The reinsurance business is doing well in Luxembourg. For the year 2023, according to the Supervisory Authority for the Insurance Sector (Commissariat aux Assurances or CAA), its collective balance sheet total is up by 4.1% to €55b. Premium income rose by 14% to €14bn, while profit after tax soared by 82.2% to €833m. By way of comparison, life insurance in Luxembourg posted an after-tax profit of €352m and non-life insurance €874m.

What is reinsurance? Valérie Widong Scheepers, head of the non-life & reinsurance department and member of the CAA’s executive board, describes this branch of activity as "insurer's insurance".

Insurers often take out insurance to protect themselves in advance. “Each insurance company is free to define its reinsurance policy,” Widong Scheepers said in an interview. “It is up to the company to decide which risks it will insure on its own and which risks it will insure with a reinsurer. Actuaries and risk managers will carry out analyses to ensure a level of protection that smoothes the profit and loss account. For the benefit of the final policyholders, who will have the assurance of being paid every time they suffer a loss, because the insurer will have protected itself properly. This is how the business has developed historically.”

This traditional market, also known as the 'commercial market', is driven by major players such as Scor, Munich Re and Swiss Re. "These are players who work on the 'classic' market, who accept risks from several types of cedents and who can also protect themselves with other reinsurers".

Captive reinsurance: Luxembourg speciality

Alongside 'commercial reinsurance', what is known as the 'captive market' has gradually developed, in which certain large groups, mainly industrial, have decided to create their own reinsurance structure whose sole purpose is to take on the risks that come from the industrial group.

"To do this, these structures will need to use an insurance company that does what is known as fronting, i.e., it will offer insurance cover and then reinsure itself with the captive. It is a company that belongs to the group from a capital and governance point of view. Everything will therefore be managed in the best interests of the group, with no exposure to third parties".

This captive reinsurance market has developed in Luxembourg thanks to a practical, tailor-made tool: the equalisation reserve. “This is a specific provision whose technical name is the provision for claims fluctuation (PFS). It's a provision that captives build up to ensure they are self-sufficient. The key principle of insurance is the pooling of risks to offset potential claims on a group of contracts by generating profits on other contracts. This is the principle of risk pooling. This principle cannot be applied to captive reinsurers, which operate on the principle of pooling by year. It is by setting aside these equalisation reserves that captives will be able to fulfil their role,” she said.

For captives, contributing to the PFS is a legal obligation checked by the CAA. The regulator authorises a captive to fund according to a precise methodology. The CAA can exempt them from this obligation if they can demonstrate with figures that they do not need to do so.

In 2023, 147 companies made an allocation, while 37 companies had to write back provisions. “This means that in 2023, 147 companies ended the year in the black and were able to set money aside, while 37 had to dip into their reserves to cover claims. This illustrates that the PFS is not a hoarding tool, but a valuable one whose use can vary over time. 2023 was a very good year because the proportion of companies that endow is much greater than those that decant. This is not always the case.”

Logically, making a profit is not the primary aim of captives. The sector's good results for 2023 are due to the commercial arm, led by Swiss Re, which has set up its European subsidiary in the grand duchy to serve the European market.

Dynamic ecosystem

Widong Scheepers stressed one point: captive reinsurers should not be pitted against traditional insurers. You might think of them as competitors, but they actually complement each other.

Firstly, they are exposed to the same macroeconomic constraints, marked by rising premium prices. "For years, insurance prices were very low. There was a lot of capacity, which led to pockets of under-pricing. In 2020, the markets started to harden, for various reasons, including climate change and inflation. It became harder for industrial groups to place their insurance programmes. It therefore became attractive for them to open a captive in order to have a negotiating tool in hand when discussing their reinsurance programme with commercial reinsurers. It also enabled them to demonstrate to their insurers that they were developing a risk culture. Creating a captive implies having a certain discipline when it comes to risk management. As for the commercial reinsurers, they don't necessarily see the captive as a competitor. For them, it is another company with which some of the risks can be shared, risks that they no longer wanted to take on or could no longer take on 100%."

The development of the captive insurance industry in Luxembourg cannot be summed up by the PFS alone. "A whole ecosystem has developed with specialist service providers who have all the skills needed to manage these captives. These service providers have the status of ‘professional of the insurance sector’ (PSA), the equivalent of ‘professional of the financial sector’ (PSF) for the financial sector.

Luxembourg's cross-border culture is also a plus for commercial reinsurers. "The European passport is fundamental for them. As a reinsurer, you have to work cross-border to facilitate the pooling of risks," explained Widong Scheepers, "and the regulator has this culture, which explains why we attract players of this type.

Although Luxembourg is the most successful European domicile for captive reinsurers, there is competition, mainly from Malta. Ireland, a traditional competitor in the investment fund sector, has specialised in insurance captives. “Here, an insurance company takes on the risks of the industrial group. In Luxembourg, we are in the next stage, that of the reinsurance captive. Why is that? Because of the provision for claims fluctuation, which does not exist in direct insurance. For us, having such a tool for our own structure seems necessary.”

Despite the challenges that lie ahead - managing climate change and increasing regulation – Widong Scheepers believes that the captive reinsurance industry will continue to develop "in a gradual and controlled way. It is a proven, resilient and very attractive tool for industrial groups".

Read the original French-language version of this interview