The highly concentrated global life reinsurance sector has promising growth prospects, owing to the dynamic environment in emerging markets, particularly Asia, where life insurance markets are still developing and underpenetrated. We also see business potential in the longevity and morbidity lines of business both in mature and developing markets. The core U.S. mortality business remains flat at best and may even face some declines due to stagnating primary insurance growth and potential regulatory changes on captive principal-based reserving and XXX/AXXX reserving. On balance, however, we believe growth potential in emerging markets will outpace the possible decline in mature markets over the next few years.
- Sound growth potential in emerging markets, as well as opportunities in longevity and morbidity, should drive growth in gross premiums written of about 3%-5% in the global life reinsurance sector in 2016-2017.
- Risk management and underwriting control capabilities of main global life reinsurance players are generally very strong and are likely to balance the strong growth and the emergence of new risks.
- The profitability outlook remains strong, with a return on equity potential of above just 10%, outperforming global property & casualty reinsurance, which is more in the 7%-9% range.
We see some risks in emerging market growth arising from increased volatility given that these markets have more limited underwriting experience and data. A rapid increase in longevity and morbidity risk lines could also change companies' risk profiles. We nevertheless consider the industry's risk management and underwriting capabilities well advanced, which should help to safeguard the industry from too aggressive growth in new regions and from underestimating new underlying risks.
We believe the industry has sound profitability prospects also based on our assumption that the growth in emerging markets, longevity, and morbidity on balance will generate similar returns compared to historically in the industry. We expect a return on equity (ROE) of just above 10% over the next two years, although cash flow patterns might change in view of potentially higher longevity and morbidity shares.
|Rated Life Reinsurance Companies’ Gross Premiums Written 2014-2015|
|Companies||--Life reinsurance gross premiums written (mil. $)--||Ratings|
|2015||2014||As of Aug. 30, 2016|
Swiss Reinsurance Co. Ltd.
Reinsurance Group of America Inc.
Hannover Rueck SE
General Reinsurance Corp.**
|*Munich Re includes health reinsurance business. **Net written life and health premiums. For Munich, Hannover, and SCOR the reported currency is euro converted into U.S. dollars.|
Emerging Market And Longevity And Morbidity Growth Outpaces The Stagnating U.S. Business
The motivation for primary insurers to use life reinsurance, and the force behind cession rates, can vary widely among regions and can be somewhat opportunistic. Nevertheless, classic risk transfer, product partnering, and regulatory capital relief remain the main motives. The life reinsurance industry's bread-and-butter business remains biometric risks, in particular mortality in developed markets, predominantly the U.S. Given its size and cession rate, the U.S. mortality market remains the most important life reinsurance market. All large competitors are significantly represented in this market and can draw on this part of the business with strong underwriting experience and data. Cession rates in the U.S., however, have gradually reduced from about 35% in the period 2004-2007 to about 25% in 2015. At the same time, the primary insurance market has reported relatively flat premium developments since 2011. We expect cession rates to level out at about 25% in view of potentially increasing regulatory hurdles for captive reinsurance and more principal-based reserving of XXX/AXXX reserves. Growth rates from developed markets, and in the U.S. in particular, will therefore remain flat at best.
Nevertheless, more promising growth prospects are developing in emerging life insurance regions, especially in the Asia-Pacific region. These underpenetrated life insurance markets could grow significantly in the next few years as the economies develop and insurance penetration rates rise. Emerging market life insurance premiums, including in the Asia-Pacific region, grew by about 8% in 2015, while the world life insurance market grew by only 1%-2%. In these countries, we generally see younger demographics, increasing wealth, and improving health care, which should point to improved mortality over time. What's more, the primary writers and reinsurers should benefit from good diversification given the small face amounts versus more developed markets. The other trend that we are seeing in the primary companies is a higher level of protection-type products being sold in emerging markets given their younger demographics and lower wealth. Some of the reinsurers are working closely with primary writers to develop new products and sales, and in exchange retain a percentage of the business underwritten. There are ample opportunities for the sector to support product development, underwriting, claims handling, and to finance acquisition costs. Business opportunities include mortality, morbidity, and longevity business, with some emphasis on morbidity, although this can vary widely between the regions. The main growth drivers will likely be China, Southeast Asia, and India.
Solvency II in Europe continues to be a business enabler for the global reinsurance sector. Although some life insurance companies are still calibrating their way through the Solvency II regime, with potential usage of volatility or matching adjustments, the U.K. longevity business is a strong example of the industry's business potential. In 2014 and 2015, there was a significant increase in longevity swap transfer deals from pension funds and corporates that transferred their longevity risks to external parties. The global life reinsurance players have participated significantly in these deals, and have demonstrated their ability and willingness to leverage these mainly regulation-driven business opportunities. While most deals are currently carried out in the U.K., we observe increasing demand from longevity deals also in The Netherlands and the U.S., creating further business potential. Although the magnitude is not yet clear, for 2016 and 2017 we expect generally positive business potential arising from Solvency II for the global life reinsurance industry in view of further optimization of the primary insurance portfolios and the need for capital to balance increasing risk-based capital requirements for interest rate-sensitive savings products.
On balance, we believe the growth in emerging markets and the generally positive impetus from Solvency II and other risk-based regulatory regimes will more than compensate a potentially flat development in mature markets. All in all, we expect the global life reinsurance sector should grow by about 3%-5% on a gross-premiums-written basis in 2016-2017.
|GDP Growth In Key Regions|
|Real GDP (% change)|
|Asia-Pacific includes Australia, Japan, and emerging markets in Asia.|
A Gradually Changing Risk Profile
Given the growth opportunities in emerging markets and the potential increase in longevity and morbidity business, the share of "traditional" mortality business from mature markets will likely shrink. Growth in emerging markets bears the risk that companies will write business with less underwriting experience and data. Moreover, volatility could arise from different regulatory regimes, legislation, and political risks in emerging regions. The potential growth in longevity and morbidity is also adding further new risks for the industry, and longevity risk is not always diversifiable from mortality business in the regions. This could change the risk profile of the industry gradually and potentially increase capital requirements, in our view.
The industry, however, has developed strong risk management capabilities in the past few years and is well advanced in underwriting, claims handling, and product development. Given the global nature of the business, the industry can draw on global underwriting experience that will help to minimize underestimation of new risks. We view the enterprise risk management (ERM) of four of the five top global reinsurance players as very strong (see table 3), while the fifth, Reinsurance Group of America, also exhibits strong risk controls. The four Europe-based players have installed very sophisticated strategic risk management tools, including fully fledged internal economic capital models. In addition, these four are composite reinsurance groups that write property/casualty reinsurance. Their mixed portfolios add significant diversification benefits given that life and property/casualty reinsurance in particular is highly uncorrelated.
|Top Five Global Life Reinsurers Enterprise Risk Management Scores*|
|Munich Reinsurance Co.||Very strong|
|Hannover Rueck SE||Very strong|
|Reinsurance Group of America Inc.||Adequate, strong risk controls|
|SCOR SE||Very strong|
|Swiss Reinsurance Co. Ltd.||Very strong|
|*S&P Global Ratings assessment.|
Sound Profitability Outlook
Since the last big acquisition in the global life reinsurance industry in 2013, when SCOR bought Generali USA Life Reassurance Company, the global industry has become concentrated, and there have been no significant market entrants or big acquisitions. The top five players therefore make up more than 90% of the global life reinsurance market. The difficulties for potential market entrants are the large global underwriting capabilities and the massive know-how that is difficult to replicate. Life insurance cedants value from their reinsurance partners a set of sophisticated underwriting, actuarial, and risk transfer capabilities, as well as a long-standing, trustful relationships. We assume the number of reinsurers on the various panels to be about three-four at most on average globally. It is therefore unlikely that start-ups or short-term capital investors would threaten the global life reinsurance market, in contrast to the situation we have seen evolve on the property & casualty reinsurance side over the past decade. Although competition and pricing pressure is visible among the established players, the high barriers to entry for new entrants will likely help the industry prospectively to perform in line with its sound history.
In addition, the global life reinsurance industry is less dependent on investment income than primary life insurance given its concentration on biometric risks and its preference not to take on market risk (equity, interest rate, and foreign exchange risk), a practice that is often embedded in savings and retirement-type products. The ongoing low interest rate environment will be visible in the industry's investment performance, but the magnitude will be limited. Nevertheless, significant changes to assumptions, such as on mortality or morbidity, can create some earnings volatility. For example, Australian disability business written in prior years has experienced some dislocation, including higher-than-expected claims and lapses in 2013, with an estimated pretax loss for the global life reinsurance industry of about $1 billion.
We believe, however, that the global life reinsurance sector will be able to post ROE just above 10% in 2016-2017, based on growth in emerging markets, longevity, and morbidity, and safeguarded by strong risk management to balance aggressive pricing and underestimation of pricing.