Reserve Credits For Reinsurance - SOA
RECORD OF SOCIETY OF ACTUARIES1989 VOL. 15 NO. 2RESERVE CREDITS FOR REINSURANCEModerator:Panelists:Recorder:oDAVID B. ATKINSONWAYNE D. BIDELMANTHOMAS G. KABELEMELVILLEJ. YOUNGBRUCE L. WILLIAMSNo prior knowledge of the subject is required of the registrant.To encourage a livelydiscussion,part of the presentationwill involve panelists debating conflictingproposals asto how best to overhaulregulationsgoverningreserve credits for reinsurance.Betweenthedebate and other presentations,the panelists will address the following subjects and currentissues:-Reinsurancereserve credits -- variationsby stateoCurrentModel Law on Credit for ReinsuranceoNew York Regulation102oLimitationson proportionreinsuredoOther limitations-Mirror reservingoAlternative definitionsoPractical difficultiesoFifth amendmentto New York Regulation20oWhat it is and why it was promulgated?oIndustryresponseoOutlook for the future-Reserve credits involving unauthorizedreinsurersoLetters of creditoTrust fundsoFunds withheldoLicensed in another state with similar solvency standards-Proposed revisionsto the NAIC Model Law on Credit for ReinsuranceoWhat is proposed?oIndustry reactionoCurrentstatusMR. DAVID B. ATKINSON:Let me give you a brief overview of what the differentspeakersaregoing to talk about.Mel will start out first and give you an overview of all the things that aregoing on. Tom will follow and go into more depth on mirror reserving, New York Regulation20,and also some of his thoughts on some other new developments.Finally, Wayne Bidelman willconclude with a reinsurer'sview of mirror reserving and New York Regulation20.Our mission is to use this occasion to our advantageto talk about all these currentissues.often we get a chance to get together like this and share opinions and thoughts.I stronglyencourageyour participation.We havea lot of controversialissues to talk about.It is notMR. MELVILLEJ. YOUNG:As David said, my primary task is to give you a bit of an overviewof what has happened in the last couple of years to reinsuranceregulations.We are going to talkfirst about the New York's Regulation102 and subsequentactivity involving the model regulationwhich follows, give you a little history of that, and then we are going to talk a little bit about themirror reservingand New York Regulation20, and then finish up with a bit of potpourriof someother things that have been happeningrecently in reinsuranceregulations.In 1984, the New York Insurance Departmentissued the first draft of its proposed Regulation102.It stopped short of declaring reinsuranceacapital offense-just short. During the public hearingthat followed100 or so industry representativespresented a series of persuasive argumentsthatconvincedthe New York InsuranceDepartmentthat some redesign was called for.969
PANELDISCUSSIONA half dozen or so working sessions followed.These were attendedby three industry representatives and the four most senior New York InsuranceDepartmentofficialsconcernedwith lifereinsurance.The result of all this effort was a compromiseregulation,of which no one wascompletelysatisfied.Those present did feel that there was mutual understandingthough.Unfortunatelythe interpretationof the languagehas changedconsiderablysince the day it waswritten and, to the cynical, it might seem as if the regulationis reinterpretedon a daily basis.New York Regulation102 was followedby the passage at the NAIC of an almost identicalmodelregulation.A handfulof states (Texas, Washington,Oklahoma,Alabama,Delawareand CaliforniaDraft Proposal)have formallyadopted their version of the model.In each case, the state addedits own stamp.For example, supposedlyDelaware'sBulletin 88-1 will be interpretedto conformwith the model regulation,but it specificallyprovides for a phased unwindingof a treaty, whichcreates an immediate surplus impact and potentialdisallowanceif the reinsuredwere insolventwithout the treaty.This would tend to make it more difficultfor a company and its regulatorstoresolve the company's financialdifficulties(the Delaware department'slogic escapes me).Oklahoma'sversion effectivelyeliminatesthe offset provisionfor treatiesmines do not meet the standardsof their statute.Reinsurerswill certainlyany form of coinsuranceto an Oklahomadomiciledcompany.that the statepause beforedeterofferingMississippidomiciles will also find some difficultyin trying to obtain coinsurance,this due t :recent court case involving GerlingGlobal Life. The court interpretedcoinsuranceto mean coinsurance,and therefore permitteda direct cut through from the policyholderto the reinsurer.Californiahas issued a draft bulletin with its version of the model regulation.If is is issued asproposed it will cause some considerablediscomfort,particularlyif it is ultimatelyinterpretedoapply to all reinsurancetreaties.Among the more troublesome provisionsare the following:1.A provision requiringthat administrativeexpenses be covered by the terms of the agrecmentin additionto commissionsand premiumtaxes. It seems that this provision,if it remains,should be limited to require coverage of marginal,variable administrativeexpenses.2.A provision that would require the establishmentof what could be a staggeringdeficiencyreserve if the modifiedcoinsurancereserve adjustmentinterest rate is fixed at a levelgreater than the valuation rate and guaranteed for more than one year. The same paragraphof the regulationwould allow the CaliforniaDepartmentto determineif a formularate is"reasonablein the opinion of the Department."3.A provisioncalling for a valuationactuary'sopinion on the agreement,to include languagewhich could be interpretedto give the Californiacommissionerthe power to reviewreinsurancerisk charges and impose a potentiallyonerous reserve in the event the commissioner deems the risk charge to be "significant."It might1.2.3.4.5.be usefulto reviewthe originalobjectivesof these regulations:Reinsuranceshould not be used (or abused) toSurplus created through reinsurancewould beon the business reinsured.The reinsurershould not take unilateralactioncreated.Reinsuranceshould not be used to hamper theWhere possible, the availabilityof reinsurancea positive contributionto the industry.distort a company's true financial position.paid back only to the extent of future profitsto deprivethe companyof the surplusregulator's already difficulttask.should be viewed by all concernedpartiesasI believe the model regulationfor surplus relief was a good starting point.It seems to me thatalmost all reinsuranceagreementsentered into embody certain characteristicswhich the modelregulationencouraged.These include the following:I.The agreementsprovide for full passage of mortality and/or morbidityrisk commensuratewith the portion of the policy reinsured.And, for a coinsurancetype agreement (i.e.,CoinsuranceFunds; CoinsuranceFunds Withheld; ModifiedCoinsuranceFunds; Mod CoFunds Withheld) full passage is provided of the persistencyrisk created by the payment of970
RESERVEthe surrenderrisk associatedCREDITSFOR REINSURANCEvalue on the portion of the policy reinsured,plus the additionalpersistencywith the payment of high first-yearallowanceswhen new business is covered.2.For coinsuranceagreements,if the reinsureris admittedin the original life company'sstateof domicile (OL SOD) the reinsurerholds a reserve not less than the minimumreserverequiredby the OL SOD. Therefore,hopefullythere should be no questionabout the cedingcompany taking full reserve credit (based on the ceding company'sreserve standard)on theportion of the policy colnsured,providedrisk passage as describedin paragraph1 hasoccurred.This matter will be addressedagain when I discuss New York Regulation20.3.Other than for the reasons providedfor in the model regulation,reinsuranceagreementscanno longer be structuredto require payback of losses by the ceding companyto the reinsurer,and the reinsureris denied the right to reduce or terminatein-forcereinsurance.Surplusrelief can be paid back only as result of the realizationof profits on the business reinsured.4.The agreementsmust provide for cash payments to the ceding company by the reinsurerwhen experiencepoorer than anticipatedresults in losses being realized on the policiesreinsured,creating negative cash flows. For agreementswhere the ceding company iswithholdingsome of the reinsurer'sfunds, those funds are availablefor the paymentofbenefits.When those funds are dissipated,the reinsureris requiredto provideadditionalcash payments to the extent experience on the block dictates.5.The agreementsmust provide thatreasonablyexpected to be received6.The reinsurancetreaties are detailedand agreed to in final form or in a letter of intentsometime during the year they take effect, and if the latter is the case, the treaty must beexecuted no later than 90 days from the execution date of the letter of intent.the reinsurer'sby the cedingincome be no greaterthan the incomecompany from the reinsuredpolicies.With this much behind us, some of the burning issues remaininginvolve investmentrisk passageon interest-sensitivepolicies; disclosure of significantreinsurancetransactions;and the use ofcash flow illustrationsto demonstratethe workings of the treaty.Investmentrisk passage has been "required" administrativelyby the New York InsuranceDepartmenton certain annuityagreementsand on interest-sensitivesingle premiumcontracts.Whether this is appropriateand how it should be addressedare importanttopics of conversation.Two topics being addressedby the surplus relief task force of the EX-5 committeeof the NAICare whether there is adequatedisclosureof reinsurancecontractsand providingregulatorssamplecash flow illustrationsat the time treaties are being reviewedby them.Mirror reservinghas recently been a much discussedtopic. New York again was first to addressthis difficultsubject through its recently promulgatedRegulation20. Regulation20 evidencedthe New York InsuranceDepartment'sconcern with offshorereinsuranceand their belief thatmany companieswith thinly priced productsand already insufficientcapital were furtherendangeringtheir solvency by entering into bogus reinsurancetransactions,secured by letters ofcredit, with offshore companies that were not holding sufficientreserves.This regulationis rather difficultfeatures includes the following:to read but my understandingof some of its more salient1,The effectivedate is December 23, 1988. All reinsuranceagreementsentereddate or to which new business is added after December 31, 1988, are affected.2,Purpose:"To prevent authorizedlife insurersfrom circumventingreservingrequirementsthrough reinsurancewith unauthorizedinsurers and prevent a ceding insurer electing creditunder section 125.4 (f) of this part from thereafterbeing eligible to elect credit undersubdivision(e) of this section."3.Regulation20 has no impact if a ceding company'sreinsurerand all its reinsurer'ssionaires are licensed in New York. Very few reinsurers are so licensed.971into afterthisrctroces-
PANELDISCUSSION4.If the reinsurer is licensedthe required reports.5.If a company is an admittedreinsurer in New York, it must, as before, continueto hold atleast New York's minimumrequired reserve. It must also provide its clients (except asdiscussedbelow) with substantiationquarterlythat it, and all its retrocessionaires,and theirretrocessionaires,are holding New York's minimum required reserve.6.If a company is not admittedas a reinsurer in New York, it need hold no reserve so long asit has depositedwith the ceding company funds sufficientto cover the New York reserve orhas funds on deposit in New York, under a New York 114 Trust agreement,equal to theNew York reserve.If a letter of credit is used as security, the reinsurerneeds to attest it isholding the New York reserve.7.The Superintendentwill accept in lieu of the quarterlyreports a plan of compliance,submittedto the Superintendentby an accreditedreinsurer, which would permit a certification to be attachedto a reinsuranceagreement with a ceding company complyingwith thissubdivision,in lieu of obtainingthe individualreports required by the subdivision."A number of reinsurershaveof this date is still consideringbut its retrocessionairesfiled proposedits response.are not, only the reinsurerplans of compliance.needsto fileThe New York DepartmentasClearly withoutsuch an approvedplan the administrativeproblems created by Regulation20 aremind boggling.Unlike Regulation102, Regulation20 is probably not a regulationthat willreceive widespreadindustry support.Since my presentationis already too verbose, I will attempt only brief nmntion of other developments which have impacted reinsurancetransactions,or threaten to do so in the near future.:1.Draft Statementof Position of the AICPA entitled "Transferof Risk in ReinsuranceContracts"Among the items discussedtherein are an implied taboo of experiencerefund provisionsanda test of reasonablenessbetween the considerationpaid and the amount of risk transferred.The points and others includedin the document suggest that at least some of its authors lackan understandingof both insuranceand reinsurancecontracts.It is widely acknowledgedthat the presence of an experiencerefund provisionin areinsurancetreaty limits the reinsurer'supside potentialwhile doing nothing to thedownside.Most people would agree that the result is an increase in risk to the reinsurer.Itcan also be clearly shown that if there is a correlationbetween the considerationpaid andrisk transferredit is a negative correlation.A reinsurer would normally be much morecomfortablewith a 40/thousandendowmentpremiumthan a 50/thousandterm premium.Obviously, an uproar followed the issuance of the last draft and all has been quiet since.2.New York and California"compromise of letter of credit form"Until New York and Californiaagreed to this compromiseit was impossibleto have a letterof credit that was in compliancein both states simultaneously.The compromisecreatedthree letters of credit forms: one to be used in Californiaif New York was not involved,one for New York if Californiawas involved, and a third to be used if both states wereinvolved.In the future,scorecardswill be necessaryfor those entering into reinsuranceagreements.3.Excise TaxesThe ReinsuranceAssociationof America is seeking federal legislation to increase thefederal excise taxes for property and casualty (P&C) premiums ceded to foreign insurersfrom 1-4%. This is to correct a perceived competitiveadvantage gained by foreignreinsurersas a result of recent federal income tax changes. The life reinsuranceindustrygenerally disagrees with the need and some efforts are being made to prevent this tax fromapplying to life reinsurance.4.The NAIC has circulateda questionnaireon public policy issues involvingthe rightoffset.Althoughthe courts have continuedto recognize that the right of offset isa972offairand
RESERVECREDITSFORREINSURANCEequitablecommon law right and despite persuasiveargumentsthat the right of offset isnecessaryto maintaina stable affordablereinsurancemarket, a few people continuetocontest offset, particularlywhen a ceding insurer'sinsolvencymakes it expedient.Amajorityof regulatorsappear to support the right of offset.However,it remainsimportantfor everyone with an interest in this subject to stay informed and to inform others of itsimportance.5.NAIC Model Law on Credit for ReinsuranceThere is a proposed amendmentto the NAIC Model Law on credit for Reinsurance.I willquote from ACLI General Bulletin #4023."Under the currentModel, reserve credit isavailable to domestic ceding companies if the reinsureris licensed in their domicile, licensedin another state with similar solvency standards,or puts up some form of security acceptableto the ceding company'sdomicile.Under the proposed amendments,a domestic cedingcompany could take reserve credit if the reinsurer was licensed in its domicile, accreditedinits domicile, or put up some form of security acceptableto the ceding company'sdomicile.The major differenceis that, under the proposed amendments,unlicensedreinsurersthat donot put up a form of acceptablesecuritymust be accreditedin order for the ceding companyto obtain reserve credit."The proposed amendmentsestablish standardsfor accreditation.The most visible proposedstandardwould be a minimumpolicyholdersurplus of 20 million.To be accredited,areinsurermust also submit to the authorityof the ceding company's domiciliarycommissioner to examine the reinsurer'sbooks and records.The proposed minimum 20 millionpolicyholdersurplus would not apply to reinsuranceceded and assumed pursuantto poolingarrangementsamong reinsurersunder common control."Those concernedabout this amendmentcite its potentialnegativeinsurancemarket, agent reinsuranceagreements,and other typesThose in favor are concernedbeyond their tof jointreinsurerson the creditventures.acceptingriskOther areas of interest include recent uses of the RICO Law in connectionwith reinsurancetransactions,the New York Junk Bond regulation,New York Regulation126 requiringasset/liabilitymatchingfor certaininterest sensitive products,and the attemptby the IRS toforce amortizationof ceding commissionsin connectionwith indemnityreinsurancetreaties.MR. THOMAS G. KABELE:I will discuss two topics: mirror reservingand the magnifyingglassproblems.Again, these are not fictional fairy tales but real terms applied to some real problems.First, I will talk about mirror reserving.There is what is called "full mirror reserving"where thereinsureris supposed to hold the reserve the ceding company would have held had it retainedthebusiness.The problem is this is not always well definedbecause the reinsurercould theoreticallydcstrengthenits reserves on ceded business and would end up with the same reserve credit.Moststates apply what Ted Becker of Texas calls "quasi mirror reserving" and that is the reinsurershould hold the minimum reserves requiredin the ceding company's state of domicile.The reservehere is presumablyof the liabilityshown on page three less due and deferredpremiumsand otheroffsettingassets shown on page two of the annual statement.What are some of the problems mirror reserving was designed to solve? Mel Young mentionedafew of them. Perhaps the most important one was to prevent reserve dumping into the AtlanticOcean. I understandthat some companiesare now looking to the Pacific as well. The regulationalso forces the reinsurerand the ceding company to discuss their liabilities.There have beencases, for example in A. M. Best, particularlyin the P&C side, where one company claims that theyhave a 5 million receivablefrom the reinsurerand you see no correspondingpayable for theceding company.The regulationalso levels the playing field between domestic and alienreinsurers.New York was somewhatconcernedthat most reinsurerswould move offshorewherethey couldn't be monitored.As a simple example of reserve dumping, the assets are 40 million, say liabilitiesare 60 million,the surplus strain is 20 million, perhaps on a new block of whole life policies.The companycedes off the block and reports net liability and assets are both zero. However, on the reinsurer's973
PANELDISCUSSIONside, the surplus strain just simply disappears.It is just simply not set up. It could be deficiencyreserves, or it could be virtuallyanything.In certain jurisdictions,the annual statementsaresecret, so the New York Departmenthad trouble finding if these companies even existed, let alonewhat was on their balance sheet.The effect in New York seemed to be rather minor. The fact is that initiallyvery few New Yorkcompanieswere very much concernedwith it. Part of the reason is that many of the New Yorkcompanies are very old, very large companies,they have very large retention,and very often theyare subsidiariesof other large companies.So mirror reserving has relativelylittle impact onyearly renewable term (YRT) reinsurancesimply because the reserves are so small. Besides that,
to how best to overhaul regulations governing reserve credits for reinsurance. Between the debate and other presentations, the panelists will address the following subjects and current issues:-- Reinsurance reserve credits --variations by state o Current Model Law on Credit for Reinsurance o New York Regulation 102 o Limitations on proportion .
(CSM stays 8) Expected reinsurance claim (cash inflow 50) Reinsurance premium (40) and fee for reinsurer (2) (cash outflows 42) Symmetrical treatment of gains from reinsurance contracts Reinsurance ceded CSM Modelling considerations Challenging to link the CSM between direct and reinsurance business CSM, potentially many to many mapping.
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