Don Solow's presentation on non-traditional reinsurance structures

1. Non-Traditional Reinsurance
Structures
Donald D. Solow, FSA, MAAA

2. What does “non-traditional” mean?
Traditional: transfer of mortality risk for the
usual reasons using the usual structures
Non-traditional: transfer unusual or non-
mortality risks; or
achieve something in addition to risk transfer
(e.g. balance sheet benefits); or
transfer mortality risk using different structures

3. Types of non-traditional reinsurance
 Financial reinsurance (surplus relief / risk-
based capital relief)
 Reinsurance of run-off or legacy blocks
 Variable annuity reinsurance
 Non-proportional reinsurance (Stop Loss /
Catastrophe Covers / Pandemics)

4. Financial Reinsurance
Goal is to improve the statutory balance sheet
General concept: reinsurance premium ceded
< statutory reserves released
Difference is often called “initial ceding
commission” or “initial expense allowance”
Statutory surplus improves by this amount
(ignoring taxes)
RBC may improve (assets and liabilities
moved off the balance sheet)

5. Financial Reinsurance (cont'd)
Reinsurer earns future profits from the block
Experience account tracks initial ceding
commission (with a “risk charge”) and
statutory profits
When experience account reaches zero, the
surplus relief is “paid off” and ceding
company generally has right, but not
obligation, to recapture
Reinsurers often seek 5 year payback

6. Financial Reinsurance (cont'd)
If block performs well, ceding company is likely
to recapture when the relief is repaid
Otherwise reinsurer is stuck with it!
Reinsurer's maximum gain is the risk charge,
but has unlimited downside
Therefore reinsurer will choose block carefully
(one where earnings are highly predictable)

7. Financial Reinsurance (cont'd)
 Structures
» Coinsurance
 Assets transferred to reinsurer
» Coinsurance with funds held
 Assets kept on deposit with ceding company
» Modified Coinsurance
 Assets stay with ceding company and ceding company
continues to hold reserves – essentially statutory book
profits are the only cash flows
» “Co/Modco”
 Designed to minimize cash movements

8. Financial Reinsurance (cont'd)
Statutory Accounting
Other than amounts needed to offset taxes, initial
ceding commission does not flow through
statutory income
Instead, is treated as a capital contribution and is
released through income over the life of the
transaction
Rationale: initial ceding commission should not be
paid out as a dividend

9. Financial Reinsurance (cont'd)
GAAP Accounting (FAS 60, 97, 113)
Generally use deposit accounting for financial
reinsurance
Rationale is that transaction is a financing or
borrowing
Risk charge is the only income statement item

10. Reinsurance of Run-off Blocks
Ceding insurer's goal is to “sell”, through
reinsurance, a non-core or legacy block of
business (closed blocks)
As with surplus relief, generally net premium
paid < statutory reserves released
This frees up capital, de-levers the balance
sheet, and allows recognition of some of the
embedded value (may be styled an
“embedded value” transaction)

11. Reinsurance of Run-off Blocks
(cont'd)
General form is coinsurance or modified
coinsurance
There may also be a transfer of servicing and
administration
Unlike surplus relief, generally there are no
recapture rights

12. Reinsurance of Run-off Blocks
(cont'd)
Important points:
Not a “true sale” (novation): ceding insurer still
has contractual obligations
May require regulatory approval or notification

13. Reinsurance of Run-off Blocks
(cont'd)
Case Study:

14. Variable Annuity Reinsurance
Variable annuities often contain secondary benefits. Examples
are:
GMDB (death benefit)
GMIB (income benefit)
GMWB (withdrawal benefit)
Under these provisions or riders, annuity writer has risk that the
underlying investment funds perform in such a way as to cause
the risk to be “in the money”
Essentially the annuity writer has written complex “put” options
… tied to underlying asset performance
… tied to other factors such as mortality and policyholder
behavior

15. Variable Annuity Reinsurance
(cont'd)
Example: simple return of principal GMDB
Investment: $1,000 in equity sub-account
Performance: -10% in year 1
GMDB Net Amount at Risk: $100 (payable only on
death)
“Financial Economics” view: each contract that
results in death has an embedded equity put option

16. Variable Annuity Reinsurance
(cont'd)
Reinsurance Objective:
… to reinsure this risk with premiums
expressed in basis points of assets and not
dollars per thousand of net amount at risk
Poor investment performance generally
increases the reinsurer's risk and decreases
the premium stream

17. Variable Annuity Reinsurance
(cont'd)
Common features in the reinsurance treaty:
Overall limits or caps
Non-guaranteed premiums (or guaranteed for a
limited time period)
Deductibles
Premiums or coverage varying by fund types

18. Non-Proportional Reinsurance
“Non-proportional” means that the amount paid
by the reinsurer on any policy is not a fixed
percentage of the face amount
Payments, if any, may depend on aggregate
experience of the block
Generally no reserve credit is obtained

19. Non-Proportional Reinsurance
(cont'd)
Stop Loss: reinsurer pays the amount by which claims in a
given period exceed a pre-agreed level (the “attachment
point”), up to a limit
Attachment point can be a fixed dollar amount but is more
likely expressed as a percentage of expected claims.
Example: reinsurer pays each year amounts in excess of
110% of expected, up to 130% of expected
Generally the cover is for one year and then must be
renegotiated, but longer periods are sometimes possible
(e.g. 3 or 5 years)
Goal is to put an overall cap on claims for the year

20. Non-Proportional Reinsurance
(cont'd)
Catastrophe (“cat”) cover: provides protection against multiple
claims resulting from a common occurrence.
Example: reinsurer pays if 3 or more claims result from a
common occurrence, subject to a deductible and a limit
Generally a one-year cover that is renegotiated each year
Reinsurer may restrict coverage where there are known
concentrations of risk (e.g. sports teams, concentrations
within a group life portfolio)
War, terrorism, nuclear events, epidemics usually excluded

21. Non-Proportional Reinsurance
(cont'd)
Pandemic: newer idea. Reinsurer pays based on
“extra deaths” caused by a pandemic
“Extra deaths” may be calculated from a population
index rather than the reinsured's actual book of
business, or a modified population index
Term of coverage may be 3 to 5 years
Risk is often placed in the capital markets as a kind
of mortality “cat bond”