Cycle-Timing: Casualty Treaty Consolidation vs. Deconsolidation

As evidenced by the most recent treaty renewals at 1/1, the Casualty reinsurance cycle has entered a time of stability after a hardening market had driven up XOL rates and driven down ceding commissions on pro rata placements. As these challenging years mature and profitability beings to be recognized, a softening of market terms and conditions is expected to emerge. In the evolving environment, buyers of Casualty reinsurance now need to reassess and optimize their reinsurance purchasing strategies.

Consolidation: A Strategy for Hard Markets

As the Casualty reinsurance market hardened, many buyers chose to consolidate their reinsurance treaties. This approach involved combining multiple portfolios, such as general casualty and professional liability, into broader, all-encompassing treaties. For global carriers, consolidation often included combining regional portfolios to establish truly global treaties.

The benefits of consolidation during this period were significant:

• Leverage Economies of Scale: Consolidation enabled buyers to negotiate more favorable terms.
• Portfolio Diversification: Combining diverse lines of business reduced volatility, resulting in a more stable, modeled outcome.
• Broader Coverage: While terms and conditions were tightened overall, buyers were able to maintain the best possible terms, by placing underperforming portfolios in conjunction with stronger performing portfolios.

This strategy proved effective in maintaining balance across portfolios, particularly when market conditions tightened, and terms became more restrictive.

Shifting Landscape: Opportunities in Deconsolidation

As market conditions soften, the benefits of consolidating portfolios to be covered by one treaty don’t just disappear. However, buyers now face an opportunity to adjust

their buying philosophy to take greater advantage of the shifting reinsurance landscape.

Underperforming or volatile portfolios, which may have previously benefited from consolidation, may now hinder efforts to secure favorable terms. As such, it may be a smart move to separate underperforming or volatile portfolios from better performing or less volatile portfolios in order to maximize improvements to terms and conditions to those portfolios that are performing better.

While price may be a driving factor, there are other areas that must be considered before deciding whether deconsolidation of treaties is the best strategic move.

Key area considerations for deconsolidation include:

1. Maximum Limits (per risk and aggregate basis): In a softening market, carriers are often pressured to expand per-risk limits. In turn, reinsurers prefer a balance between per risk limits offered and premium ceded to the reinsurance treaty in order to achieve optimal terms and conditions.
2. Aggregate Limits: Consolidated treaties typically feature larger aggregate limits due to the larger premium base and the reduced correlation of risks across portfolios (i.e. it is unlikely that all portfolios go bad in the same year). While beneficial, this feature may no longer outweigh the drawbacks of supporting underperforming portfolios. It may also depend upon whether the aggregate limit is expressed as a specific numeric loss amount or a multiple of ceded premium to loss (i.e. loss ratio).
3. Global Treaties: Consolidated global treaties tend to be placed with US reinsurers, who may not fully appreciate the nuances of the local International market coverages.

While all of this should be taken into consideration, given the softening of the marketplace the negative impact to terms and conditions on the lesser performing portfolios once deconsolidated may still be a better trade-off than maintaining a consolidated treaty throughout the soft market cycle.

Balancing Costs and Administration

One notable drawback of deconsolidation is the increased administrative burden. Managing additional treaties requires more administrative work and more

coordination with reinsurers. On the positive side, internal cost allocation pressures are alleviated once placements are separated as the costs for specific treaties becomes very transparent, allowing buyers to allocate costs more easily. Though deconsolidation introduces administrative complexity, the transparency it provides in cost allocation for specific treaties can be a significant advantage.

Tailoring Strategies to Market Cycles

Ultimately, each company buying reinsurance has their own specific needs and goals when setting their reinsurance buying strategy. While consolidation may have been the optimal strategy in a hard market, buyers must evaluate whether it continues to provide the same benefits in a softening market. The dynamic nature of the reinsurance market demands flexibility. Exploring separate treaties for different portfolios may, in certain circumstances, offer greater advantages than maintaining a consolidated structure.

The decision to consolidate or deconsolidate reinsurance treaties should be guided by market conditions and the unique characteristics of each buyer’s portfolio. As market cycles shift, the strategies that once worked well may no longer be the best fit. By carefully analyzing the trade-offs between consolidation and deconsolidation, buyers can position themselves to capitalize on favorable terms and conditions while minimizing risks.

By Brian Cole