A new study questions whether current underwriting practices could one day create a financial debacle for reinsurers.

The report, titled “Beyond Borders: Charting the Changing Global Reinsurance Landscape” and commissioned by the Insurance Intellectual Capital Initiative—a consortium of organizations associated with the Lloyd's insurance market—wraps up a three-year study of the changes taking place and the issues currently facing reinsurers and insurers.

It presents itself as “a call to arms, exhorting cedents, reinsurers and brokers to re-evaluate their trading practices and more clearly define their sources of competitive advantage.”

The report's author, Paula Jarzabkowski, an Aston Business School professor and a Marie Curie Fellow at Cornell University, tells NU that the major change the reinsurance industry is experiencing is the bundling of risks, especially catastrophic risks.

By bundling a series of exposures into a single reinsurance program, Jarzabkowski says, an insurer can cover initial losses with its own reserves and save the big losses for the reinsurer.

But she says this practice poses two problems: One, local reinsurance markets are getting less premium for business as more risks go to fewer reinsurers; and two, those risks are not subject to the scrutiny of those underwriters who “provide judgment at the local-market” level.

This bundling practice, she explains, relies heavily on modeling, which doesn't replace the expertise of the local underwriter. And if some of the assumptions used in those models prove to be wrong, the industry could expose itself to a huge loss that could throw into question the solvency of some companies.

In large programs, Jarzabkowski says individual risks get lost in the bundling of the other risks, analogous to what happened with the bundling of asset-backed securities and credit-default swaps that were a major cause of the Great Recession of 2008.

“What you are really underwriting is the quality of each policy in each region,” she notes. “I think reinsurance and insurance are actually very ethical industries and try to underwrite in a high-quality way. It is a real lesson for the finance sector that we realized, when we started studying this industry, how carefully people really try to understand the risk.

“It really bothers us to see this trend that moves away from that very high-quality judgment base,” she adds.

Jarzabkowski does not see the practice of bundling risks going away, but she says reinsurers that underwrite in niches will need to begin working with experts to review their programs to make sure bundles consist of truly similar risks.

Special Reports /

Could Reinsurers&rsquo; Bundling of Risks Lead to a Financial Debacle?

Related Stories

Recommended For You

Could Reinsurers’ Bundling of Risks Lead to a Financial Debacle?