During the last few years, the practices of both life insurers and reinsurers have undergone some dramatic changes, the most significant of which is consolidation. Alan Levin and Socheth Sor assess the impact.

Consolidation has affected life insurers and reinsurers in several ways. For life insurers, the number of dependable reinsurers decreased while the cost of life reinsurance increased. Consequently, life insurers are ceding less risk. They are looking for new solutions to address these issues and are finding alternatives in non-traditional sources of reinsurance. As a result, life reinsurers are beginning to re-examine their traditional roles in order to attend to the changing needs of life insurers. They must adapt and seek innovative solutions to fill the new roles that market concentration and its attendant effects have forced upon them.

Consolidation has changed the reinsurance landscape for both reinsurers and insurers alike. In the 1990s, life reinsurance was subject to heightened merger & acquisition (M&A) activity. In 1993, 27 companies operated in the life reinsurance arena. Within ten years, after a series of major M&A deals, only 15 life reinsurance companies remained. Today, life reinsurance is a large business concentrated in the hands of only a few players. Currently, the top five life reinsurers have 80% of all life reinsurance business in-force.

Pick of the bunch

The 18-year long trend of consolidation has greatly influenced the ways in which life insurance companies conduct their business. First, life insurers altered the way they selected reinsurers. Since the life reinsurance market has shrunk and fewer life reinsurers remain, the law of supply and demand may have finally taken hold against them. Before consolidation, life insurers had the option of ceding risks to a large number of life reinsurers while reinsurers competed for their business. After consolidation, only a handful of companies dominated the life reinsurance field as the number of life reinsurers decreased. Life insurers now use different criteria to evaluate reinsurers. Instead of selecting a reinsurer based solely on price, insurers place more value on the stability, size, rating and experience of life reinsurers.

Second, consolidation also affected the way reinsurance was priced by lending rationality to the way reinsurers valued their products. Prices firmed as the costs and complexity of providing reinsurance solutions rose. Life insurers needed to consider first-dollar quota-share. With rising prices, they were less willing to cede business, unless it was for the purposes of capital-management and/or risk-management. Consolidation led to a higher cost of reinsurance and fewer quality partners with whom to cede risks. These changes rippled and permanently altered the insurer-reinsurer relationship.

Even though the life reinsurance market is already highly consolidated, further M&A activity is likely. In the past year alone, two acquisitions furthered the trend. The French reinsurance group SCOR acquired Revios Ruckversicherung, creating SCOR Global Life, a top-tier global life reinsurer. And General Electric announced the sale of its reinsurance business, GE Insurance Solutions, including Employers Reinsurance Corp and more recently its UK life business, to Swiss Re.

Prime for new entrants

As the number of life reinsurers is further reduced, now seems to be the ideal time for new companies to enter the life reinsurance stage. New life reinsurers can alleviate problems that consolidation has caused by adding capacity. However, there are significant barriers for companies looking to enter the life reinsurance business. For one, life reinsurance requires large amounts of capital. In addition, recruiting a highly skilled management team and balancing shareholders' expectations of short-term gain versus long-term gain is not an easy task. Success and security in the life reinsurance industry are difficult to attain and a new entrant will have to overcome these barriers in order to compete with the larger companies.

Even top-tier life reinsurers are not always secure, as aptly demonstrated by Scottish Re's sharp, unexpected loss, triggering rating downgrades by credit rating agencies, including AM Best and Standard & Poor's. Scottish Re's stock lost more than half its value as a result. The reinsurer attributes its quarterly losses to higher-than-expected mortality rates in North America, write-off of goodwill, and reversal of a $15m recovery from a client, tax expenses and higher operating costs. Recently, Scottish Re announced that its shareholders had approved the sale of a majority stake to a buyout group, including Cerberus Capital Management and MassMutual Capital Partners, for as much as $600m. If a top-tier player like Scottish Re can fall from grace so easily, so too can new companies. New entrants certainly do not have a guaranteed place in the market.

However, despite the long odds, the possibility of new entrants cannot be completely ruled out. Companies that want to enter the life reinsurance business have incentive because of the capacity crunch in this arena. Life insurers are likely to scrutinise the security of new entrants, but are as likely to welcome additional partners with whom to cede risks. In the past year alone, several companies entered the life reinsurance industry, such as XL Re Life America, Wilton Re and ACE Tempest Life Re. Even if not yet operating at the same level as their top-tier counterparts, these companies have brought welcome new capacity into the market.

Changing landscape

The reinsurance industry is evolving. Higher retention rates, globalisation of reinsurance and competition from non-traditional sources are driving these changes. According to AM Best, cession rates declined by about ten percent in 2005 and are expected to decline further for several reasons. First, life insurers are retaining more risk due to the high cost of reinsurance. Second, life reinsurers' more rigorous review of treaty terms is causing life insurers to be more selective in the risks and volume of business ceded. Third, there is a movement away from quota-share reinsurance towards excess-of-loss yearly renewable terms. Companies are doing this in response to the Triple-X regulation, which requires large reserves for mortality coverage, whether a life insurer or reinsurer holds the risk.

Another change in the competitive landscape is the increasing use of affiliate reinsurers. Large companies are ceding more business to offshore captives because of lower capital requirements and tax benefits. The Reinsurance Association of America stated that premiums ceded to affiliated reinsurers rose by nearly 25% in 2005 compared with the previous year. As reinsurance becomes more globalised, the National Association of Insurance Commissioners is considering adoption of a proposal that would require foreign companies to post less collateral, thus lowering the cost of doing business in the US. The resulting introduction of foreign reinsurers, if the proposal is accepted, is likely to have a noticeable impact on the life reinsurance business in the US.

Competition from non-traditional sources is also contributing to the changing landscape and financial services companies are creating innovative ways to provide additional capital and capacity. There is increased use of securitisation to address both the Triple X and AXXX regulations. In addition, the life reinsurance industry is seeing more frequent use of longer-dated letters of credit. No longer as unavailable and expensive as they once were, letters of credit are expected to become a reasonable and more commonplace solution to fund Triple X reserves. Smaller ceding companies, once extremely reliant on reinsurance, may turn to longer-dated letters of credit to fund their redundant reserves.

The decline of cession rates, increased use of offshore captives and availability of non-traditional solutions are changes that help to build competitive pressures on life reinsurers. In order to be successful in the competitive and changing landscape, life reinsurers must find new roles. Historically, both small and large ceding companies were extremely reliant on reinsurers. Life reinsurers allowed insurers to develop new and evolving products; that is to say that reinsurance enabled insurers to provide a diverse array of policy benefits by allowing insurance companies to incur an appropriate amount of risk in order to receive a corresponding level of reward. Life insurers relied on reinsurance to protect against earnings volatility in the event of statistical fluctuations, such as the onset of a major pandemic, and to reduce the volatility of those risks an insurer was less familiar with.

However, in light of the changes in the competitive landscape, direct life and annuity writers are looking for alternatives to traditional reinsurance, such as letters of credit, offshore captives and other new vehicles for hedging risks. Life insurers are also expanding their product offerings; for example, The Hartford Financial Services and Nationwide Mutual Insurance Company have recently expanded their products to patients suffering from low-level breast and prostate cancers. As a result, patients who previously had to wait several years or pay higher premiums to get coverage are now eligible for insurance products under standard rates. As insurers are expanding their products, the life reinsurers working with them should do the same.

According to AM Best, the reinsurance industry remains stable; that is to say that insurance companies still depend on reinsurers to transfer risks and to secure capital. The rise in competitive alternatives to traditional reinsurance as a means of hedging risk will ultimately lead to positive changes in the reinsurance industry. And as the life reinsurance industry changes, reinsurers can adapt and create new roles for themselves.

Alan Levin is a partner and chair, and Socheth Sor is an associate of the insurance and reinsurance department of Edwards Angell Palmer and Dodge.