The high capital requirements of traditional fixed and fixed indexed annuities must be managed carefully.  Reinsurance is a major management tool.  Inforce blocks of business can be reinsured to manage current capital levels.  Apply reinsurance to new business to manage to your desired capital levels on an ongoing basis.  Instead of restraining sales to manage capital levels, reinsurance allows you to continue to support your distribution channels by allowing them to sell the volume of new business desired and providing them with the variety of products needed.  The insurance company can diversify their accumulation business among traditional fixed, indexed, and variable annuities.

There are many structural alternatives with fixed annuity reinsurance.  Each targets a different issue or solution.  The three main alternatives are:

·       Traditional Quota Share

·       Structured

·       Redundant Statutory Reserves

Traditional Quota Share

This is equivalent to selling a share of business to the reinsurer.  The reinsurer shares in all acquisition costs as well as all product risks and rewards.  This is a permanent transaction, i.e., business stays with the reinsurer once it is ceded, and is not likely to be recaptured.  This is the cleanest transaction for purposes of risk transfer and is readily recognized by regulators, rating agencies, statutory accounting and GAAP accounting.  Asset management is a key issue.  The parties must agree upon whether assets will stay at the ceding company or move to the reinsurer, and who will manage the assets. Reinsurers can be onshore or offshore.

Structured

Structured reinsurance is geared towards providing the ceding company with relief of the high allocated capital required of fixed annuities.  The reinsurer does not share in acquisition costs.  Instead, the reinsurer will assess a fee for holding C1 and C3 risks.  All excess profits are returned to the ceding company via an experience refund mechanism, which are then used to amortize acquisition costs and provide a profit to the ceding company.  Any poor experience first reduces the ceding company’s experience refund and then is borne by the reinsurer.  Allocated capital relief is readily recognized under statutory accounting.  Because of the order of allocating any poor experience first to the experience refund and then to the reinsurer, structured reinsurance does not always satisfy rating agency or GAAP requirements.  Each transaction needs to be considered based on its facts.

Structured reinsurance will normally contain a recapture provision so that the ceding company can take back their business.  In fact, it is typically expected that a structured transaction will not stay in place permanently.  This flexibility can be attractive to the ceding company.  Asset management is also simpler, because the reinsurer will normally allow the ceding company to retain all the assets and continue their normal management practice.  Reinsurers are typically offshore.

Redundant Statutory Reserves

There are specific annuity provisions that can result in redundant statutory reserves.  Reinsurance can be structured to target these redundant reserves.  One example is the guarantee that a policyholder will never receive less than their original premium upon surrender.  This means that a normal surrender charge cannot be collected in the first year or two, and the statutory reserve must reflect this.  The commission chargeback that economically supports this guarantee is not recognized in statutory reserves.

A second example is the 10% free withdrawal provision.  Statutory reserves are determined assuming every policyholder utilizes this feature, but only a fraction actually do so.

There are various mechanisms by which an offshore reinsurer can provide a ceding company with relief from the redundant component of these reserves.  The reinsurer will assess a fee based on the amount of reserve relief provided.  Since the reinsurer is offshore, a Letter of Credit will be posted as collateral for the ceding company’s reserve credit.

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Each of these reinsurance alternatives are offered by different niche reinsurers, which are not typically the normal North American life mortality reinsurance players.  Ruark Insurance Advisors is a reinsurance intermediary specializing in annuity reinsurance.  If you’d like to learn more about these opportunities, please contact:

Rich Tucker, FSA
Vice President
(973) 783-3168
Rich@Ruarkonline.com