Life reinsurers must adapt to a new
environment, says Chris Stroup.
As we enter the final quarter of 2006, I am reminded of a line from —which has had a material impact on the volume of premiums ceded
a song by Counting Crows: “Maybe this year will be better than the to reinsurance.
last.” When the final surveys are available next spring, we guesstimate
The effect of these changes is enumerated in the 2005 Munich Re
that the reinsurance cession rate in the US life industry will have
Survey. The survey shows that the 2004 cession rate of 59 percent
fallen to its lowest level in a decade.
dropped all the way to 45 percent by year-end 2005. As still more
Recent behavioural changes by life reinsurers (and resultant reac- companies continued to make changes to their reinsurance bases and
tions from life insurers), coupled with regulatory developments and retention levels over the course of 2006, we expect to see even fur-
capital market initiatives, likely have led to the contraction in tradi-
ther reductions—perhaps to as low as 40 percent for the year 2006.
tional reinsurance demand, and further suggest a challenging 2007
In 2007, we will see a reinsurance market competing fiercely over
for many marketplace participants.
diminished reinsurance premiums.
The most visible indicator of life reinsurance prosperity is the new
These changes also are indicative of another important develop-
business cession level, which is summarised annually by Munich Re
ment. Direct writers always have been faced with a balancing act in
under the auspices of the Society of Actuaries. Continuing a trend
their purchasing of reinsurance. Their tolerance for retaining varying
that began in 2005, cession rates have declined again in 2006. A num-
levels of risk has a direct impact on the degree to which they rely on
ber of market changes have contributed to this development. First
reinsurance as a source of capital. For the time being, higher prices
and foremost, the costs of reinsurance have increased, and the debate
and tighter terms have tilted the scales in favour of retaining higher
over whether price changes are warranted does not change this fact:
risk. Cedants’ tolerance for higher levels of risk, combined with the
reinsurance demand is price elastic. Faced with reinsurance pricing
growing variety of other financial resources (banks and investment
that may have a negative effect on overall profitability, many insurers
houses) that offer alternate capital solutions, could create a 2007 that
have chosen to cede less business.
looks to be a challenging and competitive year for life reinsurers.
In addition to the increase in reinsurance prices, many reinsurers
One example of the alternate sources of capital currently avail-
also have enacted stricter (when compared to recent treaties) terms
able to insurance companies is the option to securitise their XXX
and conditions in their reinsurance contracts. While this may have
reserves. A number of the larger insurance companies have put XXX
improved operational risk management at reinsurers (and arguably
securitisation facilities in place and have eliminated their reliance on
at cedants, although many seem to miss this subtlety), tighter terms
coinsurance with reinsurers for XXX reserve relief. While seemingly
create greater incentive for direct writers to modify retention and
an attractive alternative to reinsurance, some are finding this a much
reinsurance bases.
more costly and time-consuming endeavour than they had antici-
pated. In the end, it is another balancing act between risk tolerance,
Further, we have seen the growing emergence of capital market
the cost of reinsurance, and the expense of putting a XXX facility
solutions as alternatives to traditional reinsurance (both for financing
in place. Life reinsurers face not only increased competition over re-
and risk management). Perhaps the convergence of insurance and
duced premiums ceded, but they also face ever-growing competition
banking, and the disintermediation of reinsurers by banks, which
from sources outside of their traditional competitors.
had been forecast by many for some time, may be occurring.
2006 was witness to still another development that is already hav-
Lastly, a number of direct writers have found themselves carrying
ing a noticeable impact on the reinsurance market. The struggles
excess capital on their balance sheets. Putting that capital to work by
of Scottish Re have put direct writers on alert. The life reinsurance
funding mortality risks is viewed by some as an attractive alternative
industry has seen a substantial consolidation over the last several
to seeking costly (which is a perception) reinsurance.
years—as Swiss Re and Scottish Re increased scale via acquisitions,
One result of these developments has been a dramatic two-year
and as Lincoln Financial and ING opted to exit the market in order
decline in cession rates as direct writers increase retention levels as
to focus on core competencies.
well as migrate away from coinsurance in favour of yearly renew-
Direct writers face a 2007 with fewer choices for reliable rein-
able term (YRT). While not all insurance companies have chosen
surance partners, and we wouldn’t be surprised if there were to
this path, it has been employed by many of the largest direct writers
be continued consolidation over the course of the year to come.
BermudaReinsurance . November 2006 39
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