Reinsurance Commutations

Question 1

define commutation

Answer 1

valuation, payment, and complete discharge of all obligations between a ceding insurer and a reinsurer under a particular reinsurance contract

Question 2

motivations for commutation (4)

Answer 2

• cedant or reinsurer may wish to exit a particular line of business
• cedant or reinsurer may have concerns about one another’s solvency
• relationship between the parties may have deteriorated due to disputes over claim resolution or contract provisions
• cedant and reinsurer may have different views concerning loss development for the underlying policies, so each side believes they are benefiting from the commutation

Question 3

steps in pricing a commutation (4)

Answer 3

1) cedant and reinsurer independently estimate future claim payments
2) cedant and reinsurer independently estimate timing of future claim payments, then discount payments for risk and time value of money
3) both parties consider the effects of taxation
4) each party must reflect factors related to the motives for entering into a commutation

Question 4

accounting for a commutation

Answer 4

• reinsurer makes an immediate payment to the primary and records it as paid loss
• cedant records the payment as a recovery of paid loss

Question 5

disclosures for commutations

Answer 5

• commutations are required to be disclosed by the cedant but not the reinsurer
• disclosure in Section E of the reinsurance notes must include amount of loss and earned premium commuted
• disclosure is in aggregate and does not break down the amounts by AY or line of business