By John E. Tiller
Until recently, capital was barely an issue in the life and health reinsurance business.
The business was growing profitably and experience was stable. Profitability was fueled by bouyant investment markets and mortality improvements.
What has happened to change that happy state? As in so many situations in business, no one factor is responsible for the reversal. Rather, several factors have combined to bring capital adequacy, quality of capital and return on capital under the spotlight.
Some of those factors relate to the life reinsurance business itself and some are extraneous but have had significant effects on the industry.
Sins of the Parent. Many of the worlds largest life reinsurers are part of corporate groups that include a significant property-casualty reinsurance or large European life operation. As a result of several years of “soft” p-c market prices, the impact of the events of Sept. 11, 2001, and deteriorating claims experience on the run-off of prior years writings, these p-c operations have experienced substantial losses.
The result is a draining of capital surplus across the organization. This has forced companies to increase focus on the availability and utilization of capital and, in many instances, to take steps to strengthen their balance sheets. If additional capital is not available, then the reinsurer must reduce the business it would otherwise accept.
Given that prices in the p-c market have hardened significantly, it is likely that most new capital will be used to support p-c business at projected returns of 20% and upwards, and little will be used to write life business, which has traditionally earned 9%-12%.
Life is Not Blameless. It would be wrong to conclude that all of the life reinsurance industrys issues with capital stem from losses in the p-c business.
Falling stock market values have also had an impact. This is particularly so in Europe where life insurers and reinsurers have invested much more heavily in equities than their counterparts in the United States.
As equities have fallen in value, with no countervailing reduction in liabilities, the pressure on the capital base has increased. Added to that, lower interest rates have led to lower investment income so that another source of return has diminished.
To add to the woes of life reinsurers operating in the United States, mortality losses have risen over the past year or so.