Choosing Between Coinsurance and Assumption Reinsurance
Lakeshore Life is negotiating a 100% coinsurance agreement on a closed block of traditional whole life policies with $1.2 billion of statutory reserves and $180 million of annual premium. The reinsurer offers an 8% ceding commission on reserves, or $96 million, and will assume the reserves. Alternatively, Lakeshore can enter an assumption reinsurance transaction in which the reinsurer pays $140 million and takes over the policies entirely, but policyholder consent is required. Lakeshore's surplus is $900 million, and its RBC ratio is 380%. The block has been in runoff, with expenses of $22 million per year and expected death benefits of $160 million. The CFO favors assumption reinsurance because it removes the block from the balance sheet. The general counsel warns that consent solicitation could take 18 months and may fail for 30% of policies. The tax advisor notes that the coinsurance transaction may trigger a tax liability of $15 million, while assumption reinsurance may be tax-free to Lakeshore.
1. Compare the immediate surplus impact of the coinsurance and assumption reinsurance alternatives. Which is more favorable to Lakeshore's RBC ratio?
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The company action level is $900M / 3.80 = $236.8 million.
Under coinsurance, the ceding commission of $96 million increases surplus, but the $15 million tax liability reduces the net benefit to $81 million. Pro forma TAC is $981 million and RBC is $981M / $236.8M = 414.3%.
Under assumption reinsurance, the $140 million proceeds are tax-free and surplus rises to $1.040 billion. RBC becomes $1.040B / $236.8M = 439.2%. If only 70% of policyholders consent, Lakeshore receives 70% × $140M = $98 million and retains 30% of the block. Pro forma TAC is $998 million and RBC is 421.4%, still better than coinsurance.
On immediate surplus and RBC, assumption reinsurance is more favorable if it closes. The coinsurance alternative is more certain and faster, but it leaves the block on the balance sheet with reserve credit rather than removing it.
2. How should Lakeshore evaluate the risk that only 70% of policyholders consent to assumption reinsurance? Quantify the outcome and recommend a decision rule.
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Let x be the consent rate. Assumption reinsurance beats coinsurance on a surplus basis when $140M × x > $81M, or x > 57.9%. At 70% consent, the surplus benefit is $98 million, which is $17 million better than coinsurance. At 50% consent, the benefit is $70 million, which is $11 million worse.
The board should set a minimum consent threshold of about 60% and obtain a reinsurer commitment to cover the shortfall or to convert the transaction to coinsurance for non-consenting policies. It should also discount the expected benefit for 18 months of delay and for the cost of servicing the retained 30%. A decision rule is: proceed with assumption reinsurance only if the reinsurer accepts a 60% minimum consent condition and provides a coinsurance fallback for the remainder; otherwise, take the coinsurance transaction.
3. What other factors should the board consider before choosing between the two structures?
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The board should consider policyholder treatment and reputational risk. Assumption reinsurance transfers the contractual relationship to a new insurer, which can generate complaints and regulatory scrutiny even if the economics are superior. It should also assess the reinsurer's credit quality, because both structures depend on the reinsurer's ability to pay claims; a weak counterparty can turn a surplus gain into a future risk.
Operationally, coinsurance preserves administration and policyholder contact, while assumption reinsurance may allow Lakeshore to exit systems and staff, producing expense savings beyond the $22 million block expense. The board should quantify those savings, the tax treatment, and the impact on future growth capacity. It should also stress-test the RBC result under a mortality or lapse shock, because the block is in runoff and the retained 30% under partial assumption could be adverse. Finally, the board should confirm regulatory approval requirements for both structures before committing.