Life looks to Europe and Asia for the next generation of growth

Life reinsurance has experienced phenomenal growth over the last decade, driven largely by increased...

Life reinsurance has experienced phenomenal growth over the last decade, driven largely by increased cession rates in the US and UK markets.

As this growth levels off, and cession rates peak, Mark Geoghegan asks the world's top players to highlight which territories and product lines are going to take the baton for the next 10 years.

Of course we haven't just been talking about the US and UK markets - our discussions have covered the investment markets, the credit cycle's effect on life pricing and whether underwriting annuity business is an effective hedge against mortality risk. And, of course, we had to get a little expert reaction to all the hysteria about the prospect of a 1918-style flu pandemic and its likely effects on global life reinsurers.

So read on - we think you will find the answers illuminating ...

MG: Is the reinsurance segment of the life market set to grow in the next five years as much as it has in the past five?

MP: From the late 1990s in the UK, there was strong growth and a move to large quota-share reinsurance for the life and health business. The reserving/solvency requirements for reinsurers compared with direct writers encouraged this. Regulation reflected, in part, reinsurers' greater diversification and created a kind of arbitrage, and lower reserves/lower capital enabled competitive 'wholesale' prices.

Simultaneously, direct insurers found that investment markets were not performing. Sales of investment products fell sharply, and sales forces and intermediaries redeployed their efforts to protection products.

A booming housing market - and in the UK, protection sales are associated with mortgage sales - we had a 'perfect storm' for growth in reinsurance. These dynamics changed life reinsurance from something that was simply used to smooth out large claims to become more of a capital-management tool, creating price advantages that were then passed on to the ultimate consumers.

Currently in the UK, cession rates are holding up, but as we're seeing falling mortgage volumes due to a cooling housing market, the underlying volume is not growing as it was. I think that, for the UK in 2006 and 2007, sales of protection products will be pretty flat.

To compare and contrast this with the US, our own studies have estimated that cession rates are down from about 62% in 2002 to approximately 50% in 2005. A couple of dynamics are in play - firstly, reinsurance prices have hardened in the US. We used to feel in the life and health business that there was no reinsurance pricing cycle, but in the US we are seeing prices go up, and clients deciding to cede a little less to reinsurers as a consequence.

Another dynamic in the US is the consolidation of life reinsurers - and that means there is a greater concentration of ceded risk in a smaller number of balance sheets. Direct insurers are therefore examining the amount of exposure they want to give to any one reinsurer, the reinsurers rating as well as the reinsurance industry as a whole - and in our view, that is slowing cession rates in the US, where we expect more modest growth than in the past five years. Our challenge is to grow Swiss Re's business at a greater rate!

WB: In the US, we believe that the life reinsurance market will shrink in terms of new business, but at the same time, will grow in terms of total in-force business (and reinsurance premiums paid) in the mid-to-high single-digit percentage basis.

In other markets, mainly in Europe and Asia, the progressing expansion of the underlying life markets bodes well for reinsurers. Asia, China and Japan will be the growth drivers, but also smaller markets like Thailand and Vietnam will be doing well. In Europe we perceive an emerging market for senior-citizen products and a visible shift toward annuity products. So we expect a growth acceleration for life reinsurance here.

In the US, we generally see a decreasing use of reinsurance from the large players: cession rates will fall to 35-40% of new business written, much lower than the 60-65% experienced in the late 90s to earlier parts of this decade.

In Europe and Asia, cession rates have been typically more at 15-20% - with the UK being an exception in using higher cession rates, due to the extremely conservative valuation principles as prescribed by the Financial Services Authority (FSA). We believe that in Asia and Europe (excluding the UK), cession rates will remain at the current levels.

UE: To start with, North America: High quota-share risk reinsurance, placing essentially up to 90% of the annual business production into reinsurance, was largely driven by the motivation of the direct insurers to protect their own shareholders' capital from being locked into long-term reserve funding for the protection business.

I can't see any indications for a change in this trend, but unavoidably, the volumes of new business being ceded to reinsurers will flatten off, respectively, to be more or less equivalent to the growth of the direct market. In Europe, the strong growth in life reinsurance volumes - visible in some national markets such as Germany and the UK - had been driven by special developments. The German market had to face the loss of tax benefit, and at the same time was confronted with the financial need to strengthen reserves as a consequence of low investment yields after the bottoming out of the capital markets in 2003. In the near future, however, in all of Continental Europe, the general trend to old age-provision products cannot be supportive to life reinsurers.

An exception to the rule could be the UK market. In recent years it has tended to follow more and more the pattern that we had previously observed in the US. Here, it was driven by solvency considerations of the direct insurers, and this trend is as yet unbroken. As a consequence of the somewhat delayed Solvency II discussion in Continental Europe, this will certainly become a major issue as well, but with a deferral period of three to five years.

To sum it up, after a period of more moderate growth in the near future, there is a positive outlook in the mid term. Looking at the Asian markets, it seems very likely that the gradually growing prosperity - though still at a low level - will drive the need strongly for life insurance products long term, but with a rather moderate influence on life reinsurance in the coming five years, in particular when compared to the dominant volumes in life reinsurance produced by the traditional markets.

SW: We identified an opportunity based on market conditions in the late 90s. But what happened post-formation was beyond what we would have envisioned in terms of the nature of the opportunities.

Cession rates in the US have come down in the past two years, and I see them going down yet again in 2006 as companies are retaining more risk because they have seen reinsurance rates go up, but I believe they will probably bottom out in 2006 or 2007. However, there are factors that will stop the decline, and perhaps rates will slowly and steadily increase toward the end of the decade.

One factor is that we are that we are going into a more difficult credit cycle over the next few years - credit and financing facilities coming from banks, who have provided a lot of liquidity recently, may be more expensive, and there may not be as much capacity.

Factor two is the continued evolution of securitisation techniques that allow reinsurers to reduce the cost of capital that goes into our reinsurance pricing. We should be able to pass some of that cost saving on to our customers, and that should increase demand.

The third factor is that the primary companies in the US are not as accustomed to bearing volatility in their mortality result because they've been used to reinsuring upwards of 90% of their mortality risk. The retention of more risk potentially introduces more volatility into their profit and loss. Some companies are probably not going to react favourably to that, and they are going to re-offer portions of their book to the reinsurance market.

PK: We do not expect the traditional segment of the life reinsurance market to grow at the same rate in the next five years as in the past five. Cession rates peaked in the early 2000s, and are now starting to decline. To a large extent, the growth in cessions of the 1990s and early 2000s was driven by overcapacity in the reinsurance market and competitive pricing. With the consolidation we've seen in the last few years, rates are firming and cession rates are declining. Going forward, I think growth in the traditional segments of the market will more closely reflect growth on the direct side.

However, in the US and international markets, we're seeing new non-traditional opportunities for growth. Some of these opportunities are technology-enabled, like innovative underwriting solutions for products sold via non-traditional distribution (for example, bank assurance, direct marketing and telemarketing). Some of these opportunities are related to capitalising on strong financial strength ratings and providing financing via reinsurance agreements. And some opportunities involve capitalising on traditional strengths in mortality and risk management, in combination with technology enablers and financing capabilities.

CR: It is unlikely thatthe market will grow in the same way and at the same pace as before.Not only have reinsurers tightened pricing and contractual terms, which will result in increasing retentions, but the dynamics of the excessive reserves is changing as well. Securitisations, principle-based reserving and other developments that in one way or other mitigate cessions to traditional reinsurers will increase in prominence. It is likely that a 'back to basics' approach will prevail with - in all likelihood - a flat or low-growth market.

ES: In some of the markets, where we've seen over the last decade very material increases in the amounts of business available to reinsurers, growth rates are indeed beginning to level off. This is mainly due to a certain saturation of these markets - notably the US and Canada, but also the UK - in the sense that meanwhile, in many segments, enormous quota shares of new business (50%+) are ceded to reinsurers.

Besides attractive reinsurance rates, the growth was to a large degree fuelled by capitalisation-related issues at the primary companies, be it in connection with mergers and acquisitions (M&A) opportunities, de-mutualisations or general solvency and capital management issues - with the latter being primarily relevant in highly regulated markets.

As solvency regimes are meanwhile tightening in other regions as well (Solvency II in Europe; similar developments in Asia), we expect that demand for reinsurance will be markedly stimulated in those markets in the future. Other markets with mid-term growth potential are China and India.

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

ES: While the established Anglo-Saxon markets will continue to cater for very significant amounts of business in absolute terms, Europe and parts of Asia should display the more noticeable growth rates in the mid-term future.

MP: In Continental Europe and Asia, we are optimistic that cession rates will increase. Although European reinsurance markets have been active over a number of years, they've not utilised the benefits of the large cession rates that we've seen in the US and the UK. This is likely to change.

Reinsurers will have to be able to add value to encourage growth; for example, in product design, Asia is actually a market that is possibly more receptive to innovation than Europe. Reinsurers will be invited to the table for their skills in product pricing, life underwriting and claims handling.

CR: Nichesegments of the market are going to be increasingly attractive. Longevity risks, equity-related risks and morbidity risks have been underemphasised in recent years, and may very well become profitable areas of growth to fill the void left in the traditional market. International expansion will also be pursued more vigorously by select players.

AI: The market remains strong in Europe. There are likely to be anumber ofemerging markets such as in Eastern Europe and particularly inAsia - we see this as an area set for very big expansion. Additionally, areas like the Middle East are showing big opportunities.Success inthese regions will be driven by strong local presence and a quick grasp of the specific dynamics of these markets.

WB: We believe Europe and Asia will be the growth drivers over the next five years, and we are strengthening our local networks (subsidiaries, underwriting offices, service offices) in order to be closer to our clients.

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

UE: Unquestionably, the pricing under reinsurance arrangements has become more competitive in almost any market. But the motivation for this trend can be seen to be quite manifold.

In some of the markets, price reductions are just driven by an overcapacity provided by the competing reinsurers, while in other markets, for example in Europe, policyholders suffer under smaller bonuses caused by low investment yields, and therefore it has become more important for the individual insurance company to retain a higher profit content from the protection elements. In some places, one can find competitors such as RGA, PartnerRe, and even Scottish Re for business outside the US, to be quite hungry for new business. This is indicated by very competitive pricing.

PK: While consolidation has resulted in a firming of reinsurance rates, the market continues to offer sufficient capacity. Rates have increased in the 10% range, but it's important to note that the increase relates primarily to changes in the cost of doing business, not opportunistic pricing.

Mortality improvement, often the underpinning of inexpensive reinsurance, has been fully factored into reinsurance pricing. In addition, the current interest rate environment and emerging experience for long-term lapse rates are moving reinsurance rates upward.

MG: What are your main worries for 2006 and beyond?

WB: Actually, financial markets developments play a great role in terms of concerns! Also, the introduction of international financial reporting standards (IFRS) into our balance sheet enhances substantially the volatility of results, which 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.

A similar observation holds for many types of influenza!

PK: My first one is managing mortality risk and addressing alignment of interest issues between ourselves and our client companies in an environment where 90% of mortality and morbidity risk is being reinsured.

My second would be understanding and managing the impact that capital markets will have on the risk and profit profile of our business and our clients' business.

My third concern would be the challenge of providing good value to customers, while at the same time achieving the growth and profitability goals that would translate to a fair, risk-adjusted return to our shareholders.

AI: We continue to monitor things like bird flu, but at present we do not have any huge concerns around this. We also watch long-term trends on cancer and coronary diseases, and their impact on critical illness and mortality. Main worries would come from economic and financial risk - in particular, any economic downturns and their potential impact on disability claims.

ES: With regard to our bottom line in life reinsurance, the main worries are certainly the ongoing threat of terrorism and - more importantly - the increasing probability of an imminent pandemic.

In terms of the general development of reinsurance markets, however, all of these factors potentially affecting our life reinsurance business can be managed to a sufficient extent through setting appropriate terms and conditions (for instance, rate levels and exclusions in product design); adhering to strict underwriting standards; and an ongoing monitoring of the risk drivers and emerging situations.

CR: Themovements of the yield curve areat the top of the list for Max Re's life business, in as far as the effects of such movements on successful business growth are uncertain at this time.

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

SW: In some respects, the traditional mortality transfer business, which has been the mainstay of the US market for the past 10 years, is going to be overshadowed within a 10-year horizon by longevity-type risks that will be coming out of retirement income-oriented products.

MG: Does the potential threat of an avian flu pandemic worry you as much as it does the media?

MP: In the 1918 situation, we saw a lot of deaths in younger lives, but when we dig under the surface, you have to take account of the fact that people had just come out of a world war and had endured a period of rationing. Therefore, flu came at a time when much of the population was still suffering from diseases like tuberculosis, and their immune systems were naturally weakened.

These days, through the internet and the world media, you have vastly improved communications - if you look at how the World Health Organisation (WHO) was able to react to contain the SARS outbreak, we draw lots of encouragement that 1918 was a one-in-several-hundred-year event that the world would cope with much better now.

UE: Due to the long-term nature of the life reinsurance agreements, there are no worries for us that could materialise short term. In the mid or long term, however, we may be confronted with a stronger consolidation of the European life insurance markets, which might be driven by ongoing low-level investment yields in the bond markets and stronger solvency requirements demanded by forthcoming regulation already visible today.

MG: Do you think that we have now seen the peak of life expectancy?

PK: No. At the same time, we believe that reasonable expectations for future mortality improvement, which has long been the underpinning of inexpensive reinsurance, have been fully factored into life reinsurance pricing. We continuously study and seek to understand mortality experience and emerging trends that should be factored into our pricing.

UE: At Revios, we are convinced that we definitely have not yet seen the peak of life expectancy. It is mainly the impact of medical progress that is yet unpredictable, and fantasy sets no limits. Also, a relevant question would be whether the national health insurance industries would be accessible to large populations in the future, and whether financial means will be available to cover the cost for permanently improving health care.

ES: No, we don't think so. The long-term development of life expectancy is driven by waves in medical and social development, with ups and downs possible. The exact development pattern is not predictable.

AI: No. Better healthcare, medicine, responsive and preventative drugs means we are seeing longer life expectancy - and this is even extending to the developing world. We generally expect mortality to continue to improve, though we remain mindful of the risk of flu pandemics. That said, such one-off events would not necessarily impact future improvement.

Obesity is one other risk area that may act to slow down improvement.

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

ES: At this stage, it is our view that for life (re)insurance, the still-rather-high transaction costs associated with securitisations or ART models, as well as the high efficiency of reinsurance solutions, make it rather difficult for the capital markets to compete effectively for medium- and small-volume transactions with the reinsurance markets. In addition, a particular distinction is the reinsurers' ability to offer tailor-made solutions to their clients, versus the rather standardised solutions available through the capital markets.

In those areas where capital market solutions start getting commoditised to a certain degree due to the large scale of the transactions, and the relative uniformity of the problems and solutions, reinsurers certainly start facing new competition.

A possible remedy could be the development of more flexible and value-adding solutions that are based on the specific values reinsurance can provide, for example, the real long-term nature of our solutions. Generally, securitisation-type elements will definitely and increasingly find their way into the toolbox of solutions reinsurers provide to their customers, as well as apply to their own risk portfolios as part of the risk-management programmes.

MG: In your view, is writing annuity business a complimentary counterbalance to mortality?

MP: Swiss Re has been reluctant to engage in longevity risk in recent years. One reason was the difficulty in predicting improvements in mortality risks in the future. In the last 20 years, mortality risk improvement will have exceeded the expectations of most observers.

The longevity business is about taking in cash today and paying it back in instalments for the lifetime of the policyholder; therefore, the investment markets are key to any expectations of the buyer. Investment risk and uncertainty in longevity improvements has made us a little more conservative in this regard.

I would say that it is an area we will have to look at providing solutions for in the future since there is a huge demand from clients, which is generated by a huge need from society at large. But going back to the question, we think that it is a partial hedge, but it is not as important as you might expect. The people that give you a million dollars and say "pay me back in instalments for the rest of my life" often feel that they are going to live forever - and our experience has sometimes borne that out!

On the other hand, when the buyer of life insurance says, "I'd like to buy some insurance, but I'd rather not claim," they buy their protection and they'd be very happy to reach retirement age or pay off their mortgage without making a claim. The correlation of a natural hedge exists, but is not wholly matched.

MG: Do you see M&A activity increasing in 2006?

ES: We expect to see renewed M&A activities on the direct side, largely as a result of improved financial ability of potential acquirers in combination with tighter solvency requirements, as well as increasing profitability expectations from owners/shareholders. Markets affected are likely those where the respective regulations will tighten, respectively those that are still highly fragmented with increasing pressure on the smaller players regarding cost efficiency.

Due to the already high level of concentration on the reinsurance side, we do not expect to see an increasing number of M&As there.

PK: Further consolidation is likely at the retail life insurance market. At the life reinsurance level, we view further consolidation as unlikely, at least among the larger players. The primary reason is that we view the number of well-capitalised life reinsurers to be sufficient to provide enough reinsurance capacity to meet the needs of ceding companies.

AI: I would expect the current pace of consolidation to continue in 2006 and beyond, driven bya number of factors, such as increased capital strengthening, more transparent reporting, market globalisation, etc. The insurance industry is fragmented, and even the biggest market players do not have hugeshares. I would expect it to continue in the primary market, but not so much in reinsurance.


Scott Willkomm, Chief Executive, Scottish Re - SW

Alberto Izaga, Head of European Life & Health Business, GE Insurance Solutions - AI

Uwe Eymer, Chairman of the Board, Revios - UE

Edwin Schnauder, Chief Actuary, Life Munich Re - ES

Martyn Parker, Head of Life and Health Products, Swiss Re Group - MP

Pat Kelleher, Executive Vice-President, Transamerica Reinsurance - PK

Chris Rutten, President, Life & Annuity Division, Max Re - CR

Dr Wolf Becke, member of Hannover Re's Board and Chief Executive of Hannover Life Re - WB


H5N1: ANYONE HAVE A SPARE $133bn? (and that's just the US)

A recent study by Steven Weisbart, PhD, an economist at the Insurance Information Institute (, found that the cost of a pandemic on life insurance companies in the US caused by an H5N1 influenza outbreak could be a possible be $54bn for group policies and $79bn for individual life, for a total of $133bn.

At that level, the study noted that every company's surplus (the excess of assets over liabilities) would take a hit, and dividends were likely to be cut, possibly to zero, for a year.

Some companies - especially those most heavily into group life insurance and individual term life insurance - might have to go into the capital markets to raise additional funds for claims payments.

Mr Weisbart thought that reinsurance might help, but "since the life reinsurance market is highly concentrated and all companies with reinsurance would be seeking reimbursements at the same time, questions about some life reinsurers' ability to pay will arise." However, the economist found that: "If the death pattern were to follow a moderate forecast, and the life insurance coverage situation remained as described above, it is possible that the toll of death claims from the flu for group life insurance would be $11bn, and for individual life insurance $20bn - a total of $31bn."

Mr Weisbart concludes: "The sudden impact of such unpredicted losses would clearly affect all life insurers, particularly the weaker ones."

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