A Discussion on the State of Life Reinsurance
A Discussion On The State Of Life Reinsurance
Recently, a panel discussion on the state of life reinsurance was held via a conference call. Jay Novik, Black Diamond Group, moderated the in-depth conversation. The panel members were: Gaetano Geretto, Pelecanus Strategic Advisory Services, Inc., Kin Gee, Savont Corporation, Mel Young, RGA Reinsurance Company, and Mike Pado, Transamerica Reinsurance.
Jay: Welcome to all participants and thank you for your time in sharing your views with this panel. I appreciate your comments and questions to be used in today's panel discussion. In reviewing your input–I'm going through your comments now: what's on the horizon for reinsuring your clients, impact of changes on the reinsurance industry then and now, the impact of changes on the direct writers, what are the major issues confronting the reinsurance community today, impact of consolidation, and new reinsurers.
We see a new batch of companies starting up–with real interest in the life reinsurance industry. First off, how about discussing the successful start-ups?
Mel: That's an interesting point, what was the last successful startup?
Kin: RGA in the '80s.
Gaetano: I guess you could say Scottish Re has been the most successful of the new start-ups.
Mike: That's true.
Jay: Who else started in the late '80s as well? Among them, which subsidiaries have started that may still be active?
Mel: We mentioned Scottish Re.
Kin: ACE is still active. They may not be in the mainstream of what you may see now, but they're certainly active. They're a niche player and sticking to their knitting.
Jay: In terms of startups, Max Re has been doing alright lately, but that's because they shifted to non-life–they shifted their focus.
Mel: Again, I don't see them in the market much.
Jay: I don't think they're really in the life business anymore–they shifted to non-life. I don't think they're very active in Illinois.
Gaetano: How about London Life and Canada Life? They're bringing forces together as one. They're not what I call a recent startup, but they've been around for a little while. They're not in the top five, but they are active in traditional life through Canada Life and do both P&C and other business through London Life.
Mel: I would agree with Canada Life. Canada Life might be the last.
Gaetano: They bought the old Crown business, so you have to temper that definition of start-up for Canada.
Jay: When did Life Re re-start their business? That was a highly successful re-startup of General Re's life reinsurance business. It has now been consolidated into Swiss Re.
Gaetano: That's true.
Jay: What about ManuLife Re?
Mel: They're still theoretically a retro primarily, I think.
Jay: Let's move on and start with what would be a good second question.
Gaetano: Maybe we could group together about three to four of the ideas that you talked about, Jay–the impact of the ceding company, the reinsured, and so on. I grouped these all together and I'd like to suggest that we call it the supply chain relationship and maybe what we could just discuss is the supply chain relationship and how that's impacted how risk management is used all the way down the supply chain.
Kin: I think the supply side relationship is potentially a good one, but another alternative is to think about combining some of the ideas into trends or themes. For example, the consolidation of the insurance and reinsurance industry has significant implications. Consolidation is actually a bigger impact on the ceding companies from several aspects: (a) reinsurance of new sales–whether we can get the number of diverse reinsurers, and (b) credit risk. There's now a tremendous concentration of reinsurance receivables. We previously mentioned Scottish Re for example. Scottish Re has now jumped to, I believe, somewhere among the top three reinsurers in market share for in-force business in the United States. There is potential for credit issues for some ceding companies that have previously thought they have receivables from ERC, ING, etc., and now all these receivables are combined into a single entity. In addition, a related issue to that is obviously in pricing and competition from beyond the traditional reinsurance providers.
Jay: Kin, can you expand upon that?
Kin: There are two sides of what the impact is, depending on whether you're the buyer or the seller as well as the reaction in the marketplace and then on competition as a whole. I think Jay talked a little bit about capital earlier. Some of the reinsurance buyers are larger financial institutions with strong capital base and could afford to keep more risks if the price is not "right." However, there are products that have very significant reserve or capital requirements that make the economics without reinsurance somewhat unattractive to ceding companies. This relates to the whole issue of securitization from the Wall Street firms providing capital solutions for the XXX or A-XXX reserving requirements. It is not just the supply side (i.e., reinsurance companies) that is driving the major industry trends. In particular, the consolidation that is happening in the industry is impacting the demand side as well.
Mel: I did a survey as I was traveling around among ceding companies last year, with ING, ERC and Annuity & Life Re going away. I started talking to people about that because I thought that there would be an interesting dichotomy amongst different companies depending on their characteristics as to what they thought were the problems that the consolidation created for them. Surprisingly, I found very few companies mentioned reduced capacity as a concern. Of those I talked to, a handful feel that they're in the really large case market. Even for these companies they felt that if their competition's capacity was equally impacted that it wasn't a key issue.
Jay: You're referring to the individual risk capacity issue?
Mel: Yes, individual risk capacity. Another major concern created by the consolidation that was expressed by the number of companies was a reduction in reinsurance services, such as underwriting support.
Jay: It's always what buyers say they want. I remember years back that I felt North American Reassurance, now renamed Swiss Re America Life and Health, was a very high-service company, but if we didn't have the lowest rates, buyers were more than willing to go to a lower-service company.
Mel: I'm not disagreeing with that, Jay. The question that I asked didn't specifically address changes in their buying decisions. I asked companies the question, "how has the consolidation of the reinsurance industry impacted you?" The concern they expressed was the reduction in services provided by life reinsurers this being exacerbated by the fact that some of the recent start-ups were advertising themselves as 'no service' providers.
Mike: Or minimal service.
Mel: A lot of the companies that I visited believe that the number of service providers has diminished significantly. That was a concern that was expressed. There weren't a lot of people that were concerned about capacity. There are a handful of companies that I'm aware of that are concerned about the issue Kin mentioned–spread of risk. So far there are only a handful of companies that I'm aware of that have expressed significant concern about that. Some of those companies have changed their reinsurance practices, to go from a quota- share to an excess-share form of reinsurance. These companies generally had risk management rules defining reinsurance relationships. These rules might have dictated allowable concentration levels within rating classifications. You can go back a number of years to when there were four AAA life reinsurance companies active in the market place. Three of those are either no longer AAA or no longer in the life reinsurance business. Thus those companies with formula driven rules have had to revisit them.
Gaetano: That's right.
Mike: At Transamerica Re, we have experienced that phenomenon as well. There are a few, not a lot, but there are a few primary companies that did have more sophisticated concentration risk guidelines. Typically they were looking at how much business they ceded to any one reinsurer. As the market has continued to contract, some suddenly feel overexposed to one reinsurance company or another. Some of the companies actually changed or modernized their old formulas to adapt to changing market conditions. We feel that we have been spared somewhat because deliberate application of the old formulas would have limited the amount of business we would be able to assume from what we perceive from high quality companies.
Jay: Life companies historically haven't been as focused on reinsurance security and credit ratings as the non-life companies who tended to be very focused on this issue.
Kin: I agree with that, Jay, and I don't have the benefit of Mel's survey, I don't know how many companies he talked to. I guess my question relates to the fact that at more and more ceding companies, it's not just the business side that is doing the buying, but that there's the corporate side as well. Therefore, depending on who you talk to at the ceding company, you may get different perspectives. Some of the issues I raised tended to be more corporate concerns, not from the guys on the business side who may be involved in the buy decision. Certainly from looking at recent SOA meetings and trade conferences in the last couple years, the topic seems to be more and more of a hot topic and the meetings seemed to be reasonably well attended in terms of the audience. That's why I do raise the issue. My comments are not a view on any reinsurance company, but I know that the jump in the amount of reinsurance in force seems to make a number corporate people nervous in terms of the concentration of risk. There are also other issues, obviously, from consolidation beyond credit risks. For example, consolidation clearly had an impact on prices and the price increases seem to have some impact on buying behavior.
Mel: I should have said that the #1 concern was the increase in reinsurance price. The #2 concern expressed was the reduction in services. So far, only a few companies have reacted to the changes in the market created by consolidation.
Kin: And I guess my question–maybe because my own background is a bit different now–I think there are a number of different reactions. One is obviously with respect to new buying behaviors and practices and two is–I don't have a good answer for this, but–I am certainly aware on the capital market side. For example, there's been a lot of attention paid in terms of credit derivatives and there are things happening on the corporate and asset side of buying companies. Ceding companies have this exposure too. I'm not going to pick on XYZ reinsurer, but my understanding right now is there's been a lot of attention from Wall Street firms and even reinsurance brokers that are now coming in with credit derivatives and that may have some impact in terms of the consolidation.
Jay: So, Mel, what do you think of the issue of pricing capacity?
Mel: Certain factors, including pricing capacity are considered when initiating a start up. That's one issue, but based on recent activity some new entrants into the life reinsurance business are not really start ups. For example, ACE has been in the property & casualty business, both direct and reinsurance, for some time. My understanding is that they are now considering entering into the life reinsurance business.
Jay: Let's go back a little bit. I am intrigued by one of the questions that Mel suggested. Reflecting over the past few decades, what do we perceive as mistakes that we made or others have made in the business over the years?
Gaetano: Okay, let me start. I think, Jay, you've got a good point there. Building on Mel's point and joking about what you said earlier about the number of mistakes that have been made in the industry, the big thing that we see now, Mel, among new entrants is, they're coming in with a much different risk management framework. Granted, they may say that they are no-service companies, but they're spending all their time basically doing risk management of whomever they're dealing with. None of them are going in there with a blank check. They're generally going in and they're really assessing some of the underwriting criteria and the claims criteria, maybe not up front, but certainly within the first year of being on the pool and I think fundamentally that's what's really been different about the way business is being done now, whereas how it was done in the past. Consequently, ceding companies have been a little bit put off by that. They're not used to, say, someone coming in so soon after being on a new pool and wanting to kick tires in the underwriting, admin, and claims areas.
Jay: I was only in the life reinsurance business for a relatively short period of time compared to you or Mel. I moved on into non-life. My recollection is we did a lot of excellent claims work. We worked very closely with the companies. We did a pretty good job of understanding the companies and their products. Then we went about pricing pretty much in consistent ways to what we understood about the products and the company. I remember the select and ultimate products and the pricing assumptions that were being made. It was impossible to reconcile these assumptions with what you knew about the companies' other term products. I think that we gathered a lot of useful information. I'm not sure how well it was utilized. Mel, can you think back that far?
Mel: Yes. You know, that was a flawed process that I think we all recognized it was flawed.
Mel: During that time, overly aggressive pricing was common. Frequently market share was given more stress than pricing discipline. I suspect that we are all hoping that somehow things would get better. I wonder if there isn't a parallel to recent market conditions.
Jay: I'm thinking that it sounds really good that reinsurers these days want to understand their clients and their clients' products. What will happen when new companies have large pools of capital and the prices start to decline? Is the pricing already starting to drop? For many years, before I was in the business, I didn't think life reinsurers could do anything wrong. I'm sorry John Tiller couldn't be here today because when I got into the business in the late 70s, the first company that really became highly competitive was Transamerica. It wasn't irrationally competitive. It was just competitive. Before that the price of life reinsurance was high, probably unreasonably high.
Gaetano: So effectively Jay, we've gone through almost the second cycle, if you wish, from where things started to get very competitive, things leveled off in the late '90s when there was so much quoting going on. With 90 percent quota shares on term, we went through this accelerated roller coaster again from competitiveness and am I hearing you and Mel say that we're just ramping back up that roller coaster again to stabilization in terms of expectations between reinsurers and ceding companies?
Mel: In the 90/10 quota share environment we have been in, it should not have been unexpected that a few ceding companies recognizing that they are only assuming a small percentage of the risk, started to let that fact impact their underwriting discipline.
Jay: I think you're right, Mel.
Mel: This led to some bizarre underwriting decisions. As reinsurers became aware of the problem they have reacted in a variety of ways. Some companies have threatened to no longer pay claims, some companies have had meetings with clients and tried to rein in those underwriting actions or attitudes, some companies have terminated relationships with those direct writers whose actions were viewed to be particularly egregious.
In the 70s and 80s, companies were typically ceding 10- to 20-percent of their mortality risk. Today many companies are ceding 60 percent of their mortality risk. This change has made us all aware of the importance of a healthy life reinsurance market. Although, the recent problems have been highlighted, there is a general atmosphere emphasizing the importance of getting the problems fixed.
Jay: As prices go up, is there a chance that the reinsurers' share of the market is going to go down?
Mel: I would expect that the reinsurers' share of the market will go down.
Gaetano: That's already happening, we're witnessing it right now.
Mike: I've noticed some of the problems of the distant past and I guess the way I'd answer it is that perhaps in the past there was a push on sales and market share which in turn led to deteriorating results among a number of players. Control environments were generally ineffective or non-existent. It took a while for the related results to show up. More recently, it turns out that there has been a combination of drivers and factors that have led the charge to restore common sense and hence restore the reinsurance market toward a more prudent place. However, the tougher financial terms and stronger treaty conditions along with the exit of ING has unintentionally created quite a conundrum for the many in the primary market. They've generally seen the prices go up and experienced margin compression. We've noticed that some companies had alternatives to finance their XXX reserve strain. Some have accessed these alternatives and moved away from a first dollar quota share coinsurance and now reinsure on an EOR YRT basis. A coinsurance-oriented reinsurer can experience dramatic revenue reduction on select accounts. Generally, it's the larger companies that have these options and alternatives. So, I think it could have a rather dramatic effect on reinsurers that cannot adapt.
Gaetano: Do you foresee then that we're going to see a flattening of revenues among most of the major reinsurers?
Mike: I think there's going to be downward pressure on us for sure. There's a major account that I'm aware of that has moved away from 90/10 quota share to 50/50 quota share so it's proportional reduction. Other companies basically said that they took an intermediate step and now will only reinsure for example the portion of the risk in excess of $1 million.
Jay: Won't that be a good indicator–when you start seeing a trend toward re-establishing these 90 percent quota shares? Will it not be an indication that market pricing has now dropped to the point where companies can again use it for arbitrage?
Mike: Yes, but it's presumptive that they're dropping. I don't actually see that.
Mel: Mike, I don't think that's what Jay meant. I think what he meant was, going forward, some time in the future, if we see a return to those high quota shares that might mean that we as reinsurers are making mistakes again.
Mike: I see. I agree it might.
Jay: Right now, it appears that companies are less able to use reinsurance in an arbitrage strategy.
Mike: That's true. I would agree with that.
Jay: And when that starts again, it would be an indicator that the pricing is going in the wrong direction for reinsurers.
Mike: I think it would be a red flag, so to speak. From where I sit, it seems like, as a result of everything I just mentioned, it seems that primary companies are now seeking a diversity of solutions and so reinsurance now becomes one of, instead of the one and only, practical risk management and financing solutions available to insurers.
Mel: I have a somewhat different point of view, which might be wrong–it wouldn't be the first time. But I think that some of the people that have left the market completely were following a market-pricing leader that's no longer active. And that market-pricing leader was significantly under pricing the market–which is one of the reasons they're no longer in business. Going down the garden path, some companies are more apt to follow pricing leaders than others. Whether a reinsurer was following the pricing leaders or not, the tone that these leaders set, might have contributed to all of us taking our eye off of the ball (i.e., we probably weren't as alert to the changes in some companies underwriting practices as we should have been).
Jay: Given how reinsurance players followed the price leader, I don't even know that it's a problem.
Mel: I liken it to the days of Executive Life on the direct side–many companies believed Executive was conducting their business in an unsound manner, but over time as their market share increased some of those companies felt compelled to follow those practices.
Jay: Yes, but Annuity and Life Re's capacity was so limited. Why would you even be worried about them as a competitor?
Mel: I agree, but I do believe that some companies did follow them. It's the best argument that I can come up with to explain the pricing that was evident in the market at the time.
Mike: Isn't it true that you could generalize that? There are one or two companies that are no longer around that were followers of the "price leaders." The most aggressive price leaders are also no longer in existence.
Jay: It's like the concern that the startup of these new reinsurance companies will affect the market. My view is the market is the big boy. They're the ones who really affect the market. You're not going to get a $500 million capitalized company that's going go change the market.
Kin: I don't look at the new entrants as a negative.
Jay: No, I don't either.
Mel: The new entrants obviously serve a purpose, but I believe that a vacuum was created by the exodus of several full service reinsurers that the new low service providers have not fully addressed.
Jay: The new reinsurers might have a positive impact, in general.
Mel: Sure. But the addition of one or more well capitalized full service providers would be helpful.
Jay: I don't believe that until buyers are willing to pay for full service and until buyers are willing to pay for credit rating and reflect that, that they're going to get that. For as long as I can remember, companies talked about how much they liked service. On the other hand, when you put in, when there was a fee for service for reinsurance–I don't recall anybody ever taking a higher fee because of service.
Mel: It's not just service, Jay, and I'd love to hear what Mike's point of view is. The very dramatic exodus of several key players has shaken the market. Although, some companies may have reduced the amount of reinsurance they purchase, it is not unusual to see reinsurance being purchased from well rated full service reinsurers despite price.
Mike: I had a little trouble with the initial premise posted a few minutes ago, that is an unspecified startup acting as a price leader. With respect to the term market, I would say the recent market entrants have had little if any effect thus far.
Mel: I agree with Mike completely.
Mike: And nobody was following them per se. I think they were in a little bit of a tough position in terms of being perhaps one of the earlier life startups offshore. Perhaps they were pressured to offer more favorable terms and conditions (vis-�-vis existing reinsurers) in order to obtain foothold positions. I think that was part of their demise. From the term side, ING appeared to be the "price leader." They basically had a lot to do with the "war on pricing," so to speak. Many companies looked at their size and ratings along with their pricing and services and entered into very, very large quota shares with ING Re. In fact, for many ceding companies, ING was the sole reinsurer or had the majority position on the account, and when they were sold, each of their client companies suffered greatly. They no longer had the reinsurance support behind them. All of their capacity, in every sense of the word, was taken away. Now there is still a focus on ratings and there remains a demand for services. Companies though, carefully consider how they go about paying for them. One of the fallouts from all of this is that companies are no longer willing to stack the deck anymore and put themselves at key partner risk anymore. They are seeking to form balanced reinsurance pools with creditworthy partners. The word partners will take on more meaning as the market evolves.
Gaetano: Where I see this is in a different way than you do, Mel, when you say that was the only issue, that it was everybody following the price leader. I go back to Mike's earlier statement. I think everyone had very different revenue objectives five years ago. That's what was driving people, and that's what was driving pools to be as large as they were in terms of how many players there were on certain pools. That's in contrast to Mike's earlier point when maybe ING was only one of two players in a pool, you had a few people who could get in the back door without giving away all of their pricing. Now we see a different approach, where people are taking a much more conservative approach. They're not willing to basically go out and say I'm willing to go out and follow or I'm willing to take whatever share is out there. Rather, reinsurers are saying, I might just walk away. Fundamentally, this is a very different way of looking at the market.
Mike: And in the face of the new startups you mentioned, ceding companies are finding their way. We've been noticing that primary companies are willing to have just one or two reinsurers in their pools. It appears that ceding companies have been awarding minority shares, very small percentages to get into an account. They can, therefore, go to their Boards and say we have four reinsurers. The startups will be able to grow rapidly, albeit from the small base. I don't know that these smaller players will materially affect the traditional life reinsurance market for some time.
Jay: RGA started as an initiative of General American, right?
Jay: RGA's chief underwriter thought he was overpaying for his reinsurance and started having conversations with ceding companies who he felt had better fundamentals as far as underwriting experience. Basically discussing with some of his peers and before long they got to be pretty big and then formed a more mature unit and spun off and resulted in what we now know as RGA. So, some of these new initiatives may well end up as companies, as independent companies down the road.
Mel: It depends on the speed at which it will happen, that's all.
Part II of this article will be published in the December/January issue of The Actuary.