Annuity reinsurance; a new avenue for the convergence market to explore?

The convergence sector of the reinsurance market, where capital market money from investors is put to work in re/insurance transactions which are typically fully-collateralized, is primarily focused on writing high-yielding lines of business such as peak catastrophe risk. Some collateralized and convergence market players dabble in other segments of the market, such as energy or casualty risks, but the focus on property and catastrophe is deeply ingrained thanks to the higher premium income potential.

There comes a time when every growing segment of the market begins to look more seriously at new opportunities that present themselves. This may be down to a need for expansion in order to accommodate capital, or an offer of diversification the market requires or just a different kind of income opportunity. An article published today on Bermuda’s Royal Gazette website, suggests that annuity reinsurance business might just be an area that the convergence market decides to take a closer look at in future.

The article discusses the comments of an asset manager who suggests that the Bermuda reinsurance market has an opportunity to make itself the hub of the global annuity reinsurance marketplace. It says that the historic low-interest rates, which show no sign of rising substantially, have piqued the interest of hedge fund managers and private equity firms in the life annuity reinsurance business.

It’s a particularly timely article for us as annuities are a tool used within pension risk transfers, which we cover at times on Artemis, including within transactions designed to offload longevity risk from one party to another. They are also prime candidates for fully-collateralized, investor or capital markets backed reinsurers to begin offering reinsurance cover for.

An annuity is used within life and pension insurance as a contract between a policyholder and an insurer where the goal of the coverage is to pay for something over time, such as retirement. The policyholder pays either premium installments or a lump sum and in return the insurer commits to paying regular amounts from a specified date which can be far into the future. The insurer aims to profit from the annuity by investing the premium payments and making more in investment returns than they do in annuity payments.

Now this sounds like something that the hedge fund backed reinsurers would love to get into, although it may not exactly match a hedge funds return aims as it’s a longer term game. However, according to the article, some are coming round to the idea. The article suggests that investment managers who are desperate to find yields and have looked to shorter term reinsurance prospects such as catastrophe business, are now turning their heads to longer term business and annuities could be an area they find fits that strategic goal.

For many investors, including those who get involved in collateralized reinsurance and the insurance-linked securities market, a longer term way to access reinsurance premiums as investment collateral and profit could be very attractive. There are investors with significant capital who have a much longer investment horizon than some of the early entrants to the reinsurance market and they would likely appreciate the regular premium income that annuity reinsurance business could offer.

In a similar strategy to the hedge fund backed reinsurer, a capital market investor backed annuity reinsurer would write annuity business and invest the premiums to try to make a return which gave them an attractive profit as well as sufficient capital to make the annuity payments. Longer horizon deals would of course be the most popular, but any bulk annuity reinsurance deal might include some annuities that need paying sooner and some that are many years from beginning to make payments.

This sounds like an area that would suit a number of types of investors, both those with shorter term horizons but who need a stable source of yield as well as those with longer horizons. All of these investors are continuing to show strong interest in the catastrophe reinsurance market and we suspect that the asset manager interviewed by the Royal Gazette has hit on a potential future source of business that the convergence market may be well positioned to take advantage of. Given the size of recent annuity reinsurance deals, with a number over a billion in recent months, and the need for life insurers and pension providers to offload certain books of business due to longevity or affordability, this is an area into which investors could deploy significant sums of capital if reinsurers and funds with attractive strategies emerge. Annuity reinsurance business could become a new source of capacity for the reinsurance-linked investment space offering a different risk/return profile that might be just what certain investors need in the current economic climate.