Flow reinsurance: A popular tool in the life/annuity reinsurance market

Flow reinsurance, or the reinsurance of new policy sales, has become an increasingly popular tool in the life and annuity reinsurance market. These transactions are attractive to ceding insurance companies because they offer a steady source of capital to support product growth and profitability while reinsurers gain access to attractive products in markets where they may not be as competitive along with a steady stream of incoming cash flows to invest.

In addition to the usual items to consider when negotiating a reinsurance transaction (such as recapture, credit for reinsurance and collateral), flow reinsurance transactions carry their own unique set of issues to address when structuring a deal.

Building a long-term partnership

Flow reinsurance deals take different forms, with some operating as a fronting arrangement in which the reinsurer takes all (or nearly all) of the economics. Many operate more like partnerships with the parties more evenly splitting the economics, whether 50-50, 70-30 or somewhere in between. The relative split of these economics will be a large driver of how the deal is structured and the relative rights of the reinsurer over key decisions affecting the reinsured block, whether it be front-end pricing or future block management changes.

Flow transactions will often be built around a “new business period” during which new sales are automatically reinsured to the reinsurer. After the end of the new business period, new sales are no longer reinsured, and the transaction becomes like any other block transaction and is effectively in run-off.

In approaching the new business period, the parties must consider whether the cession of new business is subject to an aggregate limit or cutoff date. A reinsurer may not have unlimited appetite or capacity for the risk and a ceding company may only wish to reinsure a certain amount of the risk during a given period. The parties may also wish to consider whether the relationship will be exclusive during the new business period with limited termination rights, or if either party may end the “flow” of new sales at its option.

Developing a co-pricing process for flow reinsurance

Unlike “block” transactions involving the reinsurance of a defined block of existing policies, flow reinsurance puts the reinsurer in the front lines of product pricing and the parties must navigate how the reinsurer will price a business that does not yet exist.  Many life and annuity products are priced on a periodic basis based on market indicators at the time of the sale; diligence information will be limited to the historical experience of the product (or a similar product set) during different market environments. This makes it difficult for a reinsurer to gain a sufficient level of confidence to provide an attractive fixed price to the ceding company over any prolonged period.

Therefore, most flow partnerships look for ways to plug the reinsurer into the ceding company’s existing pricing process so that the reinsurance and product pricing happen in tandem. The parties may develop and agree upon a bespoke process to permit the reinsurer to price “side by side” to the ceding company during each pricing cycle for the reinsured product. For example, if the ceding company sets rates for new sales every other Friday, the parties must design a bi-weekly process that results in the parties being fully agreed on the reinsurance pricing terms by the Friday deadline.

As part of this process, other considerations include:

• Which reinsurance terms will be reset at each pricing cycle (e.g., ceding allowance, quota share), and which will be fixed (e.g., expense allowances)?
• Will the reinsurance pricing have to satisfy certain minimum thresholds or fall within agreed ranges?
• Will either party be able to opt out of the reinsurance flow for a given pricing cycle if certain parameters are not met?
• How will the parties resolve disputes in a timely manner?
• Will the parties engage in “off cycle” pricing due to certain triggering events?

The optimal structure should reflect the relative economic interest of the parties and be able to facilitate a pricing process that fits seamlessly within the ceding company’s overall rate setting process.

Flow reinsurance transactions permit significant flexibility. Parties should work collaboratively to design a structure that is designed to achieve the economic goals of the parties, and that can adapt over time to reflect the relative appetite of the parties for the reinsured risk.

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Megan Arrogante is counsel with Debevoise & Plimpton. Contact her at [email protected].