The US life insurance marketplace seems headed for a secure tomorrow, and what's good news for life insurers is also good news for life reinsurers, says Chris Stroup.

"Yesterday is not ours to recover, but tomorrow is ours to win or to lose."— President Lyndon B. Johnson address to the nation 28 Nov, 1963

The future of life reinsurance in US is certainly ours to win or to lose. The forces of today - expanding technology, tightening capital, regulatory rumblings, mergers and acquisitions - will affect the focus of tomorrow. If we wish to win the day, to prosper in a changing environment, we need to begin preparing ourselves now for the challenges that lie ahead.

But what are those challenges? Any attempt to polish a crystal ball and peer into that future yields positives and negatives, reasons to hope and reasons to tread carefully.

Reasons to be optimistic
Fortunately, the reasons for optimism are more numerous. The US life insurance marketplace seems headed for a secure tomorrow. And what's good news for life insurers is also good news for life reinsurers.

As the American people look forward to longer and healthier life spans, they'll need to set aside more money for their retirement years. The current interest rates of traditional savings vehicles are low, which makes life insurance even more attractive.

In addition, the US life insurance industry has special characteristics that keep it poised for success. As a whole, US life insurers are remarkably adept at developing new products, and their mortality knowledge gives them a significant comparative advantage on a global scale. Product distribution remains an area with great potential that has so far not been fully exploited. US insurers' investment in technology has not always been fully exploited; money has been spent, improvements have been made, but the hoped-for cost savings due to lower expense ratios are still somewhere in the future.

On the downside...
Unfortunately, not everything looks this bright. There are challenges and obstacles on the US insurance horizon that must be successfully navigated.

New competitors have a keen understanding of consumer needs, and if the factors that now give insurers an advantage - principally the tax-deferral subsidy and estate tax laws - are ever eliminated or restructured, these new competitors will eagerly move into our marketplace.

State insurance regulations remain, of course, a constant cloud on the horizon. Regulations drive up administrative costs and increase capital requirements, making it more difficult for the insurance industry to compete with financial services giants which aren't hobbled by 50 sets of state regulation.

As these giants compete for our clients, they also fish in our talent pool. The supply of underwriters, actuaries and accountants - as well as management professionals - is not unlimited. With more companies vying for these talents, fewer capable people are available to fuel the insurance industry's progress.

Fragmented roles and assets
Technology has contributed its own interesting wrinkle to the future of life insurance. With the internet's ability to seamlessly link computers and systems and companies across state lines and international boundaries, it's now apparent to the consumer just who is actually providing the services he's receiving.

In the past, a single life insurer would have been responsible for managing investment assets, manufacturing products, distributing those products, providing customer service, taking on risk and administering its accounts. With technology, however, those roles have fragmented, with life insurers often retaining only a portion of the responsibilities. Today, those functions fall to a variety of parties:

  • managing investment assets - handled by fund managers and insurers;

  • manufacturing products - still performed by life insurers;

  • distributing products and providing customer service: this may be performed by a variety of credible, trusted advisors, such as banks, brokerages and independent financial planners, in addition to insurers;

  • risk taking - often handed off to reinsurers; and

  • administering accounts - this may be outsourced to professional third-party administrators.

    This fragmentation of traditional life insurance roles has, consequently, led to a fragmentation of available assets. In 1989, before this fragmentation began, life insurers had $1.4trn in assets under management. An equal amount was being managed by mutual funds, broker/dealers and market funds. This means the total available assets were split 50:50.

    What a difference a decade makes. In 2000, with service fragmentation well underway, life insurers' assets under management rose to more than $3.1trn. But assets managed by mutual funds, broker/dealers and market funds leap-frogged ahead to $7.7trn. It was no longer a 50:50 split. Instead, life insurers managed only 29% of those assets, with the remaining 71% going to other financial services companies.

    As service fragmentation continues, life insurers are faced with managing a smaller portion of the available assets.

    Reinsurance opportunities
    For reinsurers, this service fragmentation offers new opportunities in the US. As more life insurers look to share their risk, more business is available for reinsurance companies. We can measure the growth by looking at cession rates, which represent the percentage of new face amount that has been ceded (or handed off) to the reinsurance marketplace. In 1993, the cession rate was 15%. By 2000, that amount had more than quadrupled to 64% and in 2001 looked to top 70%.

    Overall, the US reinsurance market grew at a compounded rate of 29%, compared to a mere 5% for the primary insurance market. There are several reasons for this increase in reinsurance buying:

  • primary insurers are eager to avoid earnings volatility, and reinsurance is a key tool to accomplish that goal;

  • transformation of insurers to a fee-based business model has made it more attractive; and

  • reinsurance rates are tempting.

    The last point bears expansion. Over the past five years, life reinsurance prices have actually gone down, largely due to strict underwriting that produces lower mortality assumptions.

    Moderating the future
    With falling reinsurance prices and rising cession rates, what does the future hold for US life reinsurers? Are we on an unstoppable upward path? That would be nice, but it's unlikely. There is, however, both good and bad news in life reinsurers' tea leaves:

  • cesssion rates will level off - the 64% penetration rate of 2000 will likely hit a plateau at some point and will probably not top 75%;

  • reinsurers' information advantage, an in-depth knowledge of underwriting and distribution effects on mortality will maintain their competitive edge;

  • new entrants into the life insurance business will be risk-averse, preferring to outsource mortality risk-taking and underwriting; and

  • as capital markets become more efficient and technology continues to make reinsurance arrangements transparent to the consumer, the cost of risk will eventually be driven downward to the level of commodity pricing.

    Commitment and capital
    What will it take for a reinsurer to survive - and even thrive - in this new century? Think two words - commitment and capital.

    Commitment will increasingly matter to primary carriers. They won't be satisfied with a reinsurance relationship that's merely the flavour of the month. Instead, they will want to know they can count on a long-term business relationship with a highly rated reinsurer which has a demonstrated commitment to the life reinsurance business. This spells bad news for unaffiliated reinsurers and those with marginal operations.

    Capital also will be a key issue because the supply of life reinsurance capital is bound to contract, perhaps as early as the third quarter of this year. The signs are already there; just look at the cost and capacity of current lines of credit that are used to manage the strain of surplus requirements. The result is that to survive and thrive, reinsurers must be able to offer impressive capacity.

    In the US reinsurance marketplace of tomorrow, primary carriers will want three things:

  • longer-term reinsurance relationships;

  • a few trusted places to concentrate their business, thus maintaining that relationship; and

  • a reinsurer which can supply their capital needs, product development and underwriting capacity for the long haul.

    In response, successful reinsurers must:

  • deliver a broad range of product offerings;

  • include non-traditional reinsurance options; and

  • improve their credit ratings, because lower-rated companies just won't cut it in the future.

    Preparing for tomorrow
    Clearly, there are opportunities and perils awaiting us in the future of life reinsurance. Tomorrow will be ours to win or to lose, and the prize will surely go to those companies which have prepared themselves to avoid the perils and seize the opportunities.

    Theodore Roosevelt once advised: "Whenever you are asked if you can do a job, tell 'em, `Certainly, I can!' Then get busy and find out how to do it."

    Can reinsurers meet the challenges that lie ahead? Certainly, we can. We're busy finding out how to do it. When tomorrow arrives, we'll be ready.

    By Chris Stroup

    Chris Stroup is chief executive officer, Swiss Re Life & Health America Inc

  • Topics