AAA Uncollectible Reinsurance

Question 1

Why is this relevant?

Answer 1

-A new accounting requirement by FASB (ASU 2016-13) regarding uncollectible reinsurance reserves takes effect in 2020 for certain filers of US GAAP statements and the following year for others

-Establishes rules for determining uncollectible reinsurance reserves and introduces new disclosure requirements, potentially requiring changes in reserving practices for some insurers.

Question 2

Under the new rules….

Answer 2

these reserves (URR) must be established based on anticipated ultimate uncollectible amounts

This adjustment brings FASB more in line with other established standards like IFRS 17, Solvency II, and market-consistent methodologies used in Bermuda

Previously, insurers only considered known impairments when estimating their Uncollectible Reinsurance Reserves (URR), limited to reinsurers that were already recognized as impaired or financially weak as of the balance sheet date.

Question 3

What is URR composed of?

Answer 3

URR accounts for both credit risk and dispute risk.

However, the FASB rules solely focus on the credit risk component, leaving the rules pertaining to the dispute risk portion of URR unchanged.

Question 4

2 Current Methods to determine URR

Answer 4

Expected Loss Model - URR estimate considers the ultimate uncollectible (including provisions for reinsurers not yet impaired)

Incurred Loss Model - URR estimate ONLY reflects known impairments of reinsurers as of the balance sheet date

Question 5

U.S SAP on URR

Answer 5

Requires the URR to be included in the loss reserve, with the added requirement that write-offs of previous ceded loss amounts be recorded in the same account as the initial ceded amount

Question 6

Which of the 2 current methods does U.S GAAP support?

Answer 6

supports either approach depending on the unit of account used in the valuation

-If the unit of account is the balance with an individual reinsurer, a loss is recognized only if that reinsurer is impaired.

-If the unit of account is the total balance spread over multiple reinsurers, a company may determine that a loss is highly likely for at least some portion of the total balance.

Question 7

Reasons for unwillingness to pay (reinsurers -> insurers)

Answer 7

-missing policies (this could happen if the original contract is decades old)
-late notice of claim (that’s a favorite way for insurers or reinsurers to deny claims)
-settlements made without first consulting with the reinsurer (if such a requirement is in the contract)
-definition of an “occurrence” (reinsurer may not accept that a covered event or occurrence actually happened, in the context of the contract)

Question 8

Rating Based Method

Answer 8

uses financial strength ratings of insurers as the basis for a URR estimate
2 Matrices
- Expected Future Ceded Billings by Reinsurer Rating
- Expected Cumulative Default Rates by Reinsurer Rating
take the product to get URR

Question 9

Does a reinsurer default imply that 100% of the associated reinsurance recoverable should be written off?

Answer 9

no, some reinsurers may partially or fully recover and pay some or all amounts previously in default

Question 10

When would you use incremental default rates rather than cumulative default rates?

Answer 10

use incremental default rates when future ceded balances are projected on a runoff basis
(cumulative default rates are applied to projected future reinsurance billings)

Question 11

How is the cumulative probability of default by rating estimated?

Answer 11

A.M. Best Financial Strength Ratings and associated probability of impairment
insurer’s history of reinsurer default rates by internal rating
transition matrices

Question 12

How can transition matrices help insurers estimate cumulative default probabilities?

Answer 12

an insurer without a long-term history of default ratios can use a transition matrix

Question 13

How is the URR provision for disputes treated in a rating-based method?

Answer 13

calculate dispute provision by considering any or all of:
→ insurer’s prior dispute-based reinsurance write-offs
→ industry data to the extent available and relevant
→ management’s judgment

Question 14

How can double-counting be avoided when estimating URR?

Answer 14

apply the URR rating-based method to the reinsurance recoverable net of the calculated dispute provision

Question 15

Experience Based Method

Answer 15

-Historical sum(Amount Written Off) / sum(Receiveable Due) x Current year reinsurance recoverable
- includes credit and dispute related URR

Question 16

How is the experience-based method applied in practice?

Answer 16

simplest: combine multiple years to overcome the impact of write-off delays and year-by-year variation

Question 17

What are the challenges associated with experience-based URR methods?

Answer 17

thin data (an insurer may have little or no historical reinsurance write-offs)
past uncollectible rates may not be indicative of future uncollectible rates (this is true for any predictive modeling)
experience-based uncollectible rates can be distorted by individual events (commutations, reinsurer insolvency)

Question 18

When is it appropriate for an insurer to use experience-based methods?

Answer 18

when their write-off experience has sufficient credibility

Question 19

Reasons for reinsurer disputes

Answer 19

M issing policies

L ate notice of a claim

S ettlements made without consulting the reinsurer

D ef of an occurrence

E xperience company has in processing ceded claims

B usiness relationship bw companies

R einsurer experience with types of claims being presented

A ggressiveness of ceding company in IDing and presenting claims for reimbursement

Question 20

What are four key factors that can change the characteristics of reinsurance recoverables?

Answer 20

Maturity

Ongoing vs runoff

Reinsurance quality @ purchase date

LOB