Making the news today is another large and interesting reinsurance transaction involving Warren Buffett’s Berkshire Hathaway Inc. which sees the firm taking on variable annuity risks and as a result assume some exposure to mortality and longevity risks. In a reinsurance deal worth $2.2 billion, Berkshire Hathaway will reinsure the risks associated with $4 billion of future claims for two of health insurer Cigna Corp’s run-off variable annuity businesses.
Under the terms of the transaction which was announced late yesterday, Buffett’s Berkshire Hathaway Life Insurance Co. of Nebraska will reinsure Cigna’s run-off Guaranteed Minimum Death Benefits or VADBe, and Guaranteed Minimum Income Benefits or GMIB businesses, effective Monday, 4th February.
U.S. health insurer Cigna is paying $2.2 billion in reinsurance premiums for the deal, in return for which Berkshire Hathaway will assume the risk for up to $4 billion of future claims related to the business. Cigna is selling $1.8 billion of annuity assets to Berkshire under the terms of the deal, and will also fund the transaction with $100m of cash and $300m of tax benefits.
Cigna stopped writing reinsurance including variable annuity death benefits back in 2000 and these businesses have been in run off ever since. David Cordani, President and CEO of Cigna commented, “Cigna is taking this definitive strategic step to further reduce risk and continue to improve our financial flexibility. This transaction effectively eliminates potential capital calls and income statement volatility from these run-off books of business.”
Here’s where the deal gets interesting. The book of business includes two annuity linked insurance covers which were sold to help guarantee minimum retirement incomes for pensioners, or a minimum death benefit when pension plan participants died.
Guaranteed Minimum Death Benefits, or VADBe, allow for a guaranteed payment to a named beneficiary should an annuity contract owner die while the annuity is still accumulating. As suchVADBe brings with it mortality risk, as should mortality rates rise within the covered book of business payouts of these death benefits increase.
Conversely Guaranteed Minimum Income Benefits, or GMIB, offer a guaranteed minimum retirement income to annuity contract owners for the life of their pensions and so these contracts have a longevity risk associated with them as should longevity trends rise payouts of the minimum benefit will be made for longer than forecast.
So, this book of business provides some sort of natural hedge of mortality versus longevity risks as long as the book of businesses mortality and longevity rates follow forecasted levels. However, if the mortality rate of the subject book of business rises then Berkshire Hathaway will pay out more on Guaranteed Minimum Death Benefits. Should the longevity rate rise Berkshire Hathaway will pay out Guaranteed Minimum Income Benefits for longer. So this business certainly has risks attached which no doubt Berkshire will have carefully assessed and perhaps considered hedging itself.
Underlying the business are annuities and the investable assets which support and are designed to grow the annuity cash pot. Another risk lies in the invested assets not making the forecast returns leaving the payment pot short when it comes to time to pay benefits. This means the investments need to work at a certain rate of return in order to finance the annuity contract terms, particularly as these have guarantees associated with the minimum level of benefits. The worst case scenario with this kind of business might be underperforming annuities combined with increasing longevity rates, as the guarantee of a minimum benefit may result in a shortfall.
Given Berkshire Hathaway’s strong position in investments and hedge funds we assume that one of the key reasons for undertaking the transaction will be its confidence that it can make the assets work hard enough to finance the benefit claims when they come. Some reports suggest that this is also part of the reason for Cigna seeking the deal as these run off businesses have been volatile on their books and not been performing as necessary.
In a press release, Cigna said that it believes that the $4 billion capacity of this reinsurance transaction is “Significantly in excess of current projections of future claims for this business” and that Cigna believes that the potential for actual annuity benefit claims to exceed the limit of the reinsurance coverage from Berkshire is extremely remote.
Berkshire Hathaway’s motivations for undertaking this deal will lie in the way it believes it can utilise the premiums and investable assets to improve the claims paying profile of the subject book of business and it must be confident that the mortality or longevity experience will not get sufficiently worse to impact this negatively.
Others have been pulling out of the annuity business due to historic low-interest rates and volatility in the financial markets. Buffett however appears confident that more profit can be made from investing the assets than will be required in ongoing benefit payments. So effectively Buffet is betting his investment track record and Berkshire Hathaway’s financial performance against longevity risk, some might say.
Berkshire Hathaway appears to enjoy assuming long-term exposure books of business where it can profit from underlying assets or future values of policies. Back in November we wrote about Berkshire Hathaway’s assumption of a book of life insurance policies from Spanish insurer VidaCaixa.
While not strictly on topic for our usual coverage of ILS, collateralized and alternative reinsurance, transactions like this are fascinating as they involve large amounts of risk which could have utilised the capital markets as a way to transfer it. Given the size of Berkshire Hathaway, the depth of its reinsurance portfolio and the capital markets nature of its business this deal provides an interesting example of reinsurance at scale.