Increasing regulatory capital requirements have meant that the banks have lost some of their enthusiasm for longevity risk transactions, which contain long-dated obligations. Insurers have thus been taking advantage of the new market, by providing insurance or reinsurance cover that assumes longevity and other specified risks. The recent BAE Systems /L&G/Hannover Re transaction, which will reportedly see Hannover receive premiums of £2.2 billion, and the Rolls-Royce/ Deutsche Bank/Scor deal, are illustrative of activity in the sector.
(Re)insurers wishing to do deals continue to have to consider a number of regulatory issues, particularly if the deal is being done on a cross-border basis.
Structural considerations for a (re)insurer
(Re)insurers in many countries, including the UK, are only permitted to enter into contracts of insurance. For this reason longevity cover provided by a (re)insurer will usually need to have the legal characteristics of a contract of insurance, even if the economic characteristics are different (e.g. a swap). Alternatively, and subject to local regulation, the (re)insurer may be able to establish a non-insurer subsidiary.
To qualify as a contract of insurance, legal and regulatory tests are likely to involve questions of insurable interest, risk transfer, and premium, depending on the insurer’s jurisdiction. Careful drafting will need be needed to meet these requirements, for example to show that a premium will always be paid.
This is in contrast to the position for a bank or other non-insurer, as, again depending on the country, such providers are prohibited from issuing contracts of insurance. Instead, in order for these providers’ products not to constitute insurance, they may need to be written on a parametric rather than indemnity basis, so that payment is by reference to a deterioration in a longevity index rather than by reference to a loss suffered.
Structural considerations for the cedant/insured
The cedant, or insured, will want to take full regulatory capital credit for the transaction, and, as a minimum, achieve a no less favourable regulatory treatment than that afforded to the assets it currently holds to support its obligations. Depending on the local law, an insurance contract which responds more directly to losses may be more highly favoured than a derivative-style product which responds simply to changes in an index irrespective of actual loss.
The quality of the protection provider will also be key. For example, local regulations may require that the (re)insurer be located in approved countries or blocs (such as the EEA).
The need for the (re)insurer to obtain a licence in the cedant/insured’s jurisdiction will in large part depend on how that jurisdiction prohibits unauthorised (re)insurance. For many countries with no general bar on non-admitted insurance (such as the UK), the focus will be on whether the (re)insurer is actually performing, or deemed to be performing, regulated activities in that territory. In contrast, other jurisdictions have traditionally prohibited non-admitted insurance (and sometimes reinsurance) based on the location of the risk/insured.
There is also the separate point, already highlighted, that local authorisation of the provider may improve the regulatory capital treatment of the product in the hands of the cedant/insured.
Each party will wish to ensure that the other has sufficient assets to meet its obligations, particularly where rules on security and insolvency differ cross-border. In problematic jurisdictions there may be a heightened appetite for separate custodian or trust arrangements for any posted collateral.
The form of collateral (in terms of liquidity and quality), and the frequency of recalculation, will depend on the legal and regulatory implications of insolvency in the relevant counterparty’s jurisdiction.
Other cross-border considerations
Other issues that gain additional significance in a cross-border arrangement include:
- exchange rate risk upon payments – it will most probably be the (re)insurer who bears this risk, consistent with the cedant/insured’s desire for certainty;
- the possibility of a change of law (in either country) that renders the transaction ineffective, necessitating appropriate unwind provisions in the documentation;
- data protection issues, if policyholder data is to flow cross-border; and
- the effect of tax, to the extent the cedant/insured’s country can impose any insurance premium tax or withholding tax on any claims payments.