An industry poised for change: demographic, industry and market trends are converging to open up new avenues for life reinsurers.
Following over a decade of declining reinsurance utilization, life cession rates appear to have stabilized at around 25% of new business. This is a huge difference from 2002 when cession rates sat at over 60%. Prior to the reinsurance utilization decline, cessions had been driven more by perceived mortality assumption arbitrage and by the desire to manage capital strain associated with Triple-X statutory reserve requirements introduced in 2000.
As insurers and reinsurers have seen mortality experience emerge from the underwriting-driven "term wars" of the late 1990s, the perspectives of both parties have converged, thus there is no longer a large difference in expected mortality driving large coinsurance cessions for fully underwritten business. However, there are opportunities for growth in alternatively underwritten life insurance and longevity risk. The reserve financing landscape has also changed considerably.
Statutory life insurance reserves in the United States are based on specified mortality and interest rate assumptions and, with the exception of universal life insurance with secondary guarantee policies issued after 2007, typically do not include provisions for voluntary lapses. These assumptions are necessarily conservative, as statutory reserves are by definition, a conservative standard intended to ensure that policyholder obligations will be met under moderately adverse conditions, not an economic accounting standard that would attempt to reflect best estimate expected earnings over time. As a result, statutory reserves for some lines of business are considered by many to have a significant redundant component with amounts well in excess of what would be needed if reserves were calculated using best estimates with a reasonable margin for deviation.
Insurers typically used traditional coinsurance arrangements to manage this reserve strain. In recent years, financial reinsurance transactions intended to manage redundant reserve levels largely migrated from third-party reinsurers to special-purpose captives. The most common reserves managed in this way are those for level-premium term insurance and for ULSG. These captive reinsurance transactions have been specifically and meaningfully impacted by the adoption of Actuarial Guideline 48 by the National Association of Insurance Commissioners.
AG48 originated from efforts starting in 2011 to understand captive reserve financing and how or whether these structures should be regulated differently. AG48 reflects the industry's movement toward principles-based reserves. The "Required Level of Primary Security" defined by AG48 is intended to mimic an economic reserve level--one that is based on best estimate assumptions and recent experience.
By most assessments, its application to level premium term products produces results near the economic reserve, validating the industry's belief in the redundant nature of statutory reserves in excess of that level. For ULSG products, a significant gap exists between heretofore perceived economic reserves and theAG48 results, with theAG48 results being much closer to the statutory ULSG reserves. This failure to validate expected redundancies in ULSG reserves means that companies writing these products will have significantly higher capital strain than is currently anticipated in pricing.
AG48 is firmly prospective as of Jan. 1, 2015. While no adjustments to previously ceded reserves will take place, the impact on new cessions is considerable. There was an observable push to close captive reinsurance arrangements by year-end 2014. Activity has slowed as expected so far in 2015. With the reduced benefit of the captive reinsurance cessions, insurers that are able to are warehousing their business to achieve enough scale to make such a transaction impactful and accepting additional capital strain from writing new business. Some strain will be mitigated when they are able to execute a captive transaction but the mitigating effect will be much less than previously seen. These products may need to be re-priced; many insurers are taking a wait-and-see approach and are not taking any pricing actions at this time. Other insurers have gone as far as pulling their ULSG products from the market without replacement at this time.
While AG48 is disrupting the reserve financing landscape, traditional reinsurers are exempt from the guideline, presenting a unique opportunity for them to provide solutions to start to grow their businesses again. Coinsurance and modified coinsurance could be realistic alternatives for ULSG reserve financing for mid-size blocks of inforce business. Reinsurers obviously have their own capital requirements and profit margins. These solutions will not be as efficient as the previously-feasible captive transactions. Pressure on pricing and profitability for ULSG carriers is still expected.
Looking toward the future of reinsurance and finding inspiration in the past, one area where there may be enough differential in mortality expectation and knowledge is in simple and/or guaranteed issue. With direct insurance sales stalling, insurers are seeking ways to penetrate new distribution channels, including Internet and app-driven direct sales, banking customers and the huge agency force controlled by property/casualty personal lines insurers.
Traditional life insurance sales are plagued by a long underwriting processes and a high subsequent balk rate, as applicants may not ultimately take up the policy due to frustration with the process or unhappiness with the ultimate rating decision. To combat this, insurers seek the holy grail of easy and instant issue with enough underwriting information to screen anti-selection or even to determine a preferred risk. With the graying of the agent-based sales force and changing habits around brick-and-mortar sales locations, solutions must meet the needs of today's middle market, including increasingly important millennials.
Reinsurers have been leaders in developing platforms for automated underwriting that include a short questionnaire, motor vehicle records and, more recently, prescription drug histories. With their vast claims histories they are ideally positioned to develop and test hypotheses around the protective value of information they collect. Because of this information differential, quota share reinsurance transactions for simplified underwriting are a significant part of today's cession rate of approximately 25% and one of the best chances for it growing again.
To take full advantage of this trend, reinsurers need access to even more data, data that is typically held by the ceding companies that include more aspects on the insured than are normally used for underwriting. If they can access big data in combination with their experience base, they can use predictive analytic methods to help clients select better risks and sell more efficiently. Benefits can include not only customized products and offerings to attract a targeted group of potential insureds but also the development of predictive underwriting tools that use a wide array of lifestyle factors to estimate expected mortality for those specific cohorts.
Life insurers and reinsurers have been primarily focused on managing the risk that insureds will die sooner than expected but tremendous opportunity lies in the risk that insureds will live longer than expected.
Many believe that longevity risk provides a natural hedge to mortality. In other words, increases in life expectancy may worsen liabilities that are exposed to longevity but would benefit mortality-based insurance, and vice-versa. This is directionally true for mortality or longevity events that impact whole populations, for example pandemic flu or a cure for cancer.
In actual practice it is an imperfect hedge, as the cohorts of people buying life coverage and those buying longevity coverage are often very different. For example, a typical life insurance buyer may be younger and is concerned about protecting his or her family from a large mortgage obligation and expected education expenses, while a pensioner or long-term care buyer is 65 or older, with different financial concerns.
Traditional life insurance provides financial protection to an insured's family or estate if the insured dies. However, other insurances provide financial protection directly to the insured that assist with quality of life until death.
As the U.S. baby boomer population readies for or enters retirement and the last dependents leave their households, the need increases to protect oneself, rather than protect one's family. This should lead to increased appetite for a wide variety of coverages and financial instruments with a strong longevity risk component, including income annuities, structured settlements, pensions, long-term care insurance and disability insurance.
Insurers with significant amounts of longevity risk and pension funds have accumulated huge longevity liabilities but have few reinsurance outlets to mitigate or share that risk. One potential reason is that the direct insurance comes not only with longevity risk but also sizeable initial premiums and a high asset-to-liability ratio, giving insurers significant portfolios of assets that generate income through their yields. Reinsurers, facing this longevity risk without the appeal of the concomitant assets, have hesitated to assume this very long duration liability. Longevity risk will continue to accumulate as lifestyle protection products become more prevalent and reinsurers offering solutions will have tremendous opportunities for growth.
Mergers and Acquisitions
With all these developments impacting insurers, they are likely to see tighter profit margins and a need to access more potential customers who bring better data for underwriting. This is an environment in which scale becomes a critical factor for success, which in turn is expected to spawn increasing interest in merger and acquisition opportunities. The broader insurance landscape will likely experience similar shifts in the status quo as companies seek scale, diversification and growth.
A recent example is the purchase of Wilton Re by the Canada Pension Plan Investment Board last year. Among the likely reasons CPPIB acquired Wilton Re was as a hedging strategy for their longevity liabilities.
P/C insurers and reinsurers are deep into a long underwriting cycle with low loss activity and very aggressive pricing and are seeking new sources of growth. Flush with capital, they are looking for nontraditional acquisition targets. Life insurance solutions that work effectively with their agency forces could be very attractive combinations and could fuel acquisitions even farther.
The life reinsurance industry is poised for a host of developments and changes. Those who take a strategic and innovative approach to facing these challenges are likely to achieve opportunities for profitable growth.
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|Title Annotation:||Life Reinsurance|
|Author:||Rains, David A.; Abalo, Alberto|
|Date:||Jul 1, 2015|
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