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Non-Traditional Reinsurance Structures


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Don Solow's presentation on non-traditional reinsurance structures

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Non-Traditional Reinsurance Structures

  1. 1. Non-Traditional Reinsurance Structures Donald D. Solow, FSA, MAAA
  2. 2. What does “non-traditional” mean? Traditional: transfer of mortality risk for the usual reasons using the usual structures Non-traditional: transfer unusual or non- mortality risks; or achieve something in addition to risk transfer (e.g. balance sheet benefits); or transfer mortality risk using different structures
  3. 3. Types of non-traditional reinsurance  Financial reinsurance (surplus relief / risk- based capital relief)  Reinsurance of run-off or legacy blocks  Variable annuity reinsurance  Non-proportional reinsurance (Stop Loss / Catastrophe Covers / Pandemics)
  4. 4. Financial Reinsurance Goal is to improve the statutory balance sheet General concept: reinsurance premium ceded < statutory reserves released Difference is often called “initial ceding commission” or “initial expense allowance” Statutory surplus improves by this amount (ignoring taxes) RBC may improve (assets and liabilities moved off the balance sheet)
  5. 5. Financial Reinsurance (cont'd) Reinsurer earns future profits from the block Experience account tracks initial ceding commission (with a “risk charge”) and statutory profits When experience account reaches zero, the surplus relief is “paid off” and ceding company generally has right, but not obligation, to recapture Reinsurers often seek 5 year payback
  6. 6. Financial Reinsurance (cont'd) If block performs well, ceding company is likely to recapture when the relief is repaid Otherwise reinsurer is stuck with it! Reinsurer's maximum gain is the risk charge, but has unlimited downside Therefore reinsurer will choose block carefully (one where earnings are highly predictable)
  7. 7. Financial Reinsurance (cont'd)  Structures » Coinsurance  Assets transferred to reinsurer » Coinsurance with funds held  Assets kept on deposit with ceding company » Modified Coinsurance  Assets stay with ceding company and ceding company continues to hold reserves – essentially statutory book profits are the only cash flows » “Co/Modco”  Designed to minimize cash movements
  8. 8. Financial Reinsurance (cont'd) Statutory Accounting Other than amounts needed to offset taxes, initial ceding commission does not flow through statutory income Instead, is treated as a capital contribution and is released through income over the life of the transaction Rationale: initial ceding commission should not be paid out as a dividend
  9. 9. Financial Reinsurance (cont'd) GAAP Accounting (FAS 60, 97, 113) Generally use deposit accounting for financial reinsurance Rationale is that transaction is a financing or borrowing Risk charge is the only income statement item
  10. 10. Reinsurance of Run-off Blocks Ceding insurer's goal is to “sell”, through reinsurance, a non-core or legacy block of business (closed blocks) As with surplus relief, generally net premium paid < statutory reserves released This frees up capital, de-levers the balance sheet, and allows recognition of some of the embedded value (may be styled an “embedded value” transaction)
  11. 11. Reinsurance of Run-off Blocks (cont'd) General form is coinsurance or modified coinsurance There may also be a transfer of servicing and administration Unlike surplus relief, generally there are no recapture rights
  12. 12. Reinsurance of Run-off Blocks (cont'd) Important points: Not a “true sale” (novation): ceding insurer still has contractual obligations May require regulatory approval or notification
  13. 13. Reinsurance of Run-off Blocks (cont'd) Case Study:
  14. 14. Variable Annuity Reinsurance Variable annuities often contain secondary benefits. Examples are: GMDB (death benefit) GMIB (income benefit) GMWB (withdrawal benefit) Under these provisions or riders, annuity writer has risk that the underlying investment funds perform in such a way as to cause the risk to be “in the money” Essentially the annuity writer has written complex “put” options … tied to underlying asset performance … tied to other factors such as mortality and policyholder behavior
  15. 15. Variable Annuity Reinsurance (cont'd) Example: simple return of principal GMDB Investment: $1,000 in equity sub-account Performance: -10% in year 1 GMDB Net Amount at Risk: $100 (payable only on death) “Financial Economics” view: each contract that results in death has an embedded equity put option
  16. 16. Variable Annuity Reinsurance (cont'd) Reinsurance Objective: … to reinsure this risk with premiums expressed in basis points of assets and not dollars per thousand of net amount at risk Poor investment performance generally increases the reinsurer's risk and decreases the premium stream
  17. 17. Variable Annuity Reinsurance (cont'd) Common features in the reinsurance treaty: Overall limits or caps Non-guaranteed premiums (or guaranteed for a limited time period) Deductibles Premiums or coverage varying by fund types
  18. 18. Non-Proportional Reinsurance “Non-proportional” means that the amount paid by the reinsurer on any policy is not a fixed percentage of the face amount Payments, if any, may depend on aggregate experience of the block Generally no reserve credit is obtained
  19. 19. Non-Proportional Reinsurance (cont'd) Stop Loss: reinsurer pays the amount by which claims in a given period exceed a pre-agreed level (the “attachment point”), up to a limit Attachment point can be a fixed dollar amount but is more likely expressed as a percentage of expected claims. Example: reinsurer pays each year amounts in excess of 110% of expected, up to 130% of expected Generally the cover is for one year and then must be renegotiated, but longer periods are sometimes possible (e.g. 3 or 5 years) Goal is to put an overall cap on claims for the year
  20. 20. Non-Proportional Reinsurance (cont'd) Catastrophe (“cat”) cover: provides protection against multiple claims resulting from a common occurrence. Example: reinsurer pays if 3 or more claims result from a common occurrence, subject to a deductible and a limit Generally a one-year cover that is renegotiated each year Reinsurer may restrict coverage where there are known concentrations of risk (e.g. sports teams, concentrations within a group life portfolio) War, terrorism, nuclear events, epidemics usually excluded
  21. 21. Non-Proportional Reinsurance (cont'd) Pandemic: newer idea. Reinsurer pays based on “extra deaths” caused by a pandemic “Extra deaths” may be calculated from a population index rather than the reinsured's actual book of business, or a modified population index Term of coverage may be 3 to 5 years Risk is often placed in the capital markets as a kind of mortality “cat bond”