By 1991 the distributors’ questions about reinsurance and how it worked were front and centre. One mystery was the method of paying the reinsurer for taking the risk. How were premiums transferred? What did it cost? Was it done case by case or en masse? Marketing Options editor gave me the push and the space to try and answer as best I could in terms easily understood by a mass audience (Steve’s MO was probably the most sought after life insurance publication of it’s time and its worshippers still abound and mourn its demise).
I am still at Manulife Re at the time of writing this article and thus I was deemed neutral and tried to remain so as to give none of Manulife Re’s clients cause for concern.
Reading the article today I find it still makes sense. It could be more sophisticated but to this Ontario farm boy it says what it says and brevity rules since it is time to milk the cows again. Okay I lie, Grandma and Grandpa insisted I never milk because it was too harmful to the precious teats.
There are many mysteries attached to the term reinsurance. Most mysteries are exaggerated to keep the allure of the marriage between insurer and reinsurer attractive to all concerned. Whether your favorite insurer is practicing polygamy (the use or abuse of many reinsurers) or monogamy (exclusive hanging in there with one familiar face), the methods of reinsurance and terms are rather tried and true.
The terms involved are mundane compared to the awesome terminology with which you’re familiar. One popular reinsurance term is ‘treaty’ which simply refers to the formal and, in this day and age, usually written arrangement between insurer and reinsurer. Working with a reinsurer, and insurer can either make use of a yearly renewable term (YRT) treaty or coinsurance (CO) treaty but in exotic lands the modified coinsurance (MODCO) agreement is still a practice that has maintained a role in insurance just like the rhythm method in society. The treaty can accommodate the insurer by accepting the ‘risk’ on an automatic basis (99.99% safe), a facultative basis (99.97%) safe, or the more adventurous facultative/obligatory (99.96% safe). Each could be value rated at 100% if the chance of human error is nil but as you and I know in a head office environment that is as likely as 150% first year commission on an annual renewable term plan.
Occasionally agents boasts that their favorite company makes use of only coinsurance and thus their policies are handled faster, better, and with more security that if YRT were used as a method of reinsurance. The agents making this out of character exaggeration are wrong in their perception of the relative merits of this method of reinsurance.
Coinsurance is the ‘co’insuring of the policy in a predetermined proportion that basically shares the costs of issuing the policy, the face amount, the agents commission, and all ancillary benefits attached to the policy. In the end the sharing of the claim or the cash surrender value consummates the agreement. The benevolent reinsurer pays the insurer a yearly commission that should reimburse the insurer for its costs of operation and, in most cases, a shade more- thus rewarding the insurer for having such good agents producing such sterling business. These payments are guaranteed to the insurer as long as the insurer continues to pay the reinsurer its portion of the basic premium, an event that the author recalls never witnessing otherwise.
The simplicity of the insurer and reinsurer being in synch with the premium flow allows for both to be in a profit mode at the same time. Should each of the parties assume different patterns of cash flow, one could be in a loss position while the other is in a profit position. This reflect one of two realities – one wants to have loss carry forwards while the other wants to take profits early or, one of the participants is making a mistake. In the case of the latter, and it has occurred, there is only one thing to do and that is to chalk it up to the experience. Other attractive options include readjusting mortality, expense and profit assumptions or praying that the product doesn’t sell well!
As all of us realize, mortality increases with age except for that anomaly of mortality between age 16 and 25 when brains are lagging far behind fast cars, peer pressure and cash for exotic experiences in life besides those curing acne. The humble yearly renewable term method of reinsurance simply charges the insurer for the expected mortality that should occur in the year currently being lived. The premium here is the rudimentary mortality table, an actuarial work of art that evolves from numerous statistics raised to the nth power where n is very big, plus a tiny amount for expenses and less for profit.
If an actuary were available at this juncture, we would have an elaborate and unfathomable explanation for the premiums but if one looks at an annual renewable term plan one can see at a glance what reinsurance YRT premiums resemble. The logic is the same and there is nothing wrong with the insurer paying for its risk coverage as needed provided the insurer is saving a portion of today’s premium to pay for the increasing cost of reinsurance in the future.
The agent should be safe in making the assumption that the insurer has done its homework and can accommodate all eventualities. After all, haven’t the companies’ auditors spent hours investigating the in the insurer’s and reinsurer’s practices and haven’t the provincial and federal government insurance inspectors made absolutely sure everything is safe for the consumer?
Bottom line! Whether your favorite insurer reinsures on an YRT or CO basis, the impact is, for all significant reasons, negligible to the agent.
Incidentally, MODCO is coinsurance except the reinsurer gives the investment portion of the premium or the reserves back to the insurer to invest on the premise that the insurer is a smarter investor than the reinsurer. This obviously maximizes the chances of the reinsurer’s investment yield matching the insurer’s! Enough said since the employment of MODCO in Canada is a neglected art form that is about as common as a Toronto Maple Leaf winning streak.
Trust between a reinsurer and insurer is truly evident in the automatic treaty. What this form of trust shows is how much the reinsurer is willing to allow the insurer to bind it without the necessity of the reinsurer reviewing (re-underwriting) the complete file of the proposed insured. Quite often the senior underwriting talent in the ceding company, the life company, can accept a case for millions of dollars while retaining (keeping for themselves) only a $100,000 or more. What this says is that the underwriter is acting on behalf of both the insurer and reinsurer.
The automatic treaty guarantees the case in proportion to the risk sharing and both parties have combined to the risk sharing and both parties have combined strengths to support the consumer via the agent. Wise use of the reinsurer through automatic facilities enable the ceding company to complete with other institutions who opt to retain far more of the mortality risk for themselves which is often a function of their size. The basic premise of the automatic treaty is that the insurer must cede a portion of a policy to a reinsurer and the reinsurer must accept said portion. Two musts make fro a marriage of tranquility since there are no options.
Facultative reinsurance involves the physical handling of more paper by the reinsurer since it must review (re-underwrite) all the cases. This by its very nature consumes valuable time which the agent can ill afford thus it is more often than not only employed for problem cases – those vary rare occasions when case warrants and extra premium or financial scrutiny.
An insurer can use more than one reinsurer to obtain the best possible price for the case and this ‘facultative shopping’ for the lowest price frequently involves sending copies of the underwriting evidence to several reinsurers. Once the policy is issued, regardless of ceding company’s retention on this single case, the security of the reinsurer is of the same magnitude as in the automatic treaty. The premise here in facultative land is that the insurer may seek the facilities of a reinsurer and the reinsurer may take the case or part thereof at some price.
Facultative/obligatory, or as it is affectionately called ‘fac/ob’, is simply the opportunity for an insurer to pick a case and ask the reinsurer to take it. The reinsurer is obliged to take the risk. Once again slowly – the insurer may cede the case to a reinsurer and the reinsurer must take the case. Or, as practiced by some, the insurer may cede the case but the reinsurer must take the case if it has not already filled it retention on this life with previous cases. This form of treaty can be potentially written to accommodate the most unusual of situations but in reality its purpose is diminished by the far more attractive automatic treaty.
Courageous insurers make judicious use of all forms of treaties and methods of sharing some of the meager premiums with the innovative reinsurers. The industry has been well served by the combination of talent that permeates through reinsurance treaties. Contract is never used as a term since it lacks the diplomatic and global magnetism of the word treaty which implies great powers coming together to solve the needs of the agent.
If the curious policyholder ever wanted an explanation of the world of must and mays, the industry might have to invoke a 20 day free look. Thank heaven, behind both the musts and mays is, in most instances, a formidable alliance of insurer, reinsurer and retrocessionaire (how could I forget my role?) waiting to assure the best price and best security.