Klann - Reinsurance Commutation Flashcards
What are the 9 functions of reinsurance?
F-cat-SWIPLES
(9) → Fronting arrangements
–
(2) → catastrophe protection
–
(3) → Surplus relief & capital efficiency
(6) → Withdrawal from market
(8) → Internal reinsurance transactions
(7) → Pools - mandatory & voluntary
(1) → Large line capacity
(5) → Enter market and/or U/W guidance
(4) → Stabilize results
What is a reinsurance commutation?
Short version: Is a way of ending a relationship between an insurer & reinsurer
Long Version: An agreement between a ceding insurer and reinsurer that provides for the valuation, payment, and complete discharge of all obligations between parties under a particular reinsurance contract.
Long story short, the reinsurer sells remaining losses back to the original insurer.
What are the reasons and/or motivations for a reinsurance commutation?
SEDR
- Solvency Concerns
- Exit Line of Business
- Dispute on Claims
- Reserve Differences
some instances where there is a commutation clause in the contract, so this may also be a reason.
Why would an insurer or reinsuer commute a reinsurance agreement for solvency reasons?
Insurer:
* may be concerned about reinsurer ability to pay claims and commutation removes the credit risk (think Schedule F here). Get something rather than nothing (small loss rather than large loss)
* If insurer is shaky then commuation provides cash flow.
Reinsurer: can avoid liquidation issues if primary goes insolvent
What is the “exit” reason for a reinsurance commuation?
Commutation provides a way for the reinsurer (& primary insurer) to exit a particular market
For the primary this is the first step of a loss portfolio transfer.
For reinsurer, commutation is the only step.
What is the “dispute” reason for a reinsurance commutation?
Primary and reinsurer may want to end relationship because of disputes on contract terms, payments, etc.
It may be easier to have a single negotiation over commutation price, followed by termination of the relationship, to a protracted argument over other issues
How can reserves estimates lead to a reinsurance commutation?
The Primary and Reinsurer may disagree over the value of ceded/assumed reserves. Thus, leading both to think they are getting a good deal under commutation.
Only will know who “wins” after all claims have been settled.
Who is the buyer in a reinsurance commutation?
The primary insurer is the buyer because they are receiving the item in question
However, since the primary is “buying” a liability, the seller (reinsurer) pays the primary.
It’s the opposite of a usual transaction!
How do you adjust the insurer loss triangles for a simple commutation?
Paid
* Gross: No Change
* Ceded: Increase to ceded equal to price of commuation
* Net: Decrease equal to price of commuation
Reserve
* Gross: No Change, Ceded: Goes to 0, Net: equal to Gross
Ultimate
* Gross: No Change, Ceded: Paid + Reserve, Net: Net Paid + Net Reserve
How does the reinsurer’s loss triangles change?
Paid Loss
Gross losses for the reinsurer increase by the price of the commutation because reinsurer is making payment to primary to get rid of claims.
Reserves
Gross Reserves for the reinsurer decrease to 0 (regardless of price because the reinsurer got rid of the claims. Note this amount will likely be different than price.
Ultimate
Change by the difference between price and reserves.
Note that Reinsurer may have a different opinion on ultimates losses than the primary
How is the change in taxable income from a commutation calculated?
Primary:
price – ( pR-c ) x d1
Reinsurer
( reR-g ) x d2 - price
pR-c = undiscounted reserve amount that primary insurer cedes to reinsurer before commutation
reR-g = undiscounted reserve amount that reinsurer assumes from primary insurer before commutation
d1 = primary discount factor, d2 = reinsurer discount factor
pR-c does not have to equal reR-g. Multiply by tax rate for change in taxes
What are the steps in pricing a commuation?
- Estimate the claim payments that would be made in absence of the commutation
- For insurer these are reinsurance recoverables
- For reinsurer these are loss reserves
- Discounts the loss estimates. Would need payout pattern and discount factor and are likely to be different between insurer and reinsurer
- Tax Effects
How do you calculate the price range where a primary would accept a commutation?
No other outside factors like solvency, etc.
Where the following calcualtion gives a calculation > 0
price – ( economic-discounted pR-c ) + ( pT )
The commutation price plus the tax change of taking on reserves needs to be greater than the discounted loss reserves being aquired.
A deal could possibly be struck where the ranges of primary and reinsurer overlap.
How do you calculate the price range where a reinsurer would accept a commutation?
No other outside factors like solvency, etc.
Where the following calcualtion gives a calculation > 0
– price + ( economic-discounted reR-g ) + ( reT )
The commutation price being paid plus the tax change of needs to be less than the discounted loss reserves being removed.
A deal could possibly be struck where the ranges of primary and reinsurer overlap.
Why might the insurer and reinsurer use different discount rates in commuation pricing?
Companies determine the appropriate discount factor by accident year and line of business by using either their own or IRS payment patterns and IRS published discount rates.
