Reinsurance framework assessment: Guide for direct insurers' actuaries

Reinsurance is a vital tool for direct insurance companies to manage their underwriting risks and capital. However, reinsurance also involves complex contractual arrangements, financial transactions, and regulatory compliance. Therefore, it is important for actuaries to assess the effectiveness of the inforce reinsurance framework and ensure that it meets the objectives and expectations of the direct insurer. To do so, at very minimum actuaries need to perform the following tasks:

1. Review the ceded reinsurance contracts and ensure that they are written in a clear and legally binding manner, with all the essential clauses and conditions for their validity and effectiveness. This includes checking the scope of coverage, the terms and conditions of payment, the exclusions and limitations, the dispute resolution mechanisms, and the termination clauses. This also includes ensuring that the ceded reinsurer is located in a jurisdiction where rights and obligations can be swiftly enforced, and that the contract specifies the applicable law and jurisdiction in case of disputes.

2. Monitor the creditworthiness of the reinsurers at least on a quarterly basis and evaluate their financial strength and reliability. This involves reviewing the credit ratings, credit ratings outlooks, financial statements, and solvency reports of the reinsurers, as well as the market conditions and trends that may affect their performance and stability.

3. Verify the compliance of the reinsurers with the legal and regulatory requirements in terms of solvency and liquidity at least on an annual basis. This requires checking the adherence of the reinsurers to the applicable laws and regulations in the jurisdictions where they operate, as well as the reporting and disclosure obligations to the supervisory authorities and to the direct insurer.

4. Analyse the reinsurance program and verify if it meets the following objectives:

(i) It effectively transfers the underwriting risks from the direct insurer to the reinsurer. This means that the reinsurance program reduces the net retained underwriting risk of the direct insurer and provides adequate protection against large or catastrophic losses.

(ii) It reduces the net exposure to the threshold defined by the management and diversifies the underwriting risk portfolio. This means that the reinsurance program mitigates the concentration of risk in certain lines of business, regions, or segments, and enhances the diversification of risk across different sources and types of reinsurance.

(iii) It increases the underwriting capacity and allows the direct insurer to accept more business. This means that the reinsurance program frees up capital and solvency margin for the direct insurer and enables it to expand its market share and risk-adjusted profitability.

(iv) It optimizes the economic capital management and enhances the solvency position of the direct insurer. This means that the reinsurance program improves the capital efficiency and risk-adjusted return on equity of the direct insurer and supports its solvency and credit rating objectives.

(v) It stabilizes the risk-adjusted results and reduces the volatility of the risk-adjusted earnings. This means that the reinsurance program smooths the fluctuations of the underwriting results and the risk-adjusted net income of the direct insurer and reduces the uncertainty and variability of the risk-adjusted financial performance.

(vi) It safeguards the liquidity risk and ensures the availability of cash flows to meet the obligations. This means that the reinsurance program provides timely and sufficient cash inflows from the reinsurers to cover the cash outflows to the beneficiaries and other stakeholders.

(vii) It aligns the net reinsurance risk profile with the risk appetite defined by the management. This means that the reinsurance program reflects the risk tolerance and preferences of the direct insurer and is consistent with its strategic and operational goals.

5. Evaluate the adequacy of the ceded reinsurance treaties to the direct insurance risk profile at least on a quarterly basis, using the VaR and T-VaR measures over the underwriting risk, both gross and net of reinsurance. This involves quantifying the potential losses of the direct insurer under different probability levels and comparing them with the expected recoveries from the reinsurers, taking into account the frequency and severity of the claims, the attachment and exhaustion points, the coinsurance and retention levels, and the reinstatement provisions of the reinsurance treaties.

6. Evaluate the adequacy of the ceded reinsurance coverages on an annual basis, possibly within the ORSA process, using stress and reverse stress scenario simulation to test the resilience of the reinsurance framework under extreme events. This involves identifying and simulating the scenarios that may have a significant impact on the direct insurer and the reinsurers, such as natural disasters, pandemics, terrorism, cyberattacks, regulatory changes, or market shocks, and assessing the effects of these scenarios on the solvency, liquidity, and risk-adjusted profitability of the direct insurer and the reinsurers, as well as the adequacy and availability of the reinsurance coverages under these scenarios.

7. Verify the existence of periodic reconciliations of the accounts with the reinsurers, ensuring the timely collection of commissions, payment of premiums, recoveries of claims, as well as the collection of profit sharing and/or other contractual obligations. This involves verifying the accuracy and completeness of the accounting records and transactions between the direct insurer and the reinsurers, resolving any discrepancies or disputes, and enforcing the contractual rights and obligations of both parties.

8. Express an opinion on the adequacy of the reinsurance treaties in force, both for the active and run-off businesses, based on the conclusions stemming from the above procedures. This involves summarizing the findings and conclusions of the assessment, highlighting the strengths and weaknesses of the reinsurance framework, providing recommendations for improvement or optimization, and communicating the opinion to the management and the relevant stakeholders.

By performing these tasks, actuaries can provide valuable insights and guidance to the direct insurers on the effectiveness of the inforce reinsurance framework and help them achieve their risk and capital management objectives.