United Kingdom regulators have moved closer to a decision regarding their views on reinsurance practices among U.K. life insurers (see ASR 6/17/02). The Financial Services Authority, the U.K. insurance regulator, has announced that it will be investigating the use of financial reinsurance.

Two points on which the regulator will focus are whether cash is actually transferred to the insurer at the time of reinsurance, and the issue of better transparency with regards to an insurer's solvency position.

With reinsurance, an insurer is effectively asking the reinsurer to back the future profits of policies up front through loans that cover the short-term loss of buying these policies. There are two kinds of reinsurance loans: cash and non-cash. Industry sources added that the common reinsurance sought by the majority of U.K. insurers was non-cash.

In a survey released last week by the Center for Risk and Insurance Studies at Nottingham University Business School, 11 of the 20 companies surveyed used future profits in their year-end 2001 calculations, which added GBP5.5 billion to the aggregate results. Regulators aim to improve transparency in this area in order to more accurately determine an insurer's solvency position.

According to the survey, the average amount of free assets among the top 20 U.K. life insurers dropped to 7.1% in 2001 - down from 11.7% in 2000 and 19.1% in 1999. Without the inclusion of future profits, the free assets calculation would have rung-in at 5.8%. As it stands now, simply comparing the free assets ratio is not an efficient way to calculate an insurer's financial position.

With the dismal state of the equity markets and what now increasingly looks like the dismissal of financial reinsurance, securitization techniques may become a viable option in the near future for reinsurers looking to improve their solvency position.

Financial reinsurance has historically offered a cheaper source of financing; in terms of providing capital, however, it works on a supply-and-demand basis. On the supply side, reinsurers are limited in the amount of capital they can provide, which will increase the likelihood of their use of securitization in the future.

"If the U.K. regulators rule against financial non-cash reinsurance, the effects could potentially be felt throughout Europe," said Jonathan Macdonald, Life Actuary at Fox-Pitt, Kelton, Swiss Re's corporate finance unit. "And U.K. insurance companies are increasingly looking for larger amounts of capital - that makes securitization more cost effective."

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