In Force Fixed Annuity Block Reinsurance

Transcription

1 In Frce Fixed Annuity Blck Reinsurance A Strategy t Imprve Return n Capital Many insurers are experiencing lw r negative returns n in-frce fixed annuity blcks f business. In mst cases this is driven by the current very lw interest rate envirnment. Lw rates reduce prtfli yields and lengthen liability duratin driving lw returns. Reinsuring these blcks with an ff-shre reinsurer is ften a very effective capital management strategy. In these transactins, the insurer can utilize the structural advantages f a reinsurer in rder t free up capital and redeply it t higher returning businesses. Let s examine the case fr such a transactin. The Prblem Lw prtfli yields Given the current very lw interest rate envirnment, many carriers have in-frce fixed annuity blcks with lw and decreasing prtfli yields matched with relatively high minimum crediting rates. This drives lw r negative returns n regulatry and rating agency capital. Duratin lengthening These fixed annuity blcks are typically crediting a guaranteed minimum rate which is abve the currently available market crediting rates. Accrdingly, lapse rates n these plicies are at very lw levels, thereby lengthening the liability duratin beynd the duratin f the asset prtfli backing the liability. This mismatch between prtfli duratin and liability duratin has the effect f further reducing the prtfli yield as maturing assets are reinvested in significantly lwer yielding assets. Rising rates nt a panacea While rising interest rates can imprve the prtfli yield backing these liabilities ver time, it als may drive higher lapse rates as the crediting rates available in the market exceeds the in-frce blck s current and guaranteed minimum crediting rate. This can result in unrealized lsses as assets are sld t prvide liquidity. Additinally, if the investment prtfli duratin is shrtened in anticipatin f higher lapses, there may be n imprvement r a reductin in prtfli yield. Finally, if crediting rates are increased in step with the crediting rates available in the market, lw returns will persist. Other cnsideratins In additin t addressing lw returns, reinsurance is an effective tl in accmplishing ther bjectives: Exiting nn-cre businesses. Re-balancing verall prduct mix. Aviding higher capital requirements under Slvency II, Systematically Imprtant Financial Institutin ( SIFI ), and ther regulatry cnsideratins. Mntshire Advisrs Please cntact us fr mre infrmatin. We wuld be happy t prvide a detailed presentatin tailred t the specifics f yur cmpany.

2 In Frce Fixed Annuity Blck Reinsurance A Strategy t Imprve Return n Capital The Slutin Reinsurance Offshre reinsurers pssess several significant structural advantages ver primary insurers. These advantages can ften drive a mutually beneficial reinsurance transactin. In fact, ver the past five years, there have been ver $120 billin in such transactins cmpleted. Let s lk at these structural advantages. Better incme tax prfile Offshre reinsurers generally d nt pay US incme taxes while US insurers generally have an effective tax rate abve 25%. Lwer capital requirements In tday s pst 2008 envirnment, insurers typically hld capital at levels abve 400% RBC. This is driven by cmpetitive, regulatry, and rating agency cnsideratins. Offshre reinsurers d nt benchmark against perating US insurance cmpanies and d nt face the same cmpetitive capital requirements assciated with writing business as a primary insurer. Offshre reinsurers typically hld capital which apprximates 300% t 350% n an RBC equivalent basis. Capital at this level is prudent in a reinsurance transactin given the many ther structural prtectins typically prvided fr in such transactins. Investment flexibility Offshre reinsurers typically leverage rbust and experienced investment teams. Often these teams bring expertise in structured securities and ther higher yielding fixed incme asset classes. Offshre reinsurers typically perate in regulatry envirnments which affrd greater flexibility fr investment allcatins. Accrdingly, ffshre reinsurers are ften well psitined t invest in asset classes which better ptimize risk adjusted returns. Access t capital Offshre reinsurers are typically nn-public entities fcused n lng term returns and have demnstrated they can raise capital effectively frm sphisticated investrs. Laser like fcus n managing spread risk US perating insurance cmpanies have many cmpeting stakehlders which include sharehlders, regulatrs, rating agencies, emplyees, agents, etc. Cnversely, ffshre reinsurers perate lean rganizatins with few stakehlders and have a cre fcus n managing spread risk. Mntshire Advisrs Please cntact us fr mre infrmatin. We wuld be happy t prvide a detailed presentatin tailred t the specifics f yur cmpany.

3 In Frce Fixed Annuity Blck Reinsurance A Strategy t Imprve Return n Capital The Transactin Structure and Cnsideratins Over the past several years the rbust reinsurance market has driven a template fr deal structure and terms fr these reinsurance transactins which favrably address the factrs imprtant t insurers. Let s briefly examine the key terms in a typical fixed annuity reinsurance transactin. Frm f reinsurance These reinsurance transactins are typically cmpleted in the frm f mdified cinsurance, cinsurance with funds withheld, r cinsurance with assets in a trust. Each f these structures secures reserve credit fr the ceding insurer. In the mdified cinsurance and cinsurance funds withheld transactin structures, the assets remain n the cedant s balance sheet. In the cinsurance funds withheld structure, the assets are placed in a trust fr the benefit f the cedant. These structures are very effective in essentially cllateralizing the investment prtfli fr the benefit f the cedant. This is an imprtant cnsideratin in these indemnity reinsurance structures where the cedant remains liable fr the underlying insurance plicy terms and bligatins. Overcllateralizatin Typically reinsurers will vercllateralize the investment prtfli held against reserves. Specifically, the reinsurer will hld an amunt in excess f the reserve amunt fr the benefit f the cedant. While the level varies by transactin, the amunt is typically between three t seven percent f the ceded reserves. Investment guidelines Investment assets are managed by the reinsurer pursuant t an investment plicy negtiated by the parties and set frth in the reinsurance agreement. These guidelines reflect cnstraints and risk management prvisins generally cnsistent with thse typically fllwed by insurers. Impairments The reinsurance agreement sets frth hw asset impairments are defined and accunted fr. Crediting rate determinatin The prcess t be fllwed fr setting crediting rates fr the reinsured plicies is set frth in the reinsurance agreement in a manner cnsistent with the insurers market and regulatry respnsibilities. Reimbursement f expenses The reinsurer reimburses the cedant insurer fr all expenses assciated with the reinsured plicies t include administrative expenses, excise taxes, premium taxes, agent cmpensatin and reinsurance brkerage fees. Mntshire Advisrs Please cntact us fr mre infrmatin. We wuld be happy t prvide a detailed presentatin tailred t the specifics f yur cmpany.

4 In Frce Fixed Annuity Blck Reinsurance A Strategy t Imprve Return n Capital Hypthetical Example An insurer has a $1 billin blck f single premium fixed annuities in-frce. The plicies are mstly ut f surrender and 80% f the blck is crediting at 300 basis pints ( bp ). Agent cmpensatin and administrative expense adds anther 50bp t the cst f liability, fr a ttal cst f liability f 350bp. The liability duratin based n expected lapse rates is estimated t be 7 years. The insurer s investment prtfli cnsists f 60% investment grade crprate bnds with an average credit rating f A-, 20% Agency RMBS, 10% cmmercial mrtgage lans, and 10% allcated t belw investment grade and structured securities. The prtfli bk yield is 390bp. The prtfli has an unrealized gain f 5%. The net spread is 40bps, represented by the difference between the 390bp prtfli yield and the 350bp plicy ttal cst f liability. This 40bps n the $1 billin reserve blck is equal t $4 millin in annual pre-tax prfits. Assuming a 35% tax rate, the after tax annual prfit is $2.6 millin. Depending n the capital mdel (RBC, S&P Capital, r BCAR), the ttal capital requirement fr the blck fr an A rated and 450% RBC level insurance carrier wuld be between 5.0% and 7.5%, r $50M t $75M. The after-tax annual return n capital is therefre between 3.5% and 5.2%. The insurer reinsures the blck f business in a reinsurance transactin where the assets are transferred t the reinsurer at bk value and there is n ceding cmmissin beynd the $50M (unrealized) gain transferred. The transactin frees up the $50M t $75M f capital assciated with the blck. If the insurer redeplys this capital int a 12% return business, bth net incme and return n capital wuld imprve meaningfully. The actual ceding cmmissin in a transactin will depend upn, amng ther factrs, the ttal cst f liability, the liability duratin, the key terms f the transactin (e.g. investment plicy, vercllateralizatin amunt, etc.), and the prevailing fixed incme asset yields at the time f the transactin. Mntshire Advisrs Please cntact us fr mre infrmatin. We wuld be happy t prvide a detailed presentatin tailred t the specifics f yur cmpany.

5 In Frce Fixed Annuity Blck Reinsurance A Strategy t Imprve Return n Capital Mntshire Advice and Experience Mntshire s principals have led several reinsurance transactins with an aggregate reserve value f ver $10 billin. Mst recently in 2014, Mntshire advised a large public life insurer in a transactin t cede an apprximately $1 billin reserve blck f fixed annuities. Over a several mnth perid, Mntshire wrked as part f the client s deal team (CFO, finance staff, actuaries, tax prfessinals, investment prfessinals, and inside and utside cunsel) t advise and assist the client with the transactin. Mntshire s rle included the fllwing: Prvided the insurer an analysis f the expected utcme and benefits f a reinsurance transactin. The insurer cnsidered this analysis and made the decisin t mve frward and engaged Mntshire Advisrs as its advisr and brker f recrd fr this transactin. Assisted the insurer in cnsidering the ptential reinsurers in the marketplace and in selecting the reinsurers mst aligned with the insurers needs and bjectives. Assisted the insurer in develping a bid package t ptimize the psitining f the blck with reinsurers. Evaluated the bid prpsals and made mdificatins with the reinsurers n an iterative prcess. This included negtiating n behalf f the insurer t imprve the bid structurally and financially. Recmmended ne reinsurer with whm t mve frward t cmplete the transactin. Advised the client in negtiating the quantitative and qualitative terms f the transactin including frm f reinsurance, the vercllateralizatin amunt, selectin f assets t transfer, investment guidelines, the ceding cmmissin amunt, etc. This included advising ur client in its negtiatins with the reinsurer and representing ur client as an intermediary in thse negtiatins. The transactin freed up apprximately $65M f capital fr ur client t be re-deplyed t higher returning businesses. Additinally, it assisted ur client in achieving their stated gal with investrs t imprve return n capital. Finally, the transactin prvides a template fr the insurer t use in future reinsurance transactins. Mntshire Advisrs Please cntact us fr mre infrmatin. We wuld be happy t prvide a detailed presentatin tailred t the specifics f yur cmpany.