Disruptions in the reinsurance market

Disruptions in the reinsurance market

The global and local reinsurance market is facing a number of disruptive forces including regulatory change, provision of alternative capital, intermediary capabilities and roles, and emerging risks. Elements of the traditional reinsurance value proposition such as risk transfer, balance sheet protection and provision of technical expertise may have a diminished worth in the face of these disruptions.

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Regulatory change

In a South African context, the outcome of the Solvency Assessment Management (SAM) reinsurance regulatory review is likely to affect how market participants select their reinsurance partners, structure their contracts and manage the level and mechanism of risk transfer.

A key proposed reform following the review relates to reinsurance market participants. The operation of foreign reinsurers on a branch basis will be allowed and the treatment of cross- border supply of foreign reinsurance will be revised under the new framework. This is expected to enhance reinsurance capacity, competition and the spreading of risk.

Reinsurance market competition and level playing fields was one of the principles that informed the review of the framework. In order to create a level playing field, the impact on cedants’ solvency assessment and the prudential requirements applied to the various participants will differ according to the prudential risks inherent in the mode of reinsurance.

Another key proposed reform relates to conduct of reinsurance business. Limits will be placed on the amount of business to be ceded - as measured by premium - with the intention to prevent fronting. In addition, the benefits brought by the use of financial/finite reinsurance will needto be carefully weighed up against the lack of recognition of this cover within the Solvency Capital Requirement (SCR) calculation.

Implications

It should be expected that locally incorporated reinsurers will face pressure in writing to their available capacity under increasingly competitive terms, conditions and pricing following a greater supply of international capacity. However, the proposed treatment of reinsurer credit ratings,in particular, within cedants’ solvency assessments may act to mitigate the placement of business with foreign reinsurers - branched or cross-border.

Non-proportional cover is expected to be favoured over traditional proportional arrangements in order to comply with limits on cession rates. Reinsurer contribution margins may thereforebe squeezed due to lower premium volumes. Solvency relief and financing transactions contract designs may need to be addressed and thiswill promote alternative, innovative and tailored solutions.

Emerging risks

Emerging risks are those that are particularly difficult to identify and predict as these risks are new and the development of them is largely unknown. The emergence of these risks is attributed to changes in technology and legaltheories in our society, which are likely to become actual claims in the future. In an insurance setting, these risks introduce greater uncertainty within pricing, reserving, capital modelling and solvency assessment. However, they may also present opportunities for innovation and product development.

The more the world is developing and research is being conducted, the more is discovered about potential emerging risks particularly for bodily injury and property damage. For example, research on subatomic particles on the humanbody have shown that everyday products (such as cleaning products) are harming us with the extent of the harm unknown at this point.

Global emerging risks can be grouped into five core categories:

  • Geopolitical
  • Societal
  • Economic
  • Technological
  • Environmental

Of these five, one of the most widely discussed is technological risk. Examples include autonomous vehicles, vulnerability in cloud computing and cyber security, nanotechnology, infrastructure breakdown and communications failure.

These advancements require insurers to determine changes to their insurance products and offerings. With the introduction of autonomous vehicles, this will directly impact the insurance market forcing insurers and reinsurers to consider the changes that are likely to occur within the motor insurance space and how to sustain their business in this new environment.

Implications

Emerging risks will force insurers and reinsurers to anticipate changes in the insurance market, particularly in terms of claims, new products and profitability. Even with the caveats in insurance policies now, such as restriction to claims-made policies, a change in law may expose insurers to unexpected risks and potentially large claims, as seen with the asbestos claims. This has a direct impact on reinsurers particularly for those with no aggregated limits.

Reinsurers have little to no additional information to provide technical expertise to insurers on how to deal with emerging risks and the evolution of the insurance market.

Intermediaries

Traditionally reinsurance intermediaries were a go- between function, performing largely administrative and relationship management roles. The business model and role of the reinsurance intermediaryhas evolved, fast, and is continually evolving.

Progressively they are playing sturdier roles in risk and capital management, thought leadership, analytics, software development, businessstrategy and interacting with capital markets in the development of alternative risk transfer solutions.As such, reinsurance intermediaries have positioned themselves as leaders in the understanding,pricing and transferring of insurance risk.

However, reinsurers have historically been regarded asthe experts in this regard. With reinsurance intermediaries becoming a driving force behind and facilitating the provision of alternative capital,coupled with a strong service offering, the technical expertise and risk transfer offering of reinsurance providers is being challenged.

Conclusion

The insurance market is changing rapidly and there is a risk of negative impact for reinsurers placing their value propositions in jeopardy. However,the traditional reinsurance value proposition and business model is not expected to become obsolete, but reinsurers will need to adapt to survive in the current and future risk landscape, which is continually shifting.

On the flip side of the coin, enormous potential for innovation has been revealed and reinsurers need to ensure they remain relevant and protect and grow their business in light of these challenges.

© 2024 KPMG Services Proprietary Limited, a South African company and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved.

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