Reinsurance CFO Priorities – A Frame of Reference

Over the years, the roles and responsibilities of a reinsurance CFO have undergone a sea change; in fact, some modern-day enterprises have a different connotation altogether for what the word means. From chief financial officer to chief future officer, this change has been spurred by many factors like the financial crisis (2007–2008) that took investment banks, insurance firms, and broker-dealers through quite a swirl. The reinsurance industry endured adverse effects with a steep deterioration in financial market valuations and investment portfolios, almost leading to a moral hazard. That said, crunching numbers is merely a fraction of the role of a CFO. Market-related imperatives like environmental, social, and governance (ESG)-centric data-driven decision-making, globalization, and the adjoining regulatory implications, along with fluctuations in the world economy, imply that a reinsurance CFO’s top priorities must broaden significantly.

The changing role of reinsurance CFO

From a reinsurance perspective, a CFO is essentially responsible for risk and financial management, investor relations, such as public disclosures, climate-related financial disclosures, and group reporting.

The financial management facet is more of a balancing act. One side involves diversifying liabilities (reinsurance claims) into a set of market-consistent cashflows based on risk-neutral scenarios and parameters by using the replication portfolio approach. The other side covers the valuation of underlying assets such as investments, securities, cash, among others. This helps in achieving a better understanding of the projected future reinsurance liability claims to their underlying asset values. Depending on the development of reinsurance liabilities, frequent rebalancing may be necessary.

When it comes to reinsurance risk management, a CFO’s role involves balancing claim maturities against its underlying asset maturity create (asset liability management) mismatch. Asset liability management (ALM) is a form of risk management that hedges risk associated with a mismatch between reinsurance claims and the underlying assets. The ALM risk also subsumes itself within the underlying liquidity risk for reinsurance. As maturity windows of reinsurance claims tend to be longer than the maximum market-based tenure of their underlying assets, the key to managing reinsurance risks is defining tolerance thresholds and managing mismatches.

Since yield returns on assets are near rock-bottom, firms tend to evaluate asset investments with longer duration or higher yield for greater profitability. The collateral consequences might aggravate the firm’s overall risk profile. CFOs tend to strike a harmony between appropriate reinsurance risk tolerance and returns on the underlying asset. Ultimately, the firm must be profitable and provide returns to shareholders, all within the scope of prudent financial management practices.

Netted along is the CFO paradigm for reserves and capital management. It mainly stems from holding sufficient buffers to shoulder contingencies in claims and asset valuation shocks and demonstrating financial solvency to stakeholders such as regulators, markets, and equity investors. This paradigm is a moving target such that excess reserves and capital may hamper profitability. Still, if insufficient, it can lead to a risk of eroding public confidence and the reputation of the reinsurance entity.

A second prominent facet is investor relations and disclosures. Here, the purpose is to provide the external stakeholders with a comprehensive, accurate, and transparent financial picture of the entity so that they can take informed decisions on whether to invest in the firm. Reinsurance firms can also conduct their own risk and solvency assessment (ORSA) as part of the Solvency II directive.

From a regulatory compliance perspective, a reinsurance CFO’s priorities involve adhering to:

• IFRS 17 for non-US domicile business interests
• US GAAP long duration targeted improvements (LDTI) for long-term contracts within US domicile business
• Solvency II

Additionally, reinsurance firms in EU and the UK must comply with Solvency II in both jurisdictions.

What’s next?

CFOs may consider the following steps to achieve their priorities:

• Focus on balance sheet resiliency with addressing and mitigating ALM mismatches and building a dynamic liquidity regime based on internal liquidity stress scenarios, which factor in extreme tail events with appropriate confidence intervals.
• Devise a strong risk-appetite framework that encompasses the firm’s strategy and blueprint to address the risks enlisted.
• From a profitability standpoint, investment in sustainable green bonds could be a good direction where the entity aids in addressing climate change through green investing and harnesses the benefits of tax credits owing to such investment decisions. Moreover, reinsurance firms may use this green swan revolution to decarbonize their investments portfolio, refocusing funds to green and non-carbon firms in their investment portfolio, albeit being cautious to avoid greenwashing.
• Invest efforts to address compliance, and become future-ready for compliance, especially from an ESG perspective. Institutionalize a board-level global sustainability and climate change committee to oversee climate impacts on reinsurance companies across diverse business units, geographies, and teams and incorporate the same into climate disclosures. Also, the impacts of the new EU taxonomy and Green Bond Standard for reinsurance investments and BoE Supervisory Stress Testing for reinsurers form key facets to CFO compliance priorities. Emerging disclosures impacting reinsurance firms include the new SEC norms for Form 10K reporting on climate disclosures that are applicable to US-listed entities.

Beyond just a financial steward

In summation, the role of a CFO has evolved beyond just a financial steward. Although the financials remain a fundamental responsibility, CFOs are also looked upon as the strategic change-makers for reinsurance firms. With the add-on need to ensure liquidity and ESG as a major deciding factor for investments, CFOs will play an essential function in business strategy formulation and execution, serving as an organization’s leader and external-facing advocate.