From a macroeconomic perspective, there is a lot for life insurers to digest right now – inflation, slowing rate rises, hard landings, probability of recession, and policy lapses to name but a few.
There is a near consensus that there will be continued volatility and a dispersion in asset performance throughout the rest of 2023, with a “sorting out process” that may continue for several years. Without a rising tide to raise all boats, asset allocation will be especially important for life insurers.
Life and annuity invested assets totaled approximately $4 trillion in 2020, and around $254 billion of annuities were sold in 2021. These large portfolios are typically invested in high-quality, buy-and-maintain credit strategies. The uncertain economic environment presents significant upside risks – such as potentially higher illiquidity premiums—and downside risks – such as potentially higher credit defaults and migration. In addition, the rising interest rate environment introduces additional uncertainty around policyholder behavior and stresses on capital positions, which put even further pressure on insurer profitability and capitalization.
Life insurers have successfully navigated economic cycles many times in the past decades. For those who would like to shore up some of the risks, reinsurance may be more valuable now than ever before. Asset-intensive reinsurance is growing in popularity in the life insurance industry and can be thought of as an asset class within an insurer’s investment strategy, where a “quota share” of the risk of select blocks is covered. The asset-intensive asset class offers a perfect match for liabilities, alleviating pressure on managing the portfolio. Many reinsurers have diversified investment platforms, portfolio management functions and hedging expertise, enabling them to achieve market-leading yields. Asset-intensive reinsurance gives insurers an opportunity to share in some of this upside.
There are considerations, however, when selecting an asset-intensive reinsurer.
When insurers enter an asset-intensive reinsurance transaction with a reinsurer, they transfer not only longevity/biometric risks to that reinsurer, but also the asset risks. This usually takes the form of an insurer transferring an annuity block and associated assets to a reinsurer, structured as coinsurance. Asset-intensive reinsurance can also be referred to as “full-risk transfer.”
It is worth noting that while all the ceding insurers’ existing risks associated with that annuity block are transferred to the reinsurer, that insurer does acquire counterparty default risk associated with the reinsurer in question. This concentrated counterparty risk can vary significantly across different reinsurers, making the term “full-risk transfer” somewhat misleading. To mitigate the counterparty default risk, insurers seek high-quality reinsurers and may require that those reinsurers hold collateral.
Several new entrants have emerged in the asset-intensive reinsurance space. The market now features a diverse range of players, from long-standing reinsurers with strong ratings that have withstood the test of challenging economic environments, to new reinsurers with alternative strategies that have yet to be similarly tested. Given the uncertain economic outlook, it is more important than ever for insurers to continue to seek out trusted partners that can support them through any challenges ahead.
There is a lot to look forward to this year and it will be interesting to see which views on the macroeconomic environment come to fruition.
Reprinted with permission from Best's Review.