Achieving Finality: The Commutation Process

Transcription

1 17th Achieving Finality: The Commutation Process Lucy Simpson Deloitte Actuaries & Consultants

2 What is a commutation? Reinsurer Reinsurer Reinsurer Reinsurer Outwards reinsurance contracts placed with a variety of other reinsurers Reinsurance company Inwards reinsurance contracts ceded by a variety of other reinsurers or direct insurers Cedant Cedant Cedant Cedant

3 What is a commutation? A commutation is a commercial agreement between two parties, cedant and reinsurer, where subject to the payment of a mutually agreed sum to the cedant the reinsurer is discharged of all past present and future liabilities arising from the contracts which form the subject matter of the commutation. Why are commutations topical? A ten year cycle? An environment of financial uncertainty Changing regulatory regimes A route to finality

4 What are the alternatives? Scheme of arrangement Novation Statutory transfer Recapture clause

5 Why commute? It is important to understand the motivations for commutation: Cedant believes a reinsurer is in financial trouble Reinsurer is in financial trouble & wishes to reduce the potential for deterioration in results Reinsurer believes a cedant is in financial trouble or is not reserving correctly Reinsurer disputes a treaty A treaty is producing bad results and cedant wishes to protect market reputation Cedant or reinsurer wishes to reduce admin costs

6 The commutation process The process can be broken down into 7 stages: Stage Approximate allocation of time 1. Marketing 5.0% 2. Treaty identification 10.0% 3. Reconciliation of data 40.0% 4. Actuarial evaluation 15.0% 5. Negotiation 5.0% 6. Legal agreement 5.0% 7. Post commutation administration 20.0%

7 Stage 1 - Marketing Selling the idea of negotiating a commutation to target cedants or reinsurers. Reinsurer 2 50% share Reinsurer 3 30% share Reinsurer 4 15% share Reinsurer 5 5% share Reinsurer 2 Reinsurer 1 wishes to commute an outwards reinsurance contract placed with a panel of other reinsurers 5% 3% 7% 10% Reinsurer 1 wishes to commute all inwards and outwards reinsurance contracts with reinsurer 2 Reinsurer 1 4% 5% 7% 10% Reinsurer 1

8 Stage 2 - Treaty Identification If the way forward is via the route of commutations, it is necessary to define and gather information about the treaties forming the subject matter of the commutation. Stage 3 - Reconciliation of Data Critical and often the most time consuming part of any commutation: Paid claims Unsettled balances Future claims - outstanding claim reserves only

9 Stage 4 - Actuarial Evaluation Actuarial analysis: is a fundamental part of all commutations can assist in the negotiation process enables negotiations to take place from a point of greater, but not complete, certainty gives a point of reference for an equitable outcome 4 key aspects: Determination of ultimate settlement values Estimation of future payment patterns Estimation of net present values Provision of a guide to uncertainty

10 Stage 4 - Actuarial Evaluation Methods for evaluating ultimate settlement values may include: Reserving class evaluation (inwards & outwards) Book costing (inwards & outwards) Individual costing (inwards & outwards) Other party s costing (inwards & outwards) Total limit/aggregate evaluation (outwards only) Frequency & severity analysis (outwards only) Analysis of precautionary advices (outwards only)

11 Stage 4 - Actuarial Evaluation The collection of reinsurance recoveries on commuted contracts is a very important issue: 2,500 Allocation of commutation payment 2,000 Third excess $000s 1,500 1,000 Second excess First excess 500 Cedant 0 Vertical allocation Pro-rata to ultimate Pro-rata to liabilities Actuarial allocation

12 Stage 5 - Negotiation Negotiation occurs throughout the commutation process Dictionary definitions of negotiate include: Trying to reach an agreement or compromise by discussion Finding a way over or through (an obstacle or difficult path) Conferring with another with a view to compromise Final agreement will be a commercial settlement Don t be afraid to walk away!

13 Walk away: Desired payment Stage 5 - Negotiation Maximum payment Minimum receipt Desired receipt Reinsurer Cedant Achieve settlement: $ Desired payment Minimum receipt Maximum payment Desired receipt Reinsurer Cedant Likely settlement $

14 Stage 6 - The Legal Agreement A document setting out the terms and conditions of the commutation, providing protection for both parties against future disputes

15 Stage 7 - Post Commutation Admin Activities may include: Notify third parties Notify brokers, intermediaries and managing agents Reinsurer allocate settlement paid to treaties Reinsurer set all reserves to nil Reinsurer advise reinsurers of settlement Cedant allocate settlement received to treaties Flag commuted treaties on relevant systems

16 Understand motivations Consider the alternatives 7 key steps Marketing Treaty identification Data reconciliation Actuarial evaluation Negotiation Legal agreement Post commutation admin Reinsurance recoveries Summary

17 Any questions?