Reinsurance Financial Concerns Frank J. Maffa, CFE, CIE Vice President American Re-Insurance Company

2 Agenda   Reinsurance   Regulatory Concerns   Reinsurance Program   Reinsurance Contracts   Credit for Reinsurance   Reinsurance Accounting   Reinsurance Reporting   Reinsurance Collateral   Reinsurance Audit   Security Analysis

3Reinsurance Reinsurance is Management tool. Manage Underwriting Risk Capacity / Spreading Risk Ability to write more premium while maximizing principle of insurance. Loss Control / Catastrophe Protection Minimize financial impact from losses. Manage Financial Aspects Financing Providing financial resources for growth. Stabilization Minimize variations in financial results.

4 Regulatory Concerns Reinsurance is International Many participants all over the world. Who are the participants? How financially strong are they? Is the risk, and the funds, retroceded and re-retroceded? How do we know who has the ultimate responsibility/obligation? Do the insurance laws of foreign countries/jurisdictions equally protect the claimants, the policyholder, and the regulator? Reinsurance Contracts Contracts are not of standard form. Are all safeguards included in the contract? Will reinsurer be able to deny coverage through technicality? Who will reside over disputes and which laws will govern? Is the regulator protected in the event of liquidation?

5 Regulatory Concerns (continued) Collection of reinsurance / Credit risk Reinsurance is a long term commitment. Is the reinsurer financially strong? Affiliated reinsurance transactions Risk remains within the group Ceding company is still responsible to pay obligation. Funds are transferred to affiliate possibly in a different country or jurisdiction. How are funds invested? Safeguards on assets.

6 Reinsurance Program Understand Company’s Objectives Spreading of Risk / Capacity - Working Covers - Quota Share Loss Control - Limitation of Risk - Excess of Loss Covers - Catastrophe Protection Protection of Net Retention - Stop Loss Covers - Aggregate Covers

7 Reinsurance Program (Continued) Selection of Reinsurers - -Due Diligence - -Financial Statements - -Rating Agency Reports - -IRIS Ratio Results Structure of Reinsurance Program - -Beneficial Order of Contracts - -Lines of Business Covered - -Limits of Coverage

8 Reinsurance Program Examples Catastrophe 2nd Excess 1st Excess Surplus Share Retention Quota Share Catastrophe 2nd Excess 1st Excess Retention Surplus Share Quota Share

9 Reinsurance Contracts Should Include:Name(s) of Reinsurer Period of Contract Business Covered Limits of Coverage Premium / Commission Reporting / Settlements Offset Service Of Suit Insolvency Intermediary Arbitration Governing Laws Termination

10 Regulatory Contract Requirements Insolvency Clause Reinsurance is payable without diminution regardless of the financial status of the ceding company. Intermediary Clause Credit risk for the intermediary is the responsibility of the reinsurer. Payment from the ceding company to the broker is deemed paid to the reinsurer. Payment to the broker from the reinsurer does not relieve the obligations of the reinsurer to the ceding company. Service of Suit Clause Unauthorized reinsurers must designate the Insurance Commissioner as the legal agent for the process of suit. Credit for reinsurance is denied if contract is missing above provisions.

11 Timely execution of Reinsurance contracts Nine Month Rule - NAIC’s Accounting Practices If a contract is not finalized, reduced to written form and signed within nine months, the arrangement is presumed to be retroactive and must be accounted for as retroactive contract. Retroactive means that the loss experience under the contract is known. The purpose of the contract is possibly for adverse loss development or other reasons such as finance. NAIC accounting rules do not allow insurance reserves to be decreased by Retroactive reinsurance contracts.

12 Credit for Reinsurance US Statements of Statutory Accounting Principles National Association of Insurance Commissioners (NAIC) SSAP 62 – Property and Casualty Reinsurance Appendix A-785 – Credit for Reinsurance Accounting A ceding company is allowed to decrease its insurance reserves (take credit for reinsurance) if: a. a.The reinsurance is prospective – covers future insurable events. b. b.Reinsurance is transacted with an approved/authorized reinsurer, or c. c.The reinsurer has provided collateral equal to the amount of the reinsurance. Otherwise ceding company is not allowed to decrease its insurance reserves.

13 Required Accounting Flow Chart Contract Risk Retroactive Prospective No RiskRiskNo Risk Deposit Accounting Underwriting Accounting Deposit Accounting Retroactive Accounting (a) (a) GAAP - Underwriting Accounting

14 Reinsurance Accounting NAIC’s Accounting Practices and Procedures Manual Statement of Statutory Accounting Principle - 62 Prospective Contract - A contract that covers future insurable events. “Underwriting Accounting” “Underwriting Accounting” or Traditional Reinsurance Accounting Retroactive Contract - A contract that covers past insurable events. “Retroactive Accounting” “Retroactive Accounting” - Same as old Loss Portfolio Accounting - - No Reduction in Loss Reserves - - Asset “Retroactive Reinsurance” - a write-in Contra Liability - - Gain or Loss recognized as “Other” - a write-in line - - Benefit reported as Special Surplus - restricted

15 Reinsurance Accounting NAIC’s Accounting Practices and Procedures Manual Codification - SSAP 62 (Continued) If any contract does not meet Transfer of Risk analysis “Deposit Accounting” - - No reduction in Loss Reserves - - Gain not recognized until termination of contract.

16 Transfer of Underwriting Risk NAIC SSAP – 62 Insurance risk is fortuitous - the possibility of adverse events occurring must be outside the control of the insured. The reinsurance agreement must provide for: VARIABILITY OF RESULTS UNCERTAINTIES: a. the ultimate amount of underwriting gain or loss b. the timing of the cash flows. TIMELY REIMBURSEMENT OF LOSSES REASONABLE POSSIBILITY OF SIGNIFICANT LOSS

17 NAIC - SSAP 62 Transfer of Risk (Continued) CASH FLOW ANALYSIS - Present value of all future cash flows. Under “REASONABLY POSSIBLE OUTCOMES” Includes - Commissions, interest, margin fees, and experience refunds. If exposure to reinsurance risk is remote, the contract must be accounted for as a deposit. All cash flows processed through a deposit account. Gain recognized at termination.

18 Reinsurance Report US – Schedule “F” List of all reinsurers Summary of all transactions with each reinsurer Receivable on PAID LOSSES & LAE Reconciles to amount on Balance Sheet Aged for 90 days overdue Receivable on UNPAID LOSSES & LAE Split between Case Reserves and IBNR Reconciles to Underwriting Exhibits Collateral for reinsurance By type: Funds Held, LOC’s, Trust Agree. Funds Held reconciles to Balance Sheet Provides: Deficiencies: Summary of all reinsurance with reinsurer. No rating on financial ability of reinsurer.

19 Reinsurance Collateral Funds Held by ceding company Used as a vehicle to collateralize the obligations of the reinsurer. Emanates from premium records of ceding company. Letters of Credit - LOC’s Must be issued by NAIC approved bank. Evergreen Clause - prior notice of termination. Clean & Unconditional - no contingencies on draw downs. Trust Accounts Review underlying trust agreement. Proper beneficiary clause. Valuation of securities under trust. Collateral is a substitute for financial analysis of reinsurer.

20 Reinsurance Audit Critical Elements Reinsurance Program - - Company’s Objectives - - Type of Reinsurance - - Selection of Reinsurers Audit of Reinsurance - - Review of Contracts - - Reinsurance Accounting - - Transfer of Risk

21 Reinsurance Audit Critical Elements (Continued) Reinsurance Report - Schedule “F” U.S. - - Authorized / Unauthorized - - Affiliates / Non Affiliates - - Aging of Recoverable - - Provisions for: Unauthorized Reinsurance Overdue Reinsurance

22 Reinsurance Audit Critical Elements (Continued) Collateral for Reinsurance Report – Part of Schedule “F” - - Funds Held - - Letters of Credit - - Trust Agreements - - Reciprocity (Setoff)

23 Security Analysis Company Background - History of company/reinsurer Ability of management. Profitability - Underwriting Performance Investment Performance Overall profitability Capitalization - Cushion for rainy days. Base for growth. Quality of assets.

24 Security Analysis (Continued) Leverage - Premiums - underwriting risk Loss Reserves - strength to absorb adverse events. Reinsurance Recoverable - credit risk Investments - asset risk Finance / Debt - ability to repay Liquidity - Balance Sheet Cash Flow Underwriting Overall