Europe and Asia will drive future growth as the US stays flat

WHO'S WHO

Name: Mitchell Schepps (MS)

Company: Aon Re Global

Job Title: vice-president

Name: Alberto Izaga (AI)

Company: Swiss Re

Job Title: head, life & health products

Name: Erwin Schnauder (ES)

Company: Munich Re

Job Title: chief life actuary

Name: Chris Rutten (CR)

Company: Max Re

Job Title: president, life reinsurance division

Name: Mark Geoghegan (MG)

Company: Incisive Media

Job Title: editor, Reinsurance Division

Name: Wolf Becke (WB)

Company: Hannover Life Re

Job title: chief executive officer

MG: Will the reinsurance segment of the life market grow in the next five years as much as it has in the past five? Why?

WB: I guess you will have to reflect the regional distinctions:

In the US, we are seeing major companies significantly increasing their retentions for new business. Therefore we believe that the life reinsurance market will shrink in terms of new business, but at the same time grow in terms of total in-force business (and reinsurance premiums paid).

In other markets, mainly in Europe, Australia and Asia, the progressing expansion of the underlying life markets - especially the protection markets - generally bodes well for reinsurers.

Greater China and Japan will be growth drivers, but also smaller markets like Thailand and Vietnam will be doing well. In Europe, we perceive an emerging market for senior citizens' products and a visible shift toward annuity products.

Also, bancassurance is expanding rapidly in the Eastern Mediterranean markets like Greece and Turkey, and major potential resides with the Central Eastern Europe countries, including Russia. So we expect growth acceleration for life reinsurance here.

MS: In the past several years, there has been a movement on the part of reinsurers to bring a new discipline to their clients as respects pricing and treaty terms and conditions.

We have seen a general increase in reinsurance rates for traditional reinsurance structures, as well as more difficult treaty terms for the ceding company. Ceding companies reacted by retaining more business and reinsuring less.

If reinsurance rates start to fall, we'll probably see some additional growth, but not until then. Also, we will see potential growth as the development of the life-insurance business in countries such as India or China expands.

CR: The market is unlikely to grow at levels seen during the early part of this decade due to tightening of pricing and terms, and the consequent lessening of pricing arbitrage offered by reinsurance previously.

In addition, since capital requirements for reinsured business are becoming less onerous and, at the same time, the finances of many life companies are quite strong, the demand for reinsurance to alleviate regulatory capital strain is no longer much of a driver of demand.

ES: Basically, growth in the life-reinsurance segment has been fuelled over the recent past by consolidation and restructuring in major primary life-insurance markets; reinsurers' more optimistic view of mortality trends; generally favourable demographic developments in conjunction with the withdrawal of financially troubled public-welfare systems; and the ability of life-reinsurance companies to structure tailored solutions to many of the issues facing their clientele.

Although the favourable scenarios are changing and shifting, we do also see opportunities for significant growth over the next five years, albeit at a presumably lower rate as up to now.

Consolidation also occurred in the life-reinsurance markets and has led to an increased level of pricing power for reinsurers, in particular in the US. Here, reinsurance rates for some important product lines have risen by 10% or more. However, a careful balance needs to be struck as ceding companies have alternatives available, such as simply increasing their retentions (in the wake of recently regained financial flexibility) or other means for managing their capital issues, for instance by securitisations. Therefore, we believe growth rates will be rather flat over the next few years in some of those markets that have been the dominant drivers of growth in the past (US, Canada, UK).

On a positive note, life reinsurers are set to continue to capitalise on the ongoing demographic changes and upheaval expected from new regulatory requirements, particularly in Europe (Solvency II), and the expected changes in financial reporting (the International Accounting Standards Board's Phase II project on accounting for insurance contracts).

All of these events would make client companies aware and alert to the importance of risk management in general. We also anticipate, as a consequence, an increased level of consolidation, with reinsurers expected to be among the key beneficiaries.

In addition, emerging markets like Russia, China and India are poised for significant growth, however from relatively low levels. We have deployed additional resources toward these markets, including the establishment of our life subsidiary Munich Re Life Eastern Europe and Central Asia in Moscow.

MG: What is happening in the pricing environment right now?

ES: This question has been partly addressed already in the reply above. In many important markets, though, the level of reinsurance rates has been quite competitive, and is supposed to remain so.

On a more positive note, we are seeing that in the pricing of life-insurance products, the exposure to guarantees and options is now better understood, and a more market-consistent (with financial markets) price will be charged ultimately to the policyholders.

AI: Business is performing relatively well in terms of profitability, and we have seen a stable pricing environment over the last three years.

WB: Life reinsurers have enjoyed good mortality results overall; even morbidity has done better than many observers had expected. In the US, we see a stable pricing environment, while in many European markets some pricing pressure is starting to emerge.

MS: It's in a state of flux at the moment. Established reinsurers who were perhaps 'ahead of the curve' on mortality pricing are trying to improve results by increasing rates. On the other hand, we are beginning to see the early stages of reinsurance rates being lowered as life reinsurers are facing the market reality of a reduced amount of new business.

There are several new life reinsurers opening in North America, the UK and some other countries. As a result, fresh capacity, no 'legacy' system problems and the reduced number of services provided give these new reinsurers potential advantage as their expenses are being incurred principally on new business transactions, thus giving them a 'fresh start' in controlling their pricing (to the disadvantage of some of the more traditional life reinsurers) and providing an active 'playing field' as respects more justifiably aggressive pricing.

MG: Are there any capacity issues that are worth mentioning?

WB: The life-reinsurance capacity per head appears to be stable. Capacity per catastrophe event has generally shrunk over the last five years or been limited to non-terrorist or non-nuclear, biological or chemical events.

MS: Since 9/11, there has been a real concern about risk aggregation that is bringing non-proportional covers such as life catastrophe and abnormal mortality stop-loss to the front as covers to consider. This has also led to several reinsurers having implemented maximum amounts of loss per location, per event for group-type coverages.

ES: As before, the response given last year still holds true. Expanding on this, I should like to add that, on the supply side, diversification of the business - with regard to geography or product lines - would go a long way in addressing any capacity issues.

Regarding event limits, we believe it would be very difficult to impose these on our ceding companies for proportional covers unless sanctioned by national laws. However, for non-proportional and group life covers, life reinsurers would have more room to limit their exposure to a concentration of risks or undesirable risks in general.

MG: Which territories are set for the best growth, and how are you positioned to take advantage of them?

WB: We believe Europe and Asia will be the growth drivers over the next five years.

CR: The demand for reinsurance to address longevity-related risks and morbidity exposures is increasing. This is the result of growth in the primary market for such products as a result of socio-economic developments and demographics. The ability to take on such exposures selectively and prudently, based on a solid knowledge of the underlying risks, is a differentiator that positions us and some other companies favourably.

AI: In the US, we are continuing to see a decline in cession rates, but these are down from historical highs. The Swiss Re market share improved during last year, so overall our sales in the US are stable. We are seeing strong growth in Latin America, Europe and Asia.

In Europe, we are seeing an ongoing growth rate of 4-5%, and are particularly pleased with better performance in protection-related sales in the UK. In Asia we have seen double-digit growth in profitability, and we continue to enhance our presence in emerging economies like China and Japan.

MG: What are your main worries for 2007 and beyond?

ES: After a period of change and volatility, currently both the primary and reinsurance industries appear to be quite stable.

Although there is no reason to be concerned in the near future, we follow with interest the accumulation of variable annuity products' guarantee risks on the liability side from guaranteed-benefit options such as guaranteed minimum-withdrawal benefit (GMWB). These riders have made significant inroads into the US product landscape, and have begun to spill over to some European markets.

WB: Over-regulation! We spend much more time than before dealing with regulatory topics under the various European regimes - for us, Germany, UK and Ireland are the most important ones - and may forget that our core activity is to serve our cedents!

Also, the introduction of international financial reporting standards (IFRS) into our balance sheet is increasing substantially the volatility of results that will require more extensive explanations to stakeholders.

In terms of the media's current obsessions, it should be noted that they (like bird flu and/or obesity) affect different parts of our portfolio in a reverse manner. Obesity is bad for life risks, but good for annuity risks - so payout annuities act as a natural hedge against mortality deterioration caused by obesity.

MG: How did Scottish Re get into trouble? How do we know more life reinsurers are not undergoing similar problems?

CR: The issues surrounding the developments at Scottish Re are well described in the industry press and there is not much I can add to it. The situation is quite unique. However, in general, when life reinsurers have gotten in trouble, it is usually related to either aggressive growth based on competitive pricing in the traditional market or entry into specialty segments of the market without solid risk management and knowledge to support this.

MG: What can the market learn from the Scottish Re episode of 2006?

WB: To establish a new major international player in life reinsurance requires patience - more patience than a publicly listed company will normally be able to afford!

ES: If anything, the Scottish Re experience will reinforce an existing trend of ceding companies to select financially strong reinsurers. Also, we believe long-term reinsurance relationships will be appreciated more highly.

CR: While the features described above are not necessarily harbingers of demise, with hindsight they are common stumbling blocks. For cedents, seeking security behind reinsurance arrangements and being cautious in the presence of 'erratic' reinsurer behaviour would seem to be prudent.

MG: Do you think we have seen a peak in life expectancy in the Western world?

CR: No, I don't believe so. But it does appear to me that life expectancies are not going to improve materially more than what we already anticipate as improvements. A considerable number of research studies have given the industry better tools to assess future mortality improvements and, as a result, we are better equipped to deal with longevity risks.

ES: We expect life expectancy in the Western world to keep increasing. However, the speed at which this is going to happen is hard to predict, as there are factors that could slow down mortality improvement rates.

On the other hand, there are factors that could result in even further improved mortality rates. We capture this uncertainty in mortality trends in our proprietary risk model for our life reinsurance business.

If I had to make a bet, I would bet on further improvement in life expectancy, if only for the reason that all medical research is directed toward this goal.

MS: We don't believe we've seen a peak. To the contrary, a lot of current life-reinsurance transactions deal with that very problem of improving mortality that increases the duration of payout on annuity products and forces companies to increase reserves or find a reinsurance solution.

MG: Now that the media panic over bird-flu pandemics has died down, do you think we are better or worse prepared as an industry to cope with this risk?

AI: While over 250 people have been infected with the H5N1 virus, this is still a very small number compared to the huge number of infected birds. The real concern is that the virus could mutate into a form that would be transmissible between humans, which would mark the beginning of an influenza pandemic.

In recent years, the nature of the pandemic threat has become more widely understood, and mitigation measures have made advances in surveillance, vaccine technology and national preparedness, including the stockpiling of anti-virals. Exchange of best practices between businesses, co-ordination between international organisations and an awareness of the need for national transparency makes controlling the disease more likely.

As an industry we are well prepared. Swiss Re has closely monitored potential pandemics for years, and is highly focused on ensuring it is prepared to deal with the full range of outcomes and supporting its clients in addressing the risk, particularly by transferring extreme mortality risk into the capital markets.

ES: The assessment of the exposure to a pandemics risk is unaltered. After giving this risk a lot of attention, the insurance industry now does a better job of monitoring the exposure and assessing it holistically across all lines of business. As a beneficial side effect of this review, plans for business-continuity management have also been upgraded.

MR: This varies a great deal by company. Some companies have implemented both operational and risk-contingency plans for such an event.

As an example related to operational risk, a company may have a plan in place to allow remote access to employees for critical applications. Some companies have mitigated the excess-mortality risk by purchasing Abnormal Mortality Stop Loss coverage or issuing mortality bonds.

CR: Much better, both operationally as well as with our risk profiles. Securitisations and other risk-mitigation tools are proving very valuable to mitigate the effects of such exposures.

MG: Do you see growth opportunities in the longevity market?

CR: Absolutely! Max Re has successfully focused on this segment for several years now, and it appears to me that the reinsurance market will benefit from growth in the primary market's demand for longevity products.

WB: Yes, definitely - this, coupled with the strong potential of the 'senior citizens' market', is providing insurance solutions to the needs of the 'generation 60+', which will be a major growth driver for many years to come.

MS: Most definitely. Insurance companies are becoming increasingly aware of the possible long-term-longevity risk. Also, taking on this risk can be used potentially by a mortality reinsurer as a natural hedge against mortality, including a pandemic event.

ES: Generally, we are inclined to answer this in the affirmative, but hasten to caution any too-optimistic views owing to the prevailing uncertainty about long-term trends in mortality improvements. We have reflected this uncertainty in a stiff risk-charge in our risk model.

MG: How is Solvency II affecting your financial planning?

WB: We will use a more sophisticated system of capital allocation toward each line of business we underwrite; consequently, it will affect pricing and reserving.

ES: As mentioned before, we have implemented our own risk model and thus we feel well prepared for any regulatory challenges of Solvency II. We do believe that the new regulatory requirements will provide us with significant reinsurance opportunities. We are therefore currently dedicating a lot of resources to meet the expected demand of our clients.

MG: How do you see increased use of alternative risk transfer (ART) and securitisation affecting the market?

ES: Securitisations have become more common and will increasingly play a role as a capital-management tool. However, these transactions are complex, and regulators and rating agencies are carefully monitoring the emerging market.

In contrast, reinsurance solutions, because of their flexibility and ease of implementation, will play a dominant role for years to come.

MG: How have the Swiss Re/GEIS and SCOR/Revios deals affected the market?

AI: The GEIS acquisition brought together two complimentary books of business, with only a modest overlap in treaties where both GEIS and Swiss Re had lines of business. In terms of the life business, the addition of an established portfolio in Europe - particularly in Germany - has provided Swiss Re with an excellent opportunity for organic growth. In the UK, the GEIS acquisition brought us a strong presence and expertise in critical illness, where GEIS was the market leader, and income protection.

MS: With the acquisition of GEIS by Swiss Re, another area of capacity has been eliminated, along with commensurate retrocessional business. Swiss Re, with its international array of markets and its capacity to service those markets, allows them to continue to use their intellectual as well as fiscal capital. The leverage this provides will continue to put Swiss Re in a market-leadership role.

SCOR acquiring Revios was a positive for both companies. We believe their emergence from a ratings shadow is definitely a plus for re-engaging both current clients. The new entity now brings a better balance sheet, in addition to its services, to prospective clients worldwide they wish to work with.

It also enables ceding companies, which are starting to respond to regulatory warnings on too much aggregation of risk with one reinsurer, to have a wider choice, which will provide diversification that will benefit them both, as well as satisfying regulatory interest.

MG: Do you see mergers and acquisitions (M&A) activity increasing in 2007?

WB: No, the two more obvious deals (GEIS and Revios) have been done.

MS: Yes, we expect M&A activity to pick up, especially with small- to medium-sized life-insurance companies. We believe there are many that simply have not been able to get to the necessary scale to compete. They will be forced to either merge with similar-sized companies to squeeze out expense savings, or will be acquired by larger organisations seeking growth.

ES: Following the turbulence of the early 2000s, the capital base of many life-insurance companies appears to have been restored. This is a precondition for increased M&A activity.

In North American markets, we expect in the near term (after a relatively quiet year in 2006) fewer outright sales of companies than block transactions, where non-core businesses and product lines are being shed.

For Europe, we believe consolidation and M&A activities are going to pick up only after the implementation of Solvency II. As demonstrated by past experience, the life reinsurers stand to benefit from these activities.

MG: Do you expect new start-ups in 2007?

ES: For the life-reinsurance industry, we do not expect significant further consolidation. On the other hand, however, start-up efforts will also be limited, as we believe the list of entry barriers referred to in our response last year keeps expanding - see, for instance, the increased complexity and onus of the new regulatory requirements referred to several times before.

MS: This will depend on the property and casualty (P&C) market. If the P&C market softens, investors previously attracted to the high returns may begin looking for alternative markets to invest in, and life reinsurance may provide the stable, non-correlated risk that is attractive to investor groups such as hedge funds.

CR: Other than certain exciting specialty-reinsurance ventures, I do not expect an influx of new entrants. Now that the growth prospects of the broad market appear to be moderate, there is the potential for over-capacity. In the absence of such growth expectation, investors will likely find it less compelling to commit capital to what is considered an attractive but low-teens return-on-equity business model.

WB: No - after the Annuity Life & Re and the Scottish Re experience, it may be difficult to attract financial funding in Bermuda or other preferred places.