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CHANGES TO SSAP #62 PROPERTY & CASULTY REINSURANCE. NAIC Property and Casualty Reinsurance Study Group Chicago, IL May 10, 2005 Michael Moriarty Director, Capital Markets Bureau NY Insurance Dept. SSAP # 62 CURRENT FRAMEWORK. Reinsurance Accounting or Deposit Accounting

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changes to ssap 62 property casulty reinsurance

CHANGES TO SSAP #62PROPERTY & CASULTY REINSURANCE

NAIC Property and Casualty Reinsurance Study Group

Chicago, IL

May 10, 2005

Michael Moriarty

Director, Capital Markets Bureau

NY Insurance Dept.

ssap 62 current framework
SSAP # 62 CURRENT FRAMEWORK
  • Reinsurance Accounting or Deposit Accounting
    • “Either/Or” Approach
    • Standard for Favorable Reinsurance Accounting Treatment: “Transfer of Underwriting Risk”
    • Equates to Significant Risk of Significant Loss
    • Otherwise the Deposit Accounting Approach Applies
binary approach in ssap 62
Binary Approach in SSAP #62
  • Does Not Reflect the Economics of Certain Significant Reinsurance Transactions
  • Reinsurance Agreements Can Have a Range of Transfer of Insurance Risk
  • Main Intent of Transactions May Be Financing – Temporarily Taking Reserves Off the Books/”Parking” Reserves
why finance losses in a reinsurance agreement
Why “Finance” Losses In a Reinsurance Agreement

IF Reinsurance Accounting Can Be Secured:

  • Discount in Reserves Can Be “Unlocked”
    • Enhance Capital Position
    • Improve Underwriting Results (& Earnings)
    • Improve Leverage Ratios (NPW to Surplus; Underwriting Ratios; Reserves to Surplus)
sample transaction excess of loss
Sample TransactionExcess of Loss
  • COVER - $80 Million xs $50 Million
  • GROSS WRITTEN PREMIUM $150 Million
  • EXPECTED LOSSES by Ceding Company

$120 Million

  • Probability of $110 Million in Losses>90%
  • PREMIUM for Cover $60 Million
  • ACTUAL LOSSES INCURRED $120 Million
sample transaction excess of loss financial statement impact reinsurance accounting ssap 62
Sample Transaction - Excess of Loss Financial Statement ImpactReinsurance Accounting – SSAP #62
sample transaction excess of loss what really happened
Sample Transaction - Excess of LossWhat Really Happened
  • Reinsurer Took Marginal Risk – Was Exposed to $10 Million Over Expected Losses
  • Exposure Probably Achieved Transfer of Insurance Risk Under 10/10 Rule ($10 Mln Exposure/$60Mln Premium = 16.7% Loss)
  • Ceding Company KNEW it Was Transferring Losses That Would Be Indemnified ($50 Mln to $110 Mln Layer)
sample transaction excess of loss what is driving transaction
Sample Transaction - Excess of LossWhat is Driving Transaction?
  • What is the Economic Purpose of Ceding This Layer? Is it Insurance or Financing?
  • If the Ceding Company Wanted to Hedge its Underwriting Risk, Shouldn’t it Have Secured a $10Mln xs of $120 mln Cover Instead (i.e. Variability Above Expected Losses)
  • Reinsurer May “Lose” on Transaction from Accounting Perspective, but Not Economically
  • Significant Accounting Benefit of “Parking” the Working Layer off-Balance Sheet
sample transaction excess of loss w bifurcation
Sample TransactionExcess of Loss w: Bifurcation
  • COVER - $80 Million xs $50 Million
  • GROSS WRITTEN PREMIUM $150 Million
  • EXPECTED LOSSES by Ceding Co. $120 Million
  • Probability of $110 Million in Losses>90%
  • FINANCING PREMIUM for $60 Mln xs $50 Mln = $53 Mln
  • INSURANCE PREMIUM for $20 Mln xs $110 Mln = $7 Mln
  • ACTUAL LOSSES INCURRED $120 Million
sample transaction excess of loss financial statement impact bifurcation framework
Sample Transaction - Excess of Loss Financial Statement ImpactBifurcation Framework

* $53 Mln Receivable Under Deposit Acct.

reinsurance accounting vs deposit accounting
Reinsurance Accounting Vs. Deposit Accounting
  • Reinsurance Accounting is Favorable
  • Disclosure Brings Better Transparency, but Does NOT Address the Issue that Seems to Be Driving Certain Transactions
  • How to Address: Bifurcation; Raising the Standard of Transfer of Insurance Risk; Allowing Discounting of Reserves; or Something Else??
propose revisions to ssap 62
PROPOSE REVISIONS TO SSAP # 62
  • Discussion Draft Dated May 5, 2005
  • NY Asks That It Be Received by Study Group and Exposed for Public Comment
  • Identify Issues that Need to be Addressed in Order to Connect the Concept with the Practical Application
  • Open to Alternatives
  • Casualty Actuarial Task Force Is Reviewing Issue
ssap 62 revisions continued
SSAP #62 Revisions (continued)

New Paragraph 1 (N1) - Page 1

  • Statement in the “Reinsurance Contracts Must Include Transfer of Risk” Section that Certain Reinsurance Agreements Will Require Bifurcation
  • It then Refers Readers to New Paragraphs 2, 3, & 4 for Further Guidance
ssap 62 revisions continued1
SSAP #62 Revisions (continued)

New Paragraph 2 (N1) - Page 3

  • Leads off the New “Bifurcation of Reinsurance Agreements” Section in SSAP
  • Provides Reasoning for Bifurcation of Reinsurance Agreements
  • Alerts Readers that Bifurcation Will Not be Required for All Agreements; Only Those that Exhibit “Common Characteristics of Financing”
ssap 62 revisions continued2
SSAP #62 Revisions (continued)

New Paragraph 3 (N3) - Page 3

  • Paragraph Specifies Six Categories of Reinsurance Agreements that Need NOT be Bifurcated
    • Excess Per Risk - Does Not Lend Itself To Predictability
    • Excess Per Occurrence - “ “ “
    • Fronting Arrangements - No Reserves Typically Kept by Ceding Company
ssap 62 revisions continued3
SSAP #62 Revisions (continued)

New Paragraph 3 (N3) - Page 3 (continued)

  • Six Categories of Reinsurance Agreements that Need NOT be Bifurcated
    • Facultative - Have Not See Abuses in These Types of Deals
    • Premium/Limit Ratio is Low - In Financing Deals, the Premium Is “High” in Relation to the Losses Transferred, Which are Generally Capped
    • Any Other Agreements - that do not have the “Finite” Characteristics Set Forth In New Paragraph 4
ssap 62 revisions continued4
SSAP #62 Revisions (continued)

New Paragraph 4 (N4) - Pages 3 & 4

  • Sets Forth Those Reinsurance Agreements NOT Specifically Exempted That Need to Be Bifurcated
  • Three Broad Categories
    • Contain Specific Contract Provisions
    • All Retroactive Agreements
    • All Multi-Year Agreements
  • If Exempted Under N3 OR Does Not Meet Any of the Conditions in N4, Agreement Need NOT Be Bifurcated
ssap 62 revisions continued5
SSAP #62 Revisions (continued)

New Paragraph 4 (N4) - Page 3 & 4 (continued)

  • Contractual Provisions Triggering Bifurcation
    • Premium/Limit Ratio is High - In Financing Deals, the Premium Is “High” in Relation to the Losses Transferred, Which are Generally Capped
    • Aggregate Loss Ratio Limits - Transferring Expected Losses
    • Loss Corridors - Limitations on Reinsurer’s Exposure
    • Retrospective Premium Adjustments - Revisions Intended to Reimburse Reinsurer’s Losses Under Contract
ssap 62 revisions continued6
SSAP #62 Revisions (continued)

New Paragraph 4 (N4) - Page 3 & 4 (continued)

  • Contractual Provisions Triggering Bifurcation (continued)
    • Sliding Scale/Adjustable Commissions - Can Reduce Reinsurer’s Expenses Based Upon Losses
    • Mandatory Reinstatement Premiums - Can Ensure that Reinsurer is Reimbursed for Unexpected Incurred Losses
    • Commutation Clause - allows ceding insurers a full refund of unused premiums
ssap 62 revisions continued7
SSAP #62 Revisions (continued)

New Paragraph 4 (N4) - Page 3 & 4 (continued)

  • Contractual Provisions Triggering Bifurcation (continued)
    • Conditional Cancellation Provisions That Require Entering Into New Agreements - Can Move Obligations from One Period to a Future Period
    • No Consistent Reporting - Indicative of Minimal Substance to Agreement
    • Funds Held - allows ceding insurers to retain funds to pay losses
ssap 62 revisions continued8
SSAP #62 Revisions (continued)

New Paragraph 5 (N5) - Page 4

  • Guidance on HOW to Account for Bifurcation of Reinsurance Agreements
    • Estimate Layer of Coverage Where There is a Greater than Ninety Percent Probability That Ceding Company Will be Indemnified for Losses
    • Premiums/Expenses/Losses Attributable to That Layer Gets Booked Under Deposit Accounting Guidance; Remainder Gets Booked under Reinsurance Accounting Guidance
ssap 62 revisions continued9
SSAP #62 Revisions (continued)

Changes to Eliminate Current Treatment for Retroactive Agreements - Pages 5-9

  • ALL Retroactive Reinsurance Contracts Must be Bifurcated
  • Portion that Transfers Insurance Risk Should Be Reported Under Reinsurance Guidance; Part that Finances Losses Should Be Reported Under Deposit Accounting Guidance
  • Similar to FAS 113 Approach
ssap 62 revisions continued10
SSAP #62 Revisions (continued)

Implementation Q&A - Page 9

  • NO CHANGES Pending Exposure of Concepts Under Consideration
  • Revisions WILL Be Needed
ssap 62 project p c reinsurance study group timetable
SSAP #62 PROJECT P&C REINSURANCE STUDY GROUP TIMETABLE
  • P/C Reinsurance Study Group – continue to review over Summer
  • August – Receive Report from NAIC Casualty Actuarial Task Force
  • Put a Final Proposal on Study Group’s Agenda in the Fall and Move to Statutory Accounting Principles Working Group
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