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.