Annuity Reinsurance

Insurance companies engage in reinsurance for one or many compelling reasons and benefits. Each outcome may significantly impact the risk profile and risk management strategy of participating companies. The key outcome is the change in surplus and expected pattern of profits of the ceding company.

1. Control Lapse Risk

Many insurers pay hefty sales commissions (to sales agents) in the first year of an annuity policy’s term, often soon after the sale. Evidently, the policy must persist for several years for it to become profitable for the insurer.

The typical annuity policies of today do not become profitable for the insurer until their 4^th year if the entire sales commissions were paid out right after the sale or in the first year. For instance, if an insurers expects young policies to lapse in large numbers, perhaps because it expects disintermediation, then in such a case, the insurer may reduce this expected lapse risk by giving away some of this risk to a reinsurer. Thus, via a reinsurance transaction, the insurer will have limited its future losses, should the scenario of disintermediation materialize as per its expectation.

2. Control Investment Risk

Investment risk is another key risk that insurers bear for their policyholders. If the insurer sees a difficult investment landscape in the future, it may decide to share the investment risk with a reinsurer. Occasionally, an insurer wants to utilize the expertise of a reinsurer in a niche, perhaps foreign market, and so it seeks the help of the reinsurer in generating better investment returns than are otherwise available to the insurer in the domestic market.

3. Underwrite More Business

Small or mid-size insurers may find themselves in a situation where they are selling far more policies than they are able to underwrite. In such a situation, the insurer will seek the help of a reinsurer in underwriting policies, so that it can keep utilizing its distribution (sales) system to its full capacity. Here, the insurer chooses not to reject new incoming sales despite its own underwriting limitations, because it hopes that in future, when the insurer gains more financial strength, it can underwrite its own policies and wont need the help of the reinsurer. Plus it is very difficult to sell annuities, so new sales are always welcome.

4. Change Insurer’s Risk Profile

At times, an insurer may suddenly realize (such as under new management) that certain types of annuity policies are not going to be profitable for it in the future. Or, the insurer may see a very high concentration of certain risks, and it may want to reduce those risks. In such cases, the insurer may want to ‘offload’ such annuities to a reinsurer until it feels that its overall liability risk profile are shipshape.

Let’s keep in mind that risk is relative and often a matter of perspective, and the same set of ‘risky’ annuities may be seen as immensely profitable by the reinsurer. This is particularly the case when the reinsurer has some a unique edge in manufacturing or managing such annuities, for instance, by having better derivative hedging capabilities or better investment management capabilities or some tax advantage. So, in such a case, a reinsurer may bid aggressively to reinsure (acquire) the very set of annuities that the ceding company does not want, creating a win-win scenario for both companies.

5. Expand to New Markets

Entering a new jurisdiction (new country) can be challenging for an insurer, particularly with respect to investment and regulatory landscape. Even within the same jurisdiction, launching a new line of business can be tricky, particularly in navigating pricing, commissions and competitive forces.

Reinsurance can act as a safety net, providing insurers with the ability to limit risks associated with venturing into uncharted territories. A reinsurance partner may offer much needed support and expertise, facilitating a smoother entry into additional jurisdictions or new lines of business.

6. Protect Statutory Surplus (Protect Ratings)

Statutory surplus is a critical factor influencing an insurance company’s ratings by rating agencies. State regulatory authorities also monitor insurers’ financial health and statutory surplus. So, here the motivation of reinsurance is to keep certain key financial ratios (particularly risk based capital ratios) at desirable levels.

An insurer may seek the assistance of a reinsurer in protecting its statutory surplus, ensuring it meets regulatory requirements and maintaining the insurer’s favourable standing with rating agencies in unfavourable conditions in future.

7. Sell or Buy Blocks of Business

As it is evident by now, a reinsurer very much steps into the shoes of the insurance company and assume all or most of the liability risks. In essence, a reinsurance transaction may be seen, quite simply, as the sale of an insurance business (or part of it) by the ceding company to the reinsurer. After a reinsurance transaction, the policyholders (whose policies were reinsured) may continue to receive service from the original insurer, but all their key risks and benefits are being managed by the reinsurer.