The insurance industry relies heavily on reinsurance, a strategic financial transaction that allows insurance companies to manage various risks effectively. In this primer, we’ll quickly touch upon the various reasons insurers engage in annuity reinsurance, and also delve into the methods (processes) involved in annuity reinsurance.

What is Annuity Reinsurance?

Annuity reinsurance is simply a transfer of risk from one insurance company (called ceding company) to another insurance company (called reinsurer).  Annuity contracts hold multiple forms of liability risks, particularly investment risks and longevity (mortality) risks. In a reinsurance transaction, the ceding company pays a premium to the reinsurer in return of protection (insurance) from certain risks, similar to the way an individual pays premiums to an insurer to protect herself from certain risks.

Here, a key question that begs to be asked is, if risk mitigation all there is to it? Let’s find out.

Why do Annuity Issuers buy 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 4th 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.


So, as we see, a reinsurance transaction can enable an insurer to make strategic changes regarding its portfolio of business. This flexibility is crucial for adapting to changing market dynamics and is just as crucial for the overall health and liquidity of the annuity industry.

Types of Reinsurance Transactions

Understanding the types of reinsurance is essential for insurers looking to tailor their risk management strategies. The two prominent methods are Coinsurance and Modified Coinsurance (MODCO).



Coinsurance involves the ceding of a portion of an insurance contract to a reinsurer on a pro-rata basis. Coinsurance is the most popular form of reinsurance transaction. Coinsurance is often also called as Quota Share Coinsurance.

In Coinsurance, the reinsurer participates in premiums and benefits according to a fixed percentage negotiated at the inception of the reinsurance treaty. Reinsurer will also assist the ceding company in covering all types of risk proportionally, including death benefits and surrenders. The reinsurer will receive a share of gross premiums (minus commissions and onboarding expenses) from the ceding company. In return, the reinsurer pays the ceding company a share of the covered benefits.

In coinsurance, the reinsurer manages the investments independently of the ceding company.

Modified Coinsurance (MODCO)

Modified coinsurance (MODCO) is a special form of coinsurance transaction in which the ceding company retains the statutory reserves of the reinsured policies and the associated assets . MODCO can simply be understood as ‘coinsurance with funds withheld’.  While MODCO operates similarly to coinsurance, it provides the ceding company with greater control over the general account (investment and asset management). When the policy benefits become due at a later date, the ceding company will pay premiums to the reinsurer and will also pay a part of the investment returns.

In MODCO, the reinsurer can be seen as loaning the reserves back to the ceding company (but actually the reinsurer never receives the reserves). In practice, the reinsurer receives interest on these (presumably) loaned reserves, and this interest is called MODCO Reserve Adjustment.

Negotiating Reinsurance Deals

Setting interest rates (option budgets), expenses and investment risk limits are typically subject to intense negotiations between the reinsurer and the ceding company. For instance, a ceding company may want to limit the investment risks taken by a reinsurer. At the same time, the ceding company may want the reinsurer to set higher credited rates on deferred annuities (via higher renewal rates or option budgets). Likewise, a ceding company may want the reinsurer to pay more for the reimbursement of acquisitions costs (commissions).

In MODCO treaties, the interest rate charged by the reinsurer (via MODCO Reserve Adjustment) may need to be renegotiated after inception.


Annuity reinsurance is a powerful tool that empowers insurers to navigate the complex landscape of annuity business. By strategically employing reinsurance, insurers can control lapse and investment risks, underwrite more business, expand into new markets, protect their statutory surplus, and engage in strategic portfolio management.

At Annuity Risk, we offer detailed due diligence and implementation support for the most nuanced of reinsurance treaties, providing insurers and reinsurers with unprecedented flexibility in tailoring their reinsurance transactions, managing their data and monitoring key financial and actuarial risks.

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