The many benefits of ceded reinsurance software systems with robust calculation engines—increased productivity, improved accuracy, enhanced profitability, steadfast audit and SOX compliance, improved operational control and flexibility—are well known. However, one important benefit is usually overlooked: automated "what-if" scenarios that take the guesswork out of renewal pricing for reinsurance contracts.

What-if analysis using robust calculation engines has been around since the late 1990s—so what's new? Well, nothing. It does not require automated calculation engines and it can be done manually, if you have an expert on staff with a week or two to spare.

But these days, vendor calculation engines are much more powerful and flexible. Still, only about 5% of American insurance companies have invested in sophisticated ceded reinsurance vendor systems, as most reinsurers continue to rely on Excel spreadsheets and other manual procedures. The rest are using in-house solutions, some with calculation capability relating to ceded reinsurance.

For the majority of reinsurers, robust calculation engines are a new—and useful—tool. They help underwriters for reinsurance arrangements remove guesswork from renewal pricing changes by creating fictitious terms and conditions (T&Cs) in multiple scenarios to quickly determine probable results.

Traditionally, even minor changes to T&Cs are made as a short-term field experiment. In effect, this practice says, "Let's change X to see how it works on this contract next year, and maybe we'll apply it to others if the result is positive!"

There is no need for this kind of guesswork today. Advanced core component systems with robust calculation engines have opened a whole new world of what-if analysis capabilities that require just a few minutes to run, and don't always require a data expert. No matter how large the contract—or how many contracts are involved—simply plug in the T&C changes, enter the premium amount, and click to run the calculation engine.

A Couple of Scenarios
Robust calculation engines are especially useful for reinsurance, where pricing is much less regulated, and therefore much more negotiable. Let's say an insurer has 5 million policies in its auto book. Testing a simple change or two in the T&Cs on a reinsurance program for all these policies using a robust calculation engine takes a few minutes. How long would that take doing it manually?

The most important aspect of what-if analysis is ensuring that reinsurance arrangements are optimized for pricing. For instance, a P&C firm may have a reinsurance program consisting of five or six treaties, with five different reinsurers on a claim of $10,000. The firm needs to see how this claim flows through the program, which layers to which it attaches, and which reinsurers need to be billed for what expenses. This is all based on contractual T&Cs that are not heavily regulated for the reinsurers.

Let's suppose the P&C firm wanted to find out the effect of changing the T&C relating to one layer of expenses—from an included basis to a pro-rated basis before it inures to the next layer of reinsurance. The old way of determining the effect is to simply make the change on a few contracts during renewal to see what happens—the field "experiment."

Using a sophisticated calculation engine, the firm could quickly see the effects with just a few minutes of data crunching. This reveals that under the included T&C, a $10,000 claim would break down into $10,000 in losses plus $2,500 in expenses, for a total cost of $12,500. Under a pro-rated T&C—the change in question—it would be $7,500 and $2,500 in expenses. By simply changing one field of the system—expenses from pro-rated to included—and running the calculation engine, this P&C firm would quickly discover the effect of making this change.

Change Can Be Good … And Profitable
The bottom line—there is no need to suffer unproductive price change decisions by using select contracts as guinea pigs. Robust calculation engines put a lot more science into the art of reinsurance renewal pricing adjustments, and help avoid adverse results.

The insurance/reinsurance industry has always been cautious about adapting new technologies and procedures, especially when the current way of doing things seems to be working just fine. If you're among the great majority of reinsurers that still regard core component systems as more of a beguiling possibility than a "must have" differentiating tool, there's really no rush—they'll still be there when you are ready. There is certainly no real harm in doing intuitive pricing experiments if you prefer. However, beware the old Chinese proverb: Be not afraid of going slowly. Be only afraid of standing still.

Special Reports /

Remove Guesswork from Reinsurance Price Adjustments

Related Stories

Recommended For You