In July 2020, Milliman professionals published the research report “Reinsurance as a capital management tool for life insurers.” This report was written by consultants Paul Fulcher, Rik van Beers, Rosemary Maher, and myself.
Capital management is an increasingly important topic for insurers as they look to find ways to manage their risks and the related capital requirements and to optimise their solvency balance sheets. Reinsurance is one of the key capital management tools available to insurers. The paper investigates common reinsurance strategies, along with new developments and innovative strategies that could be implemented by companies.
This blog post is the fourth in a series of posts about this research. Each one gives an overview of a section of the Milliman report.
Demonstrating that a reinsurance deal is genuinely used as a risk-mitigating technique as part of a firm’s overall risk strategy is key for regulatory approval. Engaging with regulators early in the process is important, especially when considering reinsurance contracts that are highly bespoke in nature. Demonstrating enhanced policyholder protection is also paramount for most regulators.
The main criteria for accepting reinsurance transactions that a regulator will expect to see are:
- A clear business rationale for implementing a reinsurance deal.
- A strong understanding of the risks that are being transferred, the risks that remain and any new risks that emerge as part of the transfer, particularly counterparty risk. It is not necessary to have reinsured every component of the risk, but a clear understanding of what is and is not transferred is imperative. Furthermore, a genuine transfer of risk is expected to take place rather than arbitraging regulations to reduce capital requirements.
- A low level of basis risk and a clear understanding of this basis risk.
- Clear analysis and consideration of different possible outcomes, including scenarios where the reinsurance may not be effective.
- A financially strong (and preferably large) counterparty and stringent security in the arrangement, particularly using collateral or other risk-mitigating measures. The reinsurer’s jurisdiction may also be relevant to the regulator.
- Regulators are sometimes keen to see that assets transferred as part of a reinsurance transaction are held in local custodian accounts. This is very relevant for insurers that are considering entering into deals with reinsurers that operate outside of their jurisdictions.
- Recapture plans in case of reinsurer financial distress or default.
The above criteria are typically important considerations for most insurers as part of their internal governance and risk management in any case. Early engagement with regulators is often the best way to achieve a positive outcome in terms of getting regulatory buy-in for a material new reinsurance arrangement.
Milliman research paper
The full research paper can be found on Milliman’s website here, where you can also find an executive summary version that notes some of the key highlights of the research and acts as a guide to the full paper.