Term Block YRT Rate Increase and Recapture Decision
A life insurer has a closed block of 75,000 five-year renewable term policies with $9.0 billion of face amount. Seventy percent of the mortality risk is ceded under a yearly renewable term treaty. The reinsurer has notified the company that YRT rates will rise 45% at the next renewal, adding about $19 million to annual ceded premium. The treaty permits recapture after the fifth treaty year if the reinsurer raises rates by more than 25%, with 12 months' notice. Recapture would require an $18.6 million fee, release of $310 million of ceded reserve credit, and an estimated $140 million of additional capital to keep mortality volatility within the company's risk appetite. The block currently contributes $28 million of annual pre-tax margin. Company surplus is $1.4 billion and the RBC ratio is 410%. The CFO can also negotiate a 24-month transition, buy stop-loss coverage, or recapture and retrocede a smaller share. Mortality has been 112% of expected for two years, driven by older issue ages.
1. Quantify the annual economics of recapture versus accepting the rate increase, including the cost of the additional capital. What non-quantitative factors matter?
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Accepting the increase: annual ceded premium rises $19m, so pre-tax margin falls from $28m to about $9m before any offsetting action. Recapture: saves the $19m increase but costs $18.6m upfront and requires $140m of capital. At a 10% cost of capital, that capital costs $14m per year, leaving only about $5m of annual net benefit before mortality risk; the upfront fee takes nearly four years to recover. With mortality at 112% of expected, recapture transfers a currently adverse mortality pool back to the company. The $310m reserve-credit release also reduces statutory surplus and increases C-2 risk. Quantitatively the recapture case is thin; qualitatively it is weaker because the company would bear full tail risk just when experience is bad. The better course is to accept a negotiated transition, demand experience refunds, and buy stop-loss or recapture only with substantial retrocession.
2. Design a risk-mitigation structure and explain how it changes RBC and surplus.
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A workable structure is a 24-month transition at a lower rate increase, combined with a stop-loss treaty that caps retained mortality at, say, $25m per year, and an experience-refund formula tied to the block's actual mortality. This keeps most of the reinsurer's diversification benefit while reducing the immediate $19m cost. Alternatively, recapture and immediately retrocede 50%-60% under a quota share or an aggregate stop-loss; that cuts the additional capital requirement from $140m to roughly $60m-$80m, preserves some margin, and limits C-2 volatility. In either case, surplus is protected by avoiding the full $310m reserve-credit release and by not taking 100% of mortality risk. The trade-off is a lower expected margin and continuing dependence on reinsurer credit quality, which should be monitored.