Although the recent financial crisis initially hit credit insurance and reinsurance with a vengeance, economic stabilization, enhanced risk awareness and improved terms brought product demand and reinsurance capacity back in line by 2010. Here we look at some central considerations that will help to strengthen the credit re/insurance market, in particular by reducing the likelihood of volatile reinsurance capacity deployment.

No introduction necessary

The recent financial crisis, its causes and impact on credit re/insurance need no introduction, albeit to say that as the crisis evolved, the speed and unanticipated severity of events led several capacity providers (insurers and reinsurers) to reduce their exposures, PartnerRe included. This impacted the re/insurance industry and also had a corresponding negative effect on demand for the credit insurance product itself. Withdrawing capacity was a difficult decision for PartnerRe given valued relationships with cedants and brokers, as well as our strong interest and expertise in this line of business. Recent economic stabilization combined with continued efforts on the primary side towards strictly managed limits and policy conditions, brought new players and capacity back to the table by the end of 2009. Supply and demand for credit insurance are again in equilibrium.

However, the risk assumptions have been challenged and economic growth is still questionable and expected to remain at ‘anemic’ levels for a prolonged period. Government debt and social crisis are still serious concerns. How can the market proceed with a sure footing amidst such uncertainty?

There are a number of key credentials of the insurer-reinsurer relationship that would help to deliver a stronger, sustainable and less volatile re/insurance credit market in an uncertain world – in achieving this, it is not only the re/insurance market that benefits, but the product itself. These key credentials are essentially the considerations that define PartnerRe’s approach to this important line of business.

Impact of a new scenario

Pre-crisis loss expectations were built on loss experience and on the assumed ability to apply the standard market practice of limit management. Limit management is the proactive mitigation of credit risk in time to prevent a severe deterioration in loss ratio – before and during a crisis, credit insurers take measures such as reducing cover for distressed risks, tightening payment terms and policy conditions, increasing pricing, decreasing limits and maximum recoverables, and increasing deductibles.

In this instance, however, the speed and severity of the crisis exceeded expectations, catching many by surprise. Although mitigating measures helped, the speed and severity meant that they were often too late or insufficient to prevent significant loss ratio deterioration. This new loss scenario highlighted several aspects of the insurer-reinsurer relationship that could benefit from change: namely the need to enhance the flow of information on limit management between insurers and reinsurers, the importance and benefit of a shared, transparent approach to risk analysis and prediction, and the need for better alignment of interests in credit reinsurance contracts.

Information flow

Immediately following the crisis, credit insurers moved into crisis mode and adapted their risk management approach, including the investment of considerable time and effort in enhancing information flow on limit management to reinsurers. This is extremely helpful. Timely information on the taken measures is useful to both insurers and their reinsurers as it enables monitoring of progress and provides indications of current risk conditions and trends. With quantified details throughout a cycle, reinsurers are able to more accurately evaluate the evolving risk. With less overall uncertainty, they can provide a more sustainable product to insurers.

Risk analysis and prediction

As in all new scenarios, the crisis reminds us that risk assumptions are continually changing and thus of the need for all parties to regularly update model parameters, challenge existing threat scenarios and to stay ahead in monitoring the external macro-economic risk environment.

These processes could all significantly benefit from a pooling of expertise between insurers and reinsurers, in particular as regards establishing the most appropriate economic indicators for early detection of imbalances within the economy.

The right risk management balance

But, however good we all are in all these respects, the very worst crises will continue to be difficult to manage in terms of speed and severity. Each future crisis will be driven by new, unexpected and varying factors. The risk management provisions that protect a portfolio must take this ongoing uncertainty into account; a complex balance is generally needed between limit management and other risk management tools. Reinsurance capacity is an effective risk management tool not just for known volatility, but for protection against the unknown eventualities that are an ever-present component of risk. Reinsurers can also help their clients to find the most effective balance of risk protection for a portfolio. However, for reinsurance to be effective, contractual interests need to be aligned.

Aligning interests

Sustainable reinsurance capacity that can be relied upon over the full cycle (upside and downside) requires that the economics of a contract and the interests of insurers and reinsurers be aligned over the medium term. Without an equitable share in the upside, reinsurance capacity will be more volatile in the downside. Examples of measures that reduce the need for de-stabilizing, cyclical reinsurance capacity deployment include deductions set at a level that correspond to the associated cost structure and multi-year deals (these have been well received by insurers and reinsurers). Aligning interests in this way was a central part of PartnerRe’s overall underwriting approach during the last renewal.

To Recap

PartnerRe is in the market for credit reinsurance. Our decisions are based on a fair equation of risk and return, developed through an acceptable view of the economy, professional exposure and limit management, frequent flow of information on developments, actions and results, and fair, sustainable terms and conditions that align insurer-reinsurer interests and the economics of a contract to its medium-term financials. We also believe that transparency and discussion on risk analysis and prediction are important for the industry as a whole.

Given the aforementioned considerations, we can and will continue to provide our clients with strong, sustainable capacity and continuity in the uncertain years that lie ahead.