We need to talk about the cost of reinsurance.

Primary property/casualty insurance carriers and MGAs are still squeamish following the most difficult January reinsurance renewals the industry has seen in nearly two decades. Gallagher Re called this the toughest January 1 renewal “in a generation.” As P/C insurers all compete for the same limited capacity, they face shrinking margins as the cost of reinsurance steadily rises. These costs are inevitably passed on to the insured.

While there are signs that the market may be improving, this problem isn’t going away any time soon. In a recent report, investment banking and reinsurance broking firm Stonybrook Capital said it expects reinsurers to “remain in the driver seat” with a “hard market continuing well into 2023.” The report also notes growing coverage restrictions, with reinsurers “often restricting cover to ‘named perils.'”

In the hardest-hit property sector, higher claims costs driven by inflation together with more frequent claims resulting from climate change-related natural catastrophe events and social inflation continue to take their toll on reinsurers’ profitability. On the casualty side, the core issues are the same, however, the rate increases have been somewhat easier to digest. As Michael Giusti, a senior writer and analyst for InsuranceQuotes.com, puts it, we can expect higher reinsurance costs “to reverberate through nearly every P/C policy in the market.”

With double-digit rate increases and some reinsurers exiting markets entirely to improve returns, it would be easy to suggest that insurers simply “don’t know how to price these risks.” Yet the current dynamic in the reinsurance market is evidence that the problem is not so much one of pricing risk but rather one of risk selection.

Reinsurers will continue to reward businesses that can consistently select risks based on the underlying distribution and exceedance probabilities to which their prices are set. When we talk to reinsurers and reinsurance brokers, we consistently hear that the promises made by carriers and MGAs to their upstream capacity providers are empty. A massive opportunity exists for those who can “show not tell” how they will perform against the plans they put forward.

As a P/C insurer, now is the time to start thinking about how your industry peers are achieving better results at the reinsurance negotiation table, and the proactive steps you can take today to ensure you are well positioned for the next treaty reinsurance conversation.

The Clock Is Ticking

For P/C insurers and MGAs that didn’t face the dreaded “reinsurer veto” this past January and were able to negotiate the capacity needed to scale their business, the clock immediately resets and starts counting down to the next reinsurance contract negotiation. For all but a few that are able to secure multiyear agreements, this means they have less than a year to prove to their reinsurance partners that they have the underwriting precision, portfolio strategy and controls in place to avoid passing on unnecessary losses to the reinsurer. It’s an unpredictable, “pay as you go” model where, at any given renewal date, a reinsurer may opt to raise rates, renegotiate terms or withdraw from the agreement entirely.

Insurers need a strategy for maximizing their return on reinsurance. Those with approaches driven by data and technology appear to be winning out. Here are a few key considerations to keep in mind as each contract renewal conversation edges closer.

Talk Is Cheap and Promises Are Free

Let’s walk through a hypothetical reinsurance renewal negotiation. You sit down with your reinsurer and they break it to you gently (or not) that your rates are doubling year over year—yes, doubling. The reinsurer explains that the rate increase is necessary due to consecutive years of losses they have had to absorb. When you pick your jaw up off the floor, you’re going to say to the reinsurer that you’re putting controls in place to better monitor and manage your exposure, yadda yadda.

But guess what? All your competitors are telling the reinsurer exactly the same thing. It’s a song and dance with which reinsurers are all too familiar. Their response is likely to be, “Look, you all said the same thing last year, and the year before that, so we’re going to raise rates and reduce coverage on all of you across the board.” For some, the question becomes how much can our margins get squeezed before it no longer makes sense to write the business?

While insurance is still relationship-based, the reality is reinsurers are data-driven entities, and in a world of failed promises, relationships alone are unlikely to earn an insurer the credit—or commissions—they believe they deserve. Insurers and MGAs who lead the charge on data-driven underwriting and portfolio management will inevitably have an edge in future reinsurance negotiations.

Limited Capacity Raises the Bar for Innovation

There’s an old saying in our industry that if insurers truly were experts at selecting risks and balancing their book of business, we wouldn’t need reinsurers. If there’s a silver lining in the current challenging reinsurance market, it may be a newfound urgency to modernize and transform the way insurers manage and balance their book. It’s a change that is long overdue and one that can ultimately benefit the insured we are all out to serve.

While P/C insurers have invested heavily in third-party data and new predictive models, they still struggle to precisely assess and price complex and emerging risks such as climate change, cyber and social inflation. Successful reinsurance negotiations will increasingly come down to an insurer’s ability to demonstrate to reinsurers that they have stronger portfolio management and controls in place than their competitors.

We are now in a “show not tell” market in which insurers and MGAs can no longer come to the negotiating table with a PowerPoint presentation, base metrics, a smile and a handshake, and expect superior results. Faced with flagging profitability, reinsurers, who ultimately bear the risk of a poorly managed portfolio, are demanding more detailed and rich data from insurers on their appetite, as well as the actual volatility and risk exposure they are carrying in their portfolios. Many are even pushing for real-time bordereaux from businesses, as more tech-savvy competitors start to make such system capabilities available. Surface metrics, such as aggregate accumulations of natural catastrophe exposure, are no longer enough to secure the desired capacity and commissions under the most favorable terms and conditions.

The State-of-the-Art in Portfolio Management

The capacity crunch has exposed significant deficiencies in the systems and processes many insurers use to balance their portfolios. Today, most insurers use static tools to define their portfolio strategy, setting goals and targets to balance exposures each quarter. These targets are then passed down to regional managers and ultimately front-line underwriters, typically in the form of PDF documents and spreadsheets. The onus is on overworked underwriters to not only apply the rules correctly to any given risk but to somehow, by sheer divine intervention, be coordinating large schedules of correlated risks to the aggregations and accumulations being built up by the rest of their team.

Front-line underwriters are the gatekeepers of risk; they decide whether a risk is in the portfolio or not. And once it’s in, it’s in.

But we are simply asking too much of them. It doesn’t make sense anymore. In the era of ChatGPT, electric vehicles and reusable rockets, insurers are trusting one of their most business-critical tasks—portfolio management—to disjointed spreadsheets and PDFs.

Modern software systems leveraging an advanced data architecture and reinforcement learning-based AI provide an alternative, giving insurers and their reinsurance partners a more accurate and complete view of portfolio risk. Such systems can proactively and in real time empower underwriters to play their part in balancing the portfolio, making course corrections on the fly and growing premiums in accordance with the company’s rate, retention and accumulation goals and strategies. Promises stop being promises and start being code–hard and fast embedded portfolio controls that give reinsurers market confidence.

Operational Efficiency Is Not Enough

MGAs, in particular, have long traded on their specialized expertise, whether it be in a specific geography, an underserved niche line of business, a proprietary data model that enables them to out-select the competition, or the strength of their distribution network and relationships with brokers and agents.

Reinsurers want to see proof that insurers and MGAs have the processes and technology infrastructure in place to allow them to harness their specialty to scale and grow the business. For many new insurers and MGAs, the focus tends to be on getting the business off the ground, growing their distribution network and answering the existential question, “Can I write premium?” Building a scalable infrastructure to support growth is often the farthest thing from their minds, at least early on.

While insurers need to invest in actuarial work and data science to differentiate themselves, it is unrealistic to build the workflows, operational tooling and dynamic systems of control that bring these strategies to light. Such technologies are an absolute science. There is only downside and expense to building this part of the insurance tech stack in-house. Insurers need to leverage systems with the flexibility to accommodate and protect their unique market differentiators, and then use those cost savings to further invest in areas that can move their business forward—actuaries, data scientists, underwriters and distribution.

Back in the Driver’s Seat

Competition for reinsurance capacity is stiff. How are you planning to scale your capacity this year, and are you paying too much for reinsurance? It’s time for carriers and MGAs to get back into the driver’s seat when it comes to their reinsurance renewals. It’s a good bet that a tech-first approach to underwriting and portfolio management will consistently outperform the market over the next decade and beyond. The ability to demonstrate—”show don’t tell”—underwriting precision and strong portfolio controls is the best tool insurers have to solve their capacity challenges and pave the wave for future growth.