Hiding in plain sight: How a cedant’s reinsurance recovery risk can dramatically increase at exactly the worst moment.
9th September 2022
For many cedants a well-structured reinsurance programme with well-rated reinsurers is both economically rational and central to their ability to focus on business-as-usual.
Unfortunately, this world view can mean missing a much more challenging reality about the reinsurer credit risk a cedant is taking. That reality comes from what can happen to both cedant and reinsurer balance sheets if and when severe underwriting related stress events occur.
For example, in a reserve shock three crucial consequences can combine:
- The cedant’s net retention of the shock reduces its own risk absorbing capital
- Its reinsurers’ share of the shock increases the cedant’s “reinsurance asset” (amount owed to it by reinsurers)
- Each reinsurer with cedants exposed to the shock has its own risk absorbing capital reduced by its share of that, while its own exposure to its retro’ capacity increases.
Thus, cedants facing this type of stress event can have a higher (potentially much higher) exposure to their reinsurers at exactly the moment when both their own ability to absorb the cost of any unrecoverable reinsurance is reduced and the risk of non-recovery due to reinsurer financial duress is increased.
In the simplified balance sheet below we see an illustration of how a 25% whole account reserve shock greatly increases ABC Insurance’s reinsurer credit risk exposure.
In many ways traditional reinsurance has been and remains an ideal solution to the insured risk mitigation needs of cedants. But understanding and analysing the credit risk implications during severe insurance loss events seems to us a fundamental consideration in effective risk management by cedants of their reinsurance programme.
Individual reinsurer credit profiles can be impacted very differently by the same market wide shock. See our article “Stress testing reinsurance carrier resilience to reserve shocks” on the Litmus Analysis website, please click here to see the results we generated from a test sample of 35 leading reinsurance carriers.
About Litmus Analysis
Litmus Analysis specialises in helping the insurance and reinsurance industry understand credit risk and the ratings agencies. Its main areas of work are Ratings Advisory (helping companies manage their relationships with the rating agencies), cedant analysis, insurer and reinsurer financial profiling and stress testing, market analysis, peer reviews & benchmarking and market security/counterparty credit management (including the InsurTech application LitmusQ).
The team of consultant analysts all have a rating agency and/or broker market security background and includes the former heads of S&P Ratings Europe (insurance), A.M. Best EMEA and A.M. Best Asia Pacific.