As life reinsurance professionals, we know that reading and interpreting a treaty is no easy task. While treaty language has progressed over the years, to a more standardized language, the older agreements are still relevant in today’s reinsurance eco-system.
On any given day, reinsurance analysts could be working with treaties that look very different from one another. The lack of consistency makes it increasingly harder to accurately interpret the intentions of treaties. When intent and clarity are not clear, misinterpretations occur which can put your company at risk.
Find out what happens when treaty language is misinterpreted, why it occurs, and how to prevent it from happening.
What is the cost of misinterpreting reinsurance treaty language?
If treaty language is not interpreted the way it was setup to be, blocks of businesses could end up being incorrectly administered. This can have numerous downstream impacts including:
- Overpaying premiums
- Underpaying premiums
- Erroneous data entry
- Multiple perspectives on the intent from people on the same team
- Potential for time consuming and costly audits
- Inability to effectively manage risk
- Negatively impact reputation within the industry
Overall, it can put your company at significant financial risk, especially if you don’t have parameters in place to test or validate data accuracy.
Erroneous data entry can cause major negative financial impact. Discover 6 real examples here
What factors cause treaty misinterpretation?
1. Treaty set up
As I alluded to in the introduction, treaties have progressed over the years. This can lead to misinterpretation because treaties are set up differently over time.
In older agreements, you may not find concise and detailed Schedules and Exhibits which provide a detailed summary of the terms of the agreement. In more modern agreements pertinent details may be embedded throughout the body of the agreement which requires ample understanding of the business and a thorough review of entire agreement.
2. Complexity of allowance and factor structures
Not only are there differences in ‘older’ and ‘modern’ treaties, but also between the companies setting up the contract. This can be noticeable when working with the allowance and factor structures.
One structure may have a factor for first year and another for all renewal years, inclusive of both sexes, for all underwriting classes and all issue ages up to a maximum amount. Another treaty may require factors be broken down by multiple durations, gender, underwriting classes and issue ages with banded maximum amounts.
The more complex the structure, the more important it is to ensure the tables are interpreted and set up properly.
3. Use of templates
Often, treaties are built using templates that are populated with the specifics agreed upon between the reinsurer and ceding company. By using a standard template, sometimes language within the body of the agreement conflicts with the terms found in the Schedules and Exhibits. In this case, the true intent of the treaty should be confirmed between the direct writer and reinsurer companies.
4. Training limitations
This is a prominent issue in the life reinsurance industry. New entrants are trained by those who are experienced in the industry – which means that they are often limited to their trainee’s interpretation of a treaty. This contributes to a lack of consistency in understanding treaty intent. Plus, if the trainees’ understanding of treaty terms is incorrect, the wrong message will continue to be passed on. At least until an error is detected.
5. Different terminology
Another contributing factor to misinterpretation is the fact that different terminology can be used to describe the same thing in different treaties.
For example, when referencing jumbo limit in a treaty, one agreement might use this language “Jumbo Limit equals $10,000,000” and another agreement might use this language “the amount of life insurance inforce and applied for cannot exceed 10,000,000”.
How can you prevent treaty misinterpretation and mitigate financial risk?
Communicate with your business partners
If you are administering reinsurance and find inconsistencies, are unsure of intent or something isn’t adding up – you should communicate with both your internal treaty and pricing departments along with your reinsurance partners to confirm intent instead of making assumptions and moving forward with it.
Having open communication between business partners can clarify misunderstandings, provide a better understanding of the business and help prevent financial discrepancies from happening in the future.
Another best practice is to document clarifications between business partners so that you have a refernece if the issue comes up again in the future
Conduct a comprehensive treaty review
By conducting an in-depth review of reinsurance treaties, you can identify data errors and inconsistencies that would have otherwise gone undetected. Plus, you’ll gain a big picture understanding of the business at hand.
Test treaty parameters to validate administration
Testing treaty parameters goes hand in hand with a treaty review. Essentially it involves a set of tests to ensure that treaties are being administered the way they were intended too. To be able to conduct these tests, you need to have a solid understanding of how the treaty works (which is why you conduct a review first).
How much do errors in treaty system data cost?
Find out here: 6 Small Treaty Errors That Caused Big Financial Impact