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In defence of proportional treaties

Dear Friend,

Remember proportional treaties and how laughably old-fashioned we used to think they were?

Back in the Dark Ages when I was a production broker trying (mostly in vain) to extract new business from Spain, my boss and I made a trip to a small provincial insurance company to see what services we could offer them.

Clearly no-one had been to visit this company for many years — they were extremely hospitable and pleased, if slightly puzzled to see us. After a very pleasant lunch, my managing director and I started getting down to the nitty gritty of finding out about the company’s current programme and possible future requirements. “Reinsurance?” came the slightly quizzical response “Oh, we do that with ‘La Munchener’ [Munich Re]” — how long had they been doing business together, “About 50 years”.

In fact it turned out that this little company’s proportional treaty with Munich re had been running without cancellation for over half a century, with the occasional endorsement to increase the limits. And any facultative business was sent to Munich Re’s Madrid office and dealt with by return of fax. We left our brochures for multifarious specialty coverages, exchanged business cards, and headed back tot the car park knowing that we had (albeit pleasantly) wasted a day’s work.

The long-term trend had been towards building stronger capitalised primary players for so long that traditional quota shares and surplus treaties were seen as something that were just about okay for emerging markets, but a bit of an anachronism for a first-world players. There was always a reaction of “why should I lend my balance sheet to these guys?” when such a deal was ever mooted.

There’s been a lot of soul-searching recently about how the reinsurance business has become detached from primary markets and is unable to influence underlying rates any more. But we’ve only ourselves to blame — this must be down to the demise of proportional treaties.

The beauty of proportional reinsurance is that there is no greater expression of partnership between reinsurer and reinsured. You’re in it together — “If you bleed, I bleed”.

Excess of loss automatically disconnects the buyer from supplier so now it’s “You bleed, I might not”. Any buyer having to cope with four Florida hurricane retentions last year will understand that. Whatever the industry says to the contrary, the relationship eventually moves from one of co-operation to one of exploitation.
Disputes are an inevitable consequence after big losses —just look at the looming hours clause arguments over Katrina. We’re faced with the ugly possibility of contract parties doing their sums and working out whether a one loss-event scenario or a two loss-event scenario suits them best and arguing that white is black and then black is white whenever it suits them. Where’s the “partnership in risk” in any of this?

And what’s the chance of hanging onto a customer for 50 years straight these days?

We were wrong to have laughed at our backwards provincial friends.

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