CHANGES TO SSAP 62 PROPERTY & CASULTY REINSURANCE

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CHANGES TO SSAP 62PROPERTY CASULTY REINSURANCE

• NAIC Property and Casualty Reinsurance Study
  Group
• Chicago, IL
• May 10, 2005
• Michael Moriarty
• Director, Capital Markets Bureau
• NY Insurance Dept.

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SSAP 62 CURRENT FRAMEWORK

• Reinsurance Accounting or Deposit Accounting
• Either/Or Approach
• Standard for Favorable Reinsurance Accounting
  Treatment Transfer of Underwriting Risk
• Equates to Significant Risk of Significant Loss
• Otherwise the Deposit Accounting Approach Applies

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Binary Approach in SSAP 62

• Does Not Reflect the Economics of Certain
  Significant Reinsurance Transactions
• Reinsurance Agreements Can Have a Range of
  Transfer of Insurance Risk
• Main Intent of Transactions May Be Financing
  Temporarily Taking Reserves Off the
  Books/Parking Reserves

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Why Finance Losses In a Reinsurance Agreement

• IF Reinsurance Accounting Can Be Secured
• Discount in Reserves Can Be Unlocked
• Enhance Capital Position
• Improve Underwriting Results ( Earnings)
• Improve Leverage Ratios (NPW to Surplus
  Underwriting Ratios Reserves to Surplus)

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Sample TransactionExcess of Loss

• COVER - 80 Million xs 50 Million
• GROSS WRITTEN PREMIUM 150 Million
• EXPECTED LOSSES by Ceding Company
• 120 Million
• Probability of 110 Million in Lossesgt90
• PREMIUM for Cover 60 Million
• ACTUAL LOSSES INCURRED 120 Million

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Sample Transaction - Excess of Loss Financial
Statement ImpactReinsurance Accounting SSAP 62
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Sample Transaction - Excess of LossWhat Really
Happened

• Reinsurer Took Marginal Risk Was Exposed to 10
  Million Over Expected Losses
• Exposure Probably Achieved Transfer of Insurance
  Risk Under 10/10 Rule (10 Mln Exposure/60Mln
  Premium 16.7 Loss)
• Ceding Company KNEW it Was Transferring Losses
  That Would Be Indemnified (50 Mln to 110 Mln
  Layer)

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Sample Transaction - Excess of LossWhat is
Driving Transaction?

• What is the Economic Purpose of Ceding This
  Layer? Is it Insurance or Financing?
• If the Ceding Company Wanted to Hedge its
  Underwriting Risk, Shouldnt it Have Secured a
  10Mln xs of 120 mln Cover Instead (i.e.
  Variability Above Expected Losses)
• Reinsurer May Lose on Transaction from
  Accounting Perspective, but Not Economically
• Significant Accounting Benefit of Parking the
  Working Layer off-Balance Sheet

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Sample TransactionExcess of Loss w Bifurcation

• COVER - 80 Million xs 50 Million
• GROSS WRITTEN PREMIUM 150 Million
• EXPECTED LOSSES by Ceding Co. 120 Million
• Probability of 110 Million in Lossesgt90
• FINANCING PREMIUM for 60 Mln xs 50 Mln 53
  Mln
• INSURANCE PREMIUM for 20 Mln xs 110 Mln 7
  Mln
• ACTUAL LOSSES INCURRED 120 Million

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Sample Transaction - Excess of Loss Financial
Statement ImpactBifurcation Framework
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Reinsurance Accounting Vs. Deposit Accounting

• Reinsurance Accounting is Favorable
• Disclosure Brings Better Transparency, but Does
  NOT Address the Issue that Seems to Be Driving
  Certain Transactions
• How to Address Bifurcation Raising the Standard
  of Transfer of Insurance Risk Allowing
  Discounting of Reserves or Something Else??

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PROPOSE REVISIONS TO SSAP 62

• Discussion Draft Dated May 5, 2005
• NY Asks That It Be Received by Study Group and
  Exposed for Public Comment
• Identify Issues that Need to be Addressed in
  Order to Connect the Concept with the Practical
  Application
• Open to Alternatives
• Casualty Actuarial Task Force Is Reviewing Issue

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SSAP 62 Revisions (continued)

• New Paragraph 1 (N1) - Page 1
• Statement in the Reinsurance Contracts Must
  Include Transfer of Risk Section that Certain
  Reinsurance Agreements Will Require Bifurcation
• It then Refers Readers to New Paragraphs 2, 3,
  4 for Further Guidance

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SSAP 62 Revisions (continued)

• New Paragraph 2 (N1) - Page 3
• Leads off the New Bifurcation of Reinsurance
  Agreements Section in SSAP
• Provides Reasoning for Bifurcation of Reinsurance
  Agreements
• Alerts Readers that Bifurcation Will Not be
  Required for All Agreements Only Those that
  Exhibit Common Characteristics of Financing

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SSAP 62 Revisions (continued)

• New Paragraph 3 (N3) - Page 3
• Paragraph Specifies Six Categories of Reinsurance
  Agreements that Need NOT be Bifurcated
• Excess Per Risk - Does Not Lend Itself To
  Predictability
• Excess Per Occurrence -
• Fronting Arrangements - No Reserves Typically
  Kept by Ceding Company

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SSAP 62 Revisions (continued)

• New Paragraph 3 (N3) - Page 3 (continued)
• Six Categories of Reinsurance Agreements that
  Need NOT be Bifurcated
• Facultative - Have Not See Abuses in These Types
  of Deals
• Premium/Limit Ratio is Low - In Financing Deals,
  the Premium Is High in Relation to the Losses
  Transferred, Which are Generally Capped
• Any Other Agreements - that do not have the
  Finite Characteristics Set Forth In New
  Paragraph 4

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SSAP 62 Revisions (continued)

• New Paragraph 4 (N4) - Pages 3 4
• Sets Forth Those Reinsurance Agreements NOT
  Specifically Exempted That Need to Be Bifurcated
• Three Broad Categories
• Contain Specific Contract Provisions
• All Retroactive Agreements
• All Multi-Year Agreements
• If Exempted Under N3 OR Does Not Meet Any of the
  Conditions in N4, Agreement Need NOT Be Bifurcated

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SSAP 62 Revisions (continued)

• New Paragraph 4 (N4) - Page 3 4 (continued)
• Contractual Provisions Triggering Bifurcation
• Premium/Limit Ratio is High - In Financing Deals,
  the Premium Is High in Relation to the Losses
  Transferred, Which are Generally Capped
• Aggregate Loss Ratio Limits - Transferring
  Expected Losses
• Loss Corridors - Limitations on Reinsurers
  Exposure
• Retrospective Premium Adjustments - Revisions
  Intended to Reimburse Reinsurers Losses Under
  Contract

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SSAP 62 Revisions (continued)

• New Paragraph 4 (N4) - Page 3 4 (continued)
• Contractual Provisions Triggering Bifurcation
  (continued)
• Sliding Scale/Adjustable Commissions - Can Reduce
  Reinsurers Expenses Based Upon Losses
• Mandatory Reinstatement Premiums - Can Ensure
  that Reinsurer is Reimbursed for Unexpected
  Incurred Losses
• Commutation Clause - allows ceding insurers a
  full refund of unused premiums

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SSAP 62 Revisions (continued)

• New Paragraph 4 (N4) - Page 3 4 (continued)
• Contractual Provisions Triggering Bifurcation
  (continued)
• Conditional Cancellation Provisions That Require
  Entering Into New Agreements - Can Move
  Obligations from One Period to a Future Period
• No Consistent Reporting - Indicative of Minimal
  Substance to Agreement
• Funds Held - allows ceding insurers to retain
  funds to pay losses

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SSAP 62 Revisions (continued)

• New Paragraph 5 (N5) - Page 4
• Guidance on HOW to Account for Bifurcation of
  Reinsurance Agreements
• Estimate Layer of Coverage Where There is a
  Greater than Ninety Percent Probability That
  Ceding Company Will be Indemnified for Losses
• Premiums/Expenses/Losses Attributable to That
  Layer Gets Booked Under Deposit Accounting
  Guidance Remainder Gets Booked under Reinsurance
  Accounting Guidance

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SSAP 62 Revisions (continued)

• Changes to Eliminate Current Treatment for
  Retroactive Agreements - Pages 5-9
• ALL Retroactive Reinsurance Contracts Must be
  Bifurcated
• Portion that Transfers Insurance Risk Should Be
  Reported Under Reinsurance Guidance Part that
  Finances Losses Should Be Reported Under Deposit
  Accounting Guidance
• Similar to FAS 113 Approach

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SSAP 62 Revisions (continued)

• Implementation QA - Page 9
• NO CHANGES Pending Exposure of Concepts Under
  Consideration
• Revisions WILL Be Needed

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SSAP 62 PROJECT PC REINSURANCE STUDY GROUP
TIMETABLE

• P/C Reinsurance Study Group continue to review
  over Summer
• August Receive Report from NAIC Casualty
  Actuarial Task Force
• Put a Final Proposal on Study Groups Agenda in
  the Fall and Move to Statutory Accounting
  Principles Working Group