Thursday, April 28, 2011

(No.149) Sun & Manulife: bye bye retrocession

I have long editorialized privately and publicly (including in the columns of about the risks and downright looney aspects of the reinsurance business. The chickens are coming home to roost for some companies in the part of the business involving life insurance retrocession, i.e., reinsuring life insurance risk received from reinsurers.

There are two leading Canadian life insurance companies with an involvement in the retrocession business: Sun Life which has recently sold its retrocession business and Manulife which I hear is trying to sell its retro and may succeed in doing so by the end of this year.

At the end of 2010 Sun Life sold its life retrocession business to Warren Buffet's Berkshire Hathaway Life Insurance Co. for a gain Sun said of $310 million net of taxes. In fact Berkshire is one of the few companies these days that will still take on blocks of in force retrocession business which others wish to get rid of and one of the few with the capacity to do so.

While Sun has now wisely left the retrocession business it would have been better for the company had it done so a couple of years ago when a better price might have been obtained.

In the past decade there have been several negative factors at work affecting companies like Sun and Manulife doing retrocession business (although Manu's reinsurance business was not confined to life retrocession):

1. As mortality profit improved reinsurers kept increasing their own retention of the risk reinsured with them by (retail) life insurance companies. Hence there came to be less reinsurance risk being retroceded to retrocession operations like Sun Life's. For example: in 2004 in the U.S. Sun Life assumed $10.3 billion of new "ordinary" [individual life] insurance retrocession (plus $2.1 billion in Canada). By 2009 Sun does not even show up as being in the new retrocession game.

2. In the U.S. market during the past decade many retail life insurance companies have steadily gotten back to retaining on their own books more of the insurance risk they were selling and issuing and more retail companies were moving to use their own full amount of retention of risk on such business.

In the U.S. in 2001 life insurance companies ceded to reinsurers 63% of risk; by 2010 this proportion was down to 30%. Therefore, in the biggest market for large and capital intensive risks, the increase in the amount and proportion of risk retained by the insurer and by the reinsurer left much less new business for retrocessionaires and what there was tended, as years passed, to be not all that attractive.

3. There developed an increasing use by insurers of multiple reinsurers when large amount cases were involved in order to spread the risk for fear a reinsurer might go under financially. A major effect of this pattern was that a retrocession company ended up with an unusual block of business made up of relatively few extremely large cases with the potential of large mortality swings. Moreover the price that retrocession companies asked for taking on such business was becoming high enough that it actually served to encourage a trend for higher levels of policy risk to be retained by both the insurer and its reinsurer(s).

Hence what was once a profitable segment of the insurance business -- retrocession -- continued to decline. In the U.S. new ordinary retrocession amounts declined from a total of $32.6 billion in 2003 to $7.2 billion by 2010. However it took some time before several companies accepting retrocession business (like Sun) were actually ready to fully recognize what was happening.

To the extent that Manulife's reinsurance business is comprised of retrocession, the same applies only more so since Manu has not yet disposed of its retrocession business -- one larger than Sun's for which Manu is unlikely to get as good a deal as Sun did by moving sooner to sell.

In Sun's case it looks as if Berkshire picked through Sun's blocks of retrocession and refused to touch a retrocession carcass or three, i.e., blocks of business that are losers. Sun says only that "our run-off reinsurance business, which is a closed block of reinsurance assumed from other reinsurers, is excluded from this [sale] agreement [with Berkshire]."

It would have been a victory for the cause of more detailed and useful financial disclosure had Sun Life actually stated how bad its retained block of retrocession business (i.e., the business that Berkshire would not buy) and how long its run-off by Sun Life will take.

Still, to be fair to Sun, it has sold its retrocession business. When Manulife sells whatever portion of its retrocession in force business for which it can find a buyer ( it's unlikely to go anywhere but Berkshire) I expect we will see that Manulife does not disclose any details of the in force retro business blocks it has to keep for lack of a buyer and then run off its own books.

It is worth noting that, just as with the troubled guaranteed variable annuity business that has so challenged Manulife financially in recent years, its involvement with the retrocession part of the reinsurance business has been much larger than Sun's. For example: Manu's U.S. retrocession ordinary in force had only declined to $85.7 billion by 2010 (from $97.3 billion in 2003); however the lie of the land is seen in the fact that its new assumed retrocession business in the U.S. went from $12.9 billion in 2003 down to $2.8 billion in 2010. In any case Manulife has stayed way too long at that dance.

Finally, in contrast to the U.S. where the ceded life insurance risk by retail life companies has declined so much in the past decade, note that in Canada life insurance companies still reinsured 75% of their individual life insurance risk in 2010. That's better than 90+% but far from enough of an improvement to indicate that retail life insurance companies here are in the main serious about increasing their own financial role and stake in the actual business of selling and issuing life insurance coverage to Canadians as distinct from playing about in the 'financial reinsurance business' as (they hoped) a source of profit.


by: Alastair Rickard