The life market has weathered the downturn, with life reinsurance in demand for its stablilising effect, which will increase under Solvency II. Yet prices remain high and the field is left to a battle of the giants
The summer has marked the return of corporate mergers and acquisitions. The most talked about moves included mining giant BHP Billiton offering $39bn for the extravagantly named Potash Corporation of Saskatchewan, and the Korea National Oil Corporation going hostile for Dana Petroleum.
Grabbing fewer headlines, but no less significant, has been the news that Dutch group Aegon has hired advisers at Bank of America Merrill Lynch to sell US-based Transamerica Reinsurance. Munich Re, Swiss Re, SCOR and Hannover Re have all been tipped to buy the life reinsurance group.
Executives at those giants must be licking their lips at the prospect of buying a truly global life reinsurer – and one of the top three in the USA – even though it could cost them a cool $1.2bn. Life reinsurance has been remarkably resilient through the downturn and the business can even be said to have been dragged down by poorer performing, more risky general divisions, such as property and casualty.
Managing director at Fitch’s insurance rating group, Chris Waterman, says: “Life does reduce the overall volatility of a reinsurance group. Non-life profitability is under pressure, so having a life unit does enhance the credit profile.”
Hunger for life
Life reinsurance accounts for 42% of business in Europe, with the remainder in general. Some of the biggest reinsurers are looking to adjust that balance and are eyeing up opportunities in the life market, which has shown its mettle since the credit crunch struck in 2007.
A rapidly ageing population and developing middle class in emerging markets, particularly China, accounts for the relative strength of life reinsurance, says Waterman. As primary insurers note this potential, they will protect themselves by passing on a slice of that risk to their secondary cousins.
Senior vice-president at credit rating agency Moody’s, Scott Robinson, says that its outlook for reinsurance as a whole is negative. But he points out the two groups that are judged purely by life are both rated highly.
“Swiss Re’s US operations and RGA are both rated A1 for insurance financial strength by Moody’s, reflecting upper medium-grade credit quality with low credit risk,” he says. “Overall, life operations have weathered the financial storm fairly well. Reinsurers tend to have less investment and more mortality-based risk than primary insurers.”
This last point is important. The primary life market has tried to make money by risking its funds on investments, which has proved to be unwise as the equities markets have collapsed over the past three years.
Instead, reinsurers have tended to take more risks on the likelihood of vast numbers of people dying, as age trends are relatively easy to forecast. The chances of getting the forecast wrong are low. Such prudence might not be great for making a quick buck, but it does make for a financially sound business.
Chief actuary at the life reinsurance division of Munich Re, Erwin Schnauder, says that this has resulted in a number of primary insurers looking to reduce their risk by snapping up more reinsurance. “This led to tremendous opportunities for us, which meant that we wrote a lot more one-off life business in 2009,” he says. “Some insurers were suffering from the crisis quite heavily, which meant that demand for reinsurance to help stabilise their capital and earnings base was quite extraordinary.”
Schnauder sees life reinsurance as playing an important role when the EU’s Solvency II regulation is finalised in 2012. This will force insurers to have more capital on their balance sheet so that they avoid the risk of going under should a catastrophe hit their books.
Reinsurers, says Schnauder, will be used by the primary market to help spread the risk of investments failing, resulting in more business.
For SCOR, the French reinsurance group, taking advantage of these life market opportunities is a major driver of its 2010-13 strategic growth plan. This includes 10 initiatives to increase the group’s organic growth by 5% a year, of which four are in life.
The long haul
The most eye-catching is the development of a longevity business. The policyholder receives a chunky payout if they reach a certain grand old age. As people are living longer, this has become riskier for the primary market, so they are buying more reinsurance to cover themselves in the event of a surge in average life expectancy.
SCOR has hired a team of four people in the UK, with their first deal with a primary insurer expected early next year.
Chief executive at SCOR Global Life, Gilles Meyer, explains: “Only the UK is a mature model for longevity. We think this is a good hedge, diversifying us away from mortality. We will open elsewhere: you don’t want to put all your eggs in one country.”
Hungry as some reinsurers are for life, there have been some difficulties. The primary market has been trying to sell closed life insurance blocks, which reinsurers can manage out as no new policies are being sold, to raise capital.
Despite their need for cash, sale prices have remained resolutely high. This has not been helped by evidence that other types of groups are sniffing around.
PricewaterhouseCoopers partner Achim Bauer points out that, as a result, there have been few trades made between the primary and secondary reinsurers, with prices set to skyrocket. “Asking around, there has been increased interest from private equity funds in closed blocks,” he says.
Senior vice-president at US specialist life reinsurer Wilton Re, Don Araldi, says that he has “bid on dozens” of blocks in the past year, but has only bought three. “A lot of the operations that came to market in the last six to 12 months didn’t close because the market was insisting on a higher rate for the capital than we were willing to pay,” he says. “They were asking for a pretty penny.”
Wilton Re opened less than six years ago. This is unusual, as the US life reinsurance market is concentrated in the hands of just a few players, with the rivals so big that they represent a stiff barrier to entry for any new group.
Only the strong survive
As a result of this dominance, reinsurers with smaller life operations have been leaving the market. As well as Aegon’s auction of Transamerica Re, New York- and Bermuda-listed group XL has been selling up its life reinsurance to focus on its property and casualty units.
The UK and Irish businesses are being run off, so no new business is being written. In July last year, SCOR snapped up XL’s US operations for $44.7m. “It was profitable, but small,” an XL spokesman says.
According to Munich’s Schnauder, this consolidation, particularly in the USA, means that a few hegemons will be battling for every bit of life reinsurance business. “Fifteen years ago, there were maybe between 25 and 30 life reinsurers in the USA, with perhaps 10 having a significant market share,” he says. “But now there are only a dozen left and only a handful of them with significant clout and size.”
For the primary market, this continued bulking up of a few secondary giants will offer them less choice, and they will not be able to diversify their number of partnerships as much as they would like.
For those few remaining life reinsurers, opportunities in both acquisitions and writing new business abound. GR