Optimizing the Solvency Ratio: Subordinated Debt versus Reinsurance as a Capital Management tool

The global adoption of economic value-based solvency regimes within the life insurance industry has impacted the decision-making process used by CFOs when trying to optimize their solvency ratio. Making the right choice requires a complex analysis of the different capital solutions available, and a solid understanding of their associated balance-sheet impacts.

This analysis can be simplified using a “decision tree” approach to identify the most optimal solution. The optimization process starts with basic questions on how to address important capital management decisions. These include:

• How can I achieve an adequate solvency ratio within a certain corridor level and ensure that my target dividend payments are met?
• How should I improve my solvency ratio if it falls below this corridor level?
• How can I increase solvency ratio as efficiently as possible – by increasing available capital using subordinated debt, or by reducing required capital using reinsurance?

The decision tree then branches into a subset of different factors steering the user toward the most optimal choice.

This paper provides some guidance for CFOs on how to choose between subordinated debt and reinsurance to optimize the solvency ratio. Both are efficient tools, but there are material differences in terms of how they impact the balance sheets of life insurers.