Effective solutions for improving solvency

How structured reinsurance can provide insurers with cost-efficient capital relief?

Christian Wertli from Swiss Re’s Structured (Re)Insurance Solutions team in Asia highlights the unique advantages of reinsurance — either traditional or tailor-made — for improving solvency.

With the financial crisis in full swing, insurance companies could face further deteriorations in their capital base in 2009.  The last 12 months have shown that it is impossible to predict what might happen; all that can be done is to plan and protect the balance sheet as best as one can.

What’s more, insurance companies are expected to call for more capital over the coming years — to fulfill regulatory solvency requirements; to meet credit rating criteria to avoid downgrading; to satisfy shareholders’ and lenders’ demand for higher dividends and returns; and to ensure sufficient solvency to write new business.

Capital sources are scarce now

Insurance companies have various options to obtain fresh capital. They can raise new equity, but this will dilute existing shareholdings. They can raise hybrid capital or subordinated debt, if they still have capacity for Tier 2 capital. But this is pricey at the moment.

Another option would be to liquidate assets, but this may not be preferable under current market conditions. Or they can simply write less business, but nobody likes losing market share.

Reinsurance is an attractive source of capital

Against all these options, reinsurance stands out as a very efficient alternative source of capital for insurance companies, offering unique benefits:

  • Reinsurance is quicker and easier to execute than a rights issue or issuing subordinated debt.
  • Credit spreads for many insurance companies are widened and reinsurance is often a more cost-effective way for raising capital than tapping the capital markets.
  • Capital relief can be achieved without diluting shareholder value.
  • Any adverse effect on financial ratios is minimized.
  • Improving the capital base can help relieve pressure from rating agencies and regulators.

In addition, reinsurance allows insurance companies to transfer their risks, and to improve their risk management. Reinsurance also helps reduce earnings volatility (i.e. avoid unpleasant surprises) and strengthen the credibility of a company in times of financial turmoil.

A straightforward use of reinsurance for capital relief is the traditional annual Quota Share, where economic and consequently solvency capitals are freed up according to the proportion ceded due to reduction of insurance and market risks (Solvency I).  

Clients look for customised reinsurance solutions

Due to the financial crisis, Swiss Re has received more enquiries from clients looking for customised reinsurance protection. Swiss Re has a team of specialists who work closely with clients to provide tailor-made solutions addressing individual risk-transfer and capital needs.  These solutions are an important complement to traditional offerings.

Advances in risk assessment and risk modeling technology (especially for companies that already operate under a risk-based solvency framework / Solvency II) have allowed great improvements in discrete calculations of probabilities for exposures and losses. In turn, companies can better calculate their risk-based capital and apply such findings to fulfill Solvency II requirements, credit rating criteria, or risk model requirements for other stakeholders.

For example, Swiss Re can help non-life clients model their entire general insurance risk profile and set benchmarks for risk-based capital in accordance with the client’s risk appetite or required levels set by regulators or rating agencies. A customised cover can then be offered to help the client achieve its benchmarks for capital relief. The cover provides a limit above a certain loss ratio on the underlying net business. It can also include features that enable diversification of the risk across time and participation by the client in potential profits of the cover. Such solutions can be offered on a one-year or multi-year basis.

For life insurers, Swiss Re can help clients accelerate a portion of their embedded value (e.g. from their investment-linked, or term assurance) to create regulatory capital up-front, which will be repaid in future years from surplus arising from the business.

Please see the following table for other reinsurance solutions offered by Swiss Re.


Reinsurance will continue to play a key role

How would the future look like? It is almost certain that market uncertainty will continue well into 2010. The financial crisis will continue affecting both the asset and liability sides of insurers’ balance sheets, and further negative shocks cannot be ruled out.

To avoid raising capital at this difficult time, insurers need to de-risk the asset side. On the liability side, de-risking through the reduction of underwriting risk will increase the use of reinsurance. All these drive non-life insurers towards re-focusing on underwriting discipline and profitability. For life insurers, they may seek more reinsurance to cope with capital strains and improve their solvency ratios.

In any event, reinsurance – either traditional or tailor-made – will play an important role over the next 12 to 24 months.

sigma 5/2016 – Strategic reinsurance...

There is a growing trend toward more holistic and customised use of reinsurance and insurance solutions.

Read the whole story

sigma 4/2016 - Mutual insurance...

Over the past few years, premiums written by mutual insurers have outpaced the growth of the wider insurance market. The sector has undergone a modest recovery but also faces new challenges.

Read the whole story