Halloween is the quintessential celebration of all that is spooky and scary but even with the holiday being over, financial professionals may still have year-round fears about reinsurance. Submitting a life insurance application large enough that it must enter the reinsurance marketplace shouldn’t bring up those same fears that ghosts and goblins do. At one point I believed that the biggest fear an advisor had was the conversation with their high-net-worth clients about life insurance being an integral tool in their estate plan. But after 25 years in the industry, I’ve learned that their greatest fear is the feeling of helplessness and ignorance when the word reinsurance is uttered. The good news is, unlike the zombies and ghosts of Halloween, those reinsurance fears can be put to rest for good by the end of this article.
So, what exactly is reinsurance?
Reinsurance is simply an arrangement in which one insurance company, known as the “reinsurer,” provides coverage to another insurance company, known as the “ceding insurer.” The primary purpose of reinsurance is to help the ceding insurer manage and mitigate risks associated with the policies it has underwritten. By ceding a portion of its risk exposure to a reinsurer, the ceding insurer can protect its financial stability and reduce its exposure to catastrophic losses.
There are also a few terms that must be clarified in order to understand the underwriting process when reinsurance comes into play.
Internal Retention Limit
This is the amount of death benefit that an insurer can issue on an individual without ceding any of the death benefit to a reinsurer. In the event that the insured passes away, the insurer is solely responsible for the death claim if the insurer retained the entire death benefit.
Even if the amount applied for is over the insurer’s retention limit and they must cede part of the death benefit to a reinsurer, this process is usually transparent to the broker and to the proposed insured. This is due to auto-bind agreements between the ceding insurer and the reinsurer. For example, if the auto-bind limit between a ceding insurer and a reinsurer is $20 million, then as long as the total amount being applied for is within this $20 million limit, the ceding insurer can approve the policy without the reinsurer reviewing the file. However, if the amount being applied for is over $20 million, then the entire file must be sent to the reinsurer for review, and the reinsurer must agree with the ceding insurer’s underwriting opinion before a policy can be issued.
The jumbo limit is the amount of coverage inforce and applied for with all carriers on an individual’s life. The most common jumbo limit with most carriers is $65 million. To illustrate this, if your client has $35 million inforce and wants an additional $35 million, this exceeds the jumbo limit (assuming $65 million is the jumbo limit). In this example, one of the biggest mistakes that can be made with respect to jumbo limits would be to submit formal applications with multiple life insurance companies for $35 million each, with the intent to accept the single best offer. This can cause significant problems when multiple ceding insurers contact their stable of reinsurers to reserve what they believe is $35 million of capacity but the reinsurers are receiving requests to reserve a total of $70 million, $105 million, or even $140 million of capacity.
Now that we have established the basic terminology of reinsurance, what is the best way to proceed with a case that exceeds a carrier’s auto-bind or jumbo limits?
The first step is to make sure you work with a BGA that understands the large-case market. Next, have a conversation with your BGA about the specifics of the case. The most basic pieces of information that your BGA should ask you include:
- What is the proposed insured’s full legal name?
- What is the proposed insured’s date of birth?
- How much life insurance does the proposed insured already have in force and with what insurance companies?
- How much of their in-force life insurance, if any, will be replaced?
The reason your BGA needs the answers to #1 and #2 is that the first thing they should do is contact the underwriters at the top carriers that you are considering writing the application with and ask them to check for reinsurance capacity. This means that the underwriter at the ceding insurer will contact each of their reinsurers and give them the proposed insured’s information. The reinsurer will then check to see if they already have life insurance on them through other ceding insurers. The reinsurers will then tell the ceding insurers how much death benefit they can contribute to the total overall amount. Note that this amount can change prior to a policy actually being issued for a number of reasons, including but not limited to a worse-than-expected medical rating, a lack of U.S. citizenship, or due to some avocations or occupations.
For example, we had a recent case where the proposed insured already had $40 million inforce and wanted as much additional life insurance as he could obtain. His net worth was approximately $200 million. The ceding insurers we spoke with then checked with their reinsurers and the one that was able to obtain the most capacity came back with a figure of $62 million, including the ceding insurer’s own retention. Every ceding insurer we checked with came back with a slightly different number due to the fact that the ceding insurers’ retention limits differed and the mix of reinsurers that the ceding insurers had agreements with differed.
The next step is to submit an informal inquiry to the ceding insurers that you’re considering applying with. Submitting an informal on these types of cases is almost always the best way to proceed in order to avoid reinsurance capacity issues as mentioned. The ceding insurer will fully underwrite the case (other than running MIB, MVR, and a few other database checks) and will give us a very good idea of what rate class they should ultimately be able to offer. This process will also bring up any underwriting concerns that might exist. If any significant underwriting concerns do arise, the underwriter at the ceding insurer can check informally with their reinsurers to confirm what their thoughts are on the issue. Once we have informal “offers,” a formal application can be submitted to the one ceding insurer that you and your BGA believe will be the best fit for the desired objectives.
However, when the formal application is submitted, there are still additional hurdles before a policy can be issued. The ceding insurer will package the entire file including medical records, lab results, MVR, MIB, and database results and send the file to each of the reinsurers. The reinsurers will then fully underwrite the file in order to make a formal offer. Underwriting problems don’t normally arise at this point but it’s never out of the question.
The case that I referenced did come back with one such problem. The proposed insured didn’t admit to a medication that they took or to the doctor who prescribed the medication. The information came up on the Prescription Database Report which is only ordered after a formal application is submitted. The medication wasn’t significant with respect to insurability but one of the reinsurers wanted us to obtain these additional medical records. Neither the ceding insurer nor any of the other reinsurers felt they needed these records. We therefore had three options:
- Have the underwriter at the ceding insurer call the underwriter at the reinsurer and have a conversation about the need for these records and determine if the reinsurer can provide an offer without the records.
- Proceed without the $8 million of capacity that the reinsurer who wanted the records was offering.
- Obtain the medical records. But if we did, the records would then have to be sent to all of the reinsurers, not just the one requesting them.
An attempt to get the requirement waived should always be the first option and, in our case, the chief underwriter at the ceding insurer was able to get the reinsurer to waive the additional records and they proceeded with the approval. This is ultimately why it is so important for the underwriters at the ceding insurers to have good working relationships with the underwriters at the reinsurers.
The last step of the process circles back to the first definition provided…that of internal retention. Even after we’ve exhausted reinsurance capacity, carriers can still offer additional coverage up to their internal retention limits. Some carriers’ retention limits are as small as $250,000 but some are as large as $10 million or more. So, we can then piecemeal as much additional coverage as possible using multiple carriers’ internal retention limits.
Knowledge of the preceding steps when dealing with reinsurance is incredibly important but it’s much more important that your BGA is familiar with this process as they will be working directly with the ceding insurer. Make sure that they’ve worked in the large-case marketplace in the past; make sure that they have close working relationships with the chief underwriters at the different ceding insurers; and, make sure that they understand the difference between retention limits, auto-bind limits, and jumbo limits and what each ceding insurer’s dollar amounts are that correspond to each of these. Then the next time you meet with a high-net-worth client, you should be far more knowledgeable of the steps involved when reinsurers must get involved, and far less fearful that you might take the wrong step.