Offshore Reinsurance Outsourcing to Yourself

Moody's has put a figure on something the life insurance industry would rather discuss in the passive voice. The fees that US insurers pay their own affiliates to manage money inside offshore reinsurance structures have grown by around forty per cent since 2015. The agency files this, reasonably enough, under counterparty risk and transparency. But the number is more interesting than the category it has been placed in. It is not a measure of a cost the industry has been forced to bear. It is a measure of how well the structure has been working.

Begin with the word "outsourcing," which is doing a great deal of quiet work. Outsourcing implies distance: you hand a function to someone else because they can do it better or cheaper, and the fee you pay them is the price of that arm's-length advantage. That is not what is happening here. The insurer cedes its liabilities to a reinsurer it is affiliated with, frequently sitting in Bermuda or the Cayman Islands. The assets backing those liabilities are then managed by an asset manager the insurer is also affiliated with. The fee for that management flows up to the same parent that owns both ends of the trade. The insurer has not sent the work outside. It has sent it across the room and billed itself for the journey.

This is the part the headline obscures. A forty per cent rise in fees, in an ordinary commercial relationship, is a problem to be managed — a margin leaking out of the business toward an external counterparty. In an affiliated structure it is the opposite. The fee is not leaking out; it is the channel through which value is deliberately routed to where the owner wants it. The regulated insurer is the raw material. The annuities and the long-dated liabilities they sit against are the feedstock. What the structure actually produces, and what its owners are actually in the business of producing, is fee-earning assets under management. The insurance is the wrapper. The fee is the product.

Once you see it that way, the trajectory of the figure stops being surprising. The owners of these structures are, overwhelmingly, private capital — alternative asset managers and the firms that have spent the past decade buying life and annuity books precisely because those books come with a permanent, captive, slow-moving pool of money to manage. A life insurer's liabilities run for thirty years. The fee on the assets behind them runs for thirty years too. There is no better annuity, for an asset manager, than an actual annuity. The forty per cent is not drift. It is the design maturing.

There is a familiar shape to this, and it is worth naming because the British reader will recognise it. We have our own version, conducted with a different instrument. In the bulk purchase annuity market, the lever is not an affiliated management fee but the matching adjustment — the regulatory permission to discount long-dated liabilities at a rate above the risk-free curve, and to recognise the resulting gap as value on day one. Funded reinsurance, increasingly to the same offshore jurisdictions, extends the trick. The mechanics differ; the grammar is identical. In both cases a regulated entity holding obligations to ordinary people is restructured so that a defined, present, capturable benefit accrues to the owner, while the obligation it was created to honour recedes into a longer and less visible future.

The asymmetry is the whole story, and it is an old one wearing new clothes. The fee is paid now, in cash, to a party with the discretion to set it. The risk is borne later, in instalments, by parties who did not negotiate it: the policyholders, whose annuities depend on a reinsurer two jurisdictions away; and, behind them, the public backstops that exist precisely because we have decided as a society that pensioners should not bear the full consequence of a structure they never saw. Privatise the fee, socialise the tail. It is the recurring template of the captive market, and it survives because each individual step is defensible, technical, and boring, while only the sum is alarming.

What makes the affiliated fee a purer specimen than most is that it dispenses with even the pretence of an external counterparty disciplining the price. When you pay a third-party manager, the fee is at least the outcome of a negotiation between parties with opposed interests. When you pay yourself, the fee is whatever you decide it should be, constrained only by what the regulated entity can be made to bear without tipping into visible distress. The forty per cent rise tells us, among other things, what that tolerance has turned out to be. It is higher than one might have hoped.

This is where the regulatory framing — counterparty risk, transparency — is correct but insufficient. It asks whether the offshore reinsurer is solvent and whether its assumptions are disclosed. Both are good questions. Neither is the central one. The central question is about incentive, and it is this: when the same parent owns the cedant, the reinsurer, and the manager, whose thirty-year interest is actually being served by the fee?

The honest answer is that the fee serves the owner's interest, and the owner's interest is not the policyholder's. The owner is rewarded on the assets gathered and the fees extracted, both of which are realised long before the liabilities they were created against come due. A manager paid annually on a book that pays out over decades is structurally indifferent to the back end of that book in a way that the policyholder cannot afford to be. That indifference is not malice. It is simply what the incentive describes, and incentives describe behaviour more reliably than mission statements do.

So the number deserves better than its filing category. Forty per cent is not an anomaly to be monitored, a friction to be reduced, or a transparency gap to be papered over with better disclosure. It is the visible edge of a structure functioning exactly as intended — converting other people's long-dated obligations into the owner's near-dated income. The transparency problem is real, but transparency would only let us watch the mechanism more clearly. It would not change what the mechanism is for.

The question the market is still declining to ask is not whether these structures are solvent. It is whether an arrangement in which an institution pays itself a rising fee to manage its own promises to other people is an insurance business at all, or an asset-gathering business that has found, in the regulated insurer, an unusually patient and unusually captive client. The fee has now answered that question. The forty per cent is the answer written down.

C.J. Marsden