Good Deals Doable Despite Bad Year

In Australia, investigators with the HIH Royal Commission, a government agency, have accused a property-casualty insurer of using financial reinsurance contracts that involved no actual transfer of risk to hide its poor finances. When another insurer, HIH Insurance Ltd., acquired the company, the hidden problems surfaced and killed HIH, the investigators argue.

In the United Kingdom, regulators with the Financial Services Authority say a large London life insurer used financial reinsurance to conceal its financial weakness.

At other insurers, "we have found some more examples of arrangements where it is wholly unclear whether any risk has in fact been transferred, and where the motivation seems purely presentational," FSA Chairman Howard Davies said in a January lecture, according to a copy of the speech on the authoritys Web site.

Big U.S. life insurers that have recently demutualized also show a tendency to use financial reinsurance to dress the windows, according to Rodney Clark, an insurance rating analyst at Standard & Poors, New York.

But some reinsurance arrangements "are more reasonable than others," Clark says. "I am not concerned about the [lack of] transfer of mortality risk if theres transfer of other risk, such as lapse risk or investment risk."

Most deals arranged by smaller life insurers do seem to involve a significant transfer of risk, Clark says.

Meanwhile, financial reinsurance executives want to make sure their companies are taking risks they can really afford to take.

At Manulife, "what we want is a fairly low volatility product," Leblanc says.

Leblanc looks for stable ceding insurers in stable lines of business, and comfort with both the clients product and the clients projections.

Of course, the buyers have similar concerns.

"There is a subtle flight to quality that is in the minds of the ceding companies," Willkomm says.

The Sept. 11 attacks have had a much smaller effect on financial reinsurance than on traditional reinsurance, but medical cost inflation has hurt the market for medical financial reinsurance, and the ups and downs in world stock prices and U.S. interest rates have made annuity deals considerably less attractive, the executives report.

In coming years, regulator and rating agency scrutiny could also pose a challenge for financial reinsurers, Clark says.

If so, the industry could move toward other methods of "alternative risk transfer," such as using blocks of life insurance and annuity business to back securities, Clark says.

Many credit card companies, mortgage companies and property-casualty insurers securitize business, but life securitizations have been rare.

Reproduced from National Underwriter Life & Health/Financial Services Edition, April 1, 2002. Copyright 2002 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.