Reinsurance Accounting Principles (TIA Section F) Flashcards
Reinsurance has the following benefits:
-Expands capacity (allows insurance company to write more business)
-Share large risks
-Spread the risk of catastrophes and stabilize UW results
-Finance expanding volume (by sharing the reserves)
-Aid withdrawing from a line
-Reduce the net liability to amounts appropriate to its financial resources
2 types of reinsurance contracts
Treaty and Facultative
Treaty Reinsurance
Transfers the whole class or type of business written
Facultative
Transfers individual risks
Contract provisions that affect accounting practices include:
-Reporting Responsibility of the ceding entity
-Payment terms
-Payment of premium taxes (indicates which party needs to pay the premium taxes, usually the ceding company)
-Termination
-Insolvency clause
Insolvency Clause
Claims that the reinsurer’s obligations will be maintained (without any reduction) in the event of insolvency of the ceding company
In order for the insurer to apply the impacts of reinsurance to the financial statements, the
reinsurance agreement must meet the following criteria:
the reinsurance agreement must contain an insolvency clause
recoveries due to the ceding company must be available without delay and in a
format that will facilitate the ceding company’s orderly payments of policy
obligations
the agreement should provide no guarantee of profit for either party
the agreement must provide for reporting of premiums & losses at least quarterly, unless there is no activity. The report should mention the ceding’s loss & loss expense reserves on the policy obligations, so that the respective obligations of the ceding & reinsurer can be recorded
the agreement must contain a reinsurance intermediary clause (if applicable) that mentions that the credit risk for the intermediary is the responsibility of the reinsurer
if the reinsurer is certified, the agreement must include a proper funding clause, which requires the reinsurer to provide at least sufficient security such that the ceding company does not incur any financial statement penalty
For retroactive reinsurance, the following conditions apply in addition to the above:
the premium paid must be a specific, fixed amount stated in the agreement
direct or indirect compensation to the ceding company or reinsurer is prohibited
also prohibited is a provision for adjustment based on the actual experience, (except in the case where the ceding company can participate in the reinsurer’s profit)
the contract shall not be cancelled or rescinded without approval of the commissioner of the domiciliary state of the ceding company.
Reinsurance Contracts MUST include…
i. Transfer of Insurance Risk
ii. It is reasonably possible for the reinsurer to realize a significant loss (or “substantially all” risk is transferred)
These requirements are independent, which means that the fact that one is met does not automatically mean the other is met too.
Note that investment returns are not an element of insurance risk.
Insurance Risk involves uncertainty about both…
Timing Risk and Underwriting Risk
The ultimate amount of net cash flows (UW risk) and the timing of those cash flows (timing risk)
Prospective Reinsurance Definition
Prospective reinsurance covers future insurable events
Accounting Unique to Prospective Reinsurance Agreements
Amounts paid for prospective reinsurance shall be reported as a reduction to written and earned premiums.
Reinstatement premiums (if any) should be earned over the period from the reinstatement to the expiration of the agreement.
Changes in the estimated reinsurance recoverables are recognized as changes in losses incurred in the income statement.
*Reinsurance recoverable on loss payments is an admitted asset (“reinsurance recoverable on loss and loss adjustment expense payments”).
*Reinsurance recoverable on unpaid losses is recognized by reducing the respective reserves.
Insurers should only take credit for reinsurance (e.g. book reinsurance recoverable) for non proportional reinsurance contracts to the extent that the gross incurred losses exceed the attachment point.
Retroactive Reinsurance definition
Retroactive reinsurance covers past insurable events. These contracts require special accounting treatment as they can be used by insurers to manipulate UW results.
Retroactive Reinsurance Accounting also applies to:
Liabilities transferred in court ordered rehabilitations, liquidations or receiverships
Portfolio reinsurance (transfer of entire segments of business)
The ceding company should account for retroactive reinsurance in the following manner:
reserves are recorded on a gross basis. The recoverables are recorded as a contra
liability (“retroactive reinsurance reserve ceded”).
any surplus gain from the retroactive transaction should be recorded as a special
surplus fund (“special surplus from retroactive reinsurance account”).
this gain shall not be classified as unassigned funds until the actual retroactive reinsurance recovered exceeds the consideration paid. The transfer of special surplus to unassigned surplus shall be limited to the lesser of:
-the actual amount recovered in excess of the consideration paid
-the initial surplus gain resulting from the retroactive contract
Upon elimination of the policy obligations subject to the contract, the remaining balance can be transferred from special surplus to unassigned surplus
The special surplus also needs to be adjusted to reflect any change in the ceded reserves
the initial gain should be recorded as a write in item in the statement of income (Other Income), identified as “Retroactive Reinsurance Gain”. Note that subsequent gains (due to reserve changes) are also coded to this line item.
The consideration paid reduces the assets (e.g., cash)
Example in manual
The assuming company needs to do the following:
The assumed retroactive reinsurance is excluded from the existing reserves. Instead, it is recorded as a liability, “Retroactive Reinsurance Reserve Assumed”.
The loss is recorded as a write in item, “Retroactive Reinsurance Loss” under Other Income.
The consideration received increases the assets
Example in manual
Ceding/Assuming Entity Retroactive Reinsurance Example
In 2003, a company entered into a retroactive reinsurance contract, ceding reserves of $50 million and paying consideration of $45 million.
a. How does the ceding entity reflect this contract in its Balance Sheet and Income Statement on December 31, 2003?
b. How does the assuming entity reflect this contract in its Balance Sheet and Income
Statement on December 31, 2003?
Example: 2004, Q55
In 2003, a company entered into a retroactive reinsurance contract, ceding reserves of $50 million and paying consideration of $45 million.
a. How does the ceding entity reflect this contract in its Balance Sheet and Income Statement on December 31, 2003?
b. How does the assuming entity reflect this contract in its Balance Sheet and Income
Statement on December 31, 2003?
a.
Balance Sheet:
-Cash asset decreased by $45 million.
-No change to Loss Reserve liability.
-A write-in contra-liability is established for $50 million. Result is decrease in total
liabilities of $50 million.
-The $5M of surplus gain is restricted as a special surplus write-in item.
Income Statement:
-The $5 million gain is a write-in item “Retroactive Reinsurance Gain”.
b.
Balance Sheet:
-Cash asset increased by $45 million.
-No change to Loss Reserve liability.
-A write-in liability, “Retroactive Reinsurance Reserve Assumed” is established for $50
million. This increases total liabilities by the same magnitude.
-Surplus decreases by $5 million.
Income Statement:
The $5 million loss is a write-in item, “Retroactive Reinsurance Loss” under “Other
Income.” It does not affect Underwriting Income.
Definition of Novation
A novation is a reinsurance transaction where the original insurer’s obligations are completely extinguished, where there is no more exposure to loss from the novated business. The party assuming the risk can be thought of as the “primary” party.
Novations are accounted for as
Prospective Reinsurance Agreements
-The amounts paid shall be recorded as a reduction of written or earned premium
-Novated balances shall be written off the accounts where they were originally recorded
-The assuming insurer (reinsurer) shall report the amounts received as WP and EP; and obligations assumed as incurred losses.
Assumed reinsurance
Funds held or deposited with reinsured companies are admitted assets as long as:
The funds do not exceed the liabilities they secure; and the reinsured is solvent.
Funds which exceed the liabilities they secure, or funds held by a reinsured that is insolvent, are nonadmitted
If there is no specific contract with a due date for reinsurance premiums, they are deemed
due 30 days after either of the following dates:
date at which notice of premium is provided to the ceding entity.
date at which the assuming entity books the premium
Reinsurance premiums over 90 days overdue shall be nonadmitted unless:
the reinsurer maintains UEPR and loss reserves due to the ceding entity (the admitted balance is limited to the size of the reserves), or
the ceding entity is licensed and in good standing.
Ceded Retroactive Reinsurance premiums need to be excluded…
from all schedules.
