Ten years ago, life reinsurance was widely regarded as an anachronism, and it was fashionable to speculate whether it would survive at all as a major class of business. Reinsurance, the argument went, is about protection against volatility, and there are few things in the insurance business as predictable as a life book.
Even today, ask a typical reinsurance underwriter about his colleagues on the life side, and you are quite likely to get a blank look. Yet, at the start of the new millennium, life reinsurance is big, profitable and growing far more rapidly than its larger non-life cousin.
Any assessment of a segment that is little understood, even by the standards of the industry as a whole, has to be cautious. Reliable market-wide figures are impossible to obtain. Many reinsurers do not differentiate between life and non-life in their published data. Even if they did, there would be the question of definition. There is no clear dividing line between the two.
With this qualification, a reasonable estimate of the annual net premium income for global life and health reinsurance is around $20 billion. Even more significant, the sector is thought to be growing by at least 15% per annum. According to some experts, the true figure could be around 30%.
Either way, it presents a picture of healthy growth when compared to the rest of the reinsurance industry, where expansion has come to a standstill, and long-term contraction is a real possibility as the primary market consolidates and other forms of cover become more widely understood. Despite the Unicover disaster, which affected the life and health market, life has been a highly profitable sector. Indeed, with non-life business squeezed between plunging rates and rising loss experience in recent years, it is only their life books that have kept many of the top European reinsurers in the black. To be a major global reinsurer, you really need a big life book.
There are a number of factors behind the growth of life reinsurance. With 1,600 primary life insurers to service, the North American market has traditionally been dominant, and still accounts for around half the world total. The US experience has started to spread overseas. Although there are some local conditions that make North America exceptional, such as the emphasis on private sector welfare, other developed countries are closing the gap, and will continue to do so. The ripple from the United States has spread to the United Kingdom, and industry practitioners see huge potential in the rest of Europe. Despite resistance to what are perceived as “Anglo Saxon” values, the sheer arithmetic of government finances is forcing countries to switch swathes of care provision from the public to private sectors.
A second driver is the fact that, as economies expand, a higher proportion of overall income is devoted to life insurance, creating the potential for exponential growth. While some, though by no means all, industry analysts regard the US as a mature market, offering little scope for further development, other parts of the globe are coming through. Everyone agrees that developing countries, especially in Latin America and the Far East, offer tremendous opportunity, albeit from a very low base.
Above all, however, there has been change within the life insurance industry itself. “Primary insurers have focused on their core strengths of distribution and asset management,” says John Coomber of Swiss Re. “They don't like risk - so they outsource it.”
As well as capital, reinsurers provide the know-how. “In terms of knowledge and expertise, they're relying increasingly on the reinsurance industry,” says Arthur DeTore, director of strategic planning at Lincoln Re.
This dual move by life insurers to eliminate or reduce the risk element from their business, while also tapping into the specialised and increasingly innovative skills of their reinsurers, does more than anything else to explain the sector's mushrooming growth. But so far we have only seen the tip of the iceberg.
Globally, according to Standard & Poor's, just 1.5% of life premiums are ceded to reinsurers, compared to 14% for primary non-life, the difference reflecting the low level of volatility on the life side. With life insurance premiums estimated to be around $1.2 trillion annually (of which the risk element accounts for around 15% - 20%), the potential for sustained growth, should this trend continue, is there for anyone to see.
Although the definition of life reinsurance varies, the core business is still protection against mortality. Other important elements include the guaranteeing of investment income and protection against morbidity and medical expenses. Perhaps 75% - 80% is sold via quota treaties. Excess of loss also provides a substantial market segment. Facultative tends to be more specialist, but is sometimes seen as providing a rare injection of glamour - reinsuring the life of film or sports stars can be fun, but never the basis for a substantial portfolio. There are, however, some significant territorial variations. Facultative is mainstream in South Africa, for example.
The business is dominated by a mixture of US-based life reinsurers (many of them specialist in this class) and very large general reinsurers, mostly European (See chart). Swiss Re is probably the biggest player of all. Munich Re, Cologne & General Re, Hannover Re, SCOR and ERC Frankona have also expanded in recent years. Bermuda is home to a substantial life reinsurance community, with a reputation for innovation. Dublin is growing as a centre.
Life reinsurance does not lend itself to a subscription-based approach to risk transfer, and brokers and cedants prefer to go direct to head office rather than deal with a branch or subsidiary. These two considerations mean that this is not a natural class of business for the London market. Nonetheless, some of the biggest players - most notably Swiss Re - have chosen to headquarter their life and health business in London, while Lloyd's has a presence that it is trying to grow.
London's broker-based business suffered something of a setback this year, at least on the facultative side, when Cigna pulled out of international life reinsurance. According to James Staniland, director of life, accident and health at brokers Aon, this has left a gap in the market and will create opportunities for other reinsurers.
Not surprisingly, size counts. Life reinsurance is, by definition, a long-tail business. It is often about capital management as much as risk transfer. And it is an area where there are a finite number of very large deals. Cedants prefer, therefore, even more than in the non-life sector, to trade only with companies that have large amounts of capital and that they regard as ultra-secure. Smaller, more specialist players do exist, but they normally either have the backing of a parent company guarantee or find their opportunities restricted.
Life reinsurance is highly technical and actuary-dominated, except to some extent with facultative business, where underwriters still have a sizeable role in risk assessment and negotiation. “Because of the long-term nature, the approach tends to be more scientific,” according to Kevin O'Regan of Aon. “There isn't too much scope for intuition or guesswork.”
Aon is extremely unusual in having a specialist life reinsurance department, located in London and Connecticut, US. The sector is one where brokers have made few inroads, with most deals being ceded directly on a company-to-company basis. According to Mr O'Regan, brokers can demonstrate added value by strengthening the hands of the cedants. Aon, he says, creates life reinsurance packages and then finds the right risk carrier. Since knowledge is power, this gives them greater leverage when it comes to negotiation.
According to a report from the Society of Actuaries, Lincoln Re had the largest slice of the North American market in 1999 - slightly more than 13%. Its net premium income rose by more than one third in a year - and it sees continued strong growth both in its home market and overseas.
It calculates that the direct life market in the US has grown by some 5%-7% per annum, while reinsurance has risen 25% - 30%. Whereas some observers regard the US as a developed market that will soon plateau, Lincoln Re continues to be upbeat. Recent legislative and regulatory changes, it says, will help the drive.
In particular, last year's Gramm-Leach-Bliley Act is creating additional demand. This legislation has liberalised the life insurance market, allowing new players with little experience to enter. They will depend even more heavily on reinsurers for both expertise and capital. Indeed, the distinction between primary and wholesale is becoming blurred, as some life insurance is increasingly reinsurance-driven.
Above all, Lincoln Re believes globalisation is making the American model highly exportable, albeit after allowing for regional variations. Often it will seek to achieve this through forming alliances. Earlier this year, for example, it signed an agreement with Kyoei Life of Japan. The arrangement combines its capital and specialist understanding of the sector with Kyoei's local knowledge and standing within its home patch.
Another common approach is to create “automatic contracts” with the ceding company. This is equivalent to a binder agreement, whereby the reinsurer takes a share of the risk written without prior consultation from the primary company. To facilitate the necessary consistency, it has created software to help its partners evaluate risk, known as the Lincoln Underwriting System.
Like John Coomber at Swiss Re, Lincoln Re's director of strategic planning Arthur DeTore sees the industry as benefiting from a change of tack in the primary market. “They have outsourced the management of mortality,” he says.
Buying life reinsurance is not, though, just about offsetting risk. It is a means of buying certainty, borrowing capital and expertise and enabling the most effective possible use of capital. “When setting about reinsurance, we think of risk management solutions,” says Mr DeTore. Specifically, Lincoln Re offers clients a mixture of financial reinsurance, surplus relief reinsurance, finite reinsurance, capital management advice and tax planning.
In global terms, Swiss Re is the biggest player, following a series of acquisitions in the second half of the 1990s. Most notably, it purchased London-based M&G Re in 1996, US-based Life Re in 1998 and Alhermij of Holland in 1995. Gross premium income in 1999 totalled $4 billion - $5.4 billion after including life and health.
“We took the strategic decision in spring ‘95 to move strongly into life reinsurance, because we saw it as a growth sector,” says John Coomber, head of Swiss Re Life and Health. “So far that decision has been vindicated.”
Since then the business has grown at 40% per annum, of which around 15% has been organic and the rest through acquisition. Mr Coomber is confident that other countries will start to emulate the high levels of life reinsurance found in the US, which have already started to spread to the UK. He thinks, however, that this may require patience.
“We would like to believe that this more active use of reinsurance will spread to other markets, but they're very different” he says. “We believe that these things will eventually happen as capital management moves up the agenda.”
Looking to the future, the high profit margins of life reinsurance are unlikely to last indefinitely. Rates are generally acknowledged to have fallen recently, but it may take many years for the effects of this to show in the results. “With life business it takes quite a long time to see if you're ahead,” says Kevin O'Regan of Aon.
Nonetheless, the amount of specialist expertise required makes it a more difficult business for new capital to enter than non-life reinsurance. Furthermore, it is vulnerable to new forms of risk transfer since many life reinsurance mechanisms are, in effect, alternative risk transfer (ART) products under a different name.
Crucially, demand is certain to increase as the developed economies outside North America fulfil their potential. As former communist and third world countries become more prosperous, and as they develop their economies and become more sophisticated in their management of capital, they are certain to see a sharp growth in their life insurance (and so reinsurance) sectors. Brazil alone, for example, has a population of 200 million and the world's fifth largest economy, but the country's life reinsurance industry is only in its infancy.
Life reinsurance is not the easiest of sectors to enter, but for those who have the necessary skill, capital and vision, the land of opportunity beckons.