Combining Towers While Building a Reinsurance Portfolio

The reinsurance industry has been largely fragmented till now. This is why it is common for ceding insurers to buy different reinsurance policies for their different lines of business.

For instance, ceding insurers may buy separate reinsurance policies for their marine business and their property insurance business. In insurance parlance, these lines of businesses are called “towers”.

Up until now, reinsurance was strictly segregated into towers. However, with the passage of time, reinsurance service providers, as well as buyers, have both realized that there are specific advantages to having an aggregate policy that combines different towers instead of having separate policies. These types of reinsurance policies are fairly new and hence are called non-traditional policies.

In this article, we will have a closer look at what are the benefits of combining various reinsurance towers for both the ceding insurer as well as the reinsurance service provider.

Benefits to Ceding Insurer

  1. Extended Coverage: When ceding insurance companies follow the tower approach, many of them find that reinsurance coverage is easy to find for some towers. For example, multiple reinsurance companies will be willing to provide reinsurance coverage for the property tower. This is because there is empirical data available and the risks can be easily known. However, at the same time, there are other towers such as cyber risks where it is difficult to know the possible risk.

    Hence, fewer reinsurance companies are willing to provide this cover. As a result, ceding insurers have to pay a higher premium to obtain this coverage. However, when ceding insurance companies combine multiple covers, they are able to obtain this extended coverage easily and at an affordable price. This is why many ceding insurers nowadays prefer to combine multiple towers.

  2. Eliminates Redundancy: Reinsurance programs are marred with redundancy. No matter how efficiently a ceding insurance company tries to set up its reinsurance program, it will always find that there are some risks that are being covered twice. This would mean that there are some risks for which the premium is being paid twice.

    Firstly, due to the overlapping nature of these insurance contracts, it can be very difficult to identify such redundancies. Even if they are identified, it can be very difficult to get these redundancies excluded from any one contract.

    Eventually, redundancies can also become a source of conflict when actual payouts have to be made. It is possible for the reinsurers to resort to litigation in order to avoid paying claims.

    Hence, when a ceding insurer uses a multi-tower approach, they end up eliminating redundancies. This is one of the reasons why a multi-tower non-conventional reinsurance policy is cheaper than a traditional reinsurance policy.

  3. Circumventing Minimum Capacity Requirements: Reinsurance companies are only interested in dealing in bulk business. It is for this reason that most reinsurance companies have minimum capacity requirements in place.

    From a ceding insurer’s point of view, it can become very difficult to meet the minimum capacity requirements in all the towers. This is because the amount of risk underwritten may vary in each tower. It may also vary from year to year.

    If the volume of business in a particular tower is low in a given year, then it may be difficult to find reinsurance for the same. Hence, when a ceding insurance company uses a multi-tower non-conventional policy, they are able to circumvent these minimum capacity requirements and reinsurers are legally bound to provide them with services regardless of the quantum of business provided by individual towers.

  4. Negotiating Power: As mentioned above, reinsurance companies are interested in bulk business. Hence, it can be said that economies of scale matter a lot when it comes to the reinsurance business.

    When ceding insurers sign non-conventional multi-tower policies, they are consolidating all their business into one unit. As a result, the size of the business increases. This makes it attractive to more reinsurance companies. This creates a situation wherein the ceding insurer has a higher bargaining power and hence can demand a better price.

    However, ceding insurers need to be careful while selecting their reinsurance partner. This is because non-conventional policies also mean that the ceding insurers' risk will be concentrated with a single counterparty. The economic failure of that counterparty could have disastrous ramifications for the ceding insurer.

  5. Administrative Gains: Last but not the least, reinsurance paperwork can be very complicated. Most of the contracts are customized. Hence, when a ceding insurance company signs multiple reinsurance policies, they have to hire a larger team of legal experts to check each and every contract.

    Also, the procedure to make the claims may be different in different companies. As a result, a higher degree of complication gets built into the process. These complications can be both cumbersome as well as expensive. It is possible to eliminate this additional effort and expense when a ceding insurer signs a multi-tower non-conventional reinsurance policy.

To sum it up, even though multi-tower reinsurance policies are relatively new, they have been growing rapidly in popularity. Reinsurance companies across the world now have to adjust to this new reality. The failure to do so might lead to loss of market share in the short run and extinction in the future.

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Authorship/Referencing - About the Author(s)

The article is Written By “Prachi Juneja” and Reviewed By Management Study Guide Content Team. MSG Content Team comprises experienced Faculty Member, Professionals and Subject Matter Experts. We are a ISO 2001:2015 Certified Education Provider. To Know more, click on About Us. The use of this material is free for learning and education purpose. Please reference authorship of content used, including link(s) to and the content page url.