Part One Facultative reinsurance: the need for more advanced solutions

Traditionally, facultative reinsurance has adopted a single-risk approach. However this has become limiting, as market conditions have changed and presented underwriters with new, unprecedented challenges. These factors, combined with escalating volatility, are driving the need for more sophisticated reinsurance solutions.

To understand the need for advanced solutions, we first have to acknowledge the complex risk landscape in which our industry currently operates.

There are four major pressures shaping the current climate and that are largely responsible for the prevailing volatile conditions: catastrophic climate events, geopolitical instability, pervasive cyber threats and widespread economic pressures.

Increasing threats

• Each of these aspects brings with it its own specific risk conditions and impacts for the broader industry.
• Catastrophic climate events: The increased frequency and severity of natural catastrophes is leading to higher insured losses and much greater uncertainty in risk modelling.
• Geopolitical instability: Ongoing conflicts and political tensions are causing significant supply chain disruptions and increasing political risk, which has the potential for large-scale losses.
• Pervasive cyber threats: Cyberattacks are growing in both sophistication and frequency, posing a systemic risk that can impact business continuity and financial stability.
• Economic pressures: High inflation rates directly affect claim costs, while eroding asset values impact investment portfolios, creating challenges to capital adequacy and solvency.

These challenges demand more sophisticated tactics than what has been used in the past.

A new approach

Historically, fixed terms have been utilised, an approach that can lead to high correlation and risk concentration. Concentration of similar risks exposes insurers to systemic vulnerabilities that traditional facultative cannot effectively mitigate.

The inherent rigidity of this method also makes it difficult to adapt it to the changing risk environment or to do at scale.

It is clear that the old way simply cannot address broad portfolio volatility, as today's market demands portfolio-level protection.

In essence, the market needs diversified protection to avoid exposing insurers to systemic risks. It's clear there is a growing gap between the tools we have been using and the protection we now require. Given the complexity of modern risks, a much more customisable solution is needed.

Evolving to meet new challenges

Advanced facultative reinsurance isn't a single product; it is a spectrum of solutions that broadly fall into three main categories.

• Portfolio and programmatic solutions: These are solutions like facultative facilities and binders. They offer pre-agreed terms with a panel of reinsurers, allowing for the automatic placement of risks that meet the criteria. A great example is a commercial property insurer that set up a facility for properties exposed to secondary perils. The result was that they eliminated individual submissions and reduced placement time from days to hours.
• Data-driven and parametric solutions: These use advanced analytics, AI and machine learning to automate and refine risk assessment and pricing. Parametric solutions are particularly powerful, as they trigger payouts based on predefined, objective parameters, like wind speed in a cyclone. This reduces dependency on traditional loss adjustment and accelerates claims resolution. They can also help cover gaps in areas like Non-Damage Business Interruption, where supply chain disruption is a major concern.
• Structured and bespoke solutions: These are highly customised arrangements designed for unique challenges, requiring deep collaboration between the cedant and reinsurer. They can be used strategically to smooth earnings over multiple years or to secure multi-year capacity for difficult-to-place exposures.

Facultative reinsurance has evolved from a simple case-by-case risk transfer mechanism into efficient solutions designed to address complex, unique risks and act as a strategic tool for capital optimisation.

There is no doubt, the future of facultative reinsurance will be shaped by providers that prioritise customisation, technological integration, and innovative structuring, establishing themselves as indispensable risk partners to their clients in this increasingly dynamic and complex risk landscape.