Reinsurance Q&A

Even insurance-industry veterans are often unfamiliar with reinsurance and the key ways in which it differs from the “direct” side of the business.

In addition, the International Accounting Standards Board is currently developing new standards for insurance accounting.

For these reasons, Jeremy recommends clicking each question below to learn more about it. For expert advice on your reinsurance questions, please contact Jeremy now.

Proposed International Accounting Standard #4:
Insurance Contracts

What does the proposal require for the initial entries for reinsurance of a typical life insurance product?

When new business is sold by a direct writing life insurer, initial gains are amortized and initial losses are immediately recognized. The new IFRS rules require that reinsurance of this same business have both gains and losses from the initial accounting of a reinsurance agreement be amortized. While a gain on the direct product and a similar gain on the portion of the business that is reinsured will thus be accounted for in a comparable fashion, this is not true for losses.

Losses will flow directly through to a direct writer’s bottom line, although a portion of the business is reinsured, the initial losses will not be offset by the reinsurance. Instead, the reinsurance of these losses will amortize into income over the coverage period of the reinsurance agreement.

Why did standard-setters create a mismatch between the accounting for direct business vs. for reinsured?

The Board felt that the initial impact of a reinsurance agreement represented a measure of the cost of the protection. This cost, which can be positive or negative, is based upon all future anticipated cash flows and thus this cost should be amortized over the lifetime of the agreement. To accomplish this amortization, reinsurance is allowed to have negative amortization values.

On the direct side any negative value would be taken as a loss in that period. The current reinsurance proposal, other than at the inception of the reinsurance agreement, results in net reserves that closely match net reserves that are calculated based upon cash flows after reinsurance.

Are there other areas where there is a mismatch between the accounting for direct business and that for reinsurance ceded?

A situation that was brought to the attention of the IASB Board related to the accounting for reinsurance when a contract turns onerous. An onerous contract is one where the present value of cash flows, after adjustment for risk, is negative. Should this situation occur the direct writer must recognize a loss that will flow through the profit and loss statement.

The original rules would have any offsetting reinsurance gains to continue to be amortized over the coverage period. During the 2014 redeliberations the Board decided that at the time the contract is considered onerous, the losses on the direct policy should be offset by reinsurance on that business.

Actuarial Guideline #48

What is the basic concept behind AG 48?
(National Association of Insurance Commissioners’ Actuarial Guideline #48: Using Captive Reinsurers to fund level term and universal life with secondary guarantees reserves)

Regulators were concerned that there were inadequate assets being held when insurers used reinsurance with a wholly owned captive.

Captives, prior to the effective date of AG 48, were being allowed to admit certain assets that an insurer might not be able to count as an admissible asset. In addition, these reinsurance agreements defined the reserves that would be backed by traditionally permissible assets based upon the then expected experience plus a margin (called economic reserves). The excess of the statutory reserves over these economic reserves were backed by such assets as synthetic letters of credit or by a derivative. Domiciliary states of captive insurers found these structures permissible since the probability that the captive will need more assets than the economic reserves was very remote.

The excess of the statutory reserves over these economic reserves were backed by such assets as synthetic letters of credit or by a derivative. Domiciliary states of captive insurers found these structures permissible since the probability that the captive will need more assets than the economic reserves was very remote.

AG 48 does not ban the use of captives to help finance redundant reserves, but it does require certain conditions be met for a structure to be regulatorily acceptable. The guideline defines an Actuarial Method that describes how the economic reserves are to be calculated. The Actuarial Method uses a calculation method that is closely related to reserve levels under Principle Based Reserves (PBR) requirements.

Actuarial Method reserves are required to be backed by Primary Assets. Primary Assets include cash and SVO listed securities, except those that are in effect synthetic letters of credit. For the difference between current statutory reserves and Actuarial Method reserves, assets (including Prescribed Assets that are acceptable to the Commissioner) can be used.

Is a reinsurance agreement covering level term or universal life with secondary guarantees ever exempt from the rules of AG 48?

Yes, there are four situations in which AG 48 does not apply:

  1. If the YRT reinsurance exemption is elected (from XXX rules) or the direct policy is an attained age YRT or if the direct policy is a series of n-year renewable term where the guaranteed premiums are greater than the 1980 CSO and there are no cash surrender values.
  2. The reinsurer has been certified in the domiciliary state of the cedent or if the cedents’s state has not adopted the certification process, then the reinsurer is certified in at least 5 states. Alternatively if the reinsurer holds assets in a Credit for Reinsurance trust in an amount no smaller than the level of reserves that the cedent is taking credit for.
  3. The reinsurer is either domiciled, licensed or accredited in a state that has adopted the most current version of the Model Credit for Reinsurance law and regulation. In addition the reinsurer must not be using any permitted practices or be under any solvency conditions (e.g. mandatory control level).
  4. The Financial Analysis Working Group agrees that: a) risks are out of scope or b) risks are in scope, but only due to a technicality or c) application of AG 48 is not necessary to protect policyholders.

How are reserves calculated under the Actuarial Method?

The intent behind reserves calculated using the Actuarial Method is for the values to be close to the Valuation Manual (standards for Principle Based Reserves) Chapter 20 requirements.

Level term products will need to hold the greater of the net premium reserves, as adjusted by Table 1 factors, and the deterministic reserve. Universal Life with Secondary Guarantees, the calculation requires using the maximum of the deterministic, stochastic and net level reserves as adjusted by factors in Table 2. In either event the Actuarial Method reserves shall be calculated on a gross basis. Unlike the pertinent sections of the new Principle Based Reserve requirements, no exemption testing will be permitted.

Percentages Applicable to the NPR in Determination of the Actuarial Method
(Derived from 2014 VBY Term Net Level Premium Mortality Ratios)

Table 1
Issue Age Male Non-Smoker Female Non-Smoker Male Smoker Female Smoker
< 25 55% 60% 65% 70%
25-34 55% 60% 65% 70%
35-44 55% 60% 65% 70%
45-54 55% 60% 70% 70%
55-64 60% 60% 85% 80%
65-74 70% 70% 90% 100%
75-84 75% 80% 90% 100%
85+ 75% 80% 75% 100%
Table 2
Issue Age Male Non-Smoker Female Non-Smoker Male Smoker Female Smoker
< 25 80% 80% 85% 85%
25-34 80% 80% 85% 85%
35-44 80% 80% 85% 85%
45-54 80% 80% 85% 90%
55-64 80% 85% 90% 90%
65-74 85% 90% 90% 100%
75-84 85% 95% 95% 100%
85+ 85% 95% 85% 100%

What if my company does not have sufficient assets at year end?

The guideline requires the appointed actuary to give a qualified opinion should the Primary Securities be less than Actuarial Method reserves and Other Securities are insufficient to cover the remaining reserves.

There are two ways to avoid a qualified opinion: 1) increase the assets backing the covered policies so that all reserves are backed by AG 48 compliant assets or 2) increase reserves by the amount of the deficiency (e.g, Actuarial Method reserves of $200 million, Primary Securities of $190 million. Point #2 would require reserves be increased by $10 million).