24th September 2023

Gallagher Re launches the first in a series of Gray Rhino research papers

The papers are designed to raise awareness of insurance industry challenges before a major event occurs and this first publication addresses mass-lapse risk in European life insurance.
The metaphor “Gray Rhino” was first coined by Michele Wucker, an American policy analyst specialising in the world economy and crisis anticipation, replacing the idea of the "black swan" a rare, unforeseeable, unavoidable catastrophe) with the reality of the "gray rhino"-a preventable danger that we choose to ignore.
Executive Summary:
-As interest rates rise, life insurers are increasingly aware of the capital losses that could result from rising policyholder lapses. The continuing cost-of-living crisis for consumers is also increasing the likelihood they will cancel policies and/or take their money elsewhere.
-The macroeconomic drivers of a mass-lapse event are complex and difficult to model. But the consequences are clear and could be catastrophic for the industry: large fixed-income portfolios sold at a capital loss to fund surrender values, leading to material mismatch in the duration of assets and liabilities. Driven by an extended period of low interest rates and bond yields, European insurers have moved their portfolios toward less liquid assets in recent years.
-Ratings agencies have taken note, examining this risk in detail in recent reports. Lapse risk is distributed unevenly across Europe, with insurers in some markets more exposed than others, and different mitigating factors involved.
-Lapse risk has been formally recognized by European regulators for some time, requiring insurers to hold sufficient capital under lapse up, lapse down and mass lapse scenarios. The mass lapse is defined under Solvency II as a one-off first-year shock where 40% of life policies immediately lapse(70% for some specific categories).
-Should lapse rates accelerate the situation could rapidly deteriorate. As we saw during the 2008 crisis, the collapse of a major insurer could even be a systemic risk. Mindful of this, a growing number of insurers are seeking reinsurance solutions to manage this lapse risk, as well as liquidity risk, and protect their bottom line.
-Coverage can be configured to transfer lapse risk to reinsurers, where the reinsurance policy responds if lapse rates are higher or lower than expected. The cover also provides a substantial Solvency II benefit, largely through lapse solvency capital requirement(SCR) reduction and from some risk margin relief.
-The list of European countries where lapse reinsurance transactions have been executed is growing, with an increasing number of first precedents of these transactions receiving the local regulators’ blessings, recognizing the risk management benefits of lapse reinsurance solutions.

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