More Life Reinsurance Deals Head Offshore
Life reinsurance for U.S. insurers has grown impressively over the past 5 years.
Insurers booked $110 billion in reinsurance reserve credit in 1999, a figure that increased to $193 billion by 2003, producing an annualized growth rate of 15%, according to data filed in their statutory financial statements and published by Conning Research & Consulting in its recently released Strategic Study, “Life Reinsurance, Capacity and Other Challenges2004.”
Part of this increase involves unauthorized (read “offshore”) reinsurers. While the 15% growth rate in the total is impressive, it is dwarfed by the almost 35% annual growth rate in the offshore component.
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Two of the major causes of the recent growth in life reinsurance are the Valuation of Life Insurance Policies model regulation, also known as Regulation Triple-X, with the sharply increased reserve levels that it mandates, and aggressive marketing by reinsurers. The Guideline Triple-X reserving requirement is the primary driver of reinsurance in offshore reinsurers. The reserve levels it mandates are well in excess of what many consider to be an appropriate level of economic reserve, with the excess of regulatory reserves over economic reserves being labeled “redundant.”
Companies not subject to domestic reserving requirements are quite willing to reinsure this business, with the result that there is significant regulatory arbitrage in transferring the business to an offshore reinsurer. Actuarial Guideline 38 (formerly referred to as AG AXXX), which became effective in January 2003, clarified the application of Regulation Triple-X to universal life policies, and may create a similar scenario for those products if the complications associated with product guarantees can be worked out. However, this was not a significant component of the 1999-2003 experience.
Bermuda, Barbados and the Cayman Islands appear to be the offshore locations of choice for serving the U.S. market. In addition to the advantage of lower reserve requirements, offshore reinsurers frequently benefit from lower taxes, significantly simpler financial reporting structures and less restrictive investment requirements, all of which contribute to a more efficient operating model.
The connection with the offshore reinsurer can occur in several ways. A direct relationship between a domestic insurer and an offshore reinsurer is the most obvious, but these are not very common. A more frequent configuration involves reinsuring business with an authorized U.S. reinsurer, which can then retrocede some or all of the original cession to one or more offshore reinsurers, either an affiliated subsidiary or a nonaffiliated reinsurer. Finally, there is an increasing trend for large primary insurers to establish their own offshore reinsurers. As offshore business has become more visible, as outsourcing has taken hold and as viable third-party reinsurance administrators have been established, offshore captives have become more common, and the size needed to cost-justify them has declined.
While they may not have to set up the same redundant reserves as their onshore counterparts, unauthorized reinsurers are required to collateralize the reinsurance credit taken by their primary insurers before the domestic insurer is permitted to take credit for those reserves. This is done either through:
w LOCs (letters of credit) arranged by the reinsurer with a financial institution on the approved list for such transactions;
w a reinsurance trust funded by the reinsurer with the primary insurer as beneficiary; or,