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Rethinking reinsurance

The trend of declining reinsurance cessions of casualty and non-catastrophe property business has been a strong feature in recent years as buyers are increasingly willing to retain more business net.

But the move by Chartis at 1 January 2012 to significantly slim down its catastrophe programme was an unexpected blow for property treaty writers - particularly as the American International Group (AIG) unit had historically been one of the largest buyers of cover in the sector.

Chartis - which will reinstate its AIG moniker in the coming months - trimmed down to a $2.5bn excess $2bn programme from a $4.5bn xs $2bn programme.

Significant portions of the limit have resurfaced in the capital markets through the purchase of Nephila's County Weighted Industry Loss product and a cat bond issuance via its Compass Re placement.

And at The Insurance Insider's pre-Monte Carlo briefing last week, Chartis' chief reinsurance officer Samir Shah warned the insurer will continue to cut back reinsurance programmes across its platform as it executes a new buying strategy in line with its recently centralised operating model.

Here's what he said...

On the rationale behind Chartis' new reinsurance strategy...

When Peter Hancock became CEO last year we embarked on a five-year plan to increase value by optimising the trade-off between the risk we're prepared to assume, the profit levels we want to achieve and the growth we want to pursue.

The plan is designed to leverage our size, global footprint and portfolio.

The key to this was a shift from a very decentralised operating model to one that is much more centralised. We also rolled out risk-adjusted performance measures that reflect long-term growth.

From this new vantage point you can imagine reinsurance looks very different from the past.

Previously, profit centre managers made decisions on reinsurance buying based on the earnings volatility of their product line overlaid by their risk appetite.

Now reinsurance decision-making is centralised and uses risk-adjusted performance measures, which diversifies away some of that local risk because it is now seen in the context of a global portfolio.

The reinsurance we bought to protect against that local earnings volatility really doesn't decrease risk much, if at all - and yet we would still be ceding away profit.

So those kinds of programmes are no longer economical.

On how Chartis' reinsurance buying is changing...

The new reinsurance framework is consistent with the revised Chartis business strategy, and we're evaluating all historical reinsurance purchases on a risk-adjusted basis.

It's only natural that where we used to buy proportional reinsurance to manage volatility or expense ratios by trading off absolute risk-adjusted dollar amount of profit, it's no longer economical and we expect those programmes to expire.

On the other hand, I expect non-proportional reinsurance that addresses our tail risk from a global perspective to be more economical.

Tail risk attracts the greatest capital charges and the risk is more difficult to price and assess.

This is particularly relevant where there are huge aggregations on product lines in various parts of the world. That business is ideal for reinsurance and requires counterparties to really understand the risk and be able to reasonably price it.

On a developing industry trend...

We're not the first to follow this path and I expect we're not going to be the last.

For us the catalyst was the arrival of a new CEO, business strategy and operating model. But all ceding companies that are using economic capital models are forced to take a centralised view, even if they're managed in a decentralised fashion.

So I expect this trend to continue as buyers move from local to centralised strategies.

But it's my sense that insurers are not buying enough of the kind of reinsurance that covers major aggregations, so there is opportunity for reinsurers to do more business there.

On the growing role of the insurance-linked securities market...

I don't think the market has fully recognised the potential of the capital markets.

A lot of property casualty insurance risks are uncorrelated with the capital markets, and when you diversify them in those capital markets you should get a much lower cost of capital.

Risks that lend themselves are those perceived as commoditised, and those risks should flow to the cheapest cost of capital. There are still lots of obstacles to getting that risk to the place it belongs, but we're continuing to look for ways to overcome them.

But the kind of risk that requires specialist underwriting knowledge and is difficult to assess deserves to stay in the traditional reinsurance markets and command a higher premium because of the value provided there.

I'm looking for opportunities to segment risks that can be commoditised and flow them to the cheapest source of capital.

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