Sidecars become the engine of life/annuity reinsurance growth

AM Best's annual report on global life/annuity reinsurers, covered by Reinsurance News, lands ahead of the Rendez-Vous de Septembre with a familiar headline: the market is well capitalized and poised for steady growth. Its own numbers, though, show the engine has shifted: offshore life/annuity reinsurance has grown at an average 31% a year for a decade, while the pure-life side of the market grows at roughly 4% annually.

Primary carriers are leaning on reinsurers to manage higher interest rates, strong annuity product growth, and capital-regime differences that push transactions offshore. Bermuda and, to a lesser extent, the Cayman Islands have become the preferred domiciles, drawing ceding companies with stable regulation, political stability, legal and financial talent, and flexible accounting. The required capital and reserve treatment in those jurisdictions is often less stringent than for US-domiciled reinsurers, according to AM Best, and Edward Kohlberg, a director at the firm, points to increased recoverability risk in some cases where collateralization is lacking.

The balance-sheet data makes the reliance concrete: reinsurers accounted for 41% of approximately $1.61 trillion in reserve credits taken at year-end 2016, up from about 21%, and the volume of reserve credit and funds withheld on US cedents' balance sheets has been steadily increasing. That reserve credit is the accounting mechanism behind the trade: ceding companies book it to lower required capital while the reinsurer carries the underlying risk. AM Best also flags a pocket of concern that the level of excess capitalization could be insufficient to support claims in a stress scenario.

The stress warning points back to the source of the growth. Reinsurance capital across the broader industry stands at a record $705 billion, AM Best has said in its renewal outlook, but offshore-ceded reserve credit does not always come with collateral attached. The jurisdictions that made the market efficient also made it less automatic that a recoverable will be paid in a squeeze.

Into that gap steps alternative capital: Lou Silvers, senior financial analyst at AM Best, says sidecars have gained prominence in the life/annuity space. These affiliated or non-affiliated reinsurance entities draw on third-party limited-investor capital and can provide incremental just-in-time capital to execute larger deals, with the general partner earning additional fees. Property catastrophe reinsurance has used sidecars for years; life/annuity reinsurance is applying the same structure to longer-duration, asset-intensive blocks. As this publication has argued, life/annuity sidecars are now repeat vehicles, not one-off pilots, and third-party capital will anchor longevity risk before the soft cycle ends.

The asset side of these transactions reinforces the point: asset-intensive reinsurance and capital relief solutions are supported by rising private credit investment strategies within the market, AM Best says. A sidecar gives a ceding carrier yield and duration matching for annuity liabilities; it gives a third-party investor access to a private credit portfolio that would otherwise be out of reach. Private credit does not trade in a stress, which makes the collateral question more important.

The report's warning about excess capitalization should carry the most weight in Monte Carlo. Nominal capital overstates what is actually available in a stress, and in the sidecar structure the recoverability risk Edward Kohlberg describes is the first place a stress would show. Bermuda has become the balance sheet for asset-manager-sourced longevity capital, and every new A-rated vehicle raises the standard for liquidity and reserve scrutiny. The sidecar era in life/annuity reinsurance is a bet that the standard will hold. If it does not, the next repricing will be triggered by terms, not losses.