Financial reinsurance

The 2nd Core Reading paragraph in Section 3.3 of Chapter 50 (Risk Management) reads:

"Under financial reinsurance a 'loan' is usually presented as a reinsurance commission related to the volume of business reinsured. The 'repayments' - spread over a number of years - are added to the reinsurance premiums...."

My understanding (correct me if I'm wrong here) of this type of financial reinsurance is that it provides a short-term 'boost' to the balance sheet by increasing the level of free assets. This is becuase the repayments on the 'loan' are linked to the reinsurance premiums the insurer has to pay for future periods of reinsurance cover and hence doesn't have to declare them as a liability (just yet).

Does this type of arrangement actually happen regularly in the real world? For example, wouldn't a regulator become suspicious if there was a sudden massive increase in "initial commissions" (e.g. £25m) without an increase in volume of business reinsured (& an insignificant increase in reinsurance premiums payable by the insurer)?

 

Suspicious ? I don't think so.

Does it happen regularly? No idea!

Regulators are only concerned about statutory solvency and the insurer's ability to meet claims, etc.

Before any reinsurance premium is paid in the future, the insurer must first pay out for any claims, then what's left over can pay for the reinsurance. It is not like the strain of having to repay this reinsurance will affect their ability to meet claims, since claims will have been paid first, provisions set aside, and only then whats left over will pay the reinsurance prem/loan repayment.

Also, the transaction won't be hidden - it will be shown as a reinsurance commission (i.e. profit) I suppose in the P & L a/c's (I think - maybe wrong). In essence the reinsurer is buying the insurer's future profit stream (or a percantage of it). In some financial reinsurance contracts, repayment of this "loan" is dependent on the level of future profits being high enough (otherwise it's not repayed until such time).

That's my understanding.

Comments?

(if this was an X-assignment w.r.t my answer I'd expect my marker to write "not quite" & award me only 25% of the marks available for this question. )

 

When looked at from the point of view that the regulator is only concerned about the insurers ability to meet claims (and set aside adequate provisions for them) then I can see why a regulator won't be too worried about this arrangement.

Also, as the repayments on the loan would rank behind the claims payments, the risk of not meeting claims liabilities is reduced.....