RI Accounting for Proportional Treaties Mrs Achala Nayak

RI Accounting for Proportional Treaties Mrs. Achala Nayak Director J B Boda & Co (S) PTE LTD. , Singapore 1

What is Reinsurance? l l l It is a Risk Transfer from an Insurance Company. It is Insurance of Insurance An Insurance Company pays Premium to Reinsurance for the Risk Transfer. A Reinsurance Company pays Losses to the Insurance Company. All these transactions are in a pre-decided proportion. 2

What is Retention? Retention is an amount, an insurance company is willing to risk for its own account from a single loss 3

Why Reinsurance ? l An Insurance Company has its own limitations to write business, linked to: l l l l Its Capital and Free Reserves. Size of the Risk, its Occupation & Premium Accumulation of Risks. Premium. Profitability of Portfolio Reinsurance Programme used Market Forces and Reinsurance Capacity available Such factors influence an Insurer to limit its own retention and to effect Reinsurance 4

Methods of Reinsurance PROPORTIONAL Facultative (single risk) l Treaty (multiple risks) Quota Share. Surplus Fac. / Obligatory. Open Covers l NON PROPORTIONAL Facultative (single risk) l Treaty (Contracts) (multiple risks) Risk XOL. Catastrophe XOL. Stop Loss XOL l 5

Facultative RI l Characteristics Similar to co-insurance; l Simplest and oldest method; l Optional i. e. free choice to decide; l Single risk method; l Full disclosure of all facts. l Follows all original policy conditions l 6

Facultative RI l Advantages l In case of a small portfolio, where Treaty is unattractive; l Where risk is outside the scope of the Treaty - e. g. excluded class or Geographic Scope; l Where S I exceeds the Treaty Limit; l Expertise and capacity of big reinsurance can be used, l Where the risk is hazardous and might destabilise the Treaty 7

Facultative RI l Disadvantages l l l l Full disclosure of the material facts. Delay in seeking support. High administrative costs in negotiation and administration. Lower rates of commission. No Profit Commission. Risk of overlooking the renewal placement. Negotiation procedure to be adopted at each renewal 8

Premium and Loss Distribution in Facultative RI 9

Accounts for Facultative Since Fac RI is a single risk transaction, rendering of statement of premium & Claims known as “Closing” is on individual basis. l At times there is PPW & the Cedant and the Broker must adhere to it. l Closing must follow within a reasonable time after the signed line is advised and certainly before the expiry of the PPW. If for any reason, there is a delay, Reinsurer’s permission needs to be taken for extension of PPW. l 10

Accounts for Facultative Name of Broker & Ref. No. Name of Cedant & Ref. No. Name of Assured and location. Period of Cover / Perils Covered TSI, Rate, Deductions Actual working of 100% Premium Reinsurer’s % share and the amount of net premium 11

Accounts for Facultative As regards Facultative Claims: l Each claim is Cash Claim, in so far the approval of the reinsurer is concerned. l Irrespective of the amount of the claim, they should not be adjusted in the remittance statement without obtaining concurrence of the reinsurer. l The Facultative claim advice will contain: l Name of Broker & Ref. No. Name of Cedant & Ref. No. Name of Assured and location. Period of Cover Date of Loss Perils covered Cause of loss Amount of Loss Intimated Reinsurer’s % share and share of loss Settled Outstanding 12

What is a Treaty? l It is a contract / agreement l Gives automatic and continuous Capacity to an Insurance Company. l Predefined Scope for Period l Class / Classes of business l Retention and Cession limit under treaty l Geographical Scope l Also exclusions are specified. l 13

Quota Share Treaty l Characteristics l l l Obligatory in nature. Retention and cession on every risk Operates on fixed percentage basis. Meaningful retention required Advantages l l Works like a partnership & Useful for a new company or for a new class of business, where the results of business are unpredictable. l l Simple form & easy to operate and administer. Useful for reciprocal exchange. Disadvantages l Inflexible method of RI (unless VQS). Fixed percentage of premium on each ceded risk forces large outflow of Premium. l Fails to reduce incurred claims ratio on the retained account. l Capacity offered is limited. 14

How does a QS treaty Work? Risk SI 100, 000 Premium 20, 000 Loss 25, 000 Cedant Retains fully 100, 000 Premium 20, 000 Loss 25, 000 Net balance: (5, 000) Retains 50% 50, 000 Premium 10, 000 At 30% rate Gets Comm. of 3, 000 Retains Loss 12, 500 Net balance: 500 Reinsurer If No Treaty 50% QS cession 50, 000 Premium 10, 000 Pays Comm of 3, 000 Loss 12, 500 Net balance: 5, 500 15

Quota Share Treaty Cession 16

Surplus Treaty l Characteristics l Obligatory in nature. l Cession of policies, where SI exceeds the gross retention. l Hence retention on every policy, but cession may not be on every policy (Like QS). l Placed in terms of lines (not in % like QS) l Capacity Treaty, as capacity can be stretched through number of lines & through creation of first, second and third surplus treaties. 17

Uses of Surplus Treaty l l l To handle large risks. Simple and small risks well within the retention capacity can be fully retained. Higher retained portfolio generated through retained premium & premium reserves. Higher underwriting capacity. Besides receives Profit Commission, if treaty produces profitable results. Useful for reciprocal trading. 18

How does a Surplus Treaty Work? Capacity expressed in Lines (Times of Retention). l If retention is say 100, 000 and the Surplus Treaty is of 10 lines, then the Capacity is 1, 000. l Since it is a Surplus Treaty, the Reinsured will retain all risks up to SI of 100, 000 and cede the balance to the Surplus Treaty. l Therefore every risk will not go to the Surplus Treaty Reinsure. l 19

Surplus Treaty Risks Distribution 20

QS & Surplus Treaties: Cessions 21

Distribution of Risk over QS & Surplus Treaties 22

Distribution of Risk over QS & Surplus Treaties 23

Risk Distribution over an RI Programme QS Maximum 100% limit Rs. 500 Retention 40% and Cession 60% 1 st Surplus of 8 line and 2 nd Surplus of 8 lines TSI Risk details % Premium 10, 000 Loss 2, 000 4, 000 QS Retention 200 2% 40 80 QS Cession 300 3% 60 120 1 st Surplus 4, 000 40% 800 1, 600 2 nd Surplus 4, 000 40% 800 1, 600 Facultative 1, 500 15% 300 600 10, 000 100% 2, 000 4, 000 Total 24

Why do we require RI A/c ? U/W and A/C are inextricably related. l They are two sides of the same coin. l Together they determine the financial performance of the Reinsured and the Reinsurer. l A Statement of Account (SOA) is summary of Ceding Companies transactions of l l Premiums and Claims, For a Class of business, For a Period of time. 25

Why do we require RI A/c ? l Because: l They are the records of transactions between the parties to an RI Contract. l Information contained in the RI A/c is required by the Reinsurer to enable it to prepare: l l l A/c for its own retro-cessionaries. Financial A/c (i. e. Profit & Loss, Balance Sheet) and to file returns to the Regulator. Provide data for assessment of technical reserves (i. e. unearned premium and O/S loss) and for preparation of underwriting statistics & evaluation of each treaty. 26

Premium Bordereaux Purpose: l To record each cession of premium to the reinsurance treaties so that: l l l premiums can be allocated easily to reinsurance; there is a convenient list of cessions that can be used as the basis for allocating claims; statistics may be compiled easily; reinsurers are aware of the type of business that they are accepting. 27

Premium Bordereaux l l l Class: e. g. fire, accident, etc. . Month: a bordereau should be prepared for each month. Page number: to ensure that pages are not misplaced if the bordereau for a month runs onto more than one page. Date: date of preparation of bordereau. Reinsurer: to identify the reinsurer to whom the bordereau is to be sent. Reinsurer’s share: for the reinsurer’s reference. 28

Premium Bordereaux l l l l Cession number: so that each cession to reinsurance can be identified a sequential number is allocated. Policy number. Name of insured. Effective date: date of commencement of policy, renewal date or date of endorsement, alteration, etc. Expiry date: date of termination, etc. of policy. Type: type of premium (e. g. , 1 - renewal; 2 - new; 3 - endorsement; 4 - cancellation; etc. ) Building: use of building, e. g. , dwelling, farm, office, etc. Sums insured and premiums 29

Claims Bordereaux l Purpose l To record each claim to be recovered from the reinsurance treaties so that: claims can be recovered correctly from reinsurers; l statistics may be compiled easily; l reinsurers are aware of the losses they are being asked to pay and can establish adequate reserves. l 30

Claims Bordereaux l l l Class: e. g. , fire, accident, etc. Month: a bordereau should be prepared for each month. Page number: to ensure that pages are not misplaced if the bordereau for a month runs onto more than one page. Date: date of preparation of bordereau. Reinsurer: to identify the reinsurer to whom the bordereau is to be sent. Reinsurer’s share: for the reinsurer’s reference 31

Claims Bordereaux l l l l Policy number. Cession number: so that each cession to reinsurance can be identified a sequential number is allocated. Name of insured. Claim number. Date of loss: so that the loss can be allocated to the correct year’s reinsurers. Type of loss: theft, fire, etc. Payment: to identify multiple part payments of a loss. The column should be completed with “first”, “second”, etc. , and, when a final payment is made “final” should be entered so that reinsurers will know that they can close their file on the loss. 32

Claims Bordereaux l l l Gross loss: the amount of the payment to the insured (or third party) by the company. Gross expenses: the amount of additional expenses incurred in settling the claim, for example loss adjusters’ fees. Total loss and expenses: the sum of columns 8 and 9. Retained loss: the amount of the loss that falls to the company after recoveries from reinsurance. Losses ceded: the amounts to be recovered from various reinsurance arrangements. 33

Loss Notification SHOULD BE ON COMPANY LETTER-HEAD, MENTION DATE, TREATY NAME & U/W YR The details of the loss are as follow: l Insured: ______________________ l Policy number: ______________________ l Policy period: ______________________ l Claim number: ______________________ l Date of loss: ______________________ l Cause of loss: ______________________ l Circumstances of loss: ___________________________________________ l Estimated gross loss: ______________________ l Estimated treaty loss (100%): ___________________ It is/is not expected that a cash loss settlement will be requested in respect of this claim. We will keep you informed of all developments regarding this claim. 34

Cash Loss (CL) To enable immediate recovery of very large losses. l If CL Limit is 1, 000, a loss recovery of more than 1, 000 becomes eligible for immediate Cash Call. l CL settlement by Reinsurer is kept in suspense A/c which is squared off when that particular loss is included “Paid Claims” of statement of account & CL Credit is given to reinsurers who have paid the claim. l 35

Submission of SOA l At regular intervals, a: treaty account will be dispatched to all reinsurers. The account will contain technical and financial items and forms a statement of amounts due to or from the reinsurer. l 36

SOA will usually have following debit and credit items Credited to Reinsurers o o o o Premiums net of returns and cancellations. PR Released. LR Released. Interest on Reserves. P P/F incoming. L P/F incoming. Refund on Cash Loss Debited to Reinsurers o o o o Ceding Commission. Tax on Premium. PR retained. LR retained. Paid Claims. P P/F Withdrawal. L P/F Withdrawal. Profit Commission. 37

Company Letter Head U/W Year 2009 Quarter 3 rd Q Treaty Name & Quarter Period: 1. 7. 09 to 30. 9. 2009 Date QUARTERLY STATEMENT DEBIT CREDIT PREMIUMS: RECEIVED - RETURNED COMMISSION @ 30% REINSURANCE TAX @ 5% 50, 000 15, 000 2, 500 CLAIMS PAID LESS RECOVERIES 15, 000 PREMIUM RESERVE RETAINED @ 35% 17, 500 PREMIUM RESERVE RELEASED (PREV Q) 20, 000 INTEREST ON PR RELEASED 200 BALANCE 20, 200 TOTAL 70, 200 BALANCE BROUGHT FORWARD 70, 200 20, 200 J B BODA SHARE: 30% % Net payable EAGLE REINSURANCE CO 10. 00% 2, 020 SPARROW REINSURANCE CO 15. 00% 3, 030 5. 00% 1, 010 30. 00% 6, 060 PARROT REINSURANCE CO TOTAL 38

Periodicity of rendering Accounts l Accounts can be rendered on Quarterly, Half-yearly basis. l Traditionally Quarterly system is used and is more desirable for Reinsurers as accounts prepared on longer duration delay receipt of premium & also delay submission of information. 39

Commission Consideration to meet actual net acquisition cost, excluding salaries of staff. l An agreed % of Premium, paid by the Reinsurer to the Reinsured. l Influencing factors: l 1. Type of Treaty. 2. Class of business. 3. Country. 4. Results. l l Usually uniform to all participants. May differ for reciprocity. 40

Commission l Usually three methods employed: Flat Percentage method. l Flat Percentage plus Additional Percentage. l Sliding Scale method. l 41

Flat % Commission l This is the simple and most commonly used method. The percentage of commission is defined in the treaty slip, say 35%. This percentage is to be applied to the gross or net premium, accounted in that Quarter (as defined in the terms) to arrive at the commission. l Gross Accounted Premium 1, 000 X 35% = 350 l commission. 42

Flat + Additional Commission l This is rather uncommon method. A fixed percentage of commission is guaranteed. l Besides, depending on the loss ratio, at the end of the year additional commission is payable to the Cedant. l Example commission 30% + 2 ½ % is LR below 60%. l 43

S/S Commission Sliding Scale method ensures that the actual rate payable is directly related to the loss ratio. l Which means more commission in good years and lower commission in bad years. l Key factors: l l l Payment of provisional commission. Calculation of loss ratio. The Sliding Scale of Commission table. Minimum and Maximum rate of commission payable. Payment of actual commission due. 44

S/S Commission l Provisional Commission: l l Unless loss ratios are known, the actual commission can not be determined. Hence provisional (interim) commission payable. Usually this is fixed mid-way between the minimum and maximum rate. Minimum rate is 25% Maximum rate is 35% Provisional Commission will be 30%. This is considered equitable as neither party can pre-judge the final result of the treaty. 45

S/S Commission l Calculation of Loss Ratio will depend on method of accounting – whether Underwriting year or Accounting Year. For underwriting year method of accounting it is unusual to have S/S commission e. g. Engineering, Marine and Aviation business – because these years take many years to fully develop. l Reward for profit are dealt with through Profit Commission. l 46

Calculation of L/R for S/S commission run-off Treaties l Loss ratio, being calculated at various points in development of one u/w year, will keep on changing until all liabilities expire. The rate of commission directly related to loss ratio, the actual level of commission payable to the Cedant will fluctuate and adjustments will have to be done accordingly. Amount of administrative work involved in this calculation is enormous. 47

S/S Commission Table As per practice, the treaty terms would include a detailed scale of commission payable related to actual loss ratio. l To determine the actual rate of commission payable all that is necessary is to select the appropriate rate from the scale. l Example: Loss Ratio 52. 8% Commission 28. 50% Loss Ratio 66. 60% Commission 21. 50% Loss Ratio 78. 20% Commission 15. 50% l 48

S/S Commission- Min & Max Rates The S/S commission will have a min rate and a max rate. l The min rate reflects the least amount of commission that the Cedant requires to take care of its acquisition costs. l The max rate reflects the highest amount of commission the Reinsurer is willing to give. l S/S commission itself includes the rewards for profitability, hence it is not usual to encounter the S/S commission and the PC in the same treaty, although it may happen in practice. l 49

Calculation of L/R for S/S commission l Formula used: (U/W year based treaties) Incurred Loss X 100 Earned Premium Incurred Losses Paid during the year + O/S at the end of the year + Reserve for O/S loss at the end. (LR) - Return Reserve for O/S Loss from the previous year. (RLR) Earned Premiums Ceded for the year (P) + Return reserves for unearned premium from previous year (RPR) - Reserve for unearned premium (PR) 50

Calculation of L/R for S/S commission l Formula used: (Clean Cut Treaties) Incurred Loss X 100 Earned Premium Incurred Losses Paid / debited during the year - Incoming loss portfolio transfer + Outgoing loss portfolio transfer Earned Premium Gross Premiums Ceded during the year + Incoming Premium Portfolio - Outgoing Premium Portfolio 51

Calculation of L/R for S/S commission Clean-cut Treaties l Portfolio Premium and Losses apply at the beginning and at the end of the year, regardless of Reinsurer’s share is new, increase, reduced or cancelled. Formula as follows: Incurred Losses Earned Premium Losses Paid for the year + P/F losses P/F Losses withdrawn at assumed at the end the beginning Premium + ceded for the P/F year Premiums assumed at withdrawn at the beginning the end 52

Final adjustment of S/S Commission Until the loss ratio is known, provisional commission is paid. Adjustment is done at the end of the year. l Assuming S/S Comm is 27. 50% to 37. 50% with provisional commission of 30% adjustment as follows: l 1 st Q Premium 40, 000 Provisional @ 30% 12, 000 2 nd Q Premium 50, 000 Provisional @ 30% 15, 000 3 rd Q Premium 60, 000 Provisional @ 30% 18, 000 4 th Q Premium 30, 000 Provisional @ 30% 9, 000 Total 180, 000 54, 000 Actual Commission due from L/R calculation @ 32. 50% applicable to 180, 000 58, 500 Adjustment commission due to Ceding Co. 4, 500 53

Overriding Commission l In Retrocession Treaties “Commission” will include “Original Commission + Profit Commission + Brokerage” in addition to this an Overriding Commission will be charged. l Sometimes in highly profitable & very well balanced treaties O/R commission is given. l Usually ranges between 2% to 5%. 54

Profit Commission (PC) l PC is the reward given to the reinsured for providing profitable business, by the reinsurer. l Amounts to sharing of profits of a particular treaty. l Payable in addition to commission. l Applicable to Proportional treaties and rarely seen on Non Proportional Treaties or Facultative business. 55

Profit Commission (PC) l The simplest definition of Profit is Income less Expenses. l The profitability of a reinsurance contract is also determined using the same formula. The items which will appear under the heading “Income” and “Expenses” need to be seen carefully and they are explained as follows: 56

Profit Commission (PC) Commission on Profit paid by the Reinsurers to the Reinsured as per a formula. l Income: 1. Written Premium 2. P/F Premium & Loss Entry. l Outgo: 1. Commission, O/R, Tax. 2. Paid Losses. 3. P/F Premium & Loss Withdrawal. 4. Management Expenses. l After deducting L c/f, PC % to be applied on balance. l 57

Profit Commission (PC) l Management expenses are not an accounting item. It is a notional deduction in the PC statement allowing Reinsurer’s own expenses. This is to be calculated on the Gross Premium at the rate prescribed in PC formula. l Brokerage is not included in the outgo. Because it does not appear in the Ceding Company’s original accounts. 58

Profit Commission (PC) l Income l Outgo 1) P/F Premium P/F Loss Entry. Original Gross Premiums included in the accounts for the current year. 1) Commission. Any other deductions. Paid Losses & Loss expenses. P/F Premium withdrawal. P/F Loss withdrawal. Reinsurer’s Management Expenses. 2) 3) 4) 5) 6) 59

Profit Commission (PC) l Any Premium & Loss recoveries under reinsurances which inure to the benefit of the Agreement are to be taken into account. l Any excess of Income over the Outgo, will be considered as profit. l Reinsured shall render the PC statement to the Reinsurer for each annual period, according to the PC formula. 60

Profit Commission (PC) Formula: PC 10%, deficit c/f to 3 years, ME 7. 5% (but results shown below are net of the ME) Yr 1 U/W 1 Yr 2 (5, 000) U/W 2 Yr 3 Yr 4 Yr 5 (5, 000) 1 st (2, 500) 2 nd (2, 500) 3 rd Yr Yr Yr 2, 500 U/W 3 (1, 200) U/W 4 (1, 200) 1 st (700) 2 nd Yr Yr 3, 000 U/W 5 Result 10% PC 3, 000 (5, 000) (2, 500) (3, 700) (700) 2, 300 Nil Nil 230 61

PC calculation for Engineering Treaty Underwriting Year 1. 1. 2002 to 31. 12. 2002 As at 31. 12. 03 As at 31. 12. 04 As at 31. 12. 05 As at 31. 12. 06 Premium 1, 500, 000 2, 500, 000 3, 500, 000 TOTAL INCOME 1, 500, 000 2, 500, 000 3, 500, 000 375, 000 500, 000 625, 000 750, 000 875, 000 500 1, 000, 000 1, 500, 000 2, 000 Tax on Premium @ 5% 75, 000 100, 000 125, 000 150, 000 175, 000 ME @ 5% 75, 000 100, 000 125, 000 150, 000 175, 000 O/S loss at the end of yr 10, 000 500, 000 300, 000 100, 000 TOTAL OUT GO 535, 500 751, 000 2, 250, 000 2, 850, 000 3, 325, 000 Profit / (Loss) 964, 500 1, 249, 000 250, 000 175, 000 PC at 20% 192, 900 249, 800 50, 000 35, 000 192, 900 249, 800 50, 000 30, 000 56, 900 (199, 800) (20, 000) 5, 000 INCOME OUTGO Commission at 25% Claims Paid Less PC as last year PC for this year 192, 900 62

Super Profit Commission Additional PC payable over and above the normal PC. l e. g. if the PC is 15% and Super PC is 30% the working will be done as indicated: l Net Profit : 60, 000 15% PC : 9, 000 Net Result : 51, 000 30% Super PC : 15, 300 Total PC payable: 24, 300 63

Outstanding Losses Throughout the treaty period, claims occur on policies attached to the treaty. l Many of the claims are settled by the Insurer and charged to the reinsurer in agreed proportion. l However, some of these claims will not be settled before the end of the treaty year. These claims are known as Outstanding Losses. l 64

Outstanding Losses l Ceding Company estimates the likely cost of Outstanding Losses and provides the total of the estimates to the reinsurer, usually at the end of the period. l This is for the purpose of information, so that the Reinsurers can make sufficient provisions for the losses to be paid at a future date. 65

Proportional Treaty Accounts l One of the following two methods is applied for preparation of Treaty Accounts: Underwriting Year Accounting System (Run Off) l Accounting Year based Accounting System (Clean Cut) The methods can be viewed at a glance in the following slide l 66

U/W & A/C - at a glance Accounting Year U/W Yrs 2002 2003 2004 2005 Total 2002 100 50 (120) 15 45 2003 X 80 45 5 130 2004 X X (55) 45 (10) 2005 X X X 60 60 Total 100 130 (130) 125 225 • Result of each U/W year will be finalized when liability for that year is expired. • Result of each A/C year may include items for more than one U/W year 67

U/W & A/C - at a glance 1998 Year 1 1999 Year 2 2000 Year 3 2001 Year 4 Total U/W yr 1999 2000 2001 Total A/c Yr 68

U/W Year Method (run off) l Suitable for classes where l l l Policies issued for more than 12 months (CAR/EAR), premiums are collected over more than one A/c year & exposure to the losses also extends for same period. Marine, Aviation, Liability, CAR, EAR etc. medium to long tail business Delays in settlement of account due to l l Legal judgment / medical consideration Repairs to be carried out Cost of repairs extended over length of time Recoveries to be received over bonds / credit claims 69

U/W Year Method (run off) l Any claim affecting the reinsurance treaty is allocated to those reinsurers that received the premium for that risk. l l l In any given quarter, there can be claims and premiums relating to several underwriting years. Therefore, it is essential to allocate premiums and claims to the correct underwriting years and to ensure that separate bordereaux and accounts are produced for each underwriting year. Profit commission statements will also be prepared according to underwriting year. 70

U/W Year Method (run off) A/c Yr 02 A/c Yr 03 A/c Yr 04 A/c Yr 05 Four Qtly A/c Four Qtly Run off A/c PC Calculation Revised PC O/L Advice Revised O/L Four Qtly A/c Four Qtly Run off A/c PC Calculation Revised PC O/L Advice Revised O/L Four Qtly A/c Reinsurers U/W 2002 Four Qtly Run off A/c PC Calculation Revised PC Reinsurers U/W 2003 Reinsurers U/W 2004 Continue O/L Advice 6 12 18 Revised O/L 24 71

U/W Year Method (run off) 2002 2003 2004 J F M A M J J A S O N D J F M A M J Policy Incepts A S O N D 72

SOA for Run Off Treaty Credited to Reinsurers o o o Premiums net of returns and cancellations. PR Released. LR Released. Interest on Reserves. Refund on Cash Loss Debited to Reinsurers o o o Ceding Commission. Tax on Premium. PR retained. LR retained. Paid Claims. Profit Commission (annual) 73

Why Clean Cut A/c System? Administrative costs for handling accounts are very high. l Large treaties are placed with a number of reinsurers, hence more administration. l Reinsurers may change their shares or cancel participation, hence Cedant may be required to allocate Premium, Deductions, Claims & other accounting items to many different reinsurers, until the liability is finally expired. l The concept of Portfolios was introduced to assist both Ceding Company and the Reinsurer in reduction of administrative expenses. l 74

Portfolios l The period of reinsurance treaty does not correspond to the period of all original direct insurances. l Most of the policies will be still in force at the end of the reinsurance period and for which the reinsurer would have received full premium. l For example, if the reinsurance period follows the calendar year, an annual insurance policy issued at 1 st July has at 31 st December six months until expiry during which time a claim might occur. 75

Portfolios A system has been developed whereby this unexpired liability can be withdrawn from a reinsurer canceling its participation and transferred to (assumed by) a new reinsurer who will receive a commensurate share of the premiums. l Thus, losses occurring before the date of cancellation are charged to the old reinsurer and losses occurring after the date of cancellation to the new reinsurer. l 76

Portfolios l By the same technique, the liability in respect of losses that have not been settled at the time of the change in reinsurer’s participation on the treaty will be transferred to the new reinsurer together with the corresponding claims reserve. l The old reinsurer will no longer be charged with claims that were outstanding at the date of cancellation. 77

Portfolios l This transfer of liability between old and new reinsurers when a change in participations takes place are effected as soon as possible after the end of the reinsurance period and are handled by way of a: l l l premium and loss portfolio transfer account. 35% of accounted premium during the year 90% or 100% of losses outstanding at the end of the year 78

A/c Year Method (Clean Cut) Brings into one revenue year all Premiums (less commissions and deductions) less claims payable, reported by the Cedant during that revenue year regardless the underwriting year to which the item relates. l Best suited for short tail class of business such as Fire & Accident where both Premiums and Claims are settled faster. l 79

A/c Year Method (Clean Cut) At the end of the year, the liability of Reinsurers is CUT by P/F premium & loss withdrawal and at the beginning of the nest year, the same liability is passed on to the U/W 2002 Reinsurers of next year, by P/F premium and loss entry. A B C D 2003 B C E F 2004 C E F G 2005 C E G 2006 E G 80

A/c Year Method (Clean Cut) 2002 2003 J F M A M J J A S O N D J F M A M J A S O N D 81

A/c Year Method (Clean Cut) format: Credit Debit l Premium Ceded l Commission l Portfolio Premium l Overriding Entry Commission l Portfolio Loss entry l Claims Paid l PR Release l Premium P/F withdrawal l Loss Reserve Release l Loss P/F withdrawal l Interest (Less Tax) on l PR Retained Reserve Release l LR Retained l Credit for Cash Loss l Taxes and Charged Balance: Difference between Credit and Debit 82

Portfolio Premiums At the end of an U/W year, there a number of unexpired policies. The liability of current Reinsurers is transferred to the next reinsurers through P/F Premium and Loss Transfers. P/F Premiums are usually calculated @ 35% or 40% of accounted premium during the year. 1. 1. 1998 Reinsurer A outgoing 31. 12. 1998 Earned Premium Unearned Premium P/F Premium Withdrawn 31. 12. 1999 1. 1. 1999 Reinsurer B incoming P/F Premium Assumed Unearned Premium Earned Premium P/F Premium Withdrawn 31. 12. 2000 1. 1. 2000 Reinsurer C incoming P/F Premium Assumed Earned Premium Unearned Premium 83

Portfolio Losses This means, at the end of the treaty year, the outstanding losses are withdrawn by the Ceding Company and credit is given to the incoming reinsurers. 1. 1. 1998 Reinsurer A outgoing 31. 12. 1998 Paid Losses Outstanding Losses P/F Loss Withdrawn 31. 12. 1999 1. 1. 1999 Reinsurer B incoming P/F Loss Entry Paid Losses Outstanding Losses P/F Loss Withdrawn 31. 12. 2000 1. 1. 2000 Reinsurer C incoming P/F Loss Entry Paid Losses Outstanding Losses 84

A/c Year Method (Clean Cut) 2002 2003 2004 J F M A M J J A S O N D J F M A M J Policy Incepts A S O N D 85

SOA for Clean Cut Treaty Credited to Reinsurers o o o o Premiums net of returns and cancellations. PR Released. LR Released. Interest on Reserves. P P/F incoming. L P/F incoming. Refund on Cash Loss Debited to Reinsurers o o o o Ceding Commission. Tax on Premium. PR retained. LR retained. Paid Claims. P P/F Withdrawal. L P/F Withdrawal. Profit Commission. 86

Loss Participation Clause Reinsured shall reimburse to the Reinsurer 40% of the loss ratio exceeding 75% up to 100%. l Loss Ratio = % of Incurred Claims to Earned Premium. l Example 1 Incurred Claim 52, 000 & Earned Premium 50, 000 LR = 104% Maximum loss participation by Reinsured is 40% of 25% i. e. 5, 000. l Example 2 Incurred Claim 30, 000 & Earned Premium 50, 000 LR = 60% Since LR is below 75% the Loss Participation Clause not applicable. l Example 3 Incurred Claim 45, 000 & Earned Premium is 50, 000 LR = 90% Reinsured will participate 40% of 15% LR ( 90% - 75%) i. e. 3, 000 l 87

Commutation l This is early termination of a contract of reinsurance in return for mutually agreed level of consideration. l Relieves reinsurer of his obligation. l Any losses to the contract, after the commutation will be solely and totally borne by the reinsured. 88

Commutation l For example, on a Marine Hull Surplus Treaty U/W Yr 2000, there was a large claim advised – but not paid until 2009. l The 100% Reserves are say 10 m. l The reinsurer has to provide for this reserve every year. This costs him administration cost + affects his results. l Hence the commutation will be proposed for say 7. 5 m settlement. 89

Premium Reserves (PR) Originally meant to be a security against Reinsurer’s obligation under treaty. l Also legislative requirement in certain Countries. l PR are reserves retained at pre-fixed % rate (35 to 40)on Gross Premium of each quarterly / half-yearly account and released in corresponding account next year. l Interest is paid, at prescribed rate less IT. l 90

Premium Reserves l In reciprocal trading PR are waived, if so desired by both the sides. l Non Reciprocal treaties waiving of reserves is favoured for “Cash Flow” underwriting. l Some times in a “clean cu” treaty P/F Premium entry is retained as PR and is released in each quarter, thus at the end of the year it is squared off. 91

Loss Reserves (LR) l Same purpose as PR – i. e. security against non performance of reinsurer. l Cover those losses, which have occurred but not paid. l Usually 90% of O/S losses l Some times include IBNR loading. l Interest is paid. 92

Loss Reserves l This is the consideration for Outstanding Loss liability and include Outstanding Losses + IBNR. l LR are usually 90% or 100% of Outstanding Loss + IBNR. l They are retained and released quarterly or annually as per the provisions of the treaty terms. 93

Example of PR & LR Retained & Released (1) 94

Example of PR & LR Retained & Released (2) 95

Various Reserves Strengthen Solvency of an Insurer A A = Paid Up Capital B = Free Reserves C = Premium Reserves D = Loss Reserves E = Cat or Disaster Reserves B C D E 96

Unearned Premium Reserve Despite resistance from reinsurers, it is common for ceding companies to retain a proportion of premium payable to the reinsurer. The motivation is normally that this deposit should serve as a guarantee against the failure of the reinsurer to meet its future liabilities. In some countries, the law requires this. l The calculation of premium reserves withheld should, theoretically, follow the same principle as that of portfolio premium. In practice, however, and for ease of administration, premium reserves are calculated at a fixed percentage of premiums. Very often the rate is 40%. l 97

Methods of unearned Premium l Prorata Premium for EVERY POLICY To be calculated by determining the proportion of each policy that extends beyond the treaty year. l For example: Policy Premium is 25, 000 & period is 2 nd May to 1 st May l Unearned Period 1 st Jan to 2 nd May i. e. 121 days l 121/365 X 25, 000 = 8287. 67 l Administratively cumbersome & expensive l 98

Methods of unearned Premium l 1/24 th System. l Based on following assumptions: l l Average policy ceded in any monthly period incepts in the middle of each month. Average policy period is 12 months. Therefore for the month of January 15 days of policy premium remains unearned i. e. 1/24 th For the month of February 45 days of policy premium remains unearned i. e. 3/24 th. 99

1/24 th Method J FMAM J J A S OND 1/24 th 3/24 th 5/24 th 7/24 th 9/24 th 11/24 th • Relatively accurate. • Ideally suited, where spread of policies ceded is unbalanced. 13/24 th 15/24 th 17/24 th 19/24 th 21/24 th 23/24 th 100

Methods of unearned Premium l 1/8 th System, is similar to 1/24 th System. Only the Assumptions are different: l l Average policy incepts in the middle of each quarterly period and expires in the middle of each quarterly period of the next year. Therefore for the 1 st quarter, ½ quarter of premium remains unearned at the end of the treaty year i. e. 1/8 th; for the 2 nd Quarter 1 ½ quarter of premium remains unearned i. e. 3/8 th. This method is also reasonably accurate & simple to calculate. Depends on average policy period of 12 months. 101

1/8 th Method Treaty Year 1 Treaty Year 2 Q 1 Q 2 Q 3 Q 4 1/8 th 3/8 th 5/8 th 7/8 th 102

Methods of unearned Premium l Flat percentage basis i. e 35% to 40% system Least accurate of all systems. l 35% to 40% of annual premium is withdrawn. l Unless policies are well balanced, this system will work against the interests of either party. l Most commonly used method, as simple and easy to operate. l 103

Chain of Proportional Treaty A/c l l l l l Preparation of Premium & Claims Bordereaux Loss Notifications Cash Claim Advice Rendering and settlement of A/c Q or H/Y If S/s commission, adjustment at the end of the year Submission of P/F withdrawal and entry for clean cut treaties. Submission of Premium & Loss Reserves and release statements. Submission of P/C statement. Advise of O/S loss at the end of the treaty 104

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