Glenn F Cunningham looks at current trends in the US life reinsurance sector
For decades, the US life reinsurance market was the little noticed, predictable sibling of the high profile and much more volatile property/casualty reinsurance industry. But the visibility of life reinsurance rose sharply in the 1990s when double-digit growth and a host of new players created considerable interest in the market.
Life reinsurance is still attracting attention, but instead of steep growth curves and new players, industry observers now are inclined to talk about flat markets and continuing consolidation. While these are defining features of today's market, a closer look reveals other trends that offer a view of where the US life reinsurance industry is going.
These include higher value solutions to enhance capital efficiencies, outsourcing services to help customers improve cost structures and system inefficiencies, and a drive to dramatically improve data quality in the reporting of reinsurance transactions.
Today, life reinsurance is a large, global business concentrated in the hands of a few players who possess a core competence that is scalable and not easily replicated. While the industry is not experiencing the growth rates it enjoyed in the recent past, financial analysts remain bullish, projecting revenue growth of 7.5% per year over the next ten years. This compares to their view that the primary market will only grow at 3%.
Any discussion of trends must begin with consolidation. In the past year alone, two additional life reinsurance businesses (Allianz and ERC) were either acquired or being parcelled out in anticipation of a sale. By the time of the Rendez-Vous de Septembre, another big player may have joined the ranks of the acquired; at least one or two others are rumoured to be for sale. A market recently comprising nearly two-dozen serious players is now dominated by just a handful of leviathans. In 2003, the top five US life reinsurers assumed more than 75% of new life reinsurance business; the top eight players accounted for 90%. While market withdrawal seems to be the major trend, there are indications of interest from potential new entrants.
To date, the departure of life reinsurance providers has not dramatically affected the supply or the cost of capacity in the US market. This is due, in part, to the size and strength of the remaining players and to changing buying patterns of ceding companies. After years of growth from demutualisation, regulations and decreasing rates, the need for life reinsurance - at least as it has been used during the past decade - has levelled off.
Going forward, some ceding companies may decide to keep more insurance premium and mortality risk. They also are keeping products on the shelf longer as access to cheap reinsurance subsides. Retrocession is an exception to current capacity trends in the market; a developing scarcity of capacity in the retro markets may restrict the ability of life reinsurers to provide large amount capacity to ceding companies.
While consolidation, to date, has not created a capacity crunch, it has lent rationality to the market. Most notably, prices are firming, reflecting the rising costs and complexity of providing reinsurance solutions. For example, for years the industry has benefited from improving mortality and has passed these benefits along to ceding companies. But life reinsurers have become more conservative in their assessment of future mortality gains; they are revising mortality expectations and factoring less improvement into their pricing. They are paying more for letters of credit (LOCs) for reserve collateral and are reflecting these additional expenses in their reinsurance rates. As a reaction to this, larger direct writers are examining internal solutions to deal with reserve strain issues.
Consolidation has also influenced the way reinsurance buyers select risk partners. After years of focussing almost entirely on price, ceding companies are doing more due diligence and they are placing greater value on the size, financial strength and experience of a life reinsurer. Whether this 'discipline' will be maintained in the future remains to be seen.
Focus on due diligence favours the large and financially strong reinsurers, but additional barriers are making it difficult for second-tier players and start-ups to succeed in today's market. Life reinsurance is becoming an increasingly complex market as reinsurers respond to ceding company needs for better risk management. Effective solutions demand all of the competencies of the past, plus new expertise in risk analytics and structuring that involve capital markets or third party investors. This has significantly raised the bar for market entry and success. For example, a big issue today involves the development of alternatives to LOCs to collateralise reserve credit. These new funding structures are technically demanding and require expertise and access to capital markets that life reinsurers have not needed in the past.
One of the more promising trends in today's US market relates to data quality - a critical issue for life reinsurers looking for new sources of capital to provide cost-effective capacity. These new sources of capital require rigorous and detailed reporting. Clients with consistently higher quality reporting of reinsurance transactional data will have better access through their reinsurers to the capital available under these new instruments.
The introduction of the Sarbanes-Oxley Act, far-reaching corporate governance legislation that goes into effect next year, adds urgency to the need to solve data issues that have beleaguered life reinsurers.
Life reinsurance is a changing business that requires close collaboration with business partners. While industry consolidation may not have brought about significant increases in reinsurance rates, it is encouraging reinsurers to give priority to certain companies when deploying capacity.
Life reinsurers are placing greater emphasis on doing business with ceding companies that value partnership and a healthy reinsurance community.
These ceding companies openly share mortality and lapse data to allow reinsurers to validate their assumptions. They maintain underwriting discipline and share internal audit results. They find mutual agreement on treaty terms and conditions, and work actively with reinsurers to improve policy and claims administration.
Ultimately, ceding companies play a large role in determining the health of the life reinsurance industry. Those who partner with value-added reinsurers can leverage their resources to uncover innovative solutions necessitated by regulations, accounting practices and risk management needs.
Current trends in the US life reinsurance market present both challenges and opportunities. The exceptional growth of the 1990s was just that - exceptional. But innovative reinsurers have always found ways to leverage the issues plaguing the primary industry. As long as ceding companies face regulatory, accounting, risk management and operational challenges, the best reinsurers will find opportunities to achieve growth and profit objectives.