Finite Reinsurance - Where’s the Risk?
David Molyneux, FCAS, MAAA
PartnerRe New Solutions Inc.
March 11-12, 2004
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Topics
Finite Reinsurance Basics
Risk Transfer & Accounting Treatment
Trends
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Finite Basics – Buyer’s Perspective
Smooth Earnings & Reduce Volatility
Capital/Surplus Management
M&A
Tax Management
Balance Sheet Optimization
BCAR
Cost Efficiency
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Finite Basics - Seller’s Perspective
Motivation behind transaction is not primarily Risk
Transfer
Defined maximum limit
Good balance between upside and downside
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Finite Structures
LPT/Adverse Development Covers
Aggregate Stop Loss
Finite Quota Share
Multi-Year Funding
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Finite Reinsurance - Deal Features
Highly Structured
Profit Sharing
Defined Limit
Multi-Year
Additional premiums to
offset adverse experience
Optionality
Funds Withheld or Funds
Transferred
Explicit recognition of
Investment Income
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Concern Over Finite
Post Enron – more concern over Balance Sheet
Integrity
Finite
 Explicit Recognition of Invest Income – in line with
the true underlying economics of insurance
 Reducing Volatility - same goal as traditional
reinsurance
 De-leveraging Capital – can be more cost effective
than CM
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Accounting Treatment & Measuring Risk
FASB 113
Qualifying for Reinsurance Accounting Treatment:
“It is reasonably possible that the reinsurer may realize a significant loss
from the transaction.”
Significant Loss
“… based on present value of all cash flows between the ceding and
assuming enterprises….” , “… same interest rate shall be used to
determine present value of cash flows…”
Reasonably Possible
No explicit guidance given for determining what is “reasonably possible”
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Accounting Treatment & Measuring Risk
In Practice
 Scenario Approach
 Rules of Thumb - “10/10 Rule”
Loss Measurement
 Cash flows excluding brokerage, expenses, taxes
 Single discount rate versus yield curve
Probability Measurement
 Variety of approaches
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“10/10 Rule”
Defining a 10% Loss
• Loss at 90th Percentile
• Average Loss between 90-100th Percentile
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“10/10 Rule”
Defining a 10% Probability
Past Practice
• Subjective Measurement/Scenario Approach
Current Practice
• More Technical Modeling
• On-level Loss Distributions
• Payout Patterns/Variability
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Issues – Finite Quota Share
FASB 113
2nd Test – reinsurer must assume “significant insurance risk under the
reinsured portions of underlying contracts….” ; there must be
“variation in amount or timing of payments…”; no delay in timely
reimbursement
Substantially all the risk exception
Caps
Loss Corridors
Slides
Materiality
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Issues - Aggregate Stop Loss
“In the Money” Covers
Multi-Year
Appropriate Interest Crediting Rate for FW
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Issues - LPT/ADC
Rating Agency Scrutiny
AM Best gives credit for XS of Discounted Carried
Appropriate Interest Crediting Rate for FW
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Current Environment
More Scrutiny from Regulators, Auditors & Rating
Agencies
Lack of Uniformity in Measuring Risk
“Changing Face of Finite”
 More Risk built into Structures
 Higher Cost
 Development of New Products