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The importance of transparency in markets

April 14, 2022
By Peter Cramton, Chief Economist

Insurance companies worry about finding reinsurance that works for their businesses. In today’s hard market this concern is palpable. Without clear information about what the market will bear, we see many cedents tightening their reinsurance buys, limiting the options that they consider, and driving hard on the cost of what they do buy. Through all this, opportunity is lost. Variations that might be profitable for cedent and reinsurer alike are never explored. Risk that is reinsurable is never brought to market lest it be a distraction from the coverage the cedent needs most, and ultimately risk that is re/insurable is never insured in the first place lest the cedent fail to reinsure it.

Whether we talk about simple markets for commodities like precious metals or complex markets that carry long-term relationships like employment, it is a universal truth that fear of a failing deal, doing the wrong deal, or simply doing a bad deal limits trade. Lack of market information amplifies this fear.

Transparency is the antidote. In a transparent market, participants have clear information about what the market will bear which helps them make decisions and manage business risk. Reinsurance is no exception. For example, if the reinsurance market were transparent, insurance companies in Florida would write coverage with clear knowledge of the capacity and pricing available in the reinsurance market instead of facing an existential crisis each May. Transparency replaces fear of the unknown with opportunity, improving existing deals and unlocking new trade.

The evolution of modern markets is a story of transparency. Thirty years ago, only the most significant trades would overcome the high transaction costs and deep fears of a bad deal. Modern markets evolved as technology facilitated the production, dissemination, and use of information. Modern transparent markets drive more trade that is substantially better for participants.

Procurement markets provide an example close to reinsurance. Ariba and others offer modern market tools that give companies a more transparent view of what their partners can provide. Companies use this information to drive better business decisions for themselves while structuring their plans around what their partners are optimally suited to provide. Better decisions are better for buyer and seller alike and drive growth that benefits everyone.

Wholesale electricity markets provide another example. A few decades ago, trade among utilities was limited to occasional bilateral transactions. Trading was an opaque and inefficient process. Today wholesale electricity in most of the United States is traded in highly transparent markets that unambiguously translate bids and offers into quantities and prices for all participants to see.

The shift to more transparent wholesale electricity markets has led to a substantial expansion of trading volume and significant improvements in economic efficiency—electricity is supplied at minimum cost to those who value it the most. Market participants can better manage risks and reduce costs—both sides of the market benefit. The end result is a power grid that is more flexible and reliable than anything imaginable thirty years ago, where generators can reliably sell what they produce and buyers can reliably plan ahead for their power needs.

Countless industries have benefited from transparent marketplaces. Platforms like Upwork give companies and talent a transparent platform to forge employment relationships. Zillow and Redfin allow ordinary users to browse housing inventory. Uber and Lyft allow you to see nearby drivers and pricing in real-time. Every industry is different, but the theme is the same – transparency helps drive better decisions that ultimately benefit everyone and increase trade.

Reinsurance is in the midst of the same transition. With modern marketplace technology, cedents will have a better view of the coverage reinsurers can provide, will be able to align their reinsurance purchases better with the risk appetites of their partners, and will ultimately make better business decisions that bring more risk into the re/insurance market.

Anatomy of a transparent market

Transparency requires careful design throughout the trading process:

  1. Transparency pre-trade means that everyone has clear information about what is being traded. Clear information allows participants to evaluate the costs and benefits accurately.

  2. Transparency during trade means that a market follows explicit rules that everyone can trust. A typical market mechanism asks participants to express their preferences for trade through bids and offers. Clear rules allow participants to put forward bids and offers that are competitive and honest.

  3. Transparency post-trade means that everyone can see volume and price. Participants use this information in future trade.

Transparency in reinsurance

Reinsurance exists to help the world share risk more effectively. A good market mechanism will maximize economic efficiency; it will match insurance risk to the reinsurers who are in the best position to take it on. In economic parlance, such an outcome maximizes the value of trade. The hallmarks of transparent markets are as relevant in reinsurance as they are in other industries:

  1. Pre-trade transparency is critical to bringing the right risk to the table. The current market is opaque. Cedents do not know exactly what reinsurers want, instead structuring programs based on market models and intuition. In a transparent market, cedents would see hard data about what reinsurers are able to cover and optimize structure accordingly.

  2. While trading, common rules are key. Brokered negotiations with over/undersubscription lack rules, so reinsurers universally hedge, quoting high prices and demanding better terms than they expect to get. In a transparent market, reinsurers simply put best-and-final terms forward because clear rules dictate that risk will be matched to maximize value.

  3. Post-trade, transparent reporting helps everyone understand the market. Transparent reporting helps reinsurers refine their pricing and portfolios, and it helps cedents decide what risk to bring to the market.

Today’s opaque market makes it difficult to place risk in an economically efficient way. Improved transparency will improve current placements and bring more risk to market. Both cedents and reinsurers benefit.

Transparency and Panorama

Transparency is a crucial objective of Tremor’s Panorama platform. Transparency begins with pricing. For reinsurers, clear rules dictate how authorizations map to lines – everyone knows that risk goes to those with the offers that best meet the cedent’s needs at a common market-clearing price. This enables reinsurers to put best and final pricing forward. Next, instead of setting firm order terms based on intuition, models, and inflated quotes, the cedent sees the market map with true market pricing before deciding what to buy. Post-auction transparency comes from making the market map available to all participants. The map includes the aggregate supply and demand for each product. Participants know why they won quantity at the clearing prices.

The cedent *Panorama* view

Panorama then builds on transparency in pricing to bring transparency to reinsurers’ appetite for risk. Cedents can elect to see pricing for different peril combinations and structures. Cedents then buy the coverage that best aligns their own needs with the risk preferences of their reinsurance partners. The end result is the most transparent placement experience available today.

Our Panorama platform is designed to recognize key features of reinsurance. One feature is that trade indemnity coverage is cedent-driven. Coverage cannot be contemplated until a cedent defines a program and requests reinsurers to participate. Once the program is defined, reinsurers can evaluate the program and prepare a supply curve that expresses the reinsurer’s willingness to sell more at higher prices. Whereas markets for electricity and other commodities are symmetric, Panorama is specifically asymmetric, with reinsurers authorizing before the cedent sets pricing.

While asymmetry may seem unfair at first glance, it is in fact good for everyone. It benefits the cedent, who can decide what to buy and set pricing based on hard data from reinsurers. It also helps reinsurers because the cedent is making decisions based on information that includes reinsurers’ true risk appetites and pricing. Reinsurers have a stronger voice, helping the market distribute risk more effectively. When markets are economically efficient, everyone wins.

Transparency, then, is at the heart of Panorama. Placements occur in a setting with improved market information. The transparent and fair process promotes trust and improves outcomes. Reinsurance is placed at competitive market prices.

Transparency reduces fear over time. In the short run, many cedents who worry about getting the reinsurance they need will fear a new process even more. Brokers, whose current business is interpreting the little market information available in today’s opaque market, may fear it most of all. However, this is unwarranted. Transparent markets will give cedents more information about what to buy, reinsurers more influence on the process, and brokers more information to advise their clients. The only losers will be those who don’t take advantage of it. Improved transparency is desirable and inevitable.

Learn more

If you would like to learn more about Tremor and the power of transparent markets, please reach out to us!

Peter Cramton is Chief Economist at Tremor as well as Professor of Economics at the University of Cologne and the University of Maryland (Emeritus since 2018). Since 1983, he has conducted research on auctions and market design, with a focus on the design of complex markets to best achieve goals. Applications include electricity markets, financial markets, and auctions for radio spectrum. He has introduced innovative market designs in many industries. Cramton has advised numerous governments on market design and dozens of bidders in major auctions. He is chief economist and advisor for startups in finance, insurance, and communications. From 2015-2021, he was an independent director of the board of the Electric Reliability Council of Texas (ERCOT). He received his B.S. in Engineering from Cornell University and his Ph.D. in Business from Stanford University.