Reinsurance: A Changing Product

1
Reinsurance Financial Concerns
Frank J. Maffa, CFE, CIE Vice President American
Re-Insurance Company
2
Agenda

• Reinsurance
• Regulatory Concerns
• Reinsurance Program
• Reinsurance Contracts
• Credit for Reinsurance
• Reinsurance Accounting
• Reinsurance Reporting
• Reinsurance Collateral
• Reinsurance Audit
• Security Analysis

3
Reinsurance

• Reinsurance is Management tool.
• Manage Underwriting Risk
• Capacity / Spreading Risk
• Ability to write more premium while maximizing
  principle of insurance.
• Loss Control / Catastrophe Protection
• Minimize financial impact from losses.
• Manage Financial Aspects
• Financing
• Providing financial resources for growth.
• Stabilization
• Minimize variations in financial results.

4
Regulatory Concerns
Reinsurance is International Many participants
all over the world. Who are the participants?
How financially strong are they? Is the risk, and
the funds, retroceded and re-retroceded? How do
we know who has the ultimate responsibility/obliga
tion? Do the insurance laws of foreign
countries/jurisdictions equally protect the
claimants, the policyholder, and the regulator?
Reinsurance Contracts Contracts are not of
standard form. Are all safeguards included in
the contract? Will reinsurer be able to deny
coverage through technicality? Who will reside
over disputes and which laws will govern? Is the
regulator protected in the event of liquidation?
5
Regulatory Concerns (continued)
Collection of reinsurance / Credit
risk Reinsurance is a long term commitment. Is
the reinsurer financially strong? Affiliated
reinsurance transactions Risk remains within the
group Ceding company is still responsible to pay
obligation. Funds are transferred to affiliate
possibly in a different country or
jurisdiction. How are funds invested?
Safeguards on assets.
6
Reinsurance Program

• Understand Companys Objectives
• Spreading of Risk / Capacity
• Working Covers - Quota Share
• Loss Control - Limitation of Risk
• Excess of Loss Covers
• Catastrophe Protection
• Protection of Net Retention
• Stop Loss Covers
• Aggregate Covers

7
Reinsurance Program (Continued)

• Selection of Reinsurers
• Due Diligence
• Financial Statements
• Rating Agency Reports
• IRIS Ratio Results
• Structure of Reinsurance Program
• Beneficial Order of Contracts
• Lines of Business Covered
• Limits of Coverage

8
Reinsurance Program Examples
9
Reinsurance Contracts

• Should Include Name(s) of Reinsurer
• Period of Contract
• Business Covered
• Limits of Coverage
• Premium / Commission
• Reporting / Settlements
• Offset
• Service Of Suit
• Insolvency
• Intermediary
• Arbitration
• Governing Laws
• Termination

10
Regulatory Contract Requirements
Insolvency Clause Reinsurance is payable without
diminution regardless of the financial status of
the ceding company. Intermediary Clause Credit
risk for the intermediary is the responsibility
of the reinsurer. Payment from the ceding
company to the broker is deemed paid to the
reinsurer. Payment to the broker from the
reinsurer does not relieve the obligations of
the reinsurer to the ceding company. Service of
Suit Clause Unauthorized reinsurers must
designate the Insurance Commissioner as the legal
agent for the process of suit. Credit for
reinsurance is denied if contract is missing
above provisions.
11
Timely execution of Reinsurance contracts
Nine Month Rule - NAICs Accounting Practices If
a contract is not finalized, reduced to written
form and signed within nine months, the
arrangement is presumed to be retroactive and
must be accounted for as retroactive
contract. Retroactive means that the loss
experience under the contract is known. The
purpose of the contract is possibly for adverse
loss development or other reasons such as
finance. NAIC accounting rules do not allow
insurance reserves to be decreased by Retroactive
reinsurance contracts.
12
Credit for Reinsurance

• US Statements of Statutory Accounting Principles
• National Association of Insurance Commissioners
  (NAIC)
• SSAP 62 Property and Casualty Reinsurance
• Appendix A-785 Credit for Reinsurance
• Accounting
• A ceding company is allowed to decrease its
  insurance reserves (take credit for reinsurance)
  if
• The reinsurance is prospective covers future
  insurable events.
• Reinsurance is transacted with an
  approved/authorized reinsurer, or
• The reinsurer has provided collateral equal to
  the amount of the reinsurance.
• Otherwise ceding company is not allowed to
  decrease its insurance reserves.

13
Required AccountingFlow Chart
Contract
14
Reinsurance AccountingNAICs Accounting
Practices and Procedures ManualStatement of
Statutory Accounting Principle - 62

• Prospective Contract - A contract that covers
  future insurable events.
• Underwriting Accounting or Traditional
  Reinsurance Accounting
• Retroactive Contract - A contract that covers
  past insurable events.
• Retroactive Accounting - Same as old Loss
  Portfolio Accounting
• No Reduction in Loss Reserves
• Asset Retroactive Reinsurance - a write-in
  Contra Liability
• Gain or Loss recognized as Other - a write-in
  line
• Benefit reported as Special Surplus - restricted

15
Reinsurance AccountingNAICs Accounting
Practices and Procedures ManualCodification -
SSAP 62 (Continued)

• If any contract does not meet Transfer of Risk
  analysis
• Deposit Accounting
• No reduction in Loss Reserves
• Gain not recognized until termination of
  contract.

16
Transfer of Underwriting RiskNAIC SSAP 62
Insurance risk is fortuitous - the possibility of
adverse events occurring must be outside the
control of the insured. The reinsurance
agreement must provide for VARIABILITY OF
RESULTS UNCERTAINTIES a. the ultimate amount
of underwriting gain or loss b. the
timing of the cash flows. TIMELY REIMBURSEMENT OF
LOSSES REASONABLE POSSIBILITY OF SIGNIFICANT LOSS
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NAIC - SSAP 62Transfer of Risk (Continued)
CASH FLOW ANALYSIS - Present value of all future
cash flows. Under REASONABLY POSSIBLE
OUTCOMES Includes - Commissions, interest,
margin fees, and experience refunds. If
exposure to reinsurance risk is remote, the
contract must be accounted for as a deposit. All
cash flows processed through a deposit
account. Gain recognized at termination.
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Reinsurance ReportUS Schedule F

• List of all reinsurers
• Summary of all transactions with each reinsurer
• Receivable on PAID LOSSES LAE
• Reconciles to amount on Balance Sheet
• Aged for 90 days overdue
• Receivable on UNPAID LOSSES LAE
• Split between Case Reserves and IBNR
• Reconciles to Underwriting Exhibits
• Collateral for reinsurance
• By type Funds Held, LOCs, Trust Agree.
• Funds Held reconciles to Balance Sheet

Provides
19
Reinsurance Collateral

• Funds Held by ceding company
• Used as a vehicle to collateralize the
  obligations of the reinsurer.
• Emanates from premium records of ceding company.
• Letters of Credit - LOCs
• Must be issued by NAIC approved bank.
• Evergreen Clause - prior notice of termination.
• Clean Unconditional - no contingencies on draw
  downs.
• Trust Accounts
• Review underlying trust agreement.
• Proper beneficiary clause.
• Valuation of securities under trust.
• Collateral is a substitute for financial analysis
  of reinsurer.

20
Reinsurance AuditCritical Elements

• Reinsurance Program
• Companys Objectives
• Type of Reinsurance
• Selection of Reinsurers
• Audit of Reinsurance
• Review of Contracts
• Reinsurance Accounting
• Transfer of Risk

21
Reinsurance AuditCritical Elements (Continued)

• Reinsurance Report - Schedule F U.S.
• Authorized / Unauthorized
• Affiliates / Non Affiliates
• Aging of Recoverable
• Provisions for
• Unauthorized Reinsurance
• Overdue Reinsurance

22
Reinsurance AuditCritical Elements (Continued)

• Collateral for Reinsurance Report Part of
  Schedule F
• Funds Held
• Letters of Credit
• Trust Agreements
• Reciprocity (Setoff)

23
Security Analysis
Company Background - History of
company/reinsurer Ability of management. Profita
bility - Underwriting Performance Investment
Performance Overall profitability Capitalization
- Cushion for rainy days. Base for
growth. Quality of assets.
24
Security Analysis (Continued)
Leverage - Premiums - underwriting risk Loss
Reserves - strength to absorb adverse
events. Reinsurance Recoverable - credit
risk Investments - asset risk Finance / Debt -
ability to repay Liquidity - Balance
Sheet Cash Flow Underwriting Overall