Low Rates Pinching The Annuity Reinsurance Market

"With the lower rates, there is less spread to pay the higher cost to bring the reinsurer into the equation," he said.

Bob Douglas, chief operating officer for XL Life Ltd. in Bermuda, has not noticed an appreciable decline in annuity block business. (XL Life has a double-"A" rating from S&P.)

Indeed, he said, the company has been fortunate to complete some very large deals since it got off the ground in 1999, with an initial deal of $650 million of premium in 1999.

Last year one deal registered $650 million in premium, Douglas said, and thus far this year, the company is looking at a potential deal worth about $1.4 billion.

"If youve got a proven ability to do these deals, then more tend to come your way," he said. "These are complex, time-consuming transactions, so people dont want to go to players that dont have a proven track record."

Douglas thought the interest rate environment actually may drive annuity block sales.

What hurts life companies, particularly in annuity blocks, is a combination of investment returns and changes in views on longevity, according to Douglas.

"Quite a few companies, specifically in the United Kingdom, have not been keeping up with the latest reserving bases," he said. "As soon as they move to the newer actuarial tables for annuity risks, then they suddenly find their reserves must be increased by very large absolute amounts because the portfolios themselves are large."

A company that has a portfolio of annuities of several billion pounds will see that a small percentage point change adds tens or hundreds of millions to those liabilities, he said.

"This is driving [this business]," Douglas said, "particularly in the last few years, because you have more and more companies in the United Kingdom that have demutualized, so the actual cost of capital is now becoming a far more important issue to them."

Before companies demutualized, cost of capital didnt matter as much because they did not have to answer to shareholders, he said.

Now these companies are looking at closed blocks of annuity business if they are being asked to add substantial amounts of reserves, Douglas said.

Bob Cooney, chairman, president and CEO of Max Re in Bermuda, said he has seen a decline in some of these deals since interest rates have dropped so low. Max Re is rated "A-" (Excellent) by A.M. Best Company, Oldwick, N.J., and "A" (Strong) by Fitch, Chicago.

"Were in the business of acquiring mature portfolios of life policies or disability policies, or pension and payouts from life companies," he noted.

In such business, reinsurers must discount the future stream of benefit payments into a present value, Cooney said. "If interest rates are at 3%, youre using a fairly low discount rate, which means youre going to need more money from the life company to take the block away from them," he said.

The clients may conclude that they cant make enough on the deal, so they may decide to wait a few years when rates are back up and pricing is more attractive, according to Cooney.

"In a lot of the deals weve looked at in the last 12 months, the clients didnt do a deal with anybody because they said they couldnt get enough for the block," he said.

The clients decided to hold on to the blocks for a year or two and then maybe shop them around again when interest rates are up a couple hundred basis points, Cooney said.

As a result of these trends, Max Re has pulled back a bit on its life reinsurance budget expectations and notified its shareholders that it is going to be a more challenging environment.

"We dont think well write as much as we would have if interest rates had not fallen the way they did in the last 12 months," he said.

Having said that, Cooney emphasized that life reinsurance is still a good business for the company. "We did about $300 million last year in premium volume out of a total of $800 million, so it was a meaningful part of our portfolio.

"This year were probably expecting to do about the same amount [in the life reinsurance side], but if youd asked me a year ago, I would have said, well probably do $500 million," he said.

Cooney predicted that all the merger and acquisition activity in the life industry and the demutualizations that have taken place will drive insurers to get better returns on equity.

Life reinsurance is an underutilized tool, which "I think the life industry will look at more seriously because theyre now public and their shareholders are saying a 6% ROE isnt going to cut it," he said. "Youve got to get up into double digits and youd better use every tool you can to help improve your performance."

A closed block of business, which is not current in terms of customer demand, ties up capital and ties up human resources and claims administration personnel, Cooney continued.

"I think youre going to see over the long term reinsurance will be used as a legitimate management tool to help improve capital efficiency and manage risk better," he said. "The life industry hasnt used it as much as the P&C industry for a number of reasons, but I think youre going to see more usage going forward."

Reproduced from National Underwriter Life & Health/Financial Services Edition, April 1, 2002. Copyright 2002 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.