Ah, When L&H Re Capital Was Plentiful

While there does not seem to be any evidence that aggregate mortality rates are increasing, in some instances the rate of improvement may have been slower than that assumed in the pricing and the differentials applied to preferred lives categories may have deviated from assumptions made. Mortality results have not been as stable or positive as many had assumed they would be.

Furthermore, many insurers and reinsurers have had poor operating results with many of the accident and health products.

Regulation. Regulators have increased requirements for capital to back new products, especially those with long-term guarantees.

The implementation of the Valuation of Life Insurance Policies model regulation, also known as Guideline Triple-X, in the U.S. has led to very significant increases in the reserves required for mortality risks and hence in the amount of capital needed to support that business. (Similar requirements exist in the U.K. and Canada.)

This change and the seemingly attractive rates offered by reinsurers have lead to an acceleration of the pre-existing trend for primary writers to cede large proportions of their mortality risk.

In 2001, 58% of new individual primary mortality business written in the U.S. was reinsured, compared to 15% in 1991, according to information culled from Merrill Lynch and a Munich American 2002 survey.

Many reinsurers have managed the resulting increase in their own capital requirements by ceding these blocks of business offshore using a letter of credit to achieve a reserve credit. The problem is that the letters of credit are shorter in duration than the liability; the liability rises rapidly and it is uncertain whether the letter of credit solution will be available in sufficient amounts for the life of the underlying policies.

There is also another potential strain on capital. Other reinsurers have chosen to minimize their participation in these high capital products. Similar problems exist with long-term guaranteed premiums for critical illness or other accident and health products.

AAA or BB-, That is the Question. Rating agency assessments have become increasingly important to reinsurers. The preponderance of downgrades over the past 18 months or so has signalled that a downgrade per se is not necessarily a problem, as some of these changes have been the result of a change in rating agency criteria.

But, there is a level at which a reinsurer may feel that a further downgrade will impact its ability to attract the business it desires. Thus, retaining sufficient (higher) capital to match the agencies rating standards has become a critical business consideration. Those agencies have made it clear that it is the quality of the capital, not just its quantity, which will drive their assessment. These considerations have caused many reinsurers to reconsider the real amount of capital required to support the risks they underwrite.

So, capital is now a very real issue for life reinsurers. Its availability, its nature and the return on it are all under greater scrutiny. Given the requirements of shareholders, rating agencies, analysts and regulators, life reinsurers are becoming much more selective about where they choose to utilize their capital and the return they are prepared to accept on it.

John E. Tiller is President and Chief Executive Officer of GE ERC Global Life & Health.

Reproduced from National Underwriter Edition, July 7, 2003. Copyright 2003 by The National Underwriter Company in the serial publication. All rights reserved. Copyright in this article as an independent work may be held by the author.