Life and health insur-ance manufacturers may start looking to the reinsur-ance industry to cover a newly emerging risk: that far greater numbers of people will live long and healthy lives and draw down heavily from insurance products designed to provide income prior to death.

“Manulife Financial Corp. and then Sun Life Financial Inc. have come out with popular products,” says Stephen Irwin, vice president of A.M. Best Co., the New Jersey-based rating agency. “So, there’s an opportunity there for funding from the reinsurers.”

Irwin, who spoke at a Best conference in Toronto in September, was referring to Manulife’s GIF IncomePlus and Sun Life’s SunWise Elite products, both segregated fund products that offer guaranteed minimum withdrawal benefits for life.

Best released a report last month on the reinsurance industry that looked at this trend. It was also noted by Standard & Poor’s Corp. in its global outlook on the industry, published a week later. “To compensate for the reduced growth opportunities in traditional mortality reinsurance in the U.S. and Britain, we expect that reinsurers in both countries will turn their attention to other risks, in particular longevity risk,” states the report out of S&P’s London office.

If a client buys a $500,000 GMWB policy today, starts drawing on his or her 65th birthday tomorrow and lives until 90, then the client probably gets his or her money’s worth. Throw in nasty bear markets, like the one seen in the past month, in the first two years of withdrawal, and the client will get real value. When there are too many clients like that, insurers get nervous about the bottom line and look for help.

Reinsurers step in before the anxiety begins. They sell policies to insurance companies in exchange for assuming the extra financial risks caused by natural disasters — catastrophic losses from hurricanes in Texas, earthquakes in China, pandemic viruses, for example — but also the risks that arise as a result of human activity, such as increased longevity or financial market volatility.

The reinsurance industry has a certain dark allure, and it’s also dappled with interesting and new-fangled financial instruments with fanciful names, such as “sidecars” and “cat” bonds. Zurich-based Swiss Re AG, Germany’s Munich Re AG and New York-based Reinsurance Group of America Inc. each run Canadian subsidiaries that dominate the business here. In August, Aurigen Re, based in Toronto, opened its doors, hoping for a slice of the domestic and global market.

From advisors’ and clients’ perspectives, it’s good news that reinsurers may be willing to take on the extra financial risk. Analysts such as Moshe Milevsky, professor of finance at York University, have raised concerns that insurers may be biting off more than they can chew by developing products that actually encourage people to take on more market risk than they typically would: why should they care if their segregated funds are invested 80% in equities? Their income is guaranteed contractually in any event.

But Irwin notes that reinsurers aren’t about to dive into the market unprepared. They will do their due diligence on an insurer’s investment portfolios, guarantee options, underwriting and pricing before they’ll take it on. “And they’ll also make sure they get their own pricing right,” he says.

HISTORICAL EVIDENCE

There’s historical evidence, seen in Britain, that reinsurers are willing to take on these types of policies — if the price is right. Pension funds, after all, have always faced longevity risk. In February 2008, London-based Standard Life PLC reinsured £6.7 billion (US$12 billion), or about half its annuity liabilities, with Canada Life International Re, a unit of Winnipeg-based Great-West Lifeco Inc.

Generally, health and life reinsurance accounts for less than a third of annual premiums collected by the insurance industry, which topped $160 billion globally last year. But the potential development of reinsurance for segregated funds is among the most positive in the reinsurance industry, in which margins aren’t what they were just a few years back, according to both Best and S&P.

Profitability in the reinsurance industry, led by P&C income, peaked in 2004 as global markets surged and as insurance companies emerged from equities market losses in the early 2000s.

“Premium growth [in reinsurance products] is declining,” says Robert DeRose, vice president for reinsurance and an analyst with Best. “Primary companies aren’t buying as much reinsurance because of the good earnings they’ve had in the past few years.”

@page_break@So, outside of the property and casualty arena, most originating insurers currently have enough capital to assume their own risks rather than paying for further backup from reinsurers, DeRose says.

As a result, reinsurers are looking for other growth areas. One that is drawing consideration — but not much enthusiasm — is errors and omissions insurance for company directors and officers. With some of the most respected names in U.S. banking and insurance either collapsing or selling themselves as quickly as possible, questions are arising about the quality of senior management in the financial services sector.

“In the latest crisis, hedge funds, investment managers and advisors, and investment banks are among the institutions facing lawsuits over mismanagement of funds, nondisclosure and failure to follow corporate policy, among other claims,” a Best report on the sector states.

But this niche of the reinsurance industry is still small — only about 1% of global reinsurance premiums. That’s partly because reinsurers typically have shied away from the area after the debacle of the 1980s savings-and-loan crisis in the U.S., which was only fully resolved in the early 1990s.

Indeed, the risks in this sector may be too high already, even for the thick hides of reinsurers. With both premiums and claims for executive negligence already steep, many reinsurers are choosing to steer clear. The reinsurance kicks in when losses on the policies reach peak levels, explains DeRose: “So, the probability of reinsurance [growth] is remote, but the possibility is there.”

CANADIAN SUBSIDIARIES

There are no Canadian names in the space, except potentially through subsidiaries of the big three: Munich Re, Zurich Re and Swiss Re. “They’re trying to provide for it now rather than later,” DeRose adds. “It’s going to take time for us to know how much exposure there will be on reinsurers.”

In the P&C arena, reinsurers are also finding it a challenge to raise capital for so-called “insurance-linked securities,” also known as catastrophe (“cat”) bonds. “Now, if there was a major event like a catastrophic hurricane today, given where the capital markets are, reinsurers could raise money, but it would probably be more difficult,” DeRose says. “It wouldn’t happen overnight and it would be a slower response from the markets.”

Cat bonds are created when investment banks structure instruments on behalf of the reinsurer and float them in the bond market. Bond defaults are usually triggered by industry-wide losses from a catastrophic event such as a hurricane. “The reinsurer — the sponsor of the bond — would benefit,” DeRose says, “and theoretically offset the losses that are incurred.”

From both a financial and regulatory perspective, these instruments require less work by the reinsurer. Although cats are a relatively small part of the industry — about US$7.3 billion — it has expanded quickly in the past year, growing by 55% from about US$4.7 billion in 2006. When catastrophic events don’t occur, the bonds produce returns generally uncorrelated with equities or other corporate or government-sponsored income.

“Sidecars” represent another funding alternative for reinsurers that has grown in popularity. A financier, such as a hedge fund, sidles up to the sponsoring reinsurer and sets up a secondary reinsurance facility that assumes some of the financial risk for catastrophic P&C insurance. In exchange, the sidecar vehicle receives a share of the premiums.

Although these facilities have grown substantially in the past several years, in 2007 sidecar construction was down to US$1.9 billion, from $4.5 billion in 2006. IE