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The Value and Price of an Intermediary
Last October at the Annual Society of Actuaries Meeting we attended the session on The New World of Financial Reinsurance. One of the speakers posed to the audience the question, "What is the most important factor in entering into a reinsurance transaction." In unison the attendees responded, "Price." This reminded us of a survey of the reinsurance marketplace that asked respondents to name the three most important factors in choosing a reinsurer. Interestingly enough PRICE was a leading factor all three times.
Financial strength of the reinsurer was the second choice overall. Long-term relationship and general service were the third and fourth choice.
Price is always an interesting topic for an intermediary. It's fair for a ceding company to ask, "Does the use of an intermediary add to or subtract from the cost of my reinsurance?"
As direct writers, ceding companies wrestle with pricing issues all the time. Does my price cover my administrative expenses, mortality assumptions, overhead, distribution costs, tax considerations, reinsurance costs, my cost of capital, and does it achieve my desired rate of return?
How often does the direct writer arrive at his optimum price and later finds out that the price does not stand a chance in the marketplace? Does he rework his assumptions or does he compete on the financial strength of his insurance company, his service abilities or his established relationships with his producers?
The same factors of price, financial strength, long-term relationship and general service apply to your reinsurance intermediary and your ultimate reinsurer.
Effective intermediaries must be knowledgeable of the pricing, financial strength and service capabilities of reinsurers. Reinsurers, like direct writers with their producers, cultivate long-term relationships with intermediaries.
An intermediary to be effective with ceding companies must obtain the combination of the best prices and the financial strengths offered by reinsurers. Intermediaries can differentiate themselves from other intermediaries by service capabilities and by establishing long-term relationships with ceding companies and reinsurers. An intermediary will try to anticipate a client's needs in advance and make recommendations that are in the client's interest even if it diminishes his or her brokerage commissions.
An intermediary should deliver objective advice and foster competition among the reinsurers and expand new and alternative reinsurance solutions. The common theme among intermediaries and reinsurers is trust. Having worked both sides - as a reinsurer and as a reinsurance intermediary, the price for a reinsurance transaction should be decided by the marketplace and not by whether an intermediary is involved or not.
Reinsurers that charge one price for transactions with intermediaries involved and another price for without will not earn the trust of the marketplace. The best analogy for this situation is akin to the manufacturer/wholesaler that sells his products through retailers. When the manufacturer/wholesaler decides to also sell directly to consumers the price he charges is the same as the quoted price given to his retailers. More often than not it is the retailers or intermediaries that will put downward pressure on quoted prices and lower costs to the ultimate consumer. The ultimate price will be determined by factors in the competitive marketplace subject to the levels of return desired by the reinsurer.
The value of an intermediary is not just for negotiating the price for reinsurance or knowing reinsurance treaty language terms. But rather knowing whether the reinsurer and intermediary will honor the spirit of the reinsurance treaty and are there for the long term. We remember one particular reinsurance treaty where the ceding company had extraordinary claims for a particular year causing the reinsurer to lose money. When the treaty came up for renewal the reinsurer could have walked away from this ceding company. But rather the reinsurer renewed the treaty at the same terms and price.
The "best price" is not always defined as the lowest in economic terms. The lowest price might come from a reinsurer that is financially unsound or an intermediary that offers little or no service and is not seeking a long-term relationship.
The flip side can also mean that an intermediary can also bring value to a prospective ceder that is not looking for long term relationship. In traditional forms of reinsurance - YRT, coinsurance, stop loss, etc. there is value to establishing a long term relationship with your intermediary and reinsurer. But there are other reinsurance transactions where a short term relationship is best. The best examples are block divestitures or block acquisitions.
If you are a block acquirer we recommend the following steps:
Define your parameters. The first step is for management to define what they want to accomplish. Is it a build versus buy scenario for a new market? Is it an economies of scale issue? What type of block is appropriate? Where will the capital for the transaction come? Will it be internal capital, external, or reinsurance? Prepare for analysis in the following areas: actuarial, asset/ investment, technology, marketing, and culture.
- Cast a wide net. Talk to as many intermediaries, investment bankers, and reinsurers as possible. Funnel all leads through one contact person to eliminate any question as to the original source of the potential deal.
- Be willing to pay a premium.
Assume every transaction will be a bidding war. Having the second best bid earns you nothing, your bids will not be competitive if you use internally driven ROE and ROI goals to set your price.
- Perform due diligence. It is critical that your accounting, investment, actuarial, computer, administration and compliance experts do a thorough job of analysis to make sure that you are buying what you think you are buying. It is as important to identify potential future litigation as it is to establish the value of assets and liabilities.
- Do the consolidations. Most acquisitions contemplate back room and corporate function consolidation. If that is the case, then the sooner it's done and over, the better. The block acquisition will not payoff unless these consolidations are made.
If you are contemplating a divestiture we would recommend the following steps:
- Do a valuation. Too often, companies try to save money by not doing a valuation before trying to sell a block of business. A good valuation is critical to the seller because it (1) gives you an idea of what the block is worth, (2) serves as a selling tool for the block, and (3) provides a starting point for buyers to make bids.
- Hire one intermediary firm to handle the sale. Unlike the acquisition side, you want no confusion in the marketplace as to who is authorized to sell your block. This will maintain confidentiality, protect your agents, employees, and policyholders, and preserve the value of your block.
- Use a "rifle" approach. Do not "shotgun" the block all over the market. This will make prospective buyers think that there is something wrong with the block and most will shy away from bidding or even looking at the block.
- Pre-screen and qualify buyers. This is the function of your intermediary. The intermediary can screen and qualify buyers discreetly so that only interested and capable buyers know about your plans for a divestiture.
- Run a two step auction. This process helps separate the serious buyers from the "tire kickers." Request an initial nonbinding bid prior to due diligence. Accept the best 5-7 bidders and allow them to perform due diligence and submit their final bid.
A commonality to the price of an acquisition or divestiture is usually a higher price to the buyer and a lower price to the seller. Over the years it has been our experience that the "right price" for a block transaction has been when the buyer believes he is overpaying and the seller believes he is being underpaid.
The value and price of a direct writer's product reflects his assumptions, financial strength, long-term or short-term relationships and service capabilities. The value and price of reinsurance reflects these same attributes of reinsurers and intermediaries subject to the demands of a competitive marketplace.
By Antonio D. Vila, FSA and Peter M. Wilson, FLMI
Mystic Insurance Intermediaries
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