An Introduction to Reserving
and Financial Reporting Issues
for Non-Traditional Reinsurance
Casualty Loss Reserving Seminar
September 14, 2004
Derek Jones, FCAS, MAAA
Finite Re Basics
Milliman
Overview
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Customized deals to address specific
issues of cedant
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Limited risk transferred by cedant
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Limited upside for reinsurer
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Common Uses
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Deferral of taxes
Discounting
Earnings stabilization
Risk management
Surplus protection
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Types of Deals
Retroactive
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Adverse development cover
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Loss portfolio transfer
Prospective
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Aggregate stop-loss
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Finite quota share
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Spread loss
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Loss Portfolio Transfer
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Covers prior written business
Move reserves off balance sheet
Premium = PV (reserves) + provision
for potential adverse development
Tends to cover smaller segments
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Adverse Development Cover
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Cedant retains portfolio
Premium is based on potential for
adverse development and related
timing of future payments
Tends to cover larger groupings of
business than LPTs
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Aggregate Stop-Loss
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Stabilize earnings
Typically multi-year deals
Loss ratio corridor above plan ratio
Fixed premium
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Finite Quota Share
Primary benefit = surplus relief
Differences from traditional QS
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Loss ratio cap
Loss corridor
Lower net cost
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Common Features
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Time value of money (via experience
account)
Cedant participation
Sub-limits of liability
Multiple years
Cancellation, commutation provisions
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Reserving Issues
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Understand Deal Structure
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Line(s) of business, coverage type
Limits, sub-limits for reinsurer
Reinsurance or deposit accounting
Loss reserve discounting
Experience account
Commutation provision
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Experience Account
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EAB = premium – margin – loss
payments + interest credit
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What if EA is exhausted?
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Monitor Emergence
Issue 1: temporary speed-up
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–
Could exhaust EA too quickly
Issue 2: actual > expected
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Initial estimate of nominal loss may be
understated
Under-reporting will delay triggering
additional premium
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Interest Credit
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Based on risk-free rate (e.g., U.S.
Treasury spot rates)
Spread is larger for deals on a funds
withheld basis
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Sensitivity Testing
Both magnitude and timing of
reinsurer payment are key
Nominal loss amounts
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–
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Retroactive: usually use more simplistic
approach to produce range
Prospective: stochastic simulation
Use alternative payout patterns to
evaluate impact of timing
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Bulk Reserves
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Law of large numbers doesn’t apply
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How is best estimate determined
(mode, mean, confidence level)?
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Not commonly used in practice
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Financial Reporting
Issues
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Type of Accounting
Reinsurance treatment is based on
SFAS 113 or SSAP 62
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Reinsurer must assume significant risk
It must be reasonably possible to realize
a significant loss
Deposit accounting is required unless
both conditions are met
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Prospective vs. Retroactive
Reinsurance
The following exceptions should be
treated as prospective reinsurance
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Structured settlements
Novations
Reduced participation in reinsurance
treaties
Intercompany agreements that do not
produce gain in surplus
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Deposit Accounting
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No initial impact on balance sheet or
income statement for cedant or
reinsurer
Emerges in financial statements as
actual payments are made/received
Note: deposit liabilities are not part of
lines 1 or 3 on statutory balance
sheet
Milliman
http://www.casact.org/pubs/forum/04fforum/
04ff073.pdf
derek.jones@milliman.com
646.473.3416