers and put the capital markets in closer contact with customers. (If you are a fan of Michael Lewis and insurance, you will enjoy this article, which ties nicely into this section of the article).
In the insurtech space, VCs are actually behind the game. Alternative capital has already disrupted the space, and many of the investments that VCs are making are in the other components I have highlighted. Because of the size of this component, VCs may have already missed most of the huge returns.
Component 4 – OPERATIONS
The final component is often the one overlooked. Operations includes all of the other expenses not associated with the actual risk, backing the risk or transferring the risk from customer to capital. This component includes regulatory compliance, overhead, IT operations, real estate, product development and staff, just to name a few.
It is often overlooked because it is the least connected to actually insuring a risk, but it is vitally important to the health and viability of an insurer. Mistakes here can have major ramifications. Errors in compliance can lead to regulatory problems; errors in IT infrastructure can lead to legacy issues that become very expensive to resolve. I don’t know a single mainstream insurer that does not have a legacy infrastructure that is impinging on its ability to execute its business plan. Companies such as Majesco are building cloud-based insurance platforms seeking to solve that problem.
It is this component of the business model that allows an insurer to be nimble, to get products to market faster, to outpace its competitors. It’s not a component that necessarily drives financial statements in the short term, but in the long run it can be the friction that grinds everything down to a halt or not.
I have presented a simple model that I use when I assess not just new insurtech companies but also new insurance products coming into the market. By breaking the insurance chain into these immutable components, I can estimate what impact the solution proposed will provide. In general, the bigger the impact and the more components a solution touches the more valuable it will be.
In future articles, I will use this model to assess the insurtech landscape. I will also use this model to assess how VCs are investing their capital and whether they are scrutinizing the opportunities as well as they should, or just falling prey to the fear of missing out.
The insurance industry is a $4.6 trillion market worldwide that lags when it comes to digitization and providing consumers with a great experience and service. We are looking at the five main challenges that startups face. We have covered Challenge No. 1 here, Challenge No. 2 here and Challenge No. 3 here. In this article, we will look at Challenge No. 4.
Challenge No. 4: How do you create an entrepreneurial insurance team that can build an operating system and avoid risk management errors?
Today, most founders have limited knowledge of the insurance industry. Meanwhile, most insurance industry experts have only second-hand knowledge of startups, knowledge gained in consulting or large corporate initiatives that are completely different environments than the pressure and decision-making dilemmas of insurance startups.
People who understand working in an entrepreneurial environment, know the insurance mechanics and can use startup methodology as it applies to insurance are rare.
Most startups will need to work closely with traditional insurers and reinsurers. Although these organizations have made themselves startup-friendly, the question remains: How long is their patience?
In addition, startups will need to build and manage a network of service partners. Third-parties administrators may offer to take this burden off a startup’s hands, but, for quality service, full operational control and direct relationships will be needed.
Building the full stack technology platform requires extra experience. Startups need to connect to traditional systems and service providers, where the challenge and delays will be more organizational than technical.
Over time, the startup will come under increasing regulatory and consumer protection scrutiny. That makes the operations more challenging, as does the need to manage large amounts of sensitive data.
Experience in managing the inherent risk in insurance products, managing and developing the operations and getting to profitability in a startup environment where the organization, systems and revenues are growing and evolving is only learned by doing. Fraudsters often target new insurers, which many will argue is combated by new technology but also requires human intelligence. All team members will need to be educated and kept up to date on managing data privacy and security and claims handling and the associated reputational risks.
If the startup has ambitions to provide multiple products or act multinational, then dealings with different insurance and consumer laws and regulatory bodies will multiply.
Building teams of people with varied skill sets will mostly overcome the issues. The key will be to combine startup, growth hacking, service, data analytics, insurance and mobile expertise. Creating an international team early will also provide benefits over time for those with global ambitions.
F1 teams can be sponsored and technically supported by the large car manufacturers. However, they mostly have their own culture, experts, capacity and environment for innovation. So they can adjust and fine tune quickly based on performance. Startup insurers will need the same performance and service level culture, organization setup, capacity and freedom.
Insurers and reinsurers have recognized the challenges for startups and have created suborganizations to work with startups in a friendly and less cumbersome way.
In addition, regulators are looking to provide an easier process for approvals and support.
Reinsurance represents one of the largest and most critical assets to insurance companies. Most insurance companies purchase a range of reinsurance protection – proportional treaties, risk excess of loss, catastrophe reinsurance, and facultative reinsurance. The successful collections of known reinsurance recoverables are recognized as essential assets. But what about those assets that are not even on the radar screen? Those that have not been correctly identified or processed? All too often, and for a variety of reasons, many millions of pounds are hemorrhaged by failures adequately to address this very question.
Over time, even the best-managed and attentive companies suffer from “leakage.” Leakage can be defined as the loss of assets through failures or gaps in processes or controls. Within the insurance industry these are manifested in three key areas:
The under-collection of premiums
The overpayment of direct and inwards reinsurance claim liabilities
The under-collection of outwards reinsurance collectibles
Examples of leakages within an insurance company’s claims and reinsurance departments would include:
Inadequate coverage/attachment analyses.
Failure to identify or recover deductibles and retentions.
Payments beyond policy limits.
Errors or omissions in calculating premium adjustments, reinstatement premiums and profit commissions.
Failing to deduct all inuring and facultative premiums from benefitting treaties.
Inability to identify or collect from impaired or insolvent reinsurers.
The root causes of reinsurance leakage include the following:
1. Difficulties identifying all of the parties and contracts involved.
This is particularly an issue either where many years have elapsed between the purchase of the reinsurances and the continuing identification of new and potential recoveries. Over time, contracts can be forgotten, especially smaller inuring contracts and facultative protections. We are all familiar with environmental and asbestos claims that continue to be made against policies in the 1970s, 1960s and earlier. Employees who knew the rationale behind the purchase of complex programs and understood how to interpret and process unusual wordings have long since left.
Identifying all of the parties and contracts can also be a huge challenge when companies are purchased or merged. Many cedants and reinsurers will have changed names or are cloaked behind insurance and reinsurance pools and associations. The common market practice of using fronting companies adds a further layer of complexity. Evaluating the global position between each of the parties – inwards and outwards – will then be essential when it comes to offset and commutation discussions between the parties.
2. Systems and migrations
Nowadays nearly all insurance and reinsurance companies have computer systems to help identify and process necessary reinsurance transactions. There are still a surprising number of companies however who do not have integrated systems and some still use manual processes and standalone spreadsheets. Over time, a company may have introduced several new computer systems, each of which will have necessitated a major data migration exercise. It is self-evident that the more stages involved, especially those subject to human handling, the greater the opportunities for oversights and errors.
The above challenge applies within one company’s operations. What happens when several companies and/or portfolios are merged and all of the records and data needs to be migrated and integrated? The reinsurance programs will all be different, contracts interpreted differently, the technical and accounting systems will be different. Customized systems and processes may need to be introduced. This is a huge challenge that is all too frequently underestimated and often those allocated with the task do not have the time or resource to address it adequately. Corners cut will inevitably lead to greater leakage of assets, both direct and reinsurance.
3. Correct interpretation and application of reinsurance contracts
A group’s reinsurance program commonly involves numerous company entities and countless lines of business being reinsured. The contractual terms and conditions will vary over time, each subject to a number of possible interpretations. Over time, files may be poorly organized – there may be missing treaty documents, incomplete information, undocumented endorsements and anomalous transactions – making correct interpretation and application of the reinsurance treaties and inuring contracts all the more difficult.
Thousands of disputes have arisen involving the relationship between contracts, the intentions of clauses and the meaning of words. With a diverse range of possible causes contributing to inwards claims and in turn outwards reinsurance collections, the correct application of aggregation language is essential.
The interpretations within context of “event,” “occurrence,” and “originating cause” continue to be debated and contested again and again. Loss corridors and the application of coverage sub-limits, deductibles and other terms are other common sources of omission, processing errors and inconsistent procedures.
The problem is not just the complex arguments reinsurers may raise. The issue below the surface is failing to identify relevant contractual entitlements altogether. For example, ensuring that prescribed additional premium adjustments are monitored and pursued, that reinstatements premiums have all been correctly calculated and accounted for following all triggering loss events are common omissions, especially for older and legacy books of business where only the coverage details may have been recorded on automated systems.
Changes in management and personnel, sometimes without all of the required reinsurance knowledge, and ever tightening pressure on resource contribute to the difficulties in ensuring a consistent and accurate process.
4. Follow the cash!
We all know that cash is king. In reviewing any reinsurance program it is essential to follow the cash flow, the reinsurance collateral requirements and reinsurance recoverable collection procedures.
Withheld premium and claim funds, letters of credit arrangements and similar provisions are complex. Add into the mix a matrix of cedant entities and intermediaries. The potential for oversight and error in the accounting and cash audit trails are clear. Redundant reserves can accumulate over time. As well as failing to release essential capital, redundant reserves can distort the value of companies or portfolios offered for sale or commutation.
The London market and Lloyd’s in particular has been very much alive to the challenge of forgotten funds held within brokers’ ledgers and bank accounts. Only a full and accurate reconciliation can identify all of these. Brokers often have little incentive to assist because of the resource cost of identifying the potentially high volume of low value individual transactions (as well as the benefits of holding the cash!).
5. Catastrophe insurance and reinsurance
The proportional and excess of loss markets are very familiar with catastrophe events and the adjustment and payment of claims. Every event throws up its own unique circumstances and challenges. Most of these fall into two generic categories.
The first challenge is accurate data gathering. Does the cedant have effective systems and procedures for accurately recording and tracking all of its loss settlements and capturing the essential information it will need to classify claims by event, by location, originating cause, quantum and proof that these fall within underlying policies for which premiums have been received? What are the risks of losses being incorrectly recorded and either ceded incorrectly or missed from aggregation analyses?
The second challenge is that, once the inwards claims are settled within the terms of the underlying policies, which of these claims can properly be aggregated and collected from catastrophe reinsurers?
Common adjustment challenges include the categorisation of losses as either flood or wind damage following a hurricane storm surge, the use or otherwise of anti-concurrency clauses, the differing operative clauses for triggering business interruption and contingency business interruption clauses and how underinsurance is considered and addressed.
6. Leakage analysis – some real life examples
In the first example, JTW Reinsurance assisted a fellow auditing firm IRI address leakage within a US-based reinsurance operation. It had written workers compensation program business primarily containing per occurrence and aggregate limits. Our review indicated that per occurrence limits had not been correctly applied in a number of instances – such as the impact of a tornado where a loss date for one employee had been entered incorrectly and we were able to establish that it was part of the same loss (which had already exceeded the per occurrence limit). We determined that a number of claims related to a statewide power outage were not covered under the reinsurance contract. Our accounting review indicated that the company had exceeded the aggregate limits for a number of contracts, but was still reimbursing the insured. In total, our review saved the company in excess of $1 million in respect of previously paid claims.
The second example involved an exercise for the reinsurance department of a major US reinsurance company, which had acquired several companies over the preceding ten years. The JTW Reinsurance review involved researching the reinsurance contracts and premium and loss accounting records. We determined that a number of claims had not been billed to reinsurers and also that catastrophe reinsurance premiums had been overpaid because there had been no deduction in respect of business not covered by the reinsurance contract. In total, we saved the company over $2 million being actual cash receipts.
Another claims consultancy provided examples of successes it had identifying leakage of $25 million after analysing three company’s reinsurance programs. The root causes for potential reinsurance recoveries being missed included complex reinsurance arrangements and inaccurate interpretation of these, failure accurately to code and identify facultative reinsurance contracts, systemic issues with the coding of inwards claims from TPAs, and failure to aggregate smaller claims below TPA authority levels.
Remedial action – what can be done?
The range of measures to interrogate a company’s systems, records and procedures to identify leaks and make recommendations to avoid recurrence will always need to be bespoke to each company’s individual circumstances. Examples of these might include:
Identifying reinsurance assets:
Ensuring that reinsurance programs and contracts have been correctly interpreted.
Premiums – ensuring that all inuring reinsurances have been deducted and that premiums are deducted for non-covered business (eg. TRIA for terrorism premiums).
Reviewing claims to ensure that all historic amounts have been included in reinsurance calculations when there is a system conversion.
Reviewing contracts to ensure that the company’s systems are designed to recognise all reinsurance claims, particularly for older asbestos and environmental claims.
As above and also ensuring that all historic claims values are included in any transfer to a new system and that ongoing data is in a format that will update any existing claims.
Reviewing of contracts to ensure that permanent information is correct, including the impact of reinsurance commutations.
Conducting a leakage review after implementation of new systems to check for missing assets.
Reinsurance asset leakage continues to damage the bottom line of almost every live and legacy insurance carrier. Like an iceberg, however, the true extent of the problem lies below the surface – undetected and/or un-quantified. Expeditions to explore below the surface require dedicated time and resource – and funding. Expeditions which senior management often chooses to ignore. But how would stakeholders react if they knew the true cost of such a head-in-the-sand approach? Could you look your CEO in the eye and assure him or her that your company has done all it could do?
Julian Ward collaborated with Derek Harris in writing this article. Derek is a chartered accountant who has worked extensively within the London and North American insurance and reinsurance marketplaces. After qualifying with Peat Marwick (now KPMG) in Newcastle he moved with the same firm to Bermuda where he was a senior auditor reviewing primarily insurance operations. Returning to London in 1986 Derek began his experience within legacy business with US F&G Re before joining a specialist audit firm assisting with a complex contractors all risks binding authority. Back within the carrier world Derek assisted Iron Trades with their reinsurance accounting systems and then Bankers Insurance as run-off manager for their Personal Accident LMX spiral exposures. Since joining JTW in 2001 Derek has specialized in complex technical accounting assignments (in particular reinsurance asset identification and recovery) and due dligence review work. Derek divides his time between our Boston and London offices.