Businessman PunchingI recently came across a number of articles in the insurance trade press discussing the economic effect of the recent catastrophes on the reinsurance market.   Some of the commentators wondered whether all of the property and related losses will cause reinsurance premiums to rise and end the very long soft reinsurance market.  Others thought that the recent disasters are still not enough to turn the market, which may not bode well for some reinsurers.  What does any of this have to do with reinsurance disputes?

Disputes arise under reinsurance contracts for many reasons.  Whether a claim is properly ceded and covered, whether a policy properly attached to a treaty, whether the nature and manner in which the cedent is handling the underlying business is consistent with the parties’ understanding are some examples of issues that may arise between a cedent and its reinsurer.  When the insurance and reinsurance markets are strong and everyone is making money, there is little economic incentive to dispute marginal claims or arbitrate how a cedent is conducting business under the reinsurance program.  Keeping up relationships with cedents and brokers, developing more assumed business and retaining cedents as customers is more important than disputing issues that could result in the loss of future business.  So in good times, disputes tend to get worked out.

But when reinsurers are battered by claims and when the competition to write reinsurance is under pressure from a soft reinsurance market exacerbated by additional competition from the capital markets, the incentive to work out disputes over marginal, but economically meaningful, issues diminishes.  Economic stress on reinsurers is a potential catalyst for an increase in reinsurance disputes.

Typically, when the wind blows, property rates (and sometimes casualty rates) harden and reinsurance capacity shrinks.  But that has not been the case for a long time now.  With the advent of capital markets capacity taking a good chuck of what would have been traditional reinsurance risk, reinsurers without a strong balance sheet continue to struggle.  If a reinsurer under economic stress cannot raise its premiums because of market overcapacity and capital markets competition there may be little choice but to dispute claims and other contract issues.  While in strong economic times certain issues might not ever be considered as an issue for a dispute, a reinsurer with a low RBC ratio might have no choice but to raise closer-question issues to avoid overpaying on claims.  None of this is to say that a reinsurer will dispute for dispute’s sake.  But where perhaps a questionable claim might be paid for a good client in strong economic times, in weak economic conditions a reinsurer may not be able to afford to be so generous to its cedent.

At the end of the day, the job of a reinsurance company is to indemnify its cedent for the reinsurer’s share of the cedent’s losses.  The outflow of reinsurance claim payments generally is the most significant drain on a reinsurer’s surplus.  When a reinsurer’s surplus drops, it may scrutinize ceded claims more carefully to avoid paying claims that are marginally outside the scope of the reinsurance agreement.  The question is whether the significant losses that will be coming through as a result of the recent catastrophes seen in the US and around the world will raise reinsurance rates or put new pressure on reinsurers to shore up their surplus by disputing cessions from their cedents.