Reinsurance contracts held

Reinsurance contracts held: a quota share example

An insurer issues a group of contracts with expected premiums of 1,000, expected claims of 1,050 and a risk adjustment of 50, all in present value terms, so the group is onerous with a loss of 100. Before issuing them, it bought a 40% quota share treaty: it cedes 40% of the premiums, 400, and recovers 40% of the claims, 420. The risk transferred to the reinsurer is 40% of the risk adjustment, 20.

On day one, the insurer recognises the 100 loss on the underlying group and income of 40 on the reinsurance, a net loss of 60: the 60% of the loss it kept. Without the loss-recovery rules, the reinsurance gain would have sat in the reinsurance CSM and been released over the cover, while the full loss was expensed at once.

What does the CSM on reinsurance held represent?

The contractual service margin on reinsurance held is the net cost or net gain of buying reinsurance, deferred so that neither arises on day one. Usually reinsurance is a net cost, because the reinsurer charges for taking risk; that cost is recognised as an expense over the cover. Unlike for insurance contracts issued, the CSM on reinsurance held can represent a gain. If the net cost relates to insured events that occurred before the reinsurance was bought, such as adverse development cover on old claims, it is expensed immediately.

When does the loss-recovery component apply?

When the reinsurance contract is entered into before or at the same time as the onerous underlying contracts are recognised, and covers them proportionately or otherwise. The amount is the loss on the underlying contracts multiplied by the percentage of claims on those contracts the insurer expects to recover. It is then reduced as the underlying loss component is used up.

Which cash flows are in a reinsurance treaty's boundary?

A treaty that covers policies the insurer will write over the next year includes in its boundary the expected cash flows from underlying contracts not yet issued, because the insurer has a substantive right to receive cover for them. The reinsurance can therefore be recognised before some of the contracts it covers.

How are ceding commissions treated?

Amounts received from the reinsurer that are not contingent on claims of the underlying contracts, such as fixed ceding commissions, reduce the premiums paid to the reinsurer. Amounts contingent on claims, such as sliding-scale commissions, are part of the recoveries.

How is the risk of reinsurer default reflected?

The fulfilment cash flows of reinsurance held include the effect of the reinsurer's risk of non-performance, including from collateral and disputes. Changes in that risk relate to past and current events, so they go to profit or loss rather than adjusting the CSM.

How is reinsurance presented?

Income and expenses from reinsurance held are presented separately from insurance revenue and insurance service expenses, either as a single net amount or as amounts recovered from reinsurers and an allocation of the premiums paid. Reinsurance assets are shown separately from insurance liabilities. Reinsurance held cannot use the variable fee approach, but can use the premium allocation approach if it is eligible. See onerous groups, the risk adjustment and insurance accounting under IFRS 17.

This guide is general information. It is not tax or legal advice for your situation.