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The Actuary The magazine of the Institute & Faculty of Actuaries

The implications of commoditisation

A friend of mine jokes that a life reinsurer’s core
competency is lunch, followed closely by
dinner. This is no longer the case, and the
impact on the life business, and restaurants, will be significant. The last three years have seen a major shift in the life reinsurance relationship in the UK. Reinsurance is moving from partnership to commodity.

Reasons for change
Three recent factors have affected the reinsurance industry. First, the 1% world focused attention on costs and new ways of reducing them. Reinsurance can be the biggest single external cost for many companies, although most of them do not realise it as it does not appear in management accounts.
Second, the IFA market became much more focused on price as the principal criterion. While not a new factor, the price war intensified significantly in early 2001. Furthermore, there are signs of such a price war entering the tied agents’ market, through deals such as that of Barclays with L&G.
Third, an overseas reinsurer, RGA, entered the UK market with a different business model, based on commodity pricing and minimum support services. Figure 1 shows that the reinsurance market was already broadly split into two. At the top right the large established reinsurers support a range of different benefits and offer a number of support services. More recent entrants concentrate on fewer benefits, sometimes just death and critical illness, and do not provide, for example, free seminars or automated underwriting tools. However, RGA was the first reinsurer to aim for the bottom left corner of the diagram and adopt a business model to match.
It is hard to identify a definitive starting point for the change. It could be when some of the large insurers started driving very hard price deals, splitting lines of business and rebroking them frequently. Other insurers, especially in the IFA market, had to follow them. This led reinsurers to respond by reducing costs and targeting services to key clients.

So where will this lead?
Research I have been conducting recently confirms that reinsurers are starting to catch up with the implications of commoditisation. Initially, apart from the most flagrant reinsurance price broking, reinsurers acted as if clients were still partners. They provided the same services, despite having to reduce margins and accept blocks of business selected for them by the insurer.
Reinsurers have the same strong cashflows that have enabled the insurance market to ignore reality for so long. The experience confirming their worsened position has yet to fully develop and life business is still seen as attractive compared with general reinsurance. However, actions are being taken.
One well known large reinsurer has reduced staff numbers significantly, and others are now doing the same. Services are being cut back and, in some cases, the number of benefits quoted for reduced. Will it end with all reinsurers quoting for a few benefits on a no-services basis? How would a ‘full-service’ reinsurer justify the extra premium it would need to charge, and would enough insurers pay for it? There are a few credible scenarios for the future shape of the reinsurer market, including at least one disaster case. Then again, in another ten years’ time, we may find ourselves having gone round in a circle.

Recent consequences
In the meantime, there are some more concrete effects. Reinsurance deals are being treated more on a case-by-case basis, rather than holistically across the entire insurer/reinsurer relationship. Reinsurers are tightening up on contracts: if it is a commodity, then it should be strictly defined. Treaties need to be signed, data should be provided on a timely and accurate basis, and we can expect closer adherence to claim definitions.
Such adherence is likely to affect benefits with subjective or poorly defined claim triggers. Income protection and particularly critical illness fall into this category. What will happen in a few years’ time for an insurer that feels duty bound, or under PR pressure, to pay claims that fall outside the strict claims definition? The reinsurer would be within its rights and acting as a commodity supplier if it refused payment. With reinsurance expected to cover up to 90% of the risk, the insurer could be left making large payments which it did not expect nor reserve for.
Finally, what has happened to all the services the reinsurers used to provide? One of the lessons from the US is that insurers will have to start paying for them directly: from consultants, software houses, and other sources.