Is Pricing Power Translating Into Robust Profits? Life reinsurers positive profitability trends are being offset by challenges
By Steve Tuckey
With their numbers dwindling, life reinsurers today command unprecedented pricing power. But this has not necessarily led to a golden age of robust profits, according to interviews with National Underwriter.
“The positive profitability trends are to some extent offset by the challenges they are facing in integrating operations,” says Rodney Clark, credit analyst for Standard & Poors Corp., New York.
In addition, more stringent Triple-X reserving requirements from U.S. regulators have made reinsurers explore new solutions in the capital markets to lock in long-term financing. The Valuation of Life Insurance Policies model regulation, known as Triple-X, was passed to ensure proper reserving for level premium life insurance products.
Clark says these alternatives are more costly than traditional methods of collateralizing offshore risk such as letters of credit.
“But they do eliminate the uncertainty of future pricing and capacity,” he adds. “Given the improved pricing environment, reinsurers should generally be able to pass the added costs of solutions to these customers.”
Any look at the giant life reinsurers, according to S&P, will have to start in Europe, headquarters of the Nos. 1, 2 and 5 players in the fieldSwiss Re, Munich Re and Hannover Re.
“Market upheaval has been notable in Europe where consolidation, questionable pricing and poor performance of the non-life business have caused a shake-up of the major players,” Clark says. Both Swiss Re and Munich Re have lost their triple-A ratings and now are rated “AA” and “A+”, respectively.
UBS analyst Ben Cohen sees underwriting profitability for Swiss Re to be “flattish if peaking in 2005 and the group to be delivering double-digit returns through 2006.”
But life and health reinsurance accounts for only an estimated 50% of that equation, according to Cohen. He sees the expected decline in p-c pricing to be somewhat offset by the life and health line, which he predicts will provide a 10% increase in operating profits.
Nonetheless, Cohen says UBS continues to value the life and health division of Swiss Re on a low multiple compared to its peers in Europe. “We struggle with the lack of disclosure in this market, which makes comparisons very difficult along with the lack of organic growth in the main market, the U.S. and an underlying ROE in the 8-11% range” for Swiss Res life and health division, he says.
While S&Ps “AA” rating with a negative outlook may preclude any serious capital-intensive buying spree, Cohen says “we think the group will need to maintain these [L&H acquisitions] to maintain top-line growth in 2006, and these may need to be funded by capital from other parts of the business.”
The No. 3 player in the global life reinsurance sectorEmployers Reinsurance Corp., Overland Park, Kan., of the GE familysaw its outlook downgraded to negative last fall by A.M. Best Co., Oldwick, N.J., and remain unchanged by Moodys Investor Service, New York.
Moodys analyst Jeff Berg says the companys life operations were not a significant driver in the agencys decision. Primarily, the uncertainty surrounding the parent GEs commitment to maintain ownership of its insurance operations is a more significant ratings factor.
Reinsurance Group of America, St. Louis, remains the largest stand-alone writer of life reinsurance (No. 4 globally according to S&P) and therefore would be most vulnerable to the drivers of the sector.
J.P. Morgan analyst Jimmy Bhullar says the companys better than expected third quarter results last year stemmed from favorable U.S. mortality following 4 quarters of adverse figures.
“Fundamentals in RGAs business remain favorable,” Bhullar writes. “We are concerned about the recurring unfavorable mortality in the U.S. and are relieved to see a quarter of favorable variance. Longer term, we expect slow growth [high single digit] in RGAs U.S. and Canadian operations to be offset by faster growth [high double digit] in Asian and European businesses.”
The European scene was muddled further by the fall of the German Gerling group and the financial stress suffered by the French conglomerate SCOR.
A new unit was created called Revios after Gerlings placement of its non-life portfolio into runoff to protect its life insurance operations.
S&Ps Clark notes that Revios generally has been successful at retaining its existing business. “However, the extent of Revios internal focus during 2003 and continuing uncertainty surrounding its long-term ownership have constrained its ability to capitalize on opportunities to win new business,” he says.
SCOR was downgraded in 2003 primarily due to weak performance in its U.S. non-life business. The life group that subsequently was formed raised hundreds of millions of dollars through a rights offering.
“SCOR continues to be an important player in certain niche areas, with a very strong presence in mortality and long term care risk in France, as well as strong positions in Southern Europe and Asia,” Clark writes in a recent report on the life reinsurance sector. “However, more intensive capital businesses, such as business financing or level-term reinsurance in the U.S., are now less accessible given the heightened cost of capital at SCORs current BBB+ rating level.”
One of the more recent entrants in life reinsurance and the major Bermuda representative is Scottish Re, which recently closed on its acquisition of ING Res U.S. individual life reinsurance business. Previously it had acquired ERC Life Re from General Electric. This gives the company about $1 trillion of face amount of life reinsurance in-force, $8.8 billion in assets, $2.1 billion in revenues and a capital base of about $1.3 billion.
But such impressive numbers may mask some tough times ahead, according to a UBS research report put out Jan. 18 and authored by Andrew Kligerman.
“Scottish Res risk profile seems to be rising with its recent acquisitions of large blocks in which mortality results will likely deteriorate with further seasoning,” the report states.
Kligerman expresses concern with the pricing of Scottish Res recent acquisitions along with the fact that more experienced entrants did not emerge as buyers of either property at the price Scottish Re paid.
“It is unclear why Scottish Re would have been strategically better positioned to complete these transactions,” Kligerman writes.
And the fact that the company has missed consensus for 4 of the past 5 quarters along with mortality experience that will likely worsen as the companys book ages have led UBS to reduce its price target from $26 to $19.
While the challenges Scottish Re faces may be more extreme than its competitors, they do nonetheless represent those of an industry in transition.
“Life reinsurers are seeing creative new ways to acquire business and transfer risk,” Clark says, citing Swiss Res issuance of the first mortality catastrophe bond in 2003 that raised $250 million in contingent capital, which can be tapped in the event of extreme mortality stress.
But while it provides a new source of capital, it can be replicated easily by its customers in the primary sector.
“The only certainty is that the face of life reinsurance will continue to change at a rapid pace,” Clark says.
Reproduced from National Underwriter Edition, January 27, 2005. Copyright 2005 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.