Treaty exclusions and special acceptances: why they matter

Carol Liao from Swiss Re’s Casualty underwriting team highlights the importance of treaty exclusions and special acceptances as risk management tools for both cedants and reinsurers.

Following periods of softening in Asia-Pacific markets plus the impact of the global financial crisis, both insurers’ risk appetite and reinsurers’ willingness to grant broad treaty coverage have diminished, with a subsequent tightening of treaty scope.  This fuelled negotiations around treaty exclusions, usually with insurers seeking the broadest available coverage and reinsurers trying to resist.

Now with the coming January renewal ahead, it is a good time to discuss the importance of treaty exclusions and special acceptances as insurers and reinsurers pursue underwriting best practice.

Why treaty exclusions?

As a critical risk management tool for both cedants and reinsurers, treaty exclusions are introduced mainly for determining which exposures cannot be automatically covered by a treaty. These include:

  • Uninsurable risks, which may be better dealt with on a pooled or industry-wide basis, rather than by individual underwriters (eg, war and nuclear risks);
  • Risks belonging to other classes, which are more appropriately dealt with in specific treaties with particular terms and conditions (eg, marine exposure in property treaties);
  • Non-homogeneous risks, which fall outside the pool of risks covered by a treaty (eg, a single professional indemnity risk in a portfolio which constitutes predominantly SME public liability may be better covered by a facultative solution);
  • Risks which are considered highly volatile (eg, professional indemnity for major accounting firms);
  • Risks which might cause excessive accumulations by a combination of treaty and facultative acceptances (eg, very large pharmaceutical risks, global programmes of leading corporations); and
  • Risks which are not within the pricing assumptions of the cover, thus requiring assessment of their impact on the pricing adequacy of the contract and whether a price adjustment is needed.

What is a special acceptance and how can specials help cedants?

A special acceptance is an agreement to extend the scope or sub-limit of a reinsurance contract to an individual risk which does not qualify for automatic cession to the contract.  Accordingly, risks which breach treaty exclusions need to be referred to reinsurers for a special acceptance.

Special acceptances provide cedants with efficient solutions in case of slight deviations from the treaty limits or sub-limits. Treaty reinsurers are usually willing to give green-lights under these circumstances, so that cedants do not need to seek extra facultative support.

Special acceptances also serve as a critical knowledge sharing interface between cedants and reinsurers. Through risk specific dialogues and information exchanges, cedants can gain access to additional data sets and underwriting resources, which in turn will help their risk assessment and portfolio management.

However, some cedants recently indicated that there are too many specials to treaties, and that the special acceptance process can take too much time. Also in Asia, hazards and risks faced by different markets may vary significantly.  Swiss Re understands these concerns and tries to take a differentiated approach to:

1)  Tailor more explicit exclusion lists: We undertake to review current exclusion lists upon client requests, and where we have noticed a large number of special acceptance requests and a high rate of acceptances.  Where justified, we adjust the treaty scope to reduce the number of special acceptances, taking into consideration the current portfolio context and long term sustainability.

2)  Streamline the process: We can provide our clients with a checklist of the minimum information required for assessing a special acceptance request. Upon receipt of appropriate information, we conduct a risk assessment.  If necessary, we contact the client to discuss whether it is appropriate to cover certain risks under a treaty, or seek facultative support instead. Where contracts entail frequent specials that require additional premiums for reinsurers, we consider establishing an annual adjustment of additional premiums to ease the burden of financial administration.

Working with our clients, we encourage our cedants’ underwriters to identify potential exclusionary breaches before quoting, or to discuss risks face to face with our underwriters.  Special acceptances which have been agreed in prior underwriting years should be advised as part of renewal submissions to help the renewal flow more efficiently.

At Swiss Re, we are committed to providing as much support to our treaty clients as we are able. In order to do this on a sustainable basis, we need to ensure optimal transparency of what we are covering, and to manage significant accumulating exposures.

Treaty exclusions and special acceptances are important risk management tools for both insurers and reinsurers. We believe that risk specific dialogue between underwriters is key to optimising these tools as insurers and reinsurers strive for underwriting best practice.

November 2009

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