Hello, I am getting confused with reinsurance deposits where the reinsurer pays their reserve to the insurer at (say) the start of each month. I understand how this improves counterparty risk (we are getting paid upfront) and I understand that we can make investment profit on the reserve that we are paid (provided we don’t have to pay interest back). I don’t understand why it doesn’t work with risk premium reinsurance. Do we not set up reserves with this type of reinsurance? Something to do with the rates we are charging the policyholder covering the expected claims and similarly the reinsurer’s rates cover their expected claim costs (and more) so there are no or very little reserves? Also, the notes implies it only works for level premium policies but I’m not sure why? I guess something to do with the level premiums not being sufficient in later years as the risk of claim increases so we have to set up reserves to cover this excess? But, in any case, say we have just received one premium, then the pay out will be much greater than the asset share and so wouldn’t we have to hold a reserve here (and this could happen whether the premiums are changing or staying level)?
We could in theory have a deposit back for any type of reinsurance, but it is only likely to be useful for original terms and level risk premium contracts. In both these cases the insurer pays level reinsurance premiums for an increasing risk, so the reinsurer would have to set up reserves out of its earlier premiums to cover future shortfalls from its later premiums. So there is a substantial reserve to be deposited back. For most risk premium reinsurance, the premiums are set on an annual basis. As the risk increases with policyholder age, the reinsurance premium goes up. So the premiums match the claims in any given year quite closely. Although the reinsurer will hold a reserve for claims in the coming year, it doesn't need to hold reserves for claims beyond the year end. So the reserves are much smaller and only last a short period anyway. I hope this helps to clarify the notes. Best wishes Mark
