New business financing

Such a new-business strain typi­cally origi­nates from high initial distri­bution costs and is often ampli­fied by prudent reser­ving require­ments. As a result, not only can an insurer incur an initial strain on its cash position, but, depen­ding on the accoun­ting regime it is subject to, also an initial operating loss. Espe­cially the latter strain stands in stark con­trast to the overall expected profita­bility of the new business and its positive contri­bution to the insurer’s em­bedded value. In addition, it often erodes the insurer’s capital base.

Under such a new-busi­ness finan­cial solu­tion, the client receives from Hannover Re an initial rein­surance commis­sion for each unit of new busi­ness written. In return, Hannover Re parti­cipates in the future sur­pluses emer­ging from this new busi­ness. Figure 1 depicts how such a finan­cial solu­tion signi­ficantly reduces the client’s new busi­ness strain. The graph also illus­trates that one can struc­ture the arrange­ment such that it termi­nates once the initial rein­surance commis­sion has been amor­tised. This feature ensures that the client can retain any future sur­plus that is in excess of the amount required for amor­tisation.

Depending on the client’s objec­tives, the initial rein­surance commis­sion can either be paid in cash or with­held by Hannover Re. A remit­tance in cash is usually more suita­ble if the client incurs a cash strain, but often also helps to absorb an accoun­ting strain. With­holding the commis­sion is a more econo­mical alter­native that can help to miti­gate an accoun­ting strain. The lower cost of this solution reflects the absence of an initial cash transfer. It can thus be attrac­tive to insurers that do not require liquidity.

Unlike equity or debt, a new-busi­ness finan­cing solu­tion is always directly propor­tional to the volume of policies sold and hence perfectly mirrors the scale of the client’s new busi­ness strain. This align­ment gives the client pre­cisely the finan­cing capa­city it re­quires - at a cost that re­flects only the capa­city used.

The type of new-busi­ness finan­cing des­cribed here is geared towards en­hancing the client’s assets. In some in­stances, for example if conser­vative reserves signifi­cantly contri­bute to the new-busi­ness strain, a lia­bility-redu­cing struc­ture in form of a reserve relief may be more suitable for the client.