Author: Brian Lo
For most of the last decade, the majority of large inforce reinsurance transactions were annuity based. But with the most straightforward deals already done, both carriers’ and reinsurers’ focus has changed. In the new higher interest rate environment, the market is now concentrating on more complex, often problematic lines of business, where reinsurance can stabilize risk and free up capital for other, more profitable uses. We believe this trend will continue.
Motivations to reinsure are shifting
Insurers made the most of the low interest rate environment through 2021, taking the opportunity to offload portfolios with high guaranteed rates, while realizing capital gains when they sold assets in a reinsurance transaction. But as interest rates began to quickly rise, the opportunity to realize capital gains was largely eliminated, and inforce transactions became less attractive. At the same time, however, higher interest rates have caused increased consumer demand for annuities, making reinsurance flow transactions more appealing.
In a higher interest rate environment, other motivations come to the fore, such as the need to manage the risk of more challenging blocks of inforce business. Problems with complex products such as universal life with secondary guarantees (ULSG), long term care (LTC) and variable annuities take many years to emerge. At the same time, accounting practices often understate the degree of deterioration, leaving carriers reluctant to realize a loss by reinsuring the business. However, it appears we've reached a tipping point: Reinsurance volume of ULSG in 2023 was more than twice as much as the prior five years combined.
The ability to focus on core business is an important incentive for any carrier looking to exit a line of business. The released risk capital, which may be deployed to more profitable opportunities, is also attractive and serves as an important justification — financially and for external messaging — when reinsuring at a loss.
An evolving market
The graph below illustrates the sharp movement away from annuities and towards complex products, such as ULSG, variable annuity, and company-owned life insurance/bank-owned life insurance (COLI/BOLI). After a bumper year in 2021, the reinsurance of individual account annuities decreased.
Information from S&P and other public sources.
The supply side is changing too
Private equity sponsorship of asset-intensive reinsurers is growing and provides abundant capital. The increased capacity is pursuing fewer annuity deals, driving reinsurers to seek new markets and take on more complex structures.
The largest start-up reinsurers of a few years ago are now well established and have developed robust infrastructure. They have the expertise needed to evaluate and structure complex liability transactions and are more than simply “asset players,” whose competitive pitch is an investment strategy producing higher yields.
Within the asset-intensive market, investment specialties influence the demand for certain products. Reinsurers with long-term strategies, such as investing in real estate, may find long duration liabilities appealing, while those focusing on shorter-dated assets, such as private loans, may favor fixed annuities.
Reading the tea leaves
Inforce deals aren’t going away, but they're becoming more complex. Recently we’ve seen large reinsurance transactions that combine more than one line of business. Carriers may have combined blocks to completely clean house of problematic business, or they may have paired more profitable blocks with poorly performing business to avoid realizing a loss for the total transaction. Gallagher Re believes the next frontier will be LTC: Carriers with large legacy blocks continue to be punished in the stock market, which fears the business is under-reserved. However, LTC 's asset-intensive nature, coupled with advances in claims management techniques, are likely to reduce the bid-ask spread. Manulife’s recently announced transaction with Global Atlantic, which includes LTC and structured settlements, is one such example of an insurer reshaping their portfolio through divesting of legacy/low ROE blocks. We can expect to see more large LTC deals, as well as variable annuity and ULSG transactions.
External influences in the financial markets also affect reinsurance capacity. Changes to the funding capacity of private equity investors will affect reinsurers’ access to capital. Similarly, any consolidation among reinsurers may change the balance, as a reduction of industry capital may result in more selectivity. On the other hand, further acquisitions of insurers by private equity (PE) firms may lead to more industry capacity overall, as PE-owned groups achieve the critical mass needed to become external reinsurers.
Finding the right partner
This is an opportune time for carriers of any size to take stock of their inforce blocks and consider reinsurance as an effective way to clean house, free capital and focus on core objectives. In this unpredictable setting, carriers looking for reinsurance solutions can benefit from having an experienced advocate working on their behalf. Finding a reinsurance partner that will offer an arrangement tailored to the insurer’s requirements can be daunting. Gallagher Re’s Life Solutions team has advised on the selection of blocks to include in a transaction, on complex structural features and on widely varying financial terms and treaty conditions. We help carriers identify the risks and benefits of each component in a proposed structure, and the ways to mitigate or maximize them, acting as a dedicated ally from start to finish.
