Reinsurance, in the truest sense, is the transfer of risk from one insurance company to another. On the surface, this definition could lead you to believe that the bulk of the life reinsurance company's work is in assuming mortality risk and nothing more. However, the role of the life reinsurance company continues to evolve in response to the changing needs of our clients. Today, this is as true in Latin America as in all other regions of the world.
Why would the same forces be at work in Latin America as in other more developed insurance markets of the world? Insurance penetration as a percentage of GDP in most Latin American countries is relatively low (for example, only 1.69% in Mexico as compared to 8.22% in the US), and some countries have only recently developed nascent life insurance markets and opened their reinsurance markets to outside entities. However, many of the world's leading financial services companies have made substantial investments in the financial markets in Latin America.
Why have so many large multinational companies entered these markets? For many, their home countries represented mature markets with the potential for only single digit growth. Some felt an affinity towards Latin America by virtue of a similar culture and/or language, and geographic proximity, while most perceived Latin American countries as largely untapped markets with demographics very different from their home countries and increased potential for the purchase of financial services products. Regulatory changes in the last decade enhanced and facilitated foreign participation in these markets, while the privatisation of social security systems around the region provided a catalyst for wealth accumulation products. With inflation controlled, the expansion of private pension systems throughout the region, and overall economic stability established, the general population seemed poised to look at alternatives to planning for the future, not simply surviving the present.
What has this meant for reinsurance companies? Basically, they have been able to help companies not only in the activities usually associated with start-up operations in newly developing markets, but have also been looking to assist the head offices in more strategic initiatives. In many cases, the reinsurance company walks a tightrope between the needs at the local level and direction from the head office.
Typically, life insurance companies in developing markets look to the reinsurer for risk management to protect them against large claims, unusual risks or substandard lives. For the most part, this entails providing technical expertise in product development, and setting appropriate mortality assumptions and other pricing considerations.
The reinsurance company provides its significant underwriting expertise in setting age and amount underwriting criteria, while providing underwriting training to a ceding company's underwriting staff. In many cases, the reinsurer also takes on the underwriting task during the initial phases until the ceding company underwriters have enough experience to classify the risks independently. It assumes mortality and morbidity risks either through automatic or facultative reinsurance cessions. Finally, feedback through claims analysis provides valuable information necessary for the continued profitable development of new business.
In Argentina, with re-birth of the life insurance market in the early 1990s, ceding companies looked to reinsurers to provide them with actuarial and underwriting expertise, access to relevant technology and quick responses to pressing needs. Ceding companies looked to the reinsurer to provide the technical expertise needed by start-up operations in return for reinsurance premiums in the form of quota-share contracts.
Many companies lacked the technical expertise or the money to acquire it, so working with a reinsurer was one way to get access to this expertise. Often the smaller local companies are in competition with large multinational companies with deep pockets, and reinsurers can help bridge that gap. The reinsurance company, in effect, becomes the great equaliser.
Eventually, these ceding companies develop their own in-house expertise, and reach a size where their retention levels are high. At the same time, the insurance markets may develop their own infrastructure to address technical issues such as actuarial mortality studies and to influence regulatory changes. Also, markets reach certain equilibrium in product development in which everyone has the same basic product, differentiated by price and commissions. At this point reinsurance typically transitions to be viewed as a commodity with price constrictions and movement towards excess of cover reinsurance treaties.
The Mexican market can be seen as having transitioned to this point some years ago. The Mexican insurance industry is well established with strong actuarial, underwriting, medical director and claims organisations. It has developed a series of detailed mortality studies, and has the infrastructure necessary to guarantee the quality of the data collection for the underwriting process. Product development has followed very nationalistic tendencies towards family protection and asset accumulation to meet mid-term family financial needs.
Mexico's geographic proximity to the US has left it open to US companies competing for the attention of the upper income population inclined to buy large face amount policies.
As such, many Mexican companies have looked to the reinsurer to help them develop products priced to compete with US companies.
The advent of preferred products in Mexico can be directly linked to increased competition from ‘offshore' insurance companies offering extremely competitively priced products to the upper socio-economic population. Reinsurers are asked to bring their innovative ideas and experiences from other markets to the Mexican market to tailor products to fit local needs.
In these more developed markets, although the reinsurers have been replaced in the starting line-up of the product development team, they still play a critical substitute role in clutch situations.
The insurance markets in countries such as Chile, Brazil, Peru, Colombia and Venezuela fall within the spectrum of development discussed above. The privatisation of their respective pension systems, and the growth of resultant annuity business, spring forth hope that they will result in economic stability and the growth of the life insurance industries.
While this has been happening on the local level, the reinsurance companies have also been increasingly involved in working with the large multinational financial services companies in their strategic planning process.
They have had to maintain one eye on the local team while the other is on the head office. The reinsurance company's role becomes more complex as it looks to partner with the head offices in its planning process.
The result is that they may be involved in tasks at the local level such as providing actuarial, underwriting, technology and claims expertise, while simultaneously assisting in more complex strategic issues at the corporate level.
How can reinsurance help large financial services companies with Latin American operations in varying stages of development? A given is that the reinsurance company will continue to provide services tailored to the local venture's specific needs. At a higher level, we can play an important role in the tax and capital-planning process. Reinsurance can be used to take advantage of expiring tax losses, fund the development of new products, subsidise the acquisition of new businesses, reduce capital requirements and improve investment returns based upon reinsurance ceded.
The basic principle is relatively straightforward – reinsurance contracts can be used to generate up-front profits based on the ceding company's expected future cash flows from existing or new business. The reinsurance company takes on specific risks normally assumed by the ceding company in return for advancing future profits.
The alternatives to the ceding companies may be neither appealing nor permitted by the regulatory authorities. Ceding companies could tap capital sources through additional stock offerings (which dilutes stockholder value, requires long-term conviction, and amounts may be arbitrary and discreet), direct capital infusion (the local operation may be competing with other operations within the corporation and may not be the most tax-efficient alternative), or may take on debt (usually prohibited, is very costly in Latin America, and could affect the ratings of the local operation).
However, the reinsurance contract offers immediate access to much-needed capital. The transaction can be tailored to the specific needs of the local operation or the head office.
It does not require shareholder approval, and most Latin American regulatory authorities have looked favourably upon contracts that adhere to the strict interpretation of existing laws. As such, the reinsurance company becomes a partner in the success of their international operations.
In Latin America, life reinsurance has come a long way in a relatively short time from its important role in risk management.
Today, reinsurance has also emerged as a financial-planning tool. It can be said that reinsurers in Latin America not only protect the life insurance company but are also helping to change the way life insurers do business both locally and internationally.