Friday, February 20, 2009

(No.14) An Unhealthy Situation: Life Reinsurance

Almost as far back as when I started writing my editor's column in the Canadian Journal of Life Insurance and devoted attention to "The Reinsurance Wars" I have been concerned by the role and impact on the life insurance business of reinsurance companies, 'the pros', which write reinsurance and are not in the retail marketplace selling individual life insurance policies. They have exerted a profound impact on the shape, texture and pricing of these products and indirectly on the agency systems which the industry uses to distribute them.  

Over the years I have written and spoken frequently about the steadily increasing concentration of individual life insurance risk on the books of a very few reinsurance companies. This trend was accelerated in Canada by several industry developments including the demutalization in the past decade of 4 large retail life companies (Sun, Manulife,Canada and Mutual), a process which produced a move to reinsure significantly more of not just risk amounts from new sales but also blocks of business in force. It was a way for the ex-mutuals to write business but reduce the amount of reserves otherwise required to support the new business on company books and therefore a way to improve apparent performance as stock companies -- along with ceasing to sell participating life insurance policies, the profits from which are, in terms of a stock life insurance company's allowable share, limited by law in Canada.

The massive shift to reinsurance companies of so much of the risk generated by retail life insurance companies issuing life insurance policies has produced an unhealthy pattern. Before 1970 I estimate that less than 1% of the amount of new individual life insurance sold in Canada ended up on the books of (then) more than a dozen exclusive reinsurers active in Canada, several of them Canadian-controlled. Today it is in the range of 70-75%, almost all going on the books of just a few foreign-owned reinsurance companies, most prominently Swiss Re, Munich Re and RGA.

Most of this increase has happened within the past 20 or so years. It is an  unhealthy concentration of a massive amount of risk, all the more so given the recent financial meltdown in the US and western Europe of very large financial institutions risking collapse without massive government support. The reaction over the years, private and public, to my expressed concerns about the implications for policyholders and retail life companies from excessive concentration of reinsurance risk has in the main been to minimize them if not dismiss them. Unfortunately Swiss Re has recently illustrated a major reason for my longstanding concern.

Swiss Reinsurance, currently the world's second largest reinsurance company, had -- among other errors -- jumped (like the now deeply troubled AIG in the US, among others) into the deep end financially with credit default swaps. These were actually a form of unregulated insurance, unregulated since great care was taken not to use the words 'insurance' and 'premium' so as to avoid having insurance regulators -- especially in the New York Department of Insurance -- have any formal basis on which to seek regulatory access to this activity.

In 2008 Swiss Re had to write off over 9 billion Swiss francs and in the 4th quarter of 2008 the company lost, measured by net income, 1.75 billion francs (US$1.5 billion). Its rating has been cut, its CEO fired and its stock price rests at its lowest ever price. Warren Buffett, using Berkshire Hathaway, has pumped US$2.5 billion into Swiss Re and the company may be looking for another $2 billion.  And this financial mess resides with one of the trinity of reinsurance companies that have come over time to dominate the Canadian life reinsurance business.

On the books of the 'big 3 pros' sit billions of dollars of ordinary (individual) life insurance risk issued on the lives of millions of Canadians, a fact of which they -- and apparently the financial media and analysts as well -- remain blissfully unaware. The amount of the reserves (assets) backing this Canadian risk business which are actually located in Canada and to which federal regulators would have -- if required -- easy, quick, direct and certain access could not begin to cover all of the in force risk in the event of need prompted by financial failure. I leave to one side the question of how likely it would be in such circumstances that a large reinsurance company's world wide assets would be sufficient to meet its obligations in all countries in which it solicited and accepted risk. 

The time is long past due for life insurance companies, especially the largest retail operations, to return to the business of actually retaining more of the life insurance risk represented by the policies they sell to the public rather than being so heavily into the business of generating huge volumes of risk they pass to one or more of only a few very large reinsurance companies.

One recent and perhaps hopeful note, at least for Canadian policyholders:  the federal Office of the Superintendent of Financial Institutions (OSFI) finally produced in December last year a discussion paper for consultation involving reinsurance in Canada and its supervision. A serious regulatory revisiting of the operation and supervision of life reinsurance in Canada should have happened long ago -- but better late than never. 

Something useful may come of it, especially if those who provide input as well as those who consider it are not all singing from the same tattered page in the same old life industry hymn book.  

Alastair Rickard,