Financial solutions

Embedded value transaction

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.

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 by the 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 then could 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 him, for example, to pursue profi­table organic growth or to fund an acqui­sition.

Figure 1

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.

Figure 2

Profit boost through monetisation of embedded value