At Hannover Re, we have developed tailored financial solutions that allow our clients to take immediate credit for the embedded value by converting the inadmissible and illiquid asset of future profits into cash.
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Under most current accounting regimes, life and health insurers may not recognise the embedded value of their newly written or existing business as an immediate gain. Instead, they have to defer the anticipated profits, which are then recognised only gradually over time.
We achieve the acceleration of anticipated profits through payment of an initial reinsurance commission in return for assuming a share of the actual future profits emerging from a particular portfolio.
Assume an insurer expects the present value of future profits of the portfolio to amount to 45 million, with the corresponding profit signature as depicted in Figure 1. The insurer could then enter into a financial solutions arrangement with Hannover Re, under the terms of which the insurer cedes 75% of the portfolio’s future profits and the reinsurer remits an initial reinsurance commission of 17 million.
Such a financial solutions arrangement not only gives the client immediate access to future profits, but also transfers the risk of those profits crystallising to Hannover Re. The resulting boost to cash flow, earnings, and net assets – which is depicted in Figure 2 – strengthens the client’s balance sheet and thus allows, for example, to pursue profitable organic growth or to fund an acquisition.
Profit signature under true and fair view accounting
As the after-reinsurance profit signature in Figure 2 indicates, the arrangement can be structured such that the cession of the future profits to Hannover Re terminates once the initial reinsurance commission has been amortised, which in the example at hand is expected to happen after five years. This feature ensures that the client can retain any future profit that is in excess of the amount required for amortisation.
Alternatively to a cash solution – if the client’s objective is to boost earnings and net assets, rather than to increase liquid funds – Hannover Re can provide an even more economical solution. In such a non-cash arrangement, we withhold the reinsurance commission rather than paying it immediately to the client. A lower cost to the client reflects this absence of the large initial cash transfer.
Profit boost through monetisation of embedded value