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THE REGULATOR'S PERSPECTIVE When looking at the financial position of a Life Insurer , the company's Assets and Liabilities are measured. The difference is called the 'free assets' of the company. The greater the free assets relative to the liabilities, the more 'solvent' the company is deemed to be. There are different ways of measuring assets and liabilities - it depends on who is looking. The regulator, who is interested in ensuring that insurance companies remain solvent so that they can meet their liabilities to policyholders, tends to under-estimate assets and over-estimate liabilities. In taking this conservative perspective, one of the steps taken is to effectively ignore future profits. On the one hand this makes sense - it's not prudent to anticipate future profits. On the other hand, for an entire portfolio of policies, although some may lapse - statistically we can rely on a number to still be around to contribute to the company's future profits. Future profits can thus be seen to be an inadmissible asset - an asset which may not (from the regulator's point of view, anyway) be taken into account. A BANKER'S PERSPECTIVE If a Bank were to give the insurer a loan, the insurer's assets would increase by the amount of the loan, but their liabilities would increase by the same amount too - because they owe that money back to the bank. With both assets and liabilities increasing by the same amount, the free assets remain unchanged. This is generally a sensible thing, but it's not what financial reinsurance is aiming for. THE REINSURER'S PERSPECTIVE In setting up a financial reinsurance treaty, the reinsurer will provide capital (there are a number of ways of doing this, discussed below). In return, the insurer will pay the capital back over time. The key here is to ensure that repayments only come out of surplus emerging from the reinsured block of business. The benefit of this surplus-limitation comes from the fact that in the regulatory accounts there is no value ascribed to future profits - which means the liability to repay the reinsurer is made from a series of payments which are deemed to be zero. The impact is that there is an increase in assets (from the financing), but no increase in liabilities. In other words, financial reinsurance increases the company's free assets. DIFFERENT ACCOUNTING REGIMES It's important to be clear that financial reinsurance has an impact on the regulatory balance sheet only - which itself already provides a distorted view of a company's solvency. Financial reinsurance, certainly for life insurers, has no impact on their GAAP accounts. It does not disort a company's shareholder-reported profits. A lot of the bad press around financial reinsurance is because of inappropriate designs and incorrect accounting for the transaction. It is not a problem of financial reinsurance itself. |
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