1 January 1970

Reinsurance and healthcare captives: a uniform approach

The collapse of the financial market in 2007 triggered by an overvaluation of assets and the overleveraged banks had a debilitating effect on most companies’ bottom lines. Many of our clients reported a significant decline in investment income during that period, and captives in general felt the same impact on their balance sheets.

By the end of the first quarter of 2010, most institutions had either recuperated their previous loss in investment income or were made whole as a result of the significant rebound in the stock market. However, as we investigate the lingering effects of the financial crisis, one thing becomes clear: the near collapse of powerhouses such as AIG and XL created a fundamental shift in the way clients buy their insurance and reinsurance products.

As Abraham Lincoln once said: “The dogmas of the past are inadequate for the stormy present.” Since 2008, we have seen a significant push from captives to diversify their reinsurance programmes by reducing and shifting capacity from a single carrier in favour of multiple carrier relationships. Historically, a healthcare captive could issue $100 million policy and reinsure the top $90 to $95 million with two or three reinsurers. Now that single block of capacity is very likely to be split into multiple layers with several reinsurers as a way to mitigate against carrier downgrades or outright insolvencies.

Like any other deviation from the normal pattern of behaviour, this fundamental change in buying philosophy brings with it several potential risks, the most obvious of which is the serious potential for coverage gaps and legal divergence on the settlement of claims. How, then, can captives buying reinsurance achieve both market diversification and maintain coverage continuity?

The Bermuda markets are reassessing their current model of multiple reinsurance certificates in favour of a more standardised model that will seek to eliminate these coverage inconsistencies. Such a change will shift the pendulum from a defensive posture to a more aggressive leadership position. It will help Bermuda reassert its position as the leader in creative solutions to risk transfer and risk financing, including captive reinsurance.

Aside from the current political climate in Washington vis-à-vis Bermuda’s status as a tax-exempt jurisdiction, market diversification is arguably one of the biggest threats facing the Bermuda marketplace to date. The reinsurance carriers should use their unique underwriting model, which facilitates face-to-face meetings with a majority of clients, to investigate this issue further in search of a long-term and lasting solution. The advantage of meeting clients face to face, year after year, is that it creates a unique set of opportunities to understand, investigate and solicit feedback from a big pool of existing as well as potential clients. As such, reinsurers in Bermuda are better placed than most to assess and react to client needs in a changing market environment.

Such an investigation would likely confirm a deep sense of concern and ambivalence from clients on the issue of coverage consistency. As such, Bermuda needs to be proactive and answer the call. If we fail to do so, it would not only prolong the continuing threat of losing business to the US, but it would also erode Bermuda’s sense of itself as the leader of creative solutions for the insurance and reinsurance world.

Whether we like it or not, it is happening. Clients are diversifying their programmes in favour of multiple relationships. The new reality is that to build a $100 million tower, we now need five to 10 different carriers, each with its own reinsurance certificate with potentially different subjectivities and exclusions, creating a maze of coverage gaps. This new reality presents brokers and underwriters alike with an opportunity to help our clients find ways to effectively address these coverage issues.

In this perspective, a new standardised Bermuda reinsurance certificate for captive clients would seek to eliminate that level of inconsistency and would offer our clients the unique opportunity to buy all or a majority of their capacity on a single form, while creating multiple relationships with financially sound carriers.

Why have we not done this before?

Many of the markets are simply unwilling to cede their control to a standardised reinsurance certificate, when the captive forms that they are reinsuring are anything but standard. From the markets’ perspective, having their own reinsurance certificate with its own list of subjectivities and exclusions is the only form of control they have to mitigate the risk of reinsuring a captive policy with much broader terms than what was intended. Many of these captives are multi-purpose insurance vehicles and as such their forms tend to be broader than standard commercial policies. Therefore, the likelihood of extending coverage where coverage was not intended is simply too great.

This underlying issue means that we would have to concede flexibility to the reinsurers in how and when this new reinsurance certificate could be deployed based on the acceptability of the captive policy they seek to reinsure.

Furthermore, the issue of control is more prevalent on the first excess or lead layer. A potential compromise could be to use this new reinsurance certificate on the second layer and above, thereby allowing the lead reinsurer to set the tone of coverage. Using the previous example of the $100 million tower, we could effectively place $80 million of that on a single form.

How would captives benefit from this new reinsurance certificate?

There are several key coverage enhancements being worked on, but it is our belief that the final product will likely include the following key benefits to our clients:

1) Standardised reinsurance certificate—one certificate signed by all the participating Bermuda reinsurers

2) Reduction of the time lag on policy issuance to no more than 30 days from the time of binding

3) Greater diversification of programmes, with support from six financially strong carriers, rated ‘A’ or better

4) Standardised ‘batch’ coverage, and

5) Affirmative grant for punitive damages. If we work hard enough with a single focus to satisfy our clients’ needs, and if we seize the moment as we have done in the past, this new form will strengthen Bermuda’s leadership position and enhance its competitiveness and marketability for years to come.

The Bermuda markets currently reinsure healthcare captives from many jurisdictions, including Bermuda, Cayman and Vermont. Accordingly, this standardisation can have a significant industry-wide benefit.

We expect that Bermuda reinsurers will act swiftly on the finalisation and implementation of the new certificate process to provide the same level of consistency that is provided on general liability with the standard market forms.

Wesly Guiteau is the senior vice president of Willis (Bermuda) Limited. He can be contacted at: wesly.guiteau@willis.com