23 June 2023ArticleFeature

Moody’s raises a yellow flag on life

The use of offshore reinsurers by life insurers is booming with Bermudian players leading the way in terms of both ceded premiums and the use of innovative structures. While there are many positives to such a strategy, there can also be drawbacks, Moody’s Investors Service has stressed in a new report called “The rising tide of offshore life insurance raises yellow caution flag” published on May 30.

The report notes that life insurers are increasingly using offshore reinsurers for a number of reasons, which are unique to each player. These include using cross-border transactions to capitalise on differences in accounting standards, insurance liability calculations, and capital requirements.

New markets supported by private capital are expanding life insurance companies’ balance sheets and increasing assets under management that will support business strategies, including M&A and divestiture activity. Sidecar use has expanded in tandem with private capital investment in insurance sector, the report notes.

“Despite a changing macroeconomic and interest rate environment, the increasing use of sidecars suggests that insurers and investors have overlapping motivations, where the insurer seeks capital to grow its business and investors seek opportunities to deploy capital.”

Bermuda is leading the way in the offshore space. Since 2017, Moody’s notes, the amount of life insurance and annuity reserves ceded offshore has surged to almost $0.8 trillion, or around 40 percent of the $2 trillion of total reserves ceded, with Bermuda the common destination for offshore reinsured business.

It explains a driver for this is primary insurers and reinsurers seeking to generate top-line growth while maintaining consistent profitability and managing their capital. “Given the prolonged period of low interest rates that ended only recently, along with the ever-changing complexity of insurance risk, life insurers chose to exit capital-intensive businesses, spurring M&A and divestiture activity that led to an influx of new investment,” the report notes.

“This trend accelerated during the COVID-19 pandemic, at a time when interest rates were even lower, and the combination made it difficult for life insurers, especially public companies, to generate appropriate returns. Partly in response to this environment, private capital built and expanded origination platforms centred around fixed and fixed-indexed annuities, increasing assets under management and fee income.”

It suggests that these private capital sponsored firms are leveraging life insurance companies’ balance sheets, remaking business strategies and increasingly focusing on optimal capital efficiencies, including via offshore transactions.

“By reinsuring life insurance reserves to international jurisdictions or cross-border transactions mainly between the US and Bermuda, the US ceding insurer or cedant is transferring risk to a reinsurer, thereby reducing its liabilities, releasing capital, and lowering regulatory capital requirements.”

The report highlights the growth of the use of sidecars, which has expanded in tandem with private capital investment in the insurance sector. “Despite a changing macroeconomic and interest rate environment, the growth of sidecars suggests that insurers and investors have overlapping motivations: insurers seek capital to grow their businesses and investors seek attractive opportunities to deploy capital,” the report notes.

“Insurers are drawn to sidecars because they can provide the sponsor and third parties opportunities to leverage expertise in new business or flow reinsurance activities, capital management, and asset management.”

But the report also offers warnings. In the case of sidecars, it notes that the insurer or sponsor may have to share the economics and manage complex ownership structures with third parties.

But the overarching “yellow flag”, as Moody’s terms it, is that the use of offshore structures means less transparency for investors as vehicles are generally subject to less regulation than business that resides onshore in US-regulated entities.

“Offshore entities tend to hold less capital than onshore entities,” the report notes. On this basis, the overall movement of business offshore is a credit negative for the life insurance sector, Moody’s suggests.

“The perceived benefits of offshore reinsurance by life insurers comes with risks. Offshore reinsurers need to have adequate capitalisation and controls in the company to mitigate counterparty risk and avoid a recapture of the business by the cedent or sponsor. The potential risks have not escaped US regulators, and the NAIC has highlighted offshore reinsurance as an area of focus for 2023.”