Open Communication Is Key In Avoiding Reinsurance Disputes
By Carl E. Meier
“What we have here is a failure to communicate.”
That line is familiar to many movie fans from the 1967 Paul Newman film “Cool Hand Luke.” However, it is also a very succinct description of a common real-world problem.
The disputes that arise in both our business and personal lives are frequently not the result of basic differences between our beliefs or goals and those of another party. They occur much more often because we didnt communicate those beliefs or goals clearly–or perhaps we didnt communicate them at all.
The results of poor communication can be disastrous–from failed personal relationships to actions that result in serious injury or even death. Insufficient or unclear communications cost businesses untold millions of dollars every year.
In the life insurance industry, the need for good communication is nowhere greater than in the dealings between a ceding company and its reinsurer. This is particularly true, given the growing use of reinsurance by life companies, and its critical importance both in product development and as a financial tool.
A reinsurance treaty is a legal contract between the ceding company and the reinsurer. Historically, a reinsurance treaty also has been considered to be a “gentlemens agreement” between the principals. A gentlemens agreement, although reduced to writing, places great emphasis upon the parties willingness to honorably uphold the spirit of the contract, especially when its written provisions are silent or open to varying interpretations on a particular point. If a difficulty or uncertainty should arise under such a contract, the parties expect to rely on their mutual integrity and good will to sort things out and arrive at an acceptable resolution.
If an irreconcilable difference arises between the parties to a contract, the matter is usually settled in a court of law. Most reinsurance contracts, however, incorporate an alternative method for resolving such differences: binding arbitration. The major advantages that arbitration is supposed to provide are twofold: (1) the process should be less time-consuming and less costly than litigation (and, it is hoped, less adversarial); and (2) the final result will be decided by arbitrators who are familiar with insurance and reinsurance practices and customs, as opposed to a judge and/or jurors who likely have no particular acquaintance with such matters.
Until sometime in the 1980s, most disputes between reinsurers and their client companies were resolved informally. However, as profit margins began eroding, and both reinsurers and life insurance companies became more bottom-line-oriented, formal arbitration has become more common. Over the years since then, the arbitration process itself has changed as well.
Today, it is common for both sides to be represented by legal counsel. Representatives of both companies are formally deposed. Expert witnesses may also be called. Needless to say, the time and expense involved are now much greater than had been expected. Unfortunately, the process has become more adversarial as well.
Because the results of arbitration proceedings are generally not made public, there is only anecdotal evidence regarding what the companies that have used the process think of it. Such evidence strongly suggests that the outcome is unlikely to fully satisfy even one of the parties. The reason for this is that the arbitration process often produces a decision that is a compromise between the demands of the two parties involved. Thus, neither party is likely to be particularly pleased with the results.
Given the high costs and less than satisfactory results, it seems obvious that everyone would be better served if a dispute had never arisen in the first place. “Easier said than done,” you might think, but that is not actually the case.
Conversations with several people who have served as arbitrators and/or umpires in numerous proceedings between life insurance companies and their reinsurers revealed a nearly unanimous agreement: The most frequent underlying cause of the disputes by far was “a failure to communicate.”
This is really not surprising considering the many different elements that are typically a part of the relationship between a ceding life company and its reinsurer:
The relationship usually begins with the life company requesting a quote from the reinsurer. When approaching the reinsurer, it is important that the requesting company convey clearly what it expects to achieve through reinsurance. The companys goals are key, not only to choosing the right type of coverage, but also to appropriately structuring the terms of the reinsurance agreement. An erroneous or incomplete understanding of the requesting companys objectives can result in serious dissatisfaction if the eventual results under the agreement do not meet the companys expectations.
As a part of its evaluation process, the reinsurer will request certain pricing information. This would include items such as expected mortality and lapse rates, a copy of the underwriting rules to be used and information concerning how the plans are to be marketed. If the reinsurance involves an existing block of business, the reinsurer will want to see the actual mortality and persistency experience on the block. If the reinsurance involves new issues, the reinsurer may ask for experience on similar business issued in the past.
The possibilities for misunderstanding at this stage are significant. As just one example, it is extremely important (but no small task) to set forth the limitations and special conditions which might bear upon the experience data. Thus, it is important that there be a meaningful dialogue between the two sides to minimize the likelihood that the data will be misinterpreted.
The evaluation process has a qualitative aspect as well. The reinsurer will assess the companys culture and values, as well as other “soft” items, in determining corporate compatibility. The company may find it tempting to convey the image it feels the reinsurer is looking for, but if that image is not the reality, the relationship is likely to have problems in the future.
Eventually, the reinsurer will provide a document to the requesting company setting forth the relevant details of its offer. Quote documents can vary markedly in their degree of completeness. The company should review the quote it receives carefully to make sure that those points it considers important are covered. The Reinsurance Section of the Society of Actuaries has created a checklist that can be very useful to a company in developing its own set of standards.
It is likely that a bit of negotiation back and forth on some aspects of the reinsurers offer may be necessary before there is, indeed, a mutual agreement.
The reinsurance may involve new issues of an existing product that is currently being covered by another reinsurer. If this is the case, the ceding company should carefully spell out the details of the transition and get written agreement from both reinsurers in advance of the changeover date. Such action will avoid a possible argument over which reinsurer is on the risk in the event that a large claim occurs on a policy originating around the time of the transition.
The next step in the process is for one of the parties to draw up the formal reinsurance treaty and submit it to the other for review. This document is one of the most crucial elements of the relationship. It sets forth many of the details of the coverage, such as exactly what risks are being reinsured, the form of reinsurance involved, and the procedures for administrative reporting, paying premiums and settling claims. Other provisions address special situations that may arise; included in this category are unintentional clerical errors and oversights, extra-contractual damages, and the insolvency of one or the other of the parties.
Qualified personnel at each company, preferably including an attorney well-versed in reinsurance law, should review the treaty carefully. The model reinsurance contract developed by the American Council of Life Insurers, Washington, is an excellent reference tool for this purpose, even for those who are relatively familiar with treaty language.
The models “Applicable Notes” sections provide additional guidance for circumstances that require variations in treaty language. Keep in mind, though, that the model treaty is generic; it may not deal appropriately with all of the nuances of a given agreement or the requirements of a particular jurisdiction.
Schedules appended to the contract may set forth more detailed information, such as the names or other means of identifying the plans covered by the treaty, the ceding companys retention limits, underwriting guidelines, and tables of premiums and allowances. Because of the sheer volume of information contained in these schedules, it is all too easy for errors to creep in; the ceding company should, therefore, check this material thoroughly.
Should either party determine that there is something unclear, incomplete or missing from the treaty, the situation should be corrected before the contract is finalized. Any and all questions should be answered to both parties satisfaction and any necessary modifications should be made before they sign off on the treaty. (In spite of the best efforts of everyone involved, it is sometimes found, shortly after a treaty has been signed, that an item has been misstated or overlooked; if such is the case, the contract should be amended to correct the problem as soon as possible.)
If the reinsurance treaty covers new business, problems can frequently arise as a result of the ceding companys underwriting procedures. Perhaps the most common situations are the adoption of changes to the companys normal underwriting rules, or departures from those rules, without the prior consent of the reinsurer.
Advance notice to the reinsurer is always desirable and may prove beneficial to the ceding company as well. For example, the reinsurer may have information which suggests that the course of action being contemplated is not in the companys best interest.
Today, most reinsurance is self-administered. Thus, the reporting of new issues, policy changes and terminations, and the payment of reinsurance premiums offer further opportunities for miscommunication.
For example, a systems problem may hold up the reporting process. Reinsurers can be very understanding and forgiving in such circumstances; the key is to notify the reinsurer of the problem promptly and keep them informed of what is being done to resolve it.
It may be necessary to pay an estimated premium until accurate information is available. However, this is certainly preferable to putting the companys reinsurance coverage in jeopardy for nonpayment of premiums.
Finally, there is the claims settlement process. It may be counterintuitive, but issues that arise at claim settlement time are most likely to involve incontestable claims. In such instances, the point of dispute usually revolves around (a) the ceding companys underwriting practices (see above) or (b) its failure to submit a case that exceeded the reinsurance treatys automatic limits on a facultative basis.
Problems do arise on contestable claims as well, though. For example, the ceding company is obliged to share the proof of death information it receives on such claims with the reinsurer. In certain instances, the treaty may also require that the company consult with the reinsurer before conceding liability to the claimant. The treaty may not, however, impose any time limit on the reinsurer for recommending how the ceding company should handle the claim. Delay by the reinsurer could result in the ceding company having to pay interest on the claim at a rate much higher than the current market rate; it could even put the insurer at risk for punitive damages in some cases.
The subject of punitive damages is one that can only be touched on here. The key point is that the treaty must address, to the ceding companys satisfaction, the circumstances under which the reinsurer will participate in such damages. Consider a situation where the ceding company faces punitive damages because of its decision to deny or offer a compromise settlement on a claim. The treaty should indicate that, if the course of action was one that the reinsurer had recommended or at least given its written consent to, then the reinsurer will share proportionately in any punitive damages.
As this brief survey of the major points of interaction between the ceding life insurance company and reinsurer indicates, there are many places where problems can develop in such a relationship. Furthermore, recent trends in life insurers use of reinsurance have only served to complicate matters more. To cite just a few examples:
The spectacular growth in first-dollar quota share agreements has significantly increased the volume of reinsurance ceded, straining the administrative capacities of some reinsurers.
Reinsurance of blocks of in-force business has made the determination of exactly what business is reinsured under such an agreement and for what net amount at risk, a sometimes difficult task.
X, more formally, the Valuation of Life Insurance Policies model regulation, has introduced new elements, such as the selection of X-factors, into the determination of reinsurance reserve credits for coinsured level term policies.
More life insurers are purchasing their reinsurance coverage from foreign reinsurers. This means that additional language should be included in the treaty to address how the reinsurer will secure the reserve credits due the ceding company.
At the same time that the reinsurance business is becoming more complex, pressure on the bottom line is causing all companies to become more hard-nosed in financial matters. If either party to a reinsurance treaty feels that the other party has caused it actual or potential financial damage, there is a good chance that it will push for a formal resolution of the dispute. Such a process could be long and costly, and may not produce a result that is satisfactory to either side.
There is, however, a bright side to these cautionary comments as well. The ceding company/reinsurer relationship still retains much of the gentlemens agreement character. Thus, so long as each party does its best to keep the other informed through clear and timely communication, it should be possible to solve most problems that arise without resorting to a formal dispute resolution process.
Carl E. Meier, FSA, MAAA, is an independent life and health actuary based in New Orleans. He can be reached at Cmeier4@cox.net.
Reproduced from National Underwriter Edition, February 17, 2003. Copyright 2003 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.