Life reinsurance opportunities in Europe may be generated as a result of the move to start cost shifting from the public to private sectors, says Joseph F Kolodney.
While America has served as the `pioneer' in the versatile use of life reinsurance over the past 20 years, Europe is still in a somewhat evolutionary process of recognising the use of life reinsurance as a financial management tool.
Nevertheless, an overview of life reinsurance in Europe needs to draw a distinction between the UK and continental Europe
The UK marketplace has, in the last nine years, become more like that of the US. UK companies, which have historically purchased risk reinsurance on an excess over retention basis, have now moved to what is referred to as `the American model' where it is not uncommon to see large quota-shares of 80% or 90% on term life products as the rule rather than the exception. In the UK, term life is generally referred to as protection.
One interesting element in UK reinsurance practice is that reinsurers can guarantee the risk premium rates they charge without undergoing the type of reserving requirement imposed on US companies as respects deficiency reserves, although they do have to hold an appropriate solvency margin related to their liabilities. The appointed actuary of the ceding company uniquely passes on the reinsurance structure and by `signing off' on it, de facto imprimaturs the adequacy of rate and acceptability of reinsurer security.
In addition, new business strains or the desire to improve solvency margins or free asset ratios have led to the use of financial reinsurance structures such as mod-coinsurance. The UK Financial Services Authority and its predecessor, the Department of Trade and Industry, has also allowed the use of subordinated debt as an additional `reinsurance' type tool for UK life companies. This is a form of securitisation which after the successful completion of one transaction, National Provident Indemnity (NPI), seems to have languished as a structure of choice for other companies. The NPI transaction provided capital relief on a fairly long duration basis which would not have been supported by a conventional surplus relief structure.
Key reinsurance products in the UK are geared to the protection, critical illness, and disability reinsurance marketplaces. There is also death cover to be provided on unit-linked business - analogous to the US variable life and annuity insurance products.
As mortality improves, many UK companies - and Continental companies - are faced with an economic reality that the annuities issued some years back, currently in pay-out, are probably underreserved as respects accounting for continued mortality improvements. Many companies are seeking reinsurance solutions to `carve-out' or deal with the unforeseen longevity risk through specific mortality carve-out transactions or asset-based reinsurance structures.
The continued ageing of the population, coupled with a younger workforce, confronts the reality of whether government is still going to be able to provide the type of pension benefits that have been an inherent part of the social compact between the government and its citizens.
This is an endemic problem in Europe and will require both a revolutionary and evolutionary approach to transition into a private pensions marketplace. UK companies are already aggressively structuring and marketing new pension - oriented products which will, in part, reduce what may be an unmanageable strain on continued government funding of pensions.
The UK market is served domestically by many of the well-known international life reinsurers through representative marketing offices, companies or branches in the UK.
The usual players such as Swiss Re, Gerling, Hannover, GE Frankona, GeneralCologne Re, Munich Re, SCOR Vie and others are all striving for a position on the panel of the UK life insurers. RGA, of American provenance, has established a UK presence as well.
The Continental life reinsurance market is not as dynamic or proactive as is the UK. With the exception of Ireland, which has encouraged the formation of life reinsurers by providing significant tax relief and ease of doing business, most European countries are more `traditional' users of life reinsurance. This is in part dictated by tax issues around which a product is designed, the type of distribution allowed from country to country, consumer sophistication and also local regulation, which may create a tariff environment making it difficult to stimulate competition. As life reinsurance in most cases was not considered to be much of a financial management tool, historically comfortable relationships between European ceding companies and their indigenous reinsurers developed to the point where little necessity was perceived in doing any fairly dramatic life reinsurer restructuring.
Many European countries have started to recognise that the US problem of continued solvency and financing of its social security system has to be recognised in Europe as well. Most European countries have all - encompassing - and commensurately expensive - pension and retirement schemes where the political structure of the respective countries is now recognising that the promises made may not be kept. As a result, many countries such as France, Spain and Italy have or are introducing regulations which provide tax incentives for individuals to start providing for their own retirement security. Continental countries are increasingly recognising that there will be fewer and fewer active workers on whom to levy taxes to support those that have retired. Italy, for example has a declining birth rate; this does not bode well for the future solvency of the Italian state-supported pension system. Life reinsurance opportunities may be generated as a result of the move to start cost-shifting from the public to private sectors.
In France, it is possible to buy a life insurance product, more often than not an accumulation savings product, which if held for a minimum eight-year period allows accumulated cash values to be taken out without incurring a taxable event. Better yet, hold it and annuitise it and the stream of annuity payments will also be tax-free. In Germany, until recently, there was a huge market in 12 year endowment contracts, where, after the twelfth year, accumulated values would be completely free of tax. This concentration on savings products and the culture of putting money away has significantly depressed the sale of protection products. The Human Life Value concept in the US, which has been the trigger for a more encompassing approach to both personal and family financial planning, has not gained the same aura and interest in Europe.
In a similar fashion to companies in the US, the European insurance giant AXA has reformulated its strategy. It has used simple personal lines products such as automobile and homeowners insurance as a foundation to build protection products, savings products and estate planning products.
The bull market of the last ten years has meant that more and more consumers are being made aware of the attraction of getting involved in equities. Insurance companies providing unit-linked policies where performance is tied to the ups and downs of the stock market can accomplish this. These are wrapped in a life insurance cover to qualify for attractive tax treatment. Unit-linked policies are the European equivalent of the mutual fund industry in the US. The problem here is that volatility in equity markets could have an adverse effect on both the writing carriers and their insureds, as well as a peripheral impact on reinsurers supporting the strain of new business through cash financing arrangements.
There is a truism in the US, which states that the average or uninformed investor tends to get in at a market `top' and gets out at a market `bottom'. If a unit-linked product is properly designed and structured to provide the insured with whatever economic incentives government offers to encourage private savings, it could ameliorate a situation where lapses (surrenders) could dramatically increase. However, since both ceding companies and reinsurers tend to recover their upfront expenses through participating in management and expense charges usually related to assets under management, a severe decline in equities would retard the repayment of such costs, thus reducing returns on equities (ROEs).
The same approach is taking hold in Spain. As a matter of interest, the bancassurance marketplace is growing significantly in all European countries where banks can own their own life insurance companies and market to bank customers' products that are generally uncomplicated to buy.
The introduction of the Euro as common currency in the European Monetary Union countries, is likely to create some unique distribution and reinsurance opportunities as residents of countries will not be formally tied to their respective national currencies. As a result, companies will be able to approach consumers on a more level playing field, where product cost and benefits comparisons can be made without deterring the interested and educated consumer from pursuing those products in countries that offer the best financial advantage.
From a life reinsurance marketing viewpoint, it is a reality that dealing in a highly developed market requires reinsurers interested in establishing a European presence to take a very long-term view. Historically, this marketplace has been dominated by the `usual suspects' prevalent in North America and the UK which have had, in some cases, more than 100 years of involvement in relatively protected environments to build a massive presence in their home markets and significant business in countries around them.
There is a scarcity of new life reinsurance company formations in Europe and a diminution of existing reinsurers, which have had historical presence in the European marketplace. Whether by choice or chance, Swiss Re has probably been the leading acquirer and amalgamator of many European reinsurers. Such names as Mercantile & General, Union Re, Unione Italiana, Bavarian Re and most recently Lincoln National Re, have all been acquired or owned as autonomous entities by Swiss Re. While CNA Life Re has never operated in Europe, its acquisition by Munich Re still reduces potential life reinsurance capacity.
The new players in Europe (with the exception of RGA which continues to expand in more traditional lines of life reinsurance) have tended to focus on financial and asset-based reinsurance transactions. Ace Tempest, XL, Max Re and investment banking entities such as Lehman Re fall into this category
As we sometimes say in the US, new products and trends seem to move from west to east - from California to New York - whether it's new drinks, new fashion or new attitudes.
This also holds true for life reinsurance where the evolution of the use of life reinsurance will continue to develop along structures and products created in the US, moving across the Atlantic to the European marketplace. It will be interesting to revisit this in a couple of years to see what has happened.
By Joseph F Kolodney
Joseph F Kolodney is managing director and Life Reinsurance Product group leader at Aon Re Worldwide.