Mature US market holds the key

Growth opportunities for the global life reinsurance segment are robust in emerging markets, particularly within the Asia-Pacific region. The Asia-Pacific direct life insurance market continues to grow faster than in developed countries, providing opportunities for life reinsurers to assume more business.

Even well-established companies in the US, such as the Reinsurance Group of America, (RGA), receive approximately one-third of their adjusted operating earnings outside North America.

The US life reinsurance market, in sharp contrast to the country’s primary life market, is dominated by five carriers, accounting for the vast majority of assumed business. These top-tier players have strong capital positions and earnings that reflect disciplined pricing and mortality experience, as well as a stable book of recurring business.

Moreover, the US life reinsurance business makes up a significant share of the European-based companies’ global life reinsurance premiums.

While the US traditional life reinsurance market remains pressured by historically low cession rates, there has been a gradual rise in business ceded over the last few years (Figure 1). There are several factors driving this trend: the introduction of principle-based reserves; the 2017 commissioners standard ordinary (CSO) mortality table; and the increasing use of automated underwriting.

Reinsurers view underwriting as a key area in which to add value and offer expertise, in addition to affording direct writers an avenue to lay off risk should actual results deviate from pricing.

In addition to opportunities on the traditional side, reinsurers are benefiting from an active pipeline of legacy life and annuity (L/A) blocks of business coming to market. Competition for block acquisitions is high as many companies, including direct writers and newer entrants, look to build scale and deploy capital that has grown in recent years.

Well-known carriers, particularly life reinsurers, have developed a favourable track record for execution and service, enhanced by strong client relationships, and hold an advantage without competing solely on price.

Meaningful acquisition opportunities for global life reinsurance players are also evidenced by a growing desire to lay off large pension obligations (pension buyout business) outside North America. This was most recently demonstrated by Canada Life Re’s announcement on March 6, 2019 that it entered a CAD 5.5 billion long-term longevity risk reinsurance arrangement with Dutch firm SRLEV NV (VIVAT), covering 70 percent of CAD 8 billion in-force liabilities.

Pension business and other interest-sensitive lines are benefiting from a favourable economic environment with generally rising interest rates and a benign credit environment.

Market dynamics that may affect direct L/A players negatively include the low interest rate environment, despite an uptick over the past year, and the potential for rising impairments when and if the credit cycle turns. Although lower rates affect all companies and dampen earnings, life reinsurers in general are somewhat less reliant on investment income to achieve return targets. Reinsurers take more risk on the liability side of the balance sheet and thus tend to accept less investment risk.

In addition to more conservative investment portfolios through higher allocations to bonds, the credit quality of reinsurers’ bond portfolios is also of higher quality, with larger allocations to NAIC-1 bonds and fewer rated below investment-grade.

Imbalances from asymmetric monetary policy among the US, eurozone and emerging economies, as well as trade disputes, also have negatively affected the overall market.

While the mortality rate improvement has slowed recently across several advanced nations, some life reinsurance companies believe it is too early to determine if this a short-term slowdown or a permanent shift in mortality.

Block acquisition appetite has afforded direct writers with legacy books or trapped capital a means to sell or reinsure such blocks. This allows direct writers to deploy capital to higher margin businesses. In 2018, a number of sizable block acquisitions have either closed or been announced, including a major deal between Symetra and Resolution Re for the assumption of a legacy block of structured settlements.

In addition, a group of private investors acquired Talcott Resolution, The Hartford’s run-off L/A businesses, in May 2018 for approximately $2 billion. After closing on the deal, the company reinsured approximately $9 billion of its fixed annuity, payout annuity and structured settlement business to a subsidiary of Global Atlantic Financial Group. As a result, the remaining liabilities are primarily variable annuities.

Hurdles
Barriers to entry into the US life reinsurance market are significant, which helps to solidify the market positions of well-established players. Relationships built over the years offer a competitive advantage that new entrants simply do not have. Additionally, reinsurers often are viewed as partners offering underwriting, facultative and other support. That is not to say that new entrants are non-existent. Despite a highly mature market, cedants continually explore ways to better manage earnings volatility, capital and counterparty diversification.

The common theme for new launches is the ability to provide counterparty diversification, as well as tailored solutions and capacity to clients in need of capital relief for businesses, such as annuities and new business strain from increasing life insurance sales. In addition, some entrants backed by private equity or other investor groups are often more focused on interest-sensitive business lines such as annuities.

Such companies are often backed by investment managers who have expertise in certain asset classes and have bigger risk appetites. Their business models are predicated on offering attractive prices to buy annuity businesses that may be underperforming or providing an avenue to lay off some risk in light of a potential turn in the credit cycle.

Cedants, however, may not be comfortable with more aggressive investment strategies because, in the event of insolvency, the business and the assets supporting that business may revert back to the cedant. When companies do business with unrated carriers, AM Best ensures that certain protections and asset allocation strategies are in place to safeguard the company in case of insolvency that might cause the business to revert back to the cedant.

New players
Kuvare Holdings, headquartered in Chicago, is an example of a private equity-backed new entrant that operates in both the primary insurance and the reinsurance businesses, with a middle market focus. Kuvare Life Re is its Bermuda-based reinsurance subsidiary, which has completed a number of deals, including the assumption of a block of fixed annuities with about $850 million in reserves in late 2017. The deal was the biggest since it was formed in 2016.

Industry activity such as activist shareholders and European Solvency II have forced insurers to shed certain business lines in order to free up capital and have thereby created opportunities. In addition, a better alignment between the valuations of buyers and sellers over the past few years has generated more deals.

Langhorne Re was launched by a group of investors, including RGA and RenaissanceRe Holdings (both listed on the New York Stock Exchange), affording the company meaningful access to capital that will support its planned strategy of large in-force L/A block reinsurance on a global basis. AM Best expects similar structures to emerge to allow participation in large annuity or life transactions. This underscores the availability of business, notwithstanding the challenges associated with being the successful bidder.

In addition to interest-sensitive transactions, other opportunities exist to assist direct writers saddled with legacy, underperforming books of business to enhance longer-term returns, as well as to remove the stigma that earnings may be pressured by poor performing blocks.

Reinsurers remain active in providing financial solutions, including the continued financing of redundant reserves, providing capital management solutions to assist companies working through regulatory and taxation changes, and providing avenues to exit underperforming books.

Companies also continue to see growth in the longevity space—especially in the UK, global life insurers that have capitalised on this growth in the UK are now trying to replicate that success in the US market. There is ample business opportunity in the US and internationally in the longevity space, as well as other financial solutions business.

Capital support
Given the capital-intensive nature of the business and long-tail nature of the liabilities, direct writers will surely continue to turn to the reinsurance community for capital support and underwriting assistance. The ratios often used to measure the reliance on reinsurance to support capital needs are reinsurance leverage and surplus relief (Figure 2).

The reinsurance leverage ratio is defined as aggregate reserves ceded plus amounts recoverable and funds held, divided by surplus. The surplus relief ratio, defined as reinsurance commissions and expense allowances on reinsurance ceded (reported as income on the statutory statement) divided by statutory surplus, illustrates the degree to which a company depends on reinsurance to maintain its surplus ratios (eg, NAIC RBC/AM Best’s BCAR).

With the exception of 2016, the industry maintains a ratio in a fairly narrow band of 4 to 6 percent. In 2016, several companies had some large cessions that resulted in elevated commission and expenses on reinsurance ceded business, thus raising the surplus relief ratio to roughly twice the longer-term average.

Adjusted surplus relief simply nets out expenses and commissions on reinsurance assumed (recorded as a statutory expense) before dividing by surplus. As a result, the adjusted ratio for the industry is less volatile and reports at an overall lower level. However, 2016 once again shows an elevated ratio, reflecting some large ceded transactions without a corresponding large offset in business assumed.

Life reinsurers, regardless of where they do most of their business, must continually invest in technology to stay competitive in a world that is rapidly changing. New digital solutions and automated underwriting platforms are enhancing the customer experience and enabling companies to maximise the value of their in-force business, thus contributing to the long-term value of the organisations. However, such initiatives come with a need for meaningful investment, including system upgrades and the development of innovative solutions, partnering with technology firms, and harnessing the benefits of predictive modelling.

Michael Adams, FLMI, is a senior financial analyst at AM Best. He can be contacted at:  michael.adams@ambest.com

William Pargeans is a director at AM Best. He can be contacted at:  william.pargeans@ambest.com