April 2023 question 4 (iii)

[kiki]

Hi,

I am confused with the April 2023 question 4 , part(iii), it is asking about why the commutation prem calculated by M and reinsurer

in the question , it mentioned "extended PA product's liabilities to its reinsurer have been steadily increasing due to ongoing infections across the country" , therefore it implied that there is reinsurance contract between insurer M and Reinsurer for extended PA product .

then question mentioned , M decided to commute the extended PA liabilities to its reinsurer .

my initial understanding :
- as there is RI contract between M and Reinsurer ;
- M want to commute the existing reinsurance arrangement with reinsurer , ie ask reinsurer to pay commutation premium which will be used to cover the future claim amounts (which may equivalent to RI recoveries if RI contract has not been commuted)
- there are not much information in the study material regarding "commutation" , therefore i checked in the investopedia, it mention the commutation is between ceding and reinsurer to discharge contractual obligation:
https://www.investopedia.com/terms/c/commutation-agreement.asp
- also in the core reading , it did mention the consideration (ch 14 reserving basis) about commutation is "the impact of reinsurance recoverability" , therefore I am associate M want to commute the existing RI contract as Reinsurer's existing financial position is not healthy and may not be able to meet the future obligation / better RI deal in the market

however, in the answer , it seems the commutation is referring "adverse development cover" or "loss portfolio transfer" , ie insurer M pay a premium to Reinsurer to take over all the liabilities associated extended PA cover .

can someone point out which part i have missed as i think the question is poorly wording and how to avoid it to happen in the future as after all it is 7 marks !!

thank you

 

[Katherine Young]

From the wording of the question, Company M will pay the reinsurer a ‘premium to settle all current and future claims’. This is not therefore a commutation, but more like a loss portfolio transfer.

The term commutation is being used by the examiners to mean that Company M’s liabilities are being ended. That is not the more general meaning of a commutation, which is covered in detail in Subject SA3. Your understanding of a commutation is quite correct so you can be forgiven for getting confused. It is just one of those occasions when the examiners expected the meaning to be clear from the context.

However, the examiners also recognised that the question could be interpreted as being that Company M is simply cancelling its reinsurance in return for a refund of premium, and they gave credit for that interpretation too.

Either way, the question comes down to how and why the insurer’s and reinsurer’s views of the ultimate liability value may differ, thus resulting in a difference in opinion of what the commutation amount payable may be.