Patrick Ferguson, life re/insurance practice leader, Marsh
7 April 2021Cayman analysis

A smarter approach to reinsuring long-term liabilities

​As the world begins a second year under the threat of COVID-19, the economic fallout remains significant. Companies across all industries, including financial institutions, have seen their bottom lines stretched and continue to look for smart ways to use capital.

For some institutions with significant liabilities stemming from life insurance and related financial offerings, a licensed, wholly-owned offshore reinsurance company could be a viable solution.

Managing long-term risks
Among the products that financial institutions offer to clients are some that can carry long-term liabilities and risks, including whole and term life insurance policies, creditor protection on loans and mortgages, and annuity products. Accounting for these policies create reserves on financial institutions’ balance sheets, which can represent significant risk.

Some institutions with such reserves might use a number of strategies to hedge against major risks, including changes in interest rates, longevity, and morbidity assumptions. Historically, however, organisations have often kept these liabilities on their books for many years, until they eventually seek to retrocede them to third parties, effectively removing the liabilities.

This approach, while commonplace, is not ideal, and can be costly.

A smarter approach
With interest rates in many parts of the world at or near historic lows, insurers are looking for new ways to generate returns. The countries where many large financial institutions are headquartered, however, often have strict limitations on how they can invest capital.

Increasingly, financial institutions are opting to reinsure a portion of their long-term liabilities via offshore reinsurance entities. While the costs to set up such entities can be high—frequently running into seven figures—this approach can be beneficial for a number of reasons, especially the more favourable capital environments afforded by the domiciles where reinsurance entities are often incorporated.

Popular domiciles—such as Bermuda and the Cayman Islands—offer relatively few investment restrictions, giving the owners of offshore reinsurance entities greater flexibility and potentially greater returns. These entities can also enable financial institutions to create more sophisticated structures through which they can more easily and effectively hedge against interest rate risk and manage longevity and morbidity risks—two key components of any life insurance product—than they can in their home countries.

An offshore reinsurance entity may not be the right approach for every organisation. Some financial institutions’ capital structures at the parent level may mean that running liabilities through an offshore entity will not yield substantial benefits.

But for many, the potential financial rewards will be high, and the returns will often far outweigh the costs of setting up such entities.

Getting started
For financial institutions that are interested in using offshore entities to reinsure their long-term liabilities, the first step is to conduct a feasibility study. Through this study, a prospective parent company and its advisors will work with actuaries to examine its underlying business, model premium and losses, and estimate capital requirements. This also allows them to weigh the pros and cons of setting up an entity in Bermuda, the Cayman Islands, and other domiciles.

As life insurers get started with these offshore entities, it is important to be mindful of what they need to get right to keep things running smoothly—chiefly, governance.

Many offshore domiciles have local head office requirements based on the level of business to be written there. Among other things, owners generally need to provide in-person financial and strategic oversight, hold board of directors and committee meetings locally, and have key personnel residing within the domiciles and/or visiting on a regular basis.

In many locations, such requirements have been relaxed amid the pandemic; parent employees have often been able to provide oversight via virtual meetings instead of traveling to various domiciles, but these requirements are likely to return as the health threats associated with COVID-19 fade.

For some institutions, these and other obligations of offshore reinsurance entity ownership may be significant hurdles to overcome. But financial and risk professionals can work with insurance managers to develop oversight plans that meet regulators’ requirements without being too onerous.

Finding the right insurance manager is crucial. Of particular importance is selecting an advisor with robust actuarial and management capabilities and experience working with offshore reinsurance entities within the life insurance sector.

Parent companies also need advisors who understand regulators’ demands. Completing applications to form these offshore reinsurance entities is a complex task, so it’s important to get advice from specialists who know what regulators are looking for and how to address their potential concerns.

With financial institutions looking for creative ways to improve their financial standing, it’s important that financial and risk professionals understand the opportunities presented by reinsuring risk offshore—and work with the right advisors to capitalise on them.
Patrick Ferguson is life re/insurance practice leader at Marsh. He can be contacted at: