Reinsurance: a capital idea!
Reinsurance is a powerful tool for captives owners and their managers. As well as its traditional role in risk sharing and transfer, reinsurance offers captives many other benefits. It frees up capital, clears out old liabilities to yield balance-sheet relief, and reduces collateral holdings by ceding premiums at a discount to their current collateral requirements.
The global reinsurance market is operating at historically low premium to surplus leverage ratios, and continues to attract capital, making reinsurers eager to put their assets to work. Reinsurers are also innovative and flexible: off-the-shelf products are rarely deployed for captives seeking capital solutions. Instead, reinsurers and brokers, working together, are extremely creative in crafting tailor-made financial products designed to fit captive insurance clients’ needs precisely.
“Future GAAP earnings may be shielded from the potential impact of adverse development of prior years’ losses.”
Reinsurers will consider the class of business, the type of account, the duration of the cover to be reinsured (the tail), the original premiums charged, and other relevant factors to fine-tune the reinsurance structure so that it will work best to help a captive achieve its aims.
A popular structure is the loss portfolio transfer (LPT). Unlike conventional reinsurance, which cedes losses under in-force policies, LPTs transfer some or all of the risk related to historical incurred but unpaid losses and loss adjustment expenses to the reinsurer, for an actuarially determined premium.
Depending on the structure of the agreement, the captive’s statutory surplus may increase as a result, and future GAAP earnings may be shielded from the potential impact of adverse development of prior years’ losses.
The market for this type of product is vibrant. Multiple reinsurance companies have teams dedicated to the design and execution of solutions that utilise such products. They are available in all the world’s major reinsurance centres, and are widely used, especially as regulators ramp up insurance companies’ solvency requirements.
This market is particularly creative and understands captives’ needs. It is skilled at zeroing in on a captive’s unique situation and challenges. The reinsurers that offer LPTs typically possess very strong balance sheets and high levels of actuarial, claims and legal expertise in their chosen classes of business. That provides captives with many very good options.
Benefits of LPTs
For captives owners and managers, these benefits may be substantial. First, they free up capital for other corporate purposes. That grants the captive a range of new business alternatives, for example strategically growing in the current hardening insurance market and planning for the collateral required to do so. LPT partnerships with rated carriers result in better balance sheets for captives in their capacity as unauthorised reinsurers, and they’ll be viewed more favourably as programmes are structured.
In addition to transferring older liabilities and reserves, LPTs may also release cash lodged as collateral, allowing it to be deployed for other corporate purposes. If there is an ongoing relationship with an LPT reinsurer, it can create certainty around collateral takedowns. Freed-up collateral can be rolled into new calendar years, allowing captives to plan strategically around this cycle.
In Q4 2018 we worked with the LPT reinsurance market to structure a capital relief LPT product for a large risk retention group that carried significant general liability and workers’ compensation liabilities on its books. We structured a cover that divided the book into different lines of business and the reinsurance charge varied for each of those risk portfolios. The benefits for the captive included freed-up capital, collateral takedowns, and overall a greater certainty around the balance sheet going forward.
Regardless of the approach adopted, the use of reinsurance as part of a captive’s capital management can have significant benefits, such as leaning on a reinsurers’ expertise; utilising reinsurance capacity; freeing up capital for growth and other corporate initiatives; managing collateral across multiple years; and accessing additional actuarial horsepower to evaluate loss trends and development factors.
The flexibility of the LPT product allows those benefits to meet the client’s specific needs. In the current market environment, reinsurance companies are eager to help.
Desmond Bohan is senior vice president of origination at BMS Re US. He can be contacted at: desmond.bohan@bmsgroup.com
