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Chapter 25 Reinsurance: Deposit back reserves

D

deepansh

Member
Hi all,

It is mentioned that-

On with profits business, an original terms arrangement would normally leave the reinsurer with significant investment risk, because it would have to match the insurer's bonus rates on maturity claims. By depositing back reserves it will avoid this investment risk.

Can anyone please explain how depositing back reserves will help to reduce the investment risk?

Regards,
Deepansh
 
Hi Deepansh

Depositing back the reserves means that the insurer has the full reserve to invest. Investment risk arises due to the risk that investment returns will be lower than assumed in calculating the reserves. So, with deposits back, all this investment risk is with the insurer.

Essentially the reinsurer is left with just the mortality risk as the reinsurer has to make up (the reinsured share of) the shortfall between the reserve and the death benefit.

Hope this helps
Lynn
 
Hi Lynn,

In the notes it mentions that a deposit back arrangement would be beneficial for the direct writing company as it will retain all of the potential investment profit. Why wouldn't a proportion of this investment profit belong to the reinsurer though (proportional to their share of the reserves they deposited back)?

Thanks,

Max
 
Hi Max

As Lynn says, the deposit back arrangement is basically turning a 'sum assured' type reinsurance arrangement into a 'sum at risk' type reinsurance arrangement. The reinsurer is now only responsible for paying (a proportion of) death claims in excess of the reserves, since the insurer already holds the reserves amount.

Just as for the 'sum at risk' type arrangement, the calculation of the reserves (including how the basis should be set) would be specified in the reinsurance treaty. The choice of assets to back those reserves is entirely down to the insurer (since they hold this money) - nothing to do with the reinsurer. If the insurer decides to mismatch, it runs the risk that the assets held will earn a lower rate of return than the investment return used to determine the reserves, and thus make an investment loss. However, it also has the opportunity to earn a higher rate of return, and thus make an investment profit. Such profits/losses belong to the insurer, it being the insurer that has made the decision to hold those specific assets.

As far as the reinsurer is concerned, the relevant amount is simply the reserves as calculated in accordance with the treaty.
 
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